-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R4kjNL96dmAzrMoais2g/5QJw5P8gOZeMsV2ikNg41cWhcjwF472+BjfDQsG/1Jc gv2ACWysyaKPVDKgMuhskA== 0000043300-09-000005.txt : 20090108 0000043300-09-000005.hdr.sgml : 20090108 20090108155307 ACCESSION NUMBER: 0000043300-09-000005 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20081129 FILED AS OF DATE: 20090108 DATE AS OF CHANGE: 20090108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GREAT ATLANTIC & PACIFIC TEA CO INC CENTRAL INDEX KEY: 0000043300 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-GROCERY STORES [5411] IRS NUMBER: 131890974 STATE OF INCORPORATION: MD FISCAL YEAR END: 0225 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-04141 FILM NUMBER: 09515802 BUSINESS ADDRESS: STREET 1: 2 PARAGON DR CITY: MONTVALE STATE: NJ ZIP: 07645 BUSINESS PHONE: 2015739700 MAIL ADDRESS: STREET 1: 2 PARAGON DRIVE CITY: MONTVALE STATE: NJ ZIP: 07645 10-Q 1 f10q32008.txt FORM 10-Q - 3RD QUARTER ENDED NOVEMBER 29, 2008 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Mark One [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 29, 2008 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission File Number 1-4141 THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC. ---------------------------------------------- (Exact name of registrant as specified in charter) Maryland 13-1890974 - ---------------------------------- ------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2 Paragon Drive Montvale, New Jersey 07645 ------------------------------------------------ (Address of principal executive offices) (201) 573-9700 ------------------------------------------------ (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ](Do not check if smaller reporting company) Smaller reporting company [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] As of January 6, 2009, the Registrant had a total of 57,674,799 shares of common stock - $1 par value outstanding. PART I - FINANCIAL INFORMATION ITEM 1 - Financial Statements The Great Atlantic & Pacific Tea Company, Inc. Consolidated Statements of Operations (Dollars in thousands, except share and per share amounts) (Unaudited)
12 Weeks Ended 40 Weeks Ended ----------------------------- ----------------------------- Nov. 29, 2008 Dec. 1, 2007 Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ ------------- ------------ Sales $ 2,120,954 $ 1,251,123 $ 7,226,255 $ 4,204,630 Cost of merchandise sold (1,460,569) (869,448) (5,030,741) (2,901,336) ------------ ------------ ------------ ------------ Gross margin 660,385 381,675 2,195,514 1,303,294 Store operating, general and administrative expense (648,476) (402,808) (2,193,037) (1,323,411) ------------ ------------ ------------ ------------ Income (loss) from operations 11,909 (21,133) 2,477 (20,117) Gain on sale of Canadian operations -- 495 -- 209 Gain on disposition of Metro, Inc. -- 106,063 -- 184,451 Nonoperating income 22,777 -- 114,269 -- Interest expense (36,727) (14,499) (116,621) (48,806) Interest and dividend income 86 3,910 553 12,231 Equity in earnings of Metro, Inc. -- -- -- 7,869 ------------ ------------ ------------ ------------ (Loss) income from continuing operations before income taxes (1,955) 74,836 678 135,837 Provision for income taxes (1,038) (1,754) (3,460) (4,288) ------------ ------------ ------------ ------------ (Loss) income from continuing operations (2,993) 73,082 (2,782) 131,549 Discontinued operations: Loss from operations of discontinued businesses, net of tax provision of $0 for the 12 and 40 weeks ended 11/29/08 and 12/1/07,respectively (12,466) (13,540) (30,624) (179,667) Gain (loss) on disposal of discontinued businesses, net of tax provision of $0 for the 12 and 40 weeks ended 11/29/08 and 12/1/07, respectively 1,831 (2,235) 4,653 (51,039) ------------ ------------ ------------ ------------ Loss from discontinued operations (10,635) (15,775) (25,971) (230,706) ------------ ------------ ------------ ------------ Net (loss) income $ (13,628) $ 57,307 $ (28,753) $ (99,157) ============ ============ ============ ============ Net (loss) income per share -- basic: Continuing operations $ (0.06) $ 1.74 $ (0.05) $ 3.14 Discontinued operations (0.20) (0.38) (0.52) (5.51) ------------ ------------ ------------ ------------ Net (loss) income per share -- basic $ (0.26) $ 1.36 $ (0.57) $ (2.37) ============ ============ ============ ============ Net (loss) income per share -- diluted: Continuing operations $ (1.35) $ 1.73 $ (2.33) $ 3.11 Discontinued operations (0.26) (0.38) (0.46) (5.45) ------------ ------------ ------------ ------------ Net (loss) income per share -- diluted $ (1.61) $ 1.35 $ (2.79) $ (2.34) ============ ============ ============ ============ Weighted average number of common shares outstanding: Basic 52,391,948 41,961,253 50,362,875 41,888,969 ============ ============ ============ ============ Diluted 41,462,695 42,363,903 56,190,659 42,306,348 ============ ============ ============ ============
See Notes to Consolidated Financial Statements 2 The Great Atlantic & Pacific Tea Company, Inc. Consolidated Statements of Stockholders' Equity and Comprehensive (Loss) Income (Dollars in thousands, except share amounts) (Unaudited)
Retained Accumulated Common Stock Additional Earnings Other Total ------------------------- Paid-in (Accumulated Comprehensive Stockholders' Shares Amount Capital Deficit) (Loss) Income Equity ----------- ----------- ----------- ------------ -------------- ------------- 40 Week Period Ended November 29, 2008 - -------------------------------------- Balance at beginning of period 57,100,955 $ 57,101 $ 373,594 $ 16,423 $ (28,975) $ 418,143 Net loss (28,753) (28,753) Other comprehensive loss (744) (744) Financing warrants and conversion features related to convertible debt 57,422 57,422 Stock options exercised 106,626 107 2,096 2,203 Other share based awards 455,953 456 3,186 3,642 ----------- ----------- ----------- ----------- ----------- ----------- Balance at end of period 57,663,534 $ 57,664 $ 436,298 $ (12,330) $ (29,719) $ 451,913 =========== =========== =========== =========== =========== =========== 40 Week Period Ended December 1, 2007 - ------------------------------------- Balance at beginning of period, as previously reported 41,589,195 $ 41,589 $ 212,868 $ 153,325 $ 22,888 $ 430,670 Impact of the adoption of change in measurement date under FAS 158 (643) (643) Cumulative impact of the adoption of FIN48 24,421 24,421 ----------- ----------- ----------- ----------- ----------- ----------- Balance at beginning of period, as adjusted 41,589,195 41,589 212,868 177,103 22,888 454,448 Net loss (99,157) (99,157) Other comprehensive loss (10,802) (10,802) Stock options exercised 368,974 369 5,848 6,217 Tax benefit on stock options 2,374 2,374 Other share based awards 6,597 7 7,275 7,282 ------------ ----------- ----------- ----------- ----------- ----------- Balance at end of period 41,964,766 $ 41,965 $ 228,365 $ 77,946 $ 12,086 $ 360,362 =========== =========== =========== =========== =========== ===========
Comprehensive (Loss) Income - ---------------------------
12 Weeks Ended 40 weeks Ended ------------------------------ ------------------------------ Nov. 29, 2008 Dec. 1, 2007 Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ ------------- ------------ Net (loss) income $ (13,628) $ 57,307 $ (28,753) $ (99,157) ----------- ----------- ----------- ----------- Foreign currency translation adjustment, net of tax -- (34,268) -- (9,710) Reclassification adjustment for sale of investment securities, net of tax -- (115,385) -- -- Net unrealized gain on marketable securities, net of tax -- -- -- 22 Pension and other post-retirement benefits, net of tax (154) (334) (744) (1,114) ----------- ----------- ----------- ----------- Other comprehensive loss, net of tax (154) (149,987) (744) (10,802) ----------- ----------- ----------- ----------- Total comprehensive loss $ (13,782) $ (92,680) $ (29,497) $ (109,959) =========== =========== =========== ===========
Accumulated Other Comprehensive (Loss) Income Balances - ------------------------------------------------------
Net Unrealized Net Unrealized Pension Accumulated Foreign Gain on (Loss) Gain & Other Other Currency Investment on Marketable Post-retirement Comprehensive Translation Securities Securities Benefits (Loss) Income ------------- ----------- ------------- ------------ ------------ Balance at February 23, 2008 $ -- $ -- $ -- $ (28,975) $ (28,975) Current period change -- -- -- (744) (744) ------------- ----------- ------------ ------------ ------------ Balance at November 29, 2008 $ -- $ -- $ -- $ (29,719) $ (29,719) ============= =========== ============ ============ ============ Balance at February 24, 2007 $ 9,710 $ -- $ (22) $ 13,200 $ 22,888 Current period change (9,710) -- 22 (1,114) (10,802) ------------- ----------- ------------ ------------ ------------ Balance at December 1, 2007 $ -- $ -- $ -- $ 12,086 $ 12,086 ============= =========== ============ ============ ===========
See Notes to Consolidated Financial Statements 3 The Great Atlantic & Pacific Tea Company, Inc. Consolidated Balance Sheets (Dollars in thousands, except share and per share amounts)
November 29, 2008 February 23, 2008 ----------------- ----------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 160,863 $ 100,733 Restricted cash 2,662 3,713 Restricted marketable securities 2,059 6,796 Accounts receivable, net of allowance for doubtful accounts of $9,972 and $6,152 at November 29, 2008 and February 23, 2008, respectively 170,495 173,203 Inventories 552,824 505,012 Prepaid expenses and other current assets 67,741 94,969 ----------- ----------- Total current assets 956,644 884,426 ----------- ----------- Non-current assets: Property: Property owned, net 1,647,992 1,751,440 Property leased under capital leases, net 136,805 149,363 ----------- ----------- Property - net 1,784,797 1,900,803 Goodwill 483,560 387,546 Intangible assets, net 226,972 234,086 Other assets 259,328 236,995 ----------- ----------- Total assets $ 3,711,301 $ 3,643,856 =========== =========== LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 8,209 $ 11,875 Current portion of obligations under capital leases 11,891 11,344 Current portion of other financial liabilities -- 44,539 Accounts payable 237,501 216,703 Book overdrafts 50,969 36,435 Accrued salaries, wages and benefits 146,235 175,430 Accrued taxes 45,077 46,156 Other accruals 222,583 229,333 ----------- ----------- Total current liabilities 722,465 771,815 ----------- ----------- Non-current liabilities: Long-term debt 969,810 758,886 Long-term obligations under capital leases 150,357 157,430 Long-term real estate liabilities 345,733 346,110 Deferred real estate income 77,668 81,110 Other financial liabilities 7,360 180,250 Other non-current liabilities 985,995 930,112 ----------- ----------- Total liabilities 3,259,388 3,225,713 ----------- ----------- Commitments and contingencies Stockholders' equity: Preferred stock--no par value; authorized - 3,000,000 shares; issued - none -- -- Common stock--$1 par value; authorized - 160,000,000 shares; issued and outstanding -- 57,663,534 and 57,100,955 shares at November 29, 2008 and February 23, 2008, respectively 57,664 57,101 Additional paid-in capital 436,298 373,594 Accumulated other comprehensive loss (29,719) (28,975) (Accumulated deficit) retained earnings (12,330) 16,423 ----------- ----------- Total stockholders' equity 451,913 418,143 ----------- ----------- Total liabilities and stockholders' equity $ 3,711,301 $ 3,643,856 =========== ===========
See Notes to Consolidated Financial Statements 4 The Great Atlantic & Pacific Tea Company, Inc. Consolidated Statements of Cash Flows (Dollars in thousands) (Unaudited)
40 weeks Ended ---------------------------- Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (28,753) $ (99,157) Adjustments to reconcile net loss to net cash used in operating activities: Asset disposition initiatives 9,824 120,422 Depreciation and amortization 201,362 122,614 (Gain) loss on disposal of owned property and write-down of property, net (362) 2,514 (Gain) loss on disposal of discontinued operations (4,653) 51,039 Other property impairments 2,667 3,551 Gain on sale of Canadian operations -- (209) Nonoperating income (114,269) -- Other share based awards 3,642 7,282 Equity in earnings of Metro, Inc. -- (7,869) Gain on disposition of Metro, Inc. -- (184,451) Other changes in assets and liabilities: (Increase) decrease in receivables (2,634) 31,915 (Increase) decrease in inventories (49,116) 72,741 Increase in prepaid expenses and other current assets (2,627) (14,230) Increase in other assets (11,766) (3,131) Increase (decrease) in accounts payable 21,710 (27,285) Decrease in accrued salaries, wages, benefits and taxes (30,323) (52,836) Decrease in other accruals (1,939) (5,544) Decrease in other non-current liabilities (49,042) (42,559) Other operating activities, net 8,065 (67) ----------- --------- Net cash used in operating activities (48,214) (25,260) ----------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Expenditures for property (85,659) (98,447) Proceeds from disposal of property 17,702 121,583 Purchase of business -- (765) Disposal related expenditures for sale of Canadian operations -- (395) Acquisition related expenditures for the purchase of Pathmark Stores, Inc. -- (18,668) Decrease (increase) in restricted cash 1,051 (490,933) Net proceeds from the sale of shares of Metro, Inc. -- 551,238 Proceeds from maturities of marketable securities 9,907 20,446 ----------- --------- Net cash (used in) provided by investing activities (56,999) 84,059 ----------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds under revolving lines of credit 1,683,823 459,200 Principal payments on revolving lines of credit (1,491,940) (517,900) Proceeds under line of credit 54,936 -- Principal payments on line of credit (58,607) -- Proceeds from promissory note 10,000 -- Payments on long-term borrowings (206) (31,977) Settlement of Series A warrants (45,735) -- Long term real estate liabilities 25 6,419 Principal payments on capital leases (5,567) (262) Increase in book overdrafts 14,534 1,448 Deferred financing fees 1,961 (257) Acquisition related expenditures for financing the purchase of Pathmark Stores, Inc. -- (865) Tax benefit on stock options -- 2,374 Proceeds from exercises of stock options 2,203 6,217 ----------- --------- Net cash provided by (used in) financing activities 165,427 (75,603) Effect of exchange rate changes on cash and cash equivalents (84) 20 ----------- --------- Net increase (decrease) in cash and cash equivalents 60,130 (16,784) Cash and cash equivalents at beginning of period 100,733 86,194 ----------- --------- Cash and cash equivalents at end of period $ 160,863 $ 69,410 =========== ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for interest $ 92,223 $ 48,974 Cash paid during the year for income taxes $ 3,147 $ 1,853
See Notes to Consolidated Financial Statements 5 The Great Atlantic & Pacific Tea Company, Inc. Notes to Consolidated Financial Statements (Dollars in thousands, except share and per share amounts) 1. Basis of Presentation The accompanying Consolidated Statements of Operations for the 12 and 40 weeks ended November 29, 2008 and December 1, 2007, Consolidated Statements of Stockholders' Equity and Comprehensive (Loss) Income and Consolidated Statements of Cash Flows for the 40 weeks ended November 29, 2008 and December 1, 2007, and the Consolidated Balance Sheets at November 29, 2008 and February 23, 2008 of The Great Atlantic & Pacific Tea Company, Inc. ("We," "Our," "Us" or "Our Company"), are unaudited and, in the opinion of management, contain all adjustments that are of a normal and recurring nature necessary for a fair statement of financial position and results of operations for such periods. The consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in our revised Fiscal 2007 Annual Report on Form 10-K. Interim results are not necessarily indicative of results for a full year. The consolidated financial statements include the accounts of our Company and all subsidiaries. All intercompany accounts and transactions have been eliminated. As discussed in Note 8 - Discontinued Operations, the criteria necessary to classify the operations for the Midwest and the Greater New Orleans area as discontinued were satisfied during fiscal 2007 and as such, have been reclassified in our Consolidated Statements of Operations for all periods presented. Certain reclassifications have been made to prior year amounts to conform to current year presentation. 2. Impact of New Accounting Pronouncements In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS ") No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for fiscal years beginning after November 15, 2007 (our year ending February 28, 2009). In February 2008, the FASB also issued FASB Staff Position ("FSP") No. 157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13" ("FSP FAS 157-1"). FSP FAS 157-1 excludes FASB Statement No. 13, "Accounting for Leases" ("SFAS 13"), as well as other accounting pronouncements that address fair value measurements on lease classification or measurement under SFAS 13, from the scope of SFAS 157. FSP FAS 157-1 is effective upon the initial adoption of SFAS 157. In addition, in February 2008, the FASB issued FSP No. 157-2, "Effective Date of FASB Statement No. 157" ("FSP FAS 157-2"). FSP FAS 157-2 delays the effective date of SFAS 157 for all nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. FSP FAS 157-2 states that a measurement is recurring if it happens at least annually and defines nonfinancial assets and nonfinancial liabilities as all assets and liabilities other than those meeting the definition of a financial asset or financial liability in SFAS 159, "The Fair Value Option for 6 Financial Assets and Financial Liabilities." FSP FAS 157-2 is effective upon issuance. Our Company adopted SFAS 157 as of February 24, 2008, with the exception of the application of the statement to nonrecurring nonfinancial assets and nonfinancial liabilities. Refer to Note 6 - Fair Value Measurements for further discussion. In October 2008, the FASB issued FSP 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active" ("FSP FAS 157-3"), with an immediate effective date, including prior periods for which financial statements have not been issued. FSP FAS 157-3 amends SFAS 157 to clarify the application of fair value in inactive markets and allows for the use of management's internal assumptions about future cash flows with appropriately risk-adjusted discount rates when relevant observable market data does not exist. The objective of SFAS 157 has not changed and continues to be the determination of the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date. We have evaluated the provisions of FSP FAS 157-3 and the guidance did not have an impact on our Company's financial condition or results of operations. In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities--including an amendment of FASB Statement No. 115" ("SFAS 159"). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. The provisions of SFAS 159 are effective for fiscal years beginning after November 15, 2007 (our year ending February 28, 2009). The adoption of the provisions of SFAS 159 had no effect on our Company's consolidated financial statements. In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 amends and expands the disclosure requirements of FASB Statement No. 133 with the intent to provide users of financial statement with an enhanced understanding of (i.) how and why an entity uses derivative instruments, (ii.) how derivative instruments and the related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and (iii.) how derivative instruments and related hedged items affect an entity's financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for years and interim periods beginning after November 15, 2008 (our year ended February 27, 2010). The effect of adopting SFAS 161 is not expected to have a significant effect on our reported financial position or earnings. In April 2008, the FASB issued FSP 142-3, "Determining the Useful Life of Intangible Assets" ("FSP FAS 142-3"). FSP FAS 142-3 amends the factors to be considered in determining the useful life of intangible assets. Its intent is to improve the consistency between the useful life of an intangible asset and the period of expected cash flows used to measure its fair value. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008 (our year ended February 27, 2010). Our Company is currently assessing the impact of FSP FAS 142-3 on our consolidated financial statements. In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). The new standard is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles ("GAAP") for nongovernmental entities. Prior to the issuance of SFAS 162, GAAP hierarchy was defined in the American Institute of Certified Public Accountants ("AICPA") Statement on Auditing Standards (SAS) No. 7 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SAS 69 has been criticized because it is directed to the auditor rather than the entity. SFAS 162 addresses these issues by establishing that the GAAP hierarchy should be directed to entities because it is the entity, not its auditor, that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. It is only effective for nongovernmental entities; therefore, the GAAP hierarchy will remain in SAS 69 for state and local governmental entities and federal governmental entities. We have evaluated the provisions of SFAS 162 and the guidance will not have an impact on our Company's financial condition or results of operations. In May 2008, the FASB issued FSP No. APB 14-1, Accounting for Convertible Debt Instruments that May be Settled in Cash Upon Conversion ("FSP APB 14-1"). FSP APB 14-1 requires that the liability and equity components of convertible debt that may be settled in cash upon conversion (including potential cash settlement) be separately accounted for in a manner that reflects an issuer's nonconvertible debt borrowing rate. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 (our year ended February 27, 2010), and interim periods within those fiscal years. Early adoption is not permitted. Retrospective application to all periods presented is required, except for instruments that were not outstanding during any of the periods that will be presented in the annual financial statements for the period of adoption but were outstanding during an earlier period. Once adopted, we expect an increase in our non-cash interest expense associated with our $255 million 6.75% Convertible Senior Notes that were issued in December 2007, including non-cash interest expense for prior periods as a result of its retrospective application. We believe the additional annual non-cash interest expense we may recognize for the year ended February 28, 2009 under FSP APB 14-1 would increase interest expense classified in our consolidated statements of operations by approximately $3 million, as our estimated nonconvertible debt borrowing rate of 12.00% is higher than the current contractual rate of 6.75% on our $255 million convertible senior notes. FSP APB 14-1, once adopted, would also increase our non-cash interest expense in fiscal 2009 and future periods during which our convertible notes remain outstanding. 3. Acquisition of Pathmark Stores, Inc. On December 3, 2007, our Company completed the acquisition of 100% of Pathmark for $1.4 billion in cash, stock, assumed or retired debt, warrants and options, in a transaction accounted for under SFAS No. 141 "Business Combinations" ("SFAS 141"). Pathmark is a regional supermarket chain with supermarkets in the New York, New Jersey and Philadelphia metropolitan areas. Consent Agreement - ----------------- On November 27, 2007, our Company announced that the Federal Trade Commission ("FTC") accepted a proposed consent agreement relating to our acquisition of Pathmark. The terms of the consent agreement required the divestiture of six stores located in the state of New York, which were subsequently sold for a gain of $19.4 million in fiscal 2007. Included in the Consolidated Statements of Operations for the 12 and 40 weeks ended December 1, 2007 are the sales and operating results of the five A&P stores that were divested. The sixth divested store was a Pathmark location and, accordingly, the results of operations of that store were not included in our results of 8 operations. There were no such results for the 12 and 40 weeks ended November 29, 2008. The results of the five A&P store operations are as follows:
12 weeks ended 40 weeks ended --------------- -------------- Dec. 1, 2007 Dec. 1, 2007 --------------- -------------- Sales $ 25,696 $ 85,055 =============== ============== Income from operations $ 228 $ 704 =============== ==============
Purchase Price Allocation - ------------------------- The application of purchase accounting under SFAS 141 requires that the purchase price paid is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of their fair values on the transaction date. Identified intangible assets, which are included in the consolidated balance sheets, consisted of the following:
At November 29, 2008 At Feb. 23, 2008 Weighted -------------------------------------- ---------------- Average Gross Amortization Carrying Accumulated Accumulated Period (years) Amount Amortization Amortization -------------- ------------- -------------- --------------- Loyalty card customer relationships 7 $ 19,200 $ 2,743 $ 633 In-store advertiser relationships 20 14,720 736 170 Pharmacy payor relationships 13 75,000 5,769 1,331 Pathmark trade name Indefinite 127,300 -- -- ------------- --------------- --------------- Total $ 236,220 $ 9,248 $ 2,134 ============= =============== ===============
Amortization of intangible assets for the 12 and 40 weeks ended November 29, 2008 was approximately $2.1 million and $7.1 million, respectively. The following table summarizes the estimated future amortization expense: 2008 $ 2,134 2009 9,248 2010 9,248 2011 9,248 2012 9,248 Thereafter 60,546
We have determined that the Pathmark trade name has an indefinite life and, accordingly, is not subject to amortization. Under the purchase method of accounting, the assets and liabilities of Pathmark were recorded at their respective fair values at the date of acquisition. Simultaneously, we recorded a preliminary amount to goodwill of $380.0 million. During the 40 weeks ended November 29, 2008, we increased our amount of goodwill from $380.0 million to $475.9 million at November 29, 2008. This increase primarily related to 1) an approximate $63.3 million adjustment for a Pathmark transportation agreement, which is unfavorable to market based upon information which existed as of the acquisition and 2) a $24.7 million adjustment for Pathmark's opening balance sheet liabilities for self-insurance reserves based on information we obtained regarding facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. Recognition of the unfavorable Pathmark 9 transportation agreement resulted in a reduction of operating expense of nil and $2.3 million during the 12 and 40 weeks ended November 29, 2008, respectively, relating to the prior year and the adjustment related to self-insurance reserves resulted in an insignificant adjustment to interest expense during the 12 and 40 weeks ended November 29, 2008, relating to the prior year. The following table summarizes the fair values of the Pathmark assets acquired and liabilities assumed at the date of acquisition: Current assets $ 347,376 Goodwill 475,923 Intangible assets 236,220 Property, net* 1,195,524 Other assets 150,575 ----------- Total assets acquired $ 2,405,618 Current liabilities (339,856) Long-term debt (1,194) Long-term obligations under capital leases (130,488) Long-term financing liabilities (64,138) Deferred taxes** (58,594) Other non-current liabilities (398,849) ----------- Total liabilities assumed $ (993,119) ----------- Net assets acquired $ 1,412,499 ===========
* In fiscal 2007, we acquired net favorable lease rights relating to the acquisition of Pathmark in the amount of $444.6 million which is included in Property, net and other non-current liabilities in our Consolidated Balance Sheet at November 29, 2008. The Company's net favorable lease rights are amortized on a straight-line basis until the end of the lease options but not more than 25 years. The weighted average life remaining of the net favorable lease rights at November 29, 2008 is 18.4 years. Amortization expense related to the net favorable lease rights was $4.5 million and $15.6 million for the 12 and 40 weeks ended November 29, 2008, respectively. ** The fair values reflect recognition of a significant portion of A&P's net deferred tax assets, including net operating loss carry forwards, which existed at the date of acquisition. The amount of goodwill and intangibles are $475.9 million and $236.2 million, respectively, resulting from the Pathmark acquisition. The goodwill is not deductible for tax purposes. We allocate goodwill to reporting units based on the reporting units expected to benefit from our acquisition of Pathmark. We will evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a fair value allocation approach. The following table summarizes the allocation of goodwill to our reportable segments:
At Nov. 29, 2008 -------------- Fresh $ 121,708 Price Impact 337,139 Gourmet 12,720 Other 4,356 -------------- Total Goodwill $ 475,923 ==============
The current economic environment has led to an overall decline in the stock market which has negatively impacted our stock price. We do not believe the decline in our stock price reflects changes in the fundamentals of our business. Our current expectations are that projected future results of our reporting units would not indicate an impairment of our goodwill or intangibles. However, there can be no assurance that there is not an impairment until a full analysis is completed. Our annual impairment test is performed in the fourth quarter of our fiscal year and it is possible that the estimated fair value of one or more of our reporting units may be less than their carrying amounts. If so, we may be required to record a non-cash impairment charge during our fourth quarter of fiscal 2008. 10 4. Earnings Per Share Basic (loss) earnings per share is computed by dividing net (loss) income by the weighted average shares outstanding for the reporting period. Diluted (loss) earnings per share reflects the potential dilution, using the treasury stock method, and assumes that the convertible debt, stock options, restricted stock, warrants, and other potentially dilutive financial instruments were converted into common stock upon issuance, if dilutive. Weighted average common shares of 1,749,675 and 1,738,053 for the 12 and 40 weeks ended November 29, 2008, respectively, and 94,199 and 78,257 for the 12 and 40 weeks ended December 1, 2007, respectively, related to options outstanding under our Company's stock award plan and were excluded from the computation of diluted earnings per share as the effect would be antidilutive. Weighted average common shares of 524,843 for both the 12 and 40 weeks ended November 29, 2008 related to restricted stock units outstanding under our Company's stock option plans and were excluded from the computation of diluted earnings per share as the effect would be antidilutive. Weighted average common shares of 686,277 for both the 12 and 40 weeks ended November 29, 2008 related to warrants outstanding under our Company's stock award plan and were excluded from the computation of diluted earnings per share as the effect would be antidilutive. Weighted average common shares of 11,278,988 for both the 12 and 40 weeks ended November 29, 2008 related to the financing warrants outstanding and were excluded from the computation of diluted earnings per share as the effect would be antidilutive. On September 15, 2008, Lehman Brothers Holdings Inc. ("Lehman") and certain of its subsidiaries, including Lehman Brothers International (Europe) ("Lehman Europe"), filed a petition under Chapter 11 of the U.S Bankruptcy Code with the United States Bankruptcy Court. Lehman Europe is party to a 3,206,058 share lending agreement with our Company. Due to the circumstances of the Lehman bankruptcy, we recorded these shares loaned under our share lending agreement as issued and outstanding effective September 15, 2008 for purposes of computing and reporting our Company's basic and diluted weighted average shares and earnings per share. 11 The following table sets forth the calculation of basic and diluted earnings per share:
12 Weeks Ended 12 Weeks Ended Nov. 29, 2008 Dec. 1, 2007 -------------- --------------- (Loss) income from continuing operations $ (2,993) $ 73,082 Adjustments on Convertible Debt (30,230) -- Adjustments on Convertible Warrants (22,777) -- -------------- --------------- (Loss) income from continuing operations--diluted $ (56,000) $ 73,082 ============== =============== Weighted average common shares outstanding 57,663,398 41,961,253 Share lending agreement (5,271,450) -- -------------- --------------- Weighted average common shares outstanding -- basic 52,391,948 41,961,253 ============== =============== Effect of dilutive securities: Options to purchase common stock -- 402,650 Convertible debt 11,278,988 -- Convertible warrants (22,208,241) -- -------------- --------------- Weighted average common shares outstanding--diluted 41,462,695 42,363,903 ============== ===============
40 Weeks Ended 40 Weeks Ended Nov. 29, 2008 Dec. 1, 2007 -------------- --------------- (Loss) income from continuing operations $ (2,782) $ 131,549 Adjustments on Convertible Debt (29,376) -- Adjustments on Convertible Warrants (98,742) -- -------------- --------------- (Loss) income from continuing operations--diluted $ (130,900) $ 131,549 ============== =============== Weighted average common shares outstanding 57,638,111 41,888,969 Share lending agreement (7,275,236) -- -------------- --------------- Weighted average common shares outstanding -- basic 50,362,875 41,888,969 ============== =============== Effect of dilutive securities: Options to purchase common stock -- 417,379 Convertible debt 11,278,988 -- Convertible warrants (5,451,204) -- -------------- --------------- Weighted average common shares outstanding--diluted 56,190,659 42,306,348 ============== ===============
5. Cash, Cash Equivalents, Restricted Cash and Available-for-sale Securities At November 29, 2008 and February 23, 2008, we had $2.7 million and $3.7 million, respectively, in restricted cash which represented monies held in escrow for services which our Company is required to perform in connection with the sale of our real estate properties. At November 29, 2008 and February 23, 2008, our restricted marketable securities of $8.2 million and $19.4 million, respectively, were held by Bank of America in the Columbia Fund. On December 6, 2007, Bank of America froze the Columbia Fund as a result of the increased risk in subprime asset backed securities. During the 12 and 40 weeks ended November 29, 2008, we received distributions from the Columbia Fund in the amount of $2.8 million and $9.9 million, respectively, at an amount less than 100% 12 of the net asset value of the fund resulting in realized losses on these distributions of $0.2 million and $0.4 million for the 12 and 40 weeks ended November 29, 2008, respectively. For the 12 and 40 weeks ended November 29, 2008, we realized losses of $0.7 million and $0.8 million, respectively, based on the ending net asset value of the Columbia Fund as the decline in net asset value is considered other than temporary at November 29, 2008 and will not be recovered in future distributions from the fund. The following is a summary of cash, cash equivalents, restricted cash, and restricted marketable securities as of November 29, 2008 and February 23, 2008:
At November 29, 2008 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Costs Gains Losses Value ----------- ----------- ----------- ----------- Classified as: - -------------- Cash $ 157,872 $ -- $ -- $ 157,872 Cash equivalents: Money market funds 2,991 -- -- 2,991 ----------- ----------- ----------- ----------- Total cash and cash equivalents 160,863 -- -- 160,863 ----------- ----------- ----------- ----------- Restricted cash 2,662 -- -- 2,662 Restricted marketable securities 2,059 -- -- 2,059 Restricted marketable securities included in other assets 6,177 -- -- 6,177 ----------- ----------- ----------- ----------- Total cash, cash equivalents, restricted cash and restricted marketable securities $ 171,761 $ -- $ -- $ 171,761 =========== =========== =========== =========== Securities available-for-sale: - ------------------------------ Maturing within one year $ 2,059 $ 2,059 =========== =========== Maturing greater than one year $ 6,177 $ 6,177 =========== ===========
At February 23, 2008 --------------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Costs Gains Losses Value ----------- ----------- ----------- ----------- Classified as: - -------------- Cash $ 98,382 $ -- $ -- $ 98,382 Cash equivalents: Money market funds 2,351 -- -- 2,351 ----------- ----------- ----------- ----------- Total cash and cash equivalents 100,733 -- -- 100,733 ----------- ----------- ----------- ----------- Restricted cash 3,713 -- -- 3,713 Restricted marketable securities 6,796 -- -- 6,796 Restricted marketable securities included in other assets 12,622 -- -- 12,622 ----------- ----------- ----------- ----------- Total cash, cash equivalents, restricted cash and restricted marketable securities $ 123,864 $ -- $ -- $ 123,864 =========== =========== =========== =========== Securities available-for-sale: - ------------------------------ Maturing within one year $ 6,796 $ 6,796 =========== =========== Maturing greater than one year $ 12,622 $ 12,622 =========== ===========
13 Gross realized losses on sales of investments were $0.2 million and $0.4 million for the 12 and 40 weeks ended November 29, 2008, respectively, and gross realized gains on sales of investments were $103.6 million and $182.1 million for the 12 and 40 weeks ended December 1, 2007, respectively. 6. Fair Value Measurements SFAS 157 defines and establishes a framework for measuring fair value and expands related disclosures. This Statement applies to all assets and liabilities that are being measured and reported on a fair value basis. Our Company adopted SFAS 157 for our financial assets and financial liabilities beginning in fiscal 2008. As discussed in Note 2 -- Impact of New Accounting Pronouncements, SFAS 157-2 deferred the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities recorded at fair value on a nonrecurring basis to fiscal years beginning after November 15, 2008 (our year ended February 27, 2010). SFAS 157 establishes a three-tier fair value hierarchy, which classifies the inputs used in measuring fair value. These tiers include: Level 1 -- Quoted prices in active markets for identical assets or liabilities. Our Company's Level 1 assets and liabilities include cash equivalents that are traded in an active exchange market. Level 2 -- Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Our Company's Level 2 liabilities include warrants whose value is determined using the Black Scholes pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. Level 3 -- Unobservable inputs that are supported by little or no market activity and that are financial instruments whose value is determined using pricing models, discounted cash flows, or similar methodologies, as well as instruments for which the determination of fair value requires significant judgment or estimation. Our Company's Level 3 assets include restricted marketable securities for which there is limited market activity. A financial asset or liability's classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of November 29, 2008:
Fair Value Measurements at Nov. 29, 2008 Using ------------------------------------------------ Quoted Prices Significant Other Significant Total Carrying in Active Observable Unobservable Value at Markets Inputs Inputs Nov. 29, 2008 (Level 1) (Level 2) (Level 3) -------------- ------------- ----------------- ------------ Assets: - ------- Cash equivalents $ 2,991 $ 2,991 $ -- $ -- Restricted marketable securities 8,236 -- -- 8,236 ----------- ---------- ---------- ---------- Total $11,227 $2,991 $ -- $8,236 =========== ========== ========== ========== Liabilities: - ------------ Warrant Series B $ 7,360 $ -- $ 7,360 $ -- =========== ========== ========== ==========
14 Level 3 Valuation Techniques: - ----------------------------- Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flows or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial assets include our restricted marketable securities for which there is limited market activity such that the determination of fair value requires significant judgment or estimation. At November 29, 2008, these securities were valued primarily using broker pricing models that incorporate transaction details such as contractual terms, maturity, timing and amount of future cash inflows, as well as assumptions about liquidity. The table below provides a summary of the changes in fair value, including net transfers in and/or out, of all financial assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period February 24, 2008 to November 29, 2008:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) ------------------------------- Restricted Marketable Securities ---------- Beginning Balance $ 19,418 Total realized and unrealized losses included in: Losses (1) (1,275) Comprehensive income -- Settlements (9,907) Transfers in and/or out of Level 3 -- ---------- Ending Balance $ 8,236 ========== Losses recorded in Earnings attributable to the change in unrealized losses relating to Level 3 assets still held at November 29, 2008 $ (840) ==========
(1) Amounts are recorded in Store operating, general and administrative expense in the Consolidated Statements of Operations. As discussed in Note 5 -- Cash, Cash Equivalents, Restricted Cash and Restricted Marketable Securities, on November 29, 2008, we had $8.2 million invested in a short-term fixed income fund held by Bank of America (the "Columbia Fund"). Due to market liquidity conditions, cash redemptions from the Columbia Fund were restricted. As a result of this restriction on cash redemptions, we did not consider the Columbia Fund to be traded in an active market with observable pricing on February 24, 2008 and these amounts were categorized as Level 3. 7. Valuation of Long-Lived Assets In accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), we review the carrying values of our long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. Such review is primarily based upon groups of assets and the undiscounted estimated future cash flows from such assets to determine if the carrying value of such assets is recoverable from their respective cash flows. If 15 such review indicates an impairment exists, we measure such impairment on a discounted basis using a probability-weighted approach and a 7 year U.S. Treasury risk-free rate. During the 12 and 40 weeks ended November 29, 2008, we recorded impairment losses on long-lived assets of $0.9 million and $2.7 million, respectively. During the 12 and 40 weeks ended December 1, 2007, we recorded impairment losses on long-lived assets of $4.7 million and $57.8 million, respectively. Impairments due to closure or conversion in the normal course of business - ------------------------------------------------------------------------- We review assets in stores planned for closure or conversion for impairment upon determination that such assets will not be used for their intended useful life. During the 12 and 40 weeks ended November 29, 2008, we recorded impairment losses on property of $0.9 million and $2.7 million, respectively, related to stores that were or will be closed or converted in the normal course of business, as compared to $2.5 million and $3.6 million in impairment losses on property related to stores that were closed or converted in the normal course of business during the 12 and 40 weeks ended December 1, 2007, respectively. These amounts were included in "Store operating, general and administrative expense" in our Consolidated Statements of Operations. Impairments related to our discontinued operations - -------------------------------------------------- During the 12 and 40 weeks ended December 1, 2007, we recorded impairment losses of $2.2 million and $54.2 million, respectively, related to our discontinued operations as a result of our exit of the Greater New Orleans and Midwest markets as discussed in Note 8 - Discontinued Operations. These amounts were included in our Consolidated Statements of Operations under the caption "Gain (loss) on disposal of discontinued businesses, net of tax" for the 12 and 40 weeks ended December 1, 2007. There were no such charges for the 12 and 40 weeks ended November 29, 2008. The effects of changes in estimates of useful lives were not material to ongoing depreciation expense. 8. Discontinued Operations We have had multiple transactions throughout the years which met the criteria for discontinued operations. These events are described based on the year the transaction was initiated. 2007 Events - ----------- On May 30, 2007, our Company announced advanced negotiations for the sale of our non-core stores located within the Greater New Orleans area, including inventory related to these stores. Our Company ceased sales operations in all stores not sold as of November 1, 2007. Planned sale transactions for these stores have been completed resulting in a loss on disposal of $16.5 million during fiscal 2007. On April 24, 2007, based upon unsatisfactory operating trends and the need to devote resources to our expanding Northeast core business, our Company announced negotiations for the sale of our non-core stores within our Midwest operations, including inventory related to these stores. Our Company ceased sales operations in all stores not sold as of July 7, 2007. Planned sale transactions for these stores have been completed, resulting in a loss on disposal of $34.3 million during fiscal 2007. 16 2005 Event - ---------- During the first quarter of fiscal 2005, we announced plans for a major strategic restructuring that would consolidate efforts in the Midwest. Thus, we initiated efforts to close a total of 35 stores in the Midwest, all of which were closed as of February 25, 2006. 2003 Events - ----------- During fiscal 2003, we adopted a formal plan to exit the Wisconsin markets through the sale and/or disposal of these assets. In February 2003, we announced the sale of a portion of our non-core assets, including seven stores in Madison, Wisconsin and 23 stores in Milwaukee, Wisconsin. Also in fiscal 2003, we announced an initiative to close 6 stores and convert 13 stores to our Food Basics banner in the Detroit, Michigan and Toledo, Ohio markets. Summarized below are the operating results for these discontinued businesses, which are included in our Consolidated Statements of Operations, under the captions "Loss from operations of discontinued businesses, net of tax" and "Gain (loss) on disposal of discontinued businesses, net of tax" for the 12 and 40 weeks ended November 29, 2008 and December 1, 2007.
For the 12 weeks ended For the 40 weeks ended ------------------------------- ------------------------------- Nov. 29, 2008 Dec. 1, 2007 Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ ------------- ------------ Loss from operations of discontinued businesses Sales $ -- $ 35,135 $ -- $ 562,654 ============= ============ ============= ============ Loss from operations of discontinued businesses, before tax (12,466) (13,540) (30,624) (179,667) Tax benefit -- -- -- -- ------------- ------------ ------------- ------------ Loss from operations of discontinued businesses, net of tax $ (12,466) $ (13,540) $ (30,624) $ (179,667) ============= ============ ============= ============ Gain (loss) on disposal of discontinued operations Property impairments $ -- $ (2,235) $ -- $ (54,249) Gain on sale of fixed assets 1,831 -- 4,653 3,210 ------------- ------------ ------------- ------------ Gain (loss) on disposal of discontinued businesses, before tax 1,831 (2,235) 4,653 (51,039) Tax benefit -- -- -- -- ------------- ------------ ------------- ------------ Gain (loss) on disposal of discontinued businesses, net of tax $ 1,831 $ (2,235) $ 4,653 $ (51,039) ============= ============ ============= ============
17 Summarized below is a reconciliation of the liabilities related to restructuring obligations resulting from these activities, pursuant to SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146") and SFAS No. 112, "Employers' Accounting for Postemployment Benefits" ("SFAS 112").
For the 40 weeks ended November 29, 2008 -------------------------------------------------------------------------------- Balance at Interest Balance at 2/23/2008 Accretion (1) Adjustments(2) Utilization(3) 11/29/2008 ---------- ------------- ------------- -------------- ---------- 2007 Events - ----------- Occupancy $ 62,873 $ 7,244 $ 7,936 $ (22,959) $ 55,094 Severance and pension withdrawal payments 58,520 1,157 3,730 (3,251) 60,156 ---------- ----------- ------------ ------------ ---------- 2007 events total 121,393 8,401 11,666 (26,210) 115,250 2005 Event - ---------- Occupancy 66,882 2,564 (79) (7,881) 61,486 2003 Events - ----------- Occupancy 21,579 961 (691) (2,564) 19,285 ---------- ----------- ------------ ------------ ---------- Fiscal 2008 total $ 209,854 $ 11,926 $ 10,896 $ (36,655) $ 196,021 ========== =========== ============ ============ ==========
Fiscal 2007 -------------------------------------------------------------------------------- Balance at Interest Balance at 2/24/2007 Accretion (1) Adjustments(2) Utilization(3) 2/23/2008 ---------- ------------- ------------- -------------- --------- 2007 Events - ----------- Occupancy $ -- $2,865 $ 81,234 $ (21,226) $ 62,873 Severance and pension withdrawal payments -- -- 81,642 (23,122) 58,520 ---------- ----------- ------------ ------------ ---------- 2007 events total -- 2,865 162,876 (44,348) 121,393 2005 Event - ---------- Occupancy 83,111 3,457 (7,117) (12,569) 66,882 2003 Events - ----------- Occupancy 22,262 1,269 1,141 (3,093) 21,579 ---------- ----------- ------------ ------------ ---------- Fiscal 2007 total $ 105,373 $ 7,591 $ 156,900 $ (60,010) $ 209,854 ========== =========== ============ ============ ==========
(1) The additions to occupancy and severance represents the interest accretion on future occupancy costs and future obligations for early withdrawal from multi-employer union pension plans which were recorded at present value at the time of the original charge. Interest accretion is recorded as a component of "Loss from operations of discontinued businesses" on the Consolidated Statements of Operations. (2) At each balance sheet date, we assess the adequacy of the balance of the remaining liability to determine if any adjustments are required as a result of changes in circumstances and/or estimates. Adjustments are recorded as a component of "Loss from operations of discontinued businesses" on the Consolidated Statements of Operations. For the 40 weeks ended November 29, 2008 ---------------------------------------- The charge to occupancy for the 2007 events represent adjustments for additional occupancy related costs for our properties of $7.9 million due to changes in our estimation of such future costs. The charge to severance for the 2007 18 events represents an adjustment of $3.7 million for future obligations for early withdrawal from multi-employer union pension plans. We also recorded adjustments for a reduction in occupancy related costs of $0.1 million and $0.7 million for the 2005 event and the 2003 events, respectively, due to changes in our estimation of such future costs. Fiscal 2007 ----------- The charge to occupancy for the 2007 events represents charges related to the closures of 39 stores in fiscal 2007 in conjunction with our decision to close and/or sell stores in the Midwest and the Greater New Orleans area. The charge to severance and benefits of $81.6 million for the 2007 events related to (i.) individual severings and retention incentives that were accrued as earned of $24.6 million as a result of the sale or closing of these facilities and (ii.) future obligations for early withdrawal from multi-employer union pension plans of $57.0 million. During fiscal 2007, we also recorded adjustments for the 2005 event for a reduction in occupancy related costs for our properties of $7.1 million due to (i.) changes in our estimation of such future costs of $6.4 million and (ii.) a new sublease agreement for one property of $0.7 million. We recorded adjustments for the 2003 events for additional occupancy related costs for our properties of $1.1 million due to changes in our estimation of such future costs. (3) Occupancy utilization represents payments made during those periods for rent, common area maintenance and real estate taxes. Severance and pension withdrawal payments utilization represents payments made to terminated employees during the period. Summarized below are the payments made to date from the time of the original charge and expected future payments related to these events:
2007 2005 2003 Events Event Events -------- -------- ------- Total severance payments made to date $ 26,373 $ 2,650 $22,528 Expected future severance and pension withdrawal payments 60,156 -- -- -------- -------- ------- Total severance payments expected to be incurred 86,529 2,650 $22,528 -------- -------- ------- Total occupancy payments made to date 44,185 44,053 28,890 Expected future occupancy payments, excluding interest accretion 55,094 61,486 19,285 -------- -------- ------- Total occupancy payments expected to be incurred, excluding interest accretion 99,279 105,539 48,175 -------- -------- ------- Total severance and occupancy payments made to date 70,558 46,703 51,418 Expected future severance, pension withdrawal and occupancy payments, excluding interest accretion 115,250 61,486 19,285 -------- -------- ------- Total severance, pension withdrawal and occupancy payments expected to be incurred, excluding interest accretion $185,808 $108,189 $70,703 ======== ======== =======
Payments to date were primarily for occupancy related costs such as rent, common area maintenance, real estate taxes, lease termination costs, severance, and benefits. The remaining obligation relates to expected future payments under long term leases and expected future payments for early withdrawal from multi-employer union pension plans. The expected completion dates for the 2007, 2005, and 2003 events are 2028, 2022, and 2022, respectively. 19 Summarized below are the amounts included in our balance sheet captions on our Company's Consolidated Balance Sheets related to these events:
November 29, 2008 --------------------------------------------------------- 2007 2005 2003 Events Event Events Total ---------- --------- ---------- ----------- Accrued salaries, wages and benefits $ 43 $ -- $ -- $ 43 Other accruals $ 20,858 $ 10,568 $ 3,243 $ 34,669 Other non-current liabilities $ 94,349 $ 50,918 $ 16,042 $ 161,309
February 23, 2008 --------------------------------------------------------- 2007 2005 2003 Events Event Events Total ---------- --------- ---------- ----------- Accrued salaries, wages and benefits $ 1,513 $ -- $ -- $ 1,513 Other accruals $ 24,733 $ 10,985 $ 3,241 $ 38,959 Other non-current liabilities $ 95,147 $ 55,897 $ 18,338 $ 169,382
We evaluated the reserve balances as of November 29, 2008 based on current information and have concluded that they are adequate to cover future costs. We will continue to monitor the status of the vacant and subsidized properties, severance and benefits, and pension withdrawal liabilities. Adjustments to the reserve balances may be recorded in the future, if necessary. 9. Asset Disposition Initiatives In addition to the events described in Note 8 -- Discontinued Operations there were restructuring transactions which were not primarily related to our discontinued operations. These events are referred to based on the year the transaction was initiated, as described below. Restructuring charges relate principally to employee severance and occupancy costs resulting from the closure of facilities and other workforce reductions attributable to our efforts to reduce costs. The costs of these reductions have been and will be funded through cash from operations. Occupancy costs represent facility consolidation and lease termination costs associated with our decision to consolidate and close duplicative or excess warehouse and office facilities, unproductive and excess facilities and the continued softening of real estate markets, which resulted in lower than expected sublease income. 2005 Event - ---------- During fiscal 2005, our Company sold our U.S. distribution operations and some warehouse facilities and related assets to C&S Wholesale Grocers, Inc. The Asset Purchase Agreement included the assignment of our leases in Central Islip, New York and Baltimore, Maryland, and a warranty deed for our owned facilities in Dunmore, Pennsylvania. 2001 Event - ---------- During the third quarter of fiscal 2001, our Company determined that certain underperforming operations, including 39 stores (30 in the United States and 9 in Canada) and 3 warehouses (2 in the United States and 1 in Canada) should be closed and/or sold, and certain administrative streamlining should take place. 20 1998 Event - ---------- In May 1998, we initiated an assessment of our business operations in order to identify the factors that were impacting our performance. As a result of this assessment, in fiscal 1998 and 1999, we announced a plan to close two warehouse facilities and a coffee plant in the U.S., a bakery plant in Canada and 166 stores (156 in the United States and 10 in Canada) including the exit of the Richmond, Virginia and Atlanta, Georgia markets. Summarized below is a reconciliation of the liabilities related to restructuring obligations resulting from these activities, pursuant to SFAS 146 and SFAS 112.
For the 40 weeks ended November 29, 2008 -------------------------------------------------------------------------------------- Balance at Interest Balance at 2/23/2008 Accretion (1) Adjustments(2) Utilization(3) 11/29/2008 ---------- ------------- -------------- --------------- ---------- 2005 Event - ---------- Continuing Operations Occupancy $ 1,231 $ 37 $ (91) $ (64) $ 1,113 Severance 1,686 -- -- (631) 1,055 ------- ------ ----- ------- ------- 2005 event total 2,917 37 (91) (695) 2,168 2001 Event - ---------- Continuing Operations Occupancy 6,755 271 988 (1,201) 6,813 Discontinued Operations Occupancy 12,281 535 (166) (1,162) 11,488 ------- ------ ----- ------- ------- 2001 event total 19,036 806 822 (2,363) 18,301 1998 Event - ---------- Continuing Operations Occupancy 6,958 252 268 (2,013) 5,465 Severance 1,000 -- -- (133) 867 Discontinued Operations Occupancy 1,093 40 (8) (455) 670 ------- ------ ----- ------- ------- 1998 event total 9,051 292 260 (2,601) 7,002 ------- ------ ----- ------- ------- Fiscal 2008 total $31,004 $1,135 $ 991 $(5,659) $27,471 ======= ====== ===== ======= =======
21
Fiscal 2007 ------------------------------------------------------------------------------------- Balance at Interest Balance at 2/24/2007 Accretion (1) Adjustments(2) Utilization(3) 2/23/2008 ---------- ------------- -------------- --------------- ---------- 2005 Event - ---------- Continuing Operations Occupancy $ 1,453 $ 51 $ 200 $ (473) $ 1,231 Severance 876 -- 2,366 (1,556) 1,686 Discontinued Operations Occupancy 3,997 92 (3,197) (892) -- ------- ------ ------- ------- ------- 2005 event total 6,326 143 (631) (2,921) 2,917 2001 Event - ---------- Continuing Operations Occupancy 7,338 401 10 (994) 6,755 Discontinued Operations Occupancy 13,248 747 -- (1,714) 12,281 ------- ------ ------- ------- ------- 2001 event total 20,586 1,148 10 (2,708) 19,036 1998 Event - ---------- Continuing Operations Occupancy 9,438 429 (351) (2,558) 6,958 Severance 1,210 -- -- (210) 1,000 Discontinued Operations Occupancy 1,598 79 -- (584) 1,093 ------- ------ ------- ------- ------- 1998 event total 12,246 508 (351) (3,352) 9,051 ------- ------ ------- ------- ------- Fiscal 2007 total $39,158 $1,799 $ (972) $(8,981) $31,004 ======= ====== ======= ======= =======
(1) Represents the interest accretion on future occupancy costs which were recorded at present value at the time of the original charge. These adjustments are recorded to "Store operating, general and administrative expense" for continuing operations and "Loss from operations of discontinued businesses" for discontinued businesses on our Consolidated Statements of Operations. (2) At each balance sheet date, we assess the adequacy of the balance to determine if any adjustments are required as a result of changes in circumstances and/or estimates. These adjustments are recorded to "Store operating, general and administrative expense" for continuing operations and "Loss from operations of discontinued businesses" as noted for discontinued operations on our Consolidated Statements of Operations. For the 40 weeks ended November 29, 2008 ---------------------------------------- For the 40 weeks ended November 29, 2008, we recorded an adjustment for a reduction in occupancy related costs of $0.1 million for the 2005 event due to changes in our estimation of such future costs. We also recorded adjustments for additional occupancy related costs of $0.8 million and $0.3 million, respectively, for the 2001 and 1998 events due to changes in our estimation of such future costs. Fiscal 2007 ----------- During fiscal 2007, adjustments to occupancy costs related to changes in our estimation of such future costs. We recorded additions to severance of $2.4 million for the 2005 event for health and welfare benefits for warehouse retirees of $1.7 million and pension withdrawal costs of $0.7 million. 22 (3) Occupancy utilization represents payments made during those periods for rent, common area maintenance and real estate taxes. Severance and benefits utilization represents payments made to terminated employees during the period. Summarized below are the payments made to date from the time of the original charge and expected future payments related to these events:
2005 2001 1998 Event Event Event Total ------- -------- -------- -------- Total severance payments made to date $48,564 $ 28,205 $ 30,597 $107,366 Expected future severance payments 1,055 -- 867 1,922 Total severance payments expected ------- -------- -------- -------- to be incurred 49,619 28,205 31,464 109,288 ------- -------- -------- -------- Total occupancy payments made to date 13,841 61,383 114,413 189,637 Expected future occupancy payments, excluding interest accretion 1,113 18,301 6,135 25,549 Total occupancy payments expected ------- -------- -------- -------- to be incurred, excluding interest 14,954 79,684 120,548 215,186 accretion ------- -------- -------- -------- Total severance and occupancy payments made to date $62,405 $ 89,588 $145,010 $297,003 Expected future severance and occupancy payments, excluding interest accretion 2,168 18,301 7,002 27,471 Total severance and occupancy ------- -------- -------- -------- payments expected to be incurred, $64,573 $107,889 $152,012 $324,474 excluding interest accretion ======= ======== ======== ========
Payments to date were primarily for occupancy related costs such as rent, common area maintenance, real estate taxes, lease termination costs, severance, and benefits. The remaining obligation relates to expected future payments under long-term leases and expected future payments for early withdrawal from multi-employer union pension plans. The expected completion dates for the 2005, 2001 and 1998 events are 2021, 2022 and 2020, respectively. Summarized below are the amounts included in our balance sheet captions on our Company's Consolidated Balance Sheets related to these events:
November 29, 2008 ----------------------------------------------------------- 2005 2001 1998 Event Event Event Total --------- --------- --------- --------- Other accruals $ 451 $ 2,771 $ 2,773 $ 5,995 Other non-current liabilities $ 1,717 $ 15,530 $ 4,229 $ 21,476
February 23, 2008 ----------------------------------------------------------- 2005 2001 1998 Event Event Event Total --------- --------- --------- --------- Other accruals $ 434 $ 2,754 $ 2,827 $ 6,015 Other non-current liabilities $ 2,483 $ 16,282 $ 6,224 $ 24,989
23 We evaluated the reserve balances as of November 29, 2008 based on current information and have concluded that they are adequate to cover future costs. We will continue to monitor the status of the vacant and subsidized properties, severance and benefits, and pension withdrawal liabilities. Adjustments to the reserve balances may be recorded in the future, if necessary. 10. Indebtedness and Other Financial Liabilities Series A and B Warrants - ----------------------- As part of the acquisition of Pathmark on December 3, 2007, we issued 4,657,378 and 6,965,858 roll-over stock warrants in exchange for Pathmark's 2005 Series A and Series B warrants, respectively. The number of warrants issued was computed based on a conversion factor of 0.46296. The Series A warrants were exercisable at $18.36 and expired on June 9, 2008 and the Series B warrants are exercisable at $32.40 and expire on June 9, 2015. These warrants were originally valued using the price of A&P common stock of $30.05 per common share, the quoted market price of A&P common stock on November 30, 2007, the last trading day before the transaction closing date. The Tengelmann stockholders have the right to approve any issuance of common stock under these warrants upon exercise (assuming Tengelmann's outstanding interest is at least 25% and subject to liquidity impairments defined within the Tengelmann Stockholder Agreement). In addition, Tengelmann has the ability to exercise a "Put Right" whereby it has the ability to require A&P to purchase A&P stock held by Tengelmann to settle these warrants. Based on the rights provided to Tengelmann, A&P does not have sole discretion to determine whether the payment upon exercise of these warrants will be settled in cash or through issuance of an equivalent portion of A&P shares. Therefore, these warrants are recorded as liabilities and marked-to-market each reporting period based on A&P's current stock price. On May 7, 2008, the 4,657,378 Series A warrants were exercised by Yucaipa Corporate Initiatives Fund I, L.P., Yucaipa American Alliance Fund I, L.P. and Yucaipa American Alliance (Parallel) Fund I, L.P. We opted to settle the Series A warrants in cash totaling $45.7 million rather than issuing additional common shares. Included in "Nonoperating Income" on our Consolidated Statements of Operations for the 12 and 40 weeks ended November 29, 2008, is a loss of nil and $1.2 million, respectively, for the Series A warrants through the settlement date of May 7, 2008 and a gain of $22.8 million and $98.7 million, respectively, for the Series B warrants market value adjustment. The value of the Series B warrants were $7.4 million as of November 29, 2008 and is included in "Other financial liabilities" on our Consolidated Balance Sheets. The following assumptions and estimates were used in the Black-Scholes model for the Series B warrants:
For the 40 weeks ended November 29, 2008 ----------------- Expected life 6.5 years Volatility 59.9% Dividend yield 0% Risk-free interest rate 2.35%
24 Public Debt Obligations - ----------------------- On December 18, 2007, we completed a public offering and issued $165 million 5.125% convertible senior notes due 2011 and $255 million 6.75% convertible senior notes due 2012. The 2011 notes are not redeemable at our option at any time. The 2012 notes are redeemable at our option on or after December 15, 2010, at a redemption price of 102.70% and on or after December 15, 2011, at a redemption price of 101.35%. The initial conversion price of the 2011 notes is $36.40 representing a 30.0% premium to the offering price of $28.00 and the initial conversion price of the 2012 notes is $37.80 representing a 35.0% premium to the offering price of $28.00 at maturity, and at our option, the notes are convertible into shares of our stock, cash, or a combination of stock and cash. Concurrent with this offering, we entered into call options and financing warrant transactions with financial institutions that are affiliates of the underwriters of the notes to effectively increase the conversion price of these notes and to reduce the potential dilution upon future conversion. Conversion prices were effectively increased to $46.20 or a 65% premium and $49.00 or a 75% premium for the 2011 and 2012 notes, respectively. We understand that on or about October 3, 2008, Lehman Brothers OTC Derivatives, Inc. or "LBOTC" who accounts for 50% of the call option and financing warrant transactions filed for bankruptcy protection, which is an event of default under such transactions. We are carefully monitoring the developments affecting LBOTC, noting the impact of the LBOTC bankruptcy effectively reduced conversion prices for 50% of our Notes to their stated prices of $36.40 for the 2011 notes and $37.80 for the 2012 notes. As of December 18, 2007, our Company did not have sufficient authorized shares to provide for all potential issuances of common stock. Therefore, in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," our Company accounted for the conversion features as freestanding instruments. The notes were recorded with a discount equal to the value of the conversion features at the transaction date and will be accreted to the par value of the notes over the life of the notes. The value of the conversion features were determined utilizing the Black-Scholes option pricing model and recorded as a long term liability. The portion of the conversion features for which there was not shares available for settlement of conversions were marked to market each balance sheet date. On June 26, 2008, at a special meeting of shareholders, the number of shares of common stock we have the authority to issue was increased to 160,000,000 based on a majority vote by our shareholders. During the 12 and 40 weeks ended November 29, 2008, we recorded a gain of nil and $9.4 million, respectively, in "Nonoperating Income" on our Consolidated Statements of Operations for the conversion features of the 5.125% convertible senior notes. During the 12 and 40 weeks ended November 29, 2008, the gain that was recorded in "Nonoperating Income" on our Consolidated Statements of Operations for the conversion features of the 6.75% convertible senior notes was nil and $5.1 million, respectively. Based on an increase in available shares primarily due to the exercise of our Series A warrants during the first quarter of fiscal 2008 and the increase in authorized shares during the second quarter of fiscal 2008, the fair value of the conversion features of the 5.125% and 6.75% convertible senior notes of $13.8 million and $14.7 million as of June 26, 2008, respectively, were reclassified to "Additional paid-in-capital" on our Consolidated Statements of Stockholder's Equity and Comprehensive (Loss) Income. Thus, the fair value of the conversion features for the 5.125% and 6.75% convertible notes are no longer classified as a liability at November 29, 2008. The following assumptions and estimates were used in the Black-Scholes model: 25
As of June 26, 2008 ------------- Expected life 3.0 years Volatility 33.4% Dividend yield 0% Risk-free interest rate 3.11%
Financing Warrants - ------------------ Concurrent with the issuance of the convertible senior notes, our Company issued financing warrants in conjunction with the call options recorded as equity in the Consolidated Balance Sheet to effectively increase the conversion price of these notes and reduce the potential dilution upon future conversion. The financing warrants allow holders to purchase common shares at $46.20 with respect to the 5.125% notes and $49.00 with respect to the 6.75% notes. The financing warrants were valued at $36.8 million at the issuance date. At the issuance date, we did not have sufficient authorized shares to provide all potential issuances of common stock. Therefore, the financing warrants were accounted for as freestanding derivatives, required to be settled in cash until sufficient shares were available and were recorded as a long-term liability in the Consolidated Balance Sheet. On June 26, 2008, at a special meeting of shareholders, the number of shares of common stock we have the authority to issue was increased to 160,000,000 based on a majority vote by our shareholders. Thus, the financing warrants were marked to market through June 26, 2008 utilizing the Black-Scholes option pricing model and $28.9 million was reclassified to "Additional paid-in-capital" on our Consolidated Statements of Stockholder's Equity and Comprehensive (Loss) Income as of June 26, 2008. These financing warrants are no longer classified as a liability at November 29, 2008. During the 12 and 40 weeks ended November 29, 2008, we recorded a gain of nil and $2.3 million, respectively, relating to these warrants, which is included in "Nonoperating income" on our Consolidated Statements of Operations. The following assumptions and estimates were used in the Black-Scholes model:
As of June 26, 2008 ------------- Expected life 3.3 years - 4.8 years Volatility 33.4% Dividend yield 0% Risk-free interest rate range 3.11% - 3.54%
26 11. Interest Expense Interest expense is comprised of the following:
For the 12 weeks ended For the 40 weeks ended ------------------------------ ----------------------------- Nov. 29, 2008 Dec. 1, 2007 Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ ------------- ------------ $675 million Credit Agreement $ 4,404 $ 45 $ 11,338 $ 1,231 7.75% Notes, due April 15, 2007 -- -- -- 342 9.125% Senior Notes, due December 15, 2011 270 270 900 900 5.125% Convertible Senior Notes, due June 15, 2011 1,946 -- 6,487 -- 6.750% Convertible Senior Notes, due December 15, 2012 3,961 -- 13,204 -- 9.375% Notes, due August 1, 2039 4,315 4,315 14,383 14,383 Capital Lease Obligations and Real Estate Liabilities 12,699 8,158 40,753 26,372 Amortization of Deferred Financing Fees and Discounts 4,443 173 14,873 602 Other 4,689 1,538 14,683 4,976 ------- ------- -------- ------- Total $36,727 $14,499 $116,621 $48,806 ======= ======= ======== =======
12. Other Accruals Other accruals are comprised of the following:
At At Nov. 29, 2008 Feb. 23, 2008 ------------- ------------- Self-insurance Reserves $ 61,241 $ 68,314 Closed Store and Warehouse Reserves 50,184 58,576 Pension Withdrawal Liabilities 1,835 519 Accrued Occupancy Related Costs for Open Stores 28,324 31,614 Deferred Income 35,766 22,784 Deferred Real Estate Income 2,553 2,553 Accrued Audit, Legal and Other 15,672 24,466 Accrued Interest 15,368 9,580 Pension Plan Benefits 3,333 3,333 Other Postemployment Benefits 1,932 1,932 Accrued Advertising 2,047 3,307 Other 4,328 2,355 -------- -------- Total $222,583 $229,333 ======== ========
27 13. Other Non-Current Liabilities Other non-current liabilities are comprised of the following:
At At Nov. 29, 2008 Feb. 23, 2008 ------------- ------------- Unrecognized Tax Benefits $156,255 $156,267 Self-insurance Reserves 167,217 149,235 Closed Store and Warehouse Reserves 127,646 141,000 Pension Withdrawal Liabilities 85,292 82,309 GHI Contract Liability for Employee Benefits 80,506 76,569 Pension Plan Benefits 68,785 66,863 Other Postemployment Benefits 50,162 48,281 Corporate Owned Life Insurance Liability 59,529 54,640 Deferred Rent Liabilities 54,413 52,512 Deferred Income 83,703 44,874 Unfavorable Lease Liabilities 31,659 34,421 Other 20,828 23,141 -------- -------- Total $985,995 $930,112 ======== ========
14. Retirement Plans and Benefits Defined Benefit Plans We provide retirement benefits to certain non-union and union employees under various defined benefit plans. Our defined benefit pension plans are non-contributory and benefits under these plans are generally determined based upon years of service and, for salaried employees, compensation. We fund these plans in amounts consistent with the statutory funding requirements. On August 29, 2008, the Grocery Haulers, Inc. ("GHI"), the Local 863 Union Multiemployer Pension Plan (the "Fund") and our Company entered into a series of agreements which collectively provided that: a) GHI would withdraw from the Fund; b) our Pathmark Pension Plan would be amended to a multiple employer plan to provide for the participation in the plan by GHI employees servicing Pathmark stores; and c) the Fund liabilities allocable to GHI and a portion of the Fund assets would be transferred to the Pathmark Pension Plan. We anticipate that the Pathmark Pension Plan will be amended in the fourth quarter of fiscal 2008. During the third quarter of fiscal 2008, we incurred expense of approximately $3.9 million related to these employees, prior to their transfer to the Pathmark Pension Plan which is expected to maintain its over funded status upon inclusion of this obligation. Our Company currently has an obligation recorded in "Other non-current liabilities" on our Consolidated Balance Sheets at November 29, 2008 and February 23, 2008 of $80.5 million and $76.6 million, respectively, for the net obligation expected to be transferred to the Pathmark Pension Plan. In the third quarter of fiscal 2007, we recorded a curtailment gain of $0.2 million reflecting a reduction in the estimated future costs of previously recorded pension benefits as a result of the closure of stores in the Midwest. This amount was included in "(Loss) income from operations of discontinued businesses, net of tax" on our Consolidated Statements of Operations. In addition, we recorded a settlement gain of $1.0 million resulting from lump sum payments of benefits in excess of our recorded liabilities for both former employees in the Midwest and the Northeast. Of this amount $0.9 million was included in "(Loss) income from operations of discontinued businesses, net of tax" and $0.1 million was included in "Store operating, 28 general and administrative expense" on our Consolidated Statements of Operations for the 12 and 40 weeks ended December 1, 2007. The components of net pension cost were as follows:
For the 12 Weeks Ended ---------------------------- November 29, December 1, 2008 2007 ------------ ---------- Service cost $ 1,861 $ 1,137 Interest cost 5,944 2,800 Expected return on plan assets (7,097) (3,031) Amortization of unrecognized net prior service cost 65 58 Amortization of unrecognized net loss 27 23 Curtailment gain -- (167) Settlement gain -- (1,047) Special termination benefits 300 -- ------- ------- Net pension cost $ 1,100 $ (227) ======= =======
For the 40 weeks Ended ----------------------------- November 29, December 1, 2008 2007 ------------ ---------- Service cost $ 5,355 $ 3,789 Interest cost 19,813 9,334 Expected return on plan assets (23,659) (10,103) Amortization of unrecognized net prior service cost 202 196 Amortization of unrecognized net loss 90 76 Curtailment gain -- (167) Settlement gain -- (1,047) Special termination benefits 300 -- -------- -------- Net pension cost $ 2,101 $ 2,078 ======== ========
Contributions We previously disclosed in our consolidated financial statements for the year ended February 23, 2008, that we expected to contribute $4.5 million in cash to our defined benefit plans in fiscal 2008. As of November 29, 2008, we contributed approximately $5.5 million to our defined benefit plans. We have revised our expected contributions to our defined benefit plans in fiscal 2008 to $7.2 million and plan to contribute approximately $1.7 million to our plans during the remainder of fiscal 2008. Postretirement Benefits We provide postretirement health care and life benefits to certain union and non-union employees. We recognize the cost of providing postretirement benefits during employees' active service periods. We use a February 23 measurement date for our postretirement benefits. The components of net postretirement benefits cost (income) were as follows:
For the 12 Weeks Ended ---------------------------- November 29, December 1, 2008 2007 ------------ ----------- Service cost $ 234 $ 75 Interest cost 529 243 Amortization of gain -- (105) Prior service gain (311) (311) Curtailment change in estimate -- 3,000 ----- ------- Net postretirement benefits cost $ 452 $ 2,902 ===== =======
29
For the 40 weeks Ended ------------------------------ November 29, December 1, 2008 2007 ------------ ----------- Service cost $ 780 $ 251 Interest cost 1,763 809 Amortization of gain -- (350) Prior service gain (1,036) (1,036) ------- ------- Net postretirement benefits cost (income) $ 1,507 $ (326) ======= =======
During the third quarter of fiscal 2007, we recorded a change in estimate of $3.0 million based on our revised actuarial estimate that originally reflected a reduction in the estimated future costs of previously recorded postretirement benefits. 15. Stock Based Compensation During the 12 and 40 weeks ended November 29, 2008, compensation expense related to share-based incentive plans was income due to a reversal of $3.3 million and expense of $3.7 million, after tax, respectively, compared to an expense of $2.0 million and $7.3 million, after tax, during the 12 and 40 weeks ended December 1, 2007, respectively. Included in share-based compensation expense recorded during the 12 and 40 weeks ended November 29, 2008 was $0.3 million and $1.1 million, respectively, related to expensing of stock options, a net reversal of expense of $3.8 million and expense of $2.1 million, respectively, relating to expensing of restricted stock, and $0.2 million and $0.5 million, respectively, relating to expensing of common stock granted to our Board of Directors at the Annual Meeting of Stockholders. Included in share-based compensation expense recorded during the 12 and 40 weeks ended December 1, 2007 was $0.1 million and $0.4 million, respectively, related to expensing of stock options, $1.8 million and $6.5 million, respectively, relating to expensing of restricted stock, and $0.1 million and $0.4 million, respectively, relating to expensing of common stock granted to our Board of Directors at the Annual Meeting of Stockholders. At November 29, 2008, we had stock awards outstanding under two stock-based compensation plans, the 1998 Long Term Incentive and Share Award Plan ("1998 Plan") and the 2004 Non-Employee Director Compensation Plan. The general terms of each plan are reported in our Fiscal 2007 Annual Report on Form 10-K. The 1998 Plan expired on July 14, 2008. On June 26, 2008, at a special meeting of shareholders, our shareholders approved our Company's 2008 Long Term Incentive and Share Award Plan ("2008 Plan".) The 2008 Plan provides for the same types of awards and is otherwise similar to the 1998 Plan and replaced the 1998 Plan. 30 Stock options - ------------- The following is a summary of the stock option activity during the 40 weeks ended November 29, 2008:
Weighted Weighted Average Average Remaining Aggregate Exercise Contractual Intrinsic Shares Price Term (years) Value ------------- ------------- ------------ ------------- Outstanding at February 23, 2008 1,827,529 $ 24.21 Granted 128,434 26.07 Canceled or expired (167,881) 32.50 Exercised (106,626) 20.66 -------------- -------- Outstanding at November 29, 2008 1,681,456 $ 23.75 3.3 $ 0.1 ============= ======== ============= ============= Exercisable at November 29, 2008 1,454,643 $ 23.08 2.5 $ 0.1 ============= ============= Nonvested at November 29, 2008 226,813 $ 28.06 8.7 $ -- ============= =============
Fair values for each stock option grant were estimated using a Black-Scholes valuation model which utilized assumptions as detailed in the following table for expected life based upon historical option exercise patterns, historical volatility for a period equal to the stock option's expected life, and risk-free rate based on the U.S. Treasury constant maturities in effect at the time of grant. Our stock options have a contractual term of 10 years. The following assumptions were in place for grants that occurred during the 40 weeks ended November 29, 2008 and December 1, 2007:
40 weeks ended 40 weeks ended Nov. 29, 2008 Dec. 1, 2007 -------------- -------------- Expected life 7 years 7 years Volatility 52% 54% - 55% Risk-free interest rate 2.96% 4.46% - 4.57%
The weighted average grant date fair value of stock options granted during the 40 weeks ended November 29, 2008 and December 1, 2007 was $14.64 and $19.47, respectively. As of November 29, 2008, approximately $2.4 million, after tax, of total unrecognized compensation expense related to unvested stock option awards will be recognized over a weighted average period of 2.7 years. The total intrinsic value of options exercised during the 40 weeks ended November 29, 2008 and December 1, 2007 was $0.5 million and $5.7 million, respectively. The amount of cash received from the exercise of stock options during the 40 weeks ended November 29, 2008 was approximately $2.2 million. 31 Performance Restricted Stock Units - ---------------------------------- The following is a summary of the performance restricted stock units activity during the 40 weeks ended November 29, 2008:
Weighted Average Grant Date Shares Fair Value ------------- ------------- Nonvested at February 23, 2008 1,905,427 $ 22.60 Granted 471,731 26.60 Canceled or expired (89,110) 23.09 Vested (435,600) 12.47 ------------- ------------- Nonvested at November 29, 2008 1,852,448 $ 25.98 ============= =============
Performance restricted stock units are granted at the fair market value of the Company's common stock at the date of grant, adjusted by an estimated forfeiture rate. Certain performance restricted stock units that include a market condition are granted at the awards fair market value determined on the date of grant. During the first quarter of fiscal 2008, one-third of our performance restricted units granted in fiscal 2005, vested on February 24, 2008 (the first day of our fiscal year) and one-third will vest on the first day of fiscal 2009, in accordance with and subject to all other terms, conditions, limitations, restrictions and eligibility requirements. The remaining one-third of our performance restricted units granted in fiscal 2005 were forfeited during fiscal 2007. Performance restricted stock units granted during fiscal 2006, 2007 and 2008 are earned based on our Company achieving certain operating targets in fiscal 2008, 2009 and 2010, respectively, and are 100% vested upon achievement of such targets. During the third quarter of fiscal 2008, based on changes in our current year forecast and three year strategic plan, our Company has determined that the targets as described under the terms of each plan will probably not be met. Once this determination is made, compensation expense is no longer recognized and any recognized compensation expense is reversed. As a result, for the 12 and 40 weeks ended November 29, 2008, we recorded a reversal of $5.2 million included in "Store operating, general and administrative expense" in our Consolidated Statements of Operations for compensation expense related to restricted stock that had been previously recognized. Of this amount, approximately $4.0 million of this reversal should have been recorded in fiscal 2007 as our performance targets were no longer probable due to dispositions in advance of our acquisition of Pathmark. Had our Company recorded this reversal in the prior year, the current quarter reversal for not meeting performance targets in the current quarter would have been approximately $3.0 million. No units vested under our 2006, 2007, and 2008 grants during the 40 weeks ended November 29, 2008. During the second quarter of fiscal 2008, an additional 46,949 performance restricted stock units under our non-executive Integration Program were considered granted as one of the performance targets as described in the plan was exceeded based on actual performance. These performance restricted stock units will vest subject to the achievement of certain Company stock price targets over a performance period comprised of the 24 month period following the closing of the Pathmark transaction on December 3, 2007 and other terms, conditions, limitations, restrictions and eligibility requirements as described in the Integration Program. The total fair value of shares vested during the 40 weeks ended November 29, 2008 was $12.1 million. No 32 shares vested during the 40 weeks ended December 1, 2007. During the 40 weeks ended November 29, 2008, our Company granted 471,731 shares of performance restricted stock units to selected employees for a total grant date fair value of $12.5 million. Approximately $8.8 million of unrecognized fair value compensation expense relating to our performance restricted stock units granted in fiscal 2005 and fiscal 2006, as well as performance restricted stock units granted under our executive and non-executive Integration Program in fiscal 2007, are expected to be recognized through fiscal 2011 based on estimates of attaining vesting criteria. 16. Income Taxes The income tax provisions recorded for the 12 and 40 weeks ended November 29, 2008 and December 1, 2007 reflects our estimated expected annual tax rates applied to our respective domestic and foreign financial results. SFAS No. 109 "Accounting for Income Taxes" ("SFAS 109") provides that a deferred tax asset is recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. In addition, SFAS 109 requires that a valuation allowance be recognized if, based on existing facts and circumstances, it is more likely than not that some portion or all of the deferred tax asset will not be realized. Based upon our continued assessment of the realization of our net deferred tax asset and our historic cumulative losses, we concluded that it was appropriate to record a valuation allowance in an amount that would reduce our net deferred tax asset to zero. For the 12 and 40 weeks ended November 29, 2008, the valuation allowance increased by $26.9 million and $106.0 million, respectively, to reflect the increase in deferred income tax assets recorded relating to the purchase price allocation adjustment discussed in Note 3 - Acquisition of Pathmark Stores, Inc., as well as generation of additional net operating losses. For the 12 and 40 weeks ended December 1, 2007, the valuation allowance was decreased by $4.4 million and increased by $36.7 million, respectively. To the extent that our operations generate sufficient taxable income in future periods, we will reverse the income tax valuation allowance. In future periods, we will continue to record a valuation allowance against net deferred tax assets that are created by losses until such time as the certainty of future tax benefits can be reasonably assured. As of November 29, 2008, there have been no material changes to the Company's uncertain tax positions as discussed in Note 11 of the Company's Fiscal 2007 Annual Report on Form 10-K. It is reasonably possible that the amount of unrecognized tax benefit with respect to certain of the Company's unrecognized tax positions will significantly decrease within the next 12 months. At this time, the company estimates that the amount of its gross unrecognized tax positions may decrease by up to approximately $155 million within the next 12 months primarily due to the settlement of ongoing audits and lapses of statutes of limitations in certain jurisdictions. Any decrease in the Company's gross unrecognized tax positions would require a re-evaluation of the Company's valuation allowance maintained on its net deferred tax asset and therefore will have no effect on the Company's effective tax rate. For the 12 and 40 weeks ended November 29, 2008 and December 1, 2007, no amounts were recorded for interest and penalties within "Provision for income taxes" in our Consolidated Statements of Operations. Our Company is subject to U.S. federal income tax, as well as income tax in multiple state and foreign jurisdictions. As of November 29, 2008, we were subject to examination in the U.S. federal tax jurisdiction 33 for the 1997 to 2006 tax years and we were also subject to examination in most state jurisdictions for the 1997 to 2007 tax years. The effective tax rate on continuing operations of 53.1% for the 12 weeks ended November 29, 2008 varied from the statutory rate of 35% primarily due to the recording of state and local income taxes, recording additional valuation allowance offset by a permanent difference related to nonoperating income from the fair value adjustments related to the conversion features, financing warrants and Series B warrants. The effective tax rate on continuing operations of 2.3% for the 12 weeks ended December 1, 2007 varied from the statutory rate of 35% primarily due to state and local income taxes and a decrease to our valuation allowance as a result of the utilization of loss carryforwards that were not previously tax benefited. The effective tax rate on continuing operations of 510.3% for the 40 weeks ended November 29, 2008 varied from the statutory rate of 35% primarily due to the recording of state and local income taxes, recording additional valuation allowance offset by a permanent difference related to nonoperating income from the fair value adjustments related to the conversion features, financing warrants and Series A and B warrants. The effective tax rate on continuing operations of 3.2% for the 40 weeks ended December 1, 2007 varied from the statutory rate of 35% primarily due to state and local income taxes and a decrease to our valuation allowance as a result of the utilization of loss carryforwards that were not previously tax benefited. As of November 29, 2008, we had $540.3 million in federal NOL carryforwards that expire beginning in 2023, some of which are subject to an annual limitation. Management believes such limitations will not have a material impact on the Company's ability to utilize such losses. At November 29, and February 23, 2008, we had a net current deferred tax asset which is included in "Prepaid expenses and other current assets" on our Consolidated Balance Sheets of $36.3 million and $64.8 million, respectively, a net non-current deferred tax asset, which is included in "Other Assets" on our Consolidated Balance Sheets of $66.5 million and $38.0 million, respectively, and a non-current tax liability for uncertain tax positions, which is included in "Other non-current liabilities" on our Consolidated Balance Sheets of $156.3 million and $156.3 million, respectively. On July 30, 2008, The Housing Assistance Act of 2008 ("the Act") was signed into law. The Act contains a provision allowing corporate taxpayers to make an election to treat certain unused research and AMT credit carryforwards as refundable in lieu of claiming bonus and accelerated depreciation for "eligible qualified property." We are currently evaluating the impact of making this election; however, we do not expect that making such election will have a material impact on our consolidated financial statements. 17. Operating Segments Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our President and Chief Executive Officer. Through the first quarter ended June 14, 2008, we operated under seven reportable segments: North, Central, South, Price Impact, Gourmet, Other and our investment in Metro, Inc. During the second quarter ended September 6, 2008, our chief operating decision maker changed the manner by which our results are 34 evaluated, therefore, our reportable segments have been revised to be consistent with the way we currently manage our business. Accordingly, we have revised our segment reporting to report in five operating segments: Fresh, Price Impact, Gourmet, Other and our investment in Metro, Inc. The Other segment includes our Food Basics and Liquor businesses. Our investment in Metro, Inc. represents our former economic interest in Metro, Inc. and is required to be reported as an operating segment in accordance with SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" as our investment was greater than 10% of our Company's combined assets of all operating segments and the investment generated operating income during the 40 weeks ended December 1, 2007. The criteria necessary to classify the Midwest and Greater New Orleans areas as discontinued were satisfied in fiscal 2007 and these operations have been reclassified as such in our Consolidated Statements of Operations for all periods presented. Refer to Note 8 -- Discontinued Operations for further discussion. Prior year information has been restated to conform to current year presentation. The accounting policies for these segments are the same as those described in the summary of significant accounting policies included in our Fiscal 2007 Annual Report. We measure segment performance based upon segment income (loss). Reconciling amounts between segment income (loss) and income (loss) from operations include corporate-level activity not specifically attributed to a segment, which includes 1) the merchandising department (including the design and production of private label merchandise sold in our retail stores), 2) real estate management and 3) information technology, finance and other corporate administrative personnel, as well as, other reconciling items primarily attributed to nonrecurring activities. Assets and capital expenditures are not allocated to segments for internal reporting presentations. Certain segment reclassifications have been made to segment information disclosed previously to conform to how our chief operating decision maker currently manages our business. Interim information on segments is as follows:
For the 12 weeks ended November 29, 2008 ----------------------------------------------------------------------------------- Grocery (1) Meat (2) Produce (3) Other (4) Total --------------- -------------- --------------- -------------- ------------- Sales by Category $ 1,506,284 $ 388,577 $ 226,093 $ -- $ 2,120,954 =============== ============== =============== ============== ============= For the 12 weeks ended December 1, 2007 ----------------------------------------------------------------------------------- Grocery (1) Meat (2) Produce (3) Other (4) Total --------------- -------------- --------------- -------------- ------------- Sales by Category $ 851,860 $ 241,636 $ 157,611 $ 16 $ 1,251,123 =============== ============== =============== ============== =============
35
For the 12 weeks ended ------------------------------------------------- November 29, 2008 December 1, 2007 ---------------------- ---------------------- Sales Fresh* $ 1,071,370 $ 1,103,409 Price Impact* 924,371 32,587 Gourmet 67,145 62,969 Other 58,068 52,142 Investment in Metro, Inc. -- 16 ---------------------- ---------------------- Total sales $ 2,120,954 $ 1,251,123 ====================== ====================== Segment income (loss) Fresh* $ 36,051 $ 9,474 Price Impact* (1,898) (232) Gourmet 6,735 5,419 Other 548 (672) ---------------------- ---------------------- Total segment income 41,436 13,989 Corporate (24,013) (26,129) Reconciling items ** (5,514) (8,993) ---------------------- ---------------------- Income (loss) from operations 11,909 (21,133) Gain on sale of Canadian operations -- 495 Gain on disposition of Metro, Inc. -- 106,063 Nonoperating income 22,777 - Interest expense (36,727) (14,499) Interest and dividend income 86 3,910 ---------------------- ---------------------- (Loss) income from continuing operations before income taxes $ (1,955) $ 74,836 ====================== ======================
For the 12 weeks ended ------------------------------------------------- November 29, 2008 December 1, 2007 ---------------------- ---------------------- Segment depreciation and amortization - continuing operations Fresh* $ 20,997 $ 23,012 Price Impact* 22,962 513 Gourmet 2,303 2,323 Other 866 1,030 ---------------------- ---------------------- Total segment depreciation and amortization 47,128 26,878 Corporate 13,410 5,776 ---------------------- ---------------------- Total company depreciation and amortization $ 60,538 $ 32,654 ====================== ======================
For the 40 weeks ended November 29, 2008 ----------------------------------------------------------------------------------- Grocery (1) Meat (2) Produce (3) Other (4) Total --------------- --------------- --------------- -------------- ------------- Sales by Category $ 5,045,012 $ 1,357,820 $ 823,423 $ -- $ 7,226,255 =============== ============== =============== ============== ============= For the 40 weeks ended December 1, 2007 ----------------------------------------------------------------------------------- Grocery (1) Meat (2) Produce (3) Other (4) Total --------------- --------------- --------------- -------------- ------------- Sales by Category $ 2,811,474 $ 826,217 $ 561,147 $ 5,792 $ 4,204,630 =============== ============== =============== ============== =============
(1) The grocery category includes grocery, frozen foods, dairy, general merchandise/health and beauty aids, liquor and pharmacy. (2) The meat category includes meat, deli, bakery and seafood. (3) The produce category includes produce and floral. (4) Other includes sales from an information technology services agreement with Metro, Inc. 36
For the 40 weeks ended ------------------------------------------------- November 29, 2008 December 1, 2007 ---------------------- ---------------------- Sales Fresh* $ 3,658,229 $ 3,722,685 Price Impact* 3,168,120 110,077 Gourmet 208,890 192,443 Other 191,016 173,633 Investment in Metro, Inc. -- 5,792 ---------------------- ---------------------- Total sales $ 7,226,255 $ 4,204,630 ====================== ====================== Segment income (loss) Fresh* $ 100,043 $ 60,864 Price Impact* 16,146 54 Gourmet 16,610 11,005 Other 1,825 (2,287) ---------------------- ---------------------- Total segment income 134,624 69,636 Corporate (94,741) (96,401) Reconciling items ** (37,406) 6,648 ---------------------- ---------------------- Income (loss) from operations 2,477 (20,117) Gain on sale of Canadian operations -- 209 Gain on disposition of Metro, Inc. -- 184,451 Nonoperating income 114,269 -- Interest expense (116,621) (48,806) Interest and dividend income 553 12,231 Equity earnings in Metro, Inc. -- 7,869 ---------------------- ---------------------- Income from continuing operations before income taxes $ 678 $ 135,837 ====================== ======================
For the 40 weeks ended ------------------------------------------------- November 29, 2008 December 1, 2007 ---------------------- ---------------------- Segment depreciation and amortization - continuing operations Fresh* $ 70,965 $ 76,921 Price Impact* 76,331 1,902 Gourmet 7,873 7,606 Other 2,847 3,318 ---------------------- ---------------------- Total segment depreciation and amortization - continuing 158,016 89,747 operations Corporate 43,346 24,230 ---------------------- ---------------------- Total depreciation and amortization - continuing operations 201,362 113,977 Discontinued operations -- 8,637 ---------------------- ---------------------- Total depreciation and amortization $ 201,362 $ 122,614 ====================== ======================
* Due to store conversions during the third quarter of fiscal 2008, segment information on a comparable basis has been reclassified from the Fresh segment to the Price Impact segment. ** Reconciling items which are not included in segment income (loss) include LIFO reserve adjustment, stock awards expense, restructuring events, real-estate related activity, integration costs and other nonrecurring adjustments. 18. Related Party Transaction On September 2, 2008, our Company issued a three year, unsecured promissory note in the amount of $10 million to Erivan Karl Haub. Erivan Haub is the father of Christian W. E. Haub, our Executive Chairman, and is a limited partner of Tengelmann which owns an interest in our Company's stock. The principal is 37 due in a lump sum payment on August 18, 2011 and will bear interest at a rate of 6% per year, payable in twelve equal payments of $0.15 million over the term of the note. 19. Investment in Metro, Inc. On March 13, 2007, in connection with our agreement to acquire Pathmark Stores, Inc., our Company sold 6,350,000 shares of our holdings in Metro, Inc. for proceeds of approximately $203.5 million resulting in a net gain of $78.4 million. Of the proceeds received, $190 million was held as restricted cash collateralizing letters of credit under our Letter of Credit Agreement, which was terminated on December 3, 2007, and was designated to be used to fund a portion of our acquisition of Pathmark Stores, Inc. On November 26, 2007, also in connection with our agreement to acquire Pathmark Stores, Inc., our Company sold the remaining 11,726,645 shares of our holdings in Metro, Inc. for proceeds of approximately $345.3 million, resulting in a net gain of $103.6 million. The proceeds were held to fund a portion of our acquisition of Pathmark Stores, Inc. As a result of these sales, our Company no longer holds Class A subordinate shares of Metro, Inc. Through March 13, 2007, we recorded our pro-rata equity earnings relating to our equity investment in Metro, Inc. on about a three-month lag period as permitted by APB 18, "The Equity Method of Accounting for Investments in Common Stock." Thus, during the 40 weeks ended December 1, 2007, we recorded $7.9 million in equity earnings relating to our equity investment in Metro, Inc. and included this amount in "Equity in earnings of Metro, Inc." on our Consolidated Statements of Operations. In accordance with SFAS 115, we recorded dividend income of $1.3 million based on Metro, Inc.'s dividend declaration on April 17, 2007 and included this amount in "Interest and dividend income" on our Consolidated Statements of Operations for the 40 weeks ended December 1, 2007. Metro, Inc.'s summarized financial information, derived from its unaudited second quarter ended March 17, 2007 financial statements, is as follows (in millions):
12 Weeks Ended March 17, 2007 -------------- Income statement: Net sales $ 2,096.5 ============= Cost of sales and operating expenses $ 1,967.1 ============= Net income $ 55.0 =============
20. Commitments and Contingencies Antitrust Class Action Litigation - --------------------------------- In connection with a settlement reached in the VISA/MasterCard antitrust class action litigation, our Company is entitled to a portion of the settlement fund that will be distributed to class members. Pursuant to our review of our historical records as well as estimates provided by the Claims Administrator, we recorded a pre-tax recovery of $2.2 million as a credit to "Store operating, general and administrative expense" in our Statements of Consolidated Operations during the 12 and 40 weeks ended November 29, 2008. 38 Lease Assignment - ---------------- On August 14, 2007, Pathmark entered into a leasehold assignment contract for the sale of its leasehold interests in one of its stores to CPS Operating Company LLC, a Delaware limited liability company ("CPS"). Pursuant to the terms of the agreement, Pathmark was to receive $87 million for assigning and transferring to CPS all of Pathmark's interest in the lease and CPS was to have assumed all of the duties and obligations of Pathmark under the lease. CPS deposited $6 million in escrow as a deposit against the purchase price for the lease, which is non-refundable to CPS, except as otherwise expressly provided in the agreement. The assignment of the lease was scheduled to close on December 28, 2007. On December 27, 2007, CPS issued a notice terminating the agreement for reason of a purported breach of the agreement, which, if proven, would require the return of the escrow. We are disputing the validity of CPS's notice of termination as we believe CPS's position is without merit. Because we are challenging the validity of CPS's December 27, 2007 notice of termination, we issued our own notice to CPS on December 31, 2007, asserting CPS's breach of the agreement as a result of their failure to close on December 28, 2007. CPS's breach, if proven, would entitle us to keep the escrow. Both parties have taken legal action to obtain the $6 million deposit held in escrow. LaMarca et al v. The Great Atlantic & Pacific Tea Company, Inc ("Defendants") - ------------------------------------------------------------------------------ On June 24, 2004, a class action complaint was filed in the Supreme Court of the State of New York against The Great Atlantic & Pacific Tea Company, Inc., d/b/a A&P, The Food Emporium, and Waldbaum's alleging violations of the overtime provisions of the New York Labor Law. Three named plaintiffs, Benedetto Lamarca, Dolores Guiddy, and Stephen Tedesco, alleged on behalf of a class that our Company failed to pay overtime wages to full-time hourly employees who were either required or permitted to work more than 40 hours per week. In April 2006, the plaintiffs filed a motion for class certification. In July 2007, the Court granted the plaintiffs' motion and certified the class as follows: All full-time hourly employees of Defendants who were employed in Defendants' supermarket stores located in the State of New York, for any of the period from June 24, 1998 through the date of the commencement of the action, whom Defendants required or permitted to perform work in excess of 40 hours per week without being paid overtime wages. The Court also ruled that the issue of whether to include an "opt-in" or "opt-out" provision is premature and can be decided after discovery. As the order granting class certification is currently being appealed, and as discovery on the prospective plaintiffs comprising the class has yet to be conducted, neither the number of class participants nor the sufficiency of their respective claims can be determined at this time. Other - ----- We are subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. We are also subject to certain environmental claims. While the outcome of these claims cannot be predicted with certainty, Management does not believe that the outcome of any of these legal matters will have a material adverse effect on our consolidated results of operations, financial position or cash flows. 39 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations INTRODUCTION - ------------ The following Management's Discussion and Analysis is intended to help the reader understand the financial position, operating results, and cash flows of The Great Atlantic and Pacific Tea Company, Inc. It should be read in conjunction with our consolidated financial statements and the accompanying notes ("Notes"). It discusses matters that Management considers relevant to understanding the business environment, financial position, results of operations and our Company's liquidity and capital resources. These items are presented as follows: o Basis of Presentation -- a discussion of our Company's results during the 12 and 40 weeks ended November 29, 2008 and December 1, 2007. o Overview -- a general description of our business; the value drivers of our business; measurements; opportunities; challenges and risks; and initiatives. o Outlook -- a discussion of certain trends or business initiatives for the remainder of fiscal 2008 to assist in understanding our business. o Review of Continuing Operations and Liquidity and Capital Resources -- a discussion of results for the 12 weeks ended November 29, 2008 compared to the 12 weeks ended December 1, 2007; results for the 40 weeks ended November 29, 2008 compared to the 40 weeks ended December 1, 2007; current and expected future liquidity; and the impact of various market risks on our Company. o Critical Accounting Estimates -- a discussion of significant estimates made by Management. o Market Risk -- a discussion of the impact of market changes on our consolidated financial statements. BASIS OF PRESENTATION - --------------------- The accompanying consolidated financial statements of The Great Atlantic & Pacific Tea Company, Inc. for the 12 and 40 weeks ended November 29, 2008 and December 1, 2007 are unaudited and, in the opinion of management, contain all adjustments that are of a normal and recurring nature necessary for a fair statement of financial position and results of operations for such periods. The consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in our Fiscal 2007 Annual Report on Form 10-K. Interim results are not necessarily indicative of results for a full year. The consolidated financial statements include the accounts of our Company and all of our subsidiaries. OVERVIEW - -------- The Great Atlantic & Pacific Tea Company, Inc., based in Montvale, New Jersey, operates conventional supermarkets, combination food and drug stores and discount food stores in eight U.S. states and the District of Columbia. Our business consists strictly of our retail operations, which totaled 444 stores as of November 29, 2008. During the second quarter ended September 6, 2008, our chief operating decision maker changed the manner by which our results are evaluated, therefore, our reportable segments have been revised to be consistent with the way we currently manage our business. Accordingly, we have revised our segment reporting to report in 40 five operating segments: Fresh, Price Impact, Gourmet, Other and our investment in Metro, Inc. The Other segment includes our Food Basics and Liquor businesses. Our investment in Metro, Inc. represents our former economic interest in Metro, Inc. The criteria necessary to classify the Midwest and Greater New Orleans area as discontinued were satisfied in fiscal 2007 and these operations have been reclassified as such in our Consolidated Statements of Operations for the 12 and 40 weeks ended November 29, 2008 and December 1, 2007. RECENT ANNOUNCEMENTS - -------------------- On March 7, 2008, our Company entered into a definitive agreement with C&S Wholesale Grocers, Inc. ("C&S") whereby C&S will provide warehousing, logistics, procurement and purchasing services (the "Services") in support of the Company's entire supply chain. This agreement replaces and supersedes three (3) separate wholesale supply agreements under which the parties have been operating. The term of the agreement is ten and one-half (10-1/2) years, which includes a six-month "ramp-up" period during which the parties will transition to the new contractual terms and conditions. The agreement provides that the actual costs of performing the services shall be reimbursed to C&S on an "open-book" or "cost-plus" basis, whereby the parties will negotiate annual budgets that will be reconciled against actual costs on a periodic basis. The parties will also annually negotiate services specifications and performance standards that will govern warehouse operations. The agreement defines the parties' respective responsibilities for the procurement and purchase of merchandise intended for use or resale at the Company's stores, as well as the parties' respective remuneration for warehousing and procurement/purchasing activities. In consideration for the services it provides under the agreement, C&S will be paid an annual fee and will have incentive income opportunities based upon A&P's cost savings and increases in retail sales volume. On May 7, 2008, the 4,657,378 Series A warrants, scheduled to expire on June 9, 2008, were exercised by Yucaipa Corporate Initiatives Fund I, L.P., Yucaipa American Alliance Fund I, L.P. and Yucaipa American Alliance (Parallel) Fund I, L.P. Our Company opted to settle the Series A warrants in cash totaling $45.7 million rather than issuing additional common shares. On September 27, 2008, our Company agreed to sell C&S all general merchandise, heath beauty and cosmetics, seasonal grocery and other such merchandise warehoused at our distribution center located in Edison, New Jersey. The cost of this inventory was approximately $29.9 million and we have repurchased all of the inventory at the end of our third quarter of fiscal 2008. No gain, loss or revenue was recorded on the sale. OPERATING RESULTS - ----------------- Despite the challenging economic environment, our Company has delivered another quarter of improved operating performance. Our format strategy continues to be successful as it allows us to be relevant in every market we serve. The Pathmark integration has been completed and while there have been some challenges, we are already realizing many of the synergies from this strategic acquisition. At the end of the third quarter, our Company's run rate of synergies was approximately $140 million since our acquisition of Pathmark, solidifying that the original target of $150 million will be achieved as anticipated. We realized approximately $30 million during the third quarter of fiscal 2008, comprised of reduced administrative costs ($18 million), reduced merchandise costs ($7 million) as well as reductions in store operating and marketing and advertising costs ($5 million). 41 We maintained all necessary liquidity during the third quarter of fiscal 2008 with availability of $77.6 million under our Credit Agreement and invested cash available to reduce borrowings and/or for future operations of $46 million as of November 29, 2008. Fresh Format (A&P, Waldbaum's and SuperFresh) Our Fresh Format continues to deliver strong sales and strong earnings growth that more than triple the prior year. Our Fresh Team has been working hard to deliver a superior store experience and our stores and performance illustrates their effectiveness. Price Impact (Pathmark and Pathmark Sav-A-Center) Our Price Impact format's top line was softer than expected due to promotional activity during the November holiday. Having acquired Pathmark almost a year ago, we have experienced some challenges with the integration and operations of the business. Since the second quarter, we have experienced significant improvements in our gross margin rate, with the exception of stock losses in our center store, which have increased with the declining economy. In addition, we have incurred higher labor costs, both in productive and fringe costs. We have improved gross margin rates by increasing merchandising income as a result of the proper people and strategies being in place and improvements to system and process issues. In-stock positions have also improved dramatically in the third quarter. We are currently working to reduce stock losses and increase labor efficiencies by executing strategies that improved results in our other formats and we are confident that this format is on track to deliver promising results although there can be no assurance that this will happen. Gourmet (The Food Emporium) Our Gourmet stores located in Manhattan continue to produce significant growth in sales and segment income despite the crisis driven through Wall Street. This banner is delivering top line sales growth that exceeds the industry average and a bottom line that is 24% better than the prior year. We believe the Gourmet Team's commitment to new product innovation and better store standards is delivering on customer and financial expectations. Other (Food Basics, Best Cellars and A&P Liquors) Our Discount business operating under the Food Basics banner is realizing growth in both sales and segment income. This business is doing extremely well as it is a particularly relevant format during this challenging economic environment. The Food Basics banner is realizing tremendous growth, with double digit comparable sales and a bottom line that outpaces the prior year as well as our internal expectations. We believe this format has much future growth potential. Additionally we have opened two new A&P Best Cellars stand alone liquor stores in West Orange, NJ and Riverside, CT and expect to commence more in-store renovations to come. 42 OUTLOOK - ------- This has been a very turbulent year with an unprecedented challenging economic environment. Despite this challenge, we continued to deliver solid overall results in our third quarter of fiscal 2008 with solid sales and improved earnings year-over-year while at the same time completing the integration of the Pathmark acquisition. We believe combining with Pathmark has strengthened our Company and positioned us well to withstand economic challenges. Additionally, we realized significant synergies from the acquisition which we believe will continue into 2009 and provide the necessary resources to effectively compete in this difficult environment. We expect that in 2009 the US retail market will face one of the most difficult and challenging years as our customers will have lower disposable income. However, we believe our Company is preparing for the challenges ahead shifting our strategy to meet the demands of our customers who have lowered their weekly shopping budget while, still providing high quality, nutritious foods. Our comprehensive new private label program is a critical component of our strategy as well as strategic store conversions. In 2009, we will celebrate our historic 150th anniversary. We believe that our strong strategic position in the Northeast, our successful format strategy and our resolve to implement strategic changes, positions us to effectively manage the challenging economic environment and remain cautiously optimistic in our long-term prospects. We recognize that this recession has been projected to worsen and have consequently been tailoring new merchandising strategies that we will employ to be more effective offering cost-effective alternatives for our customers. We believe that our present cash resources, including invested cash on hand, available borrowings from our $675 million Credit Agreement and other sources, are sufficient to meet our needs. Based on information available to us, as of our filing date, we have no indication that the financial institutions acting as lenders under our $675 million Credit Agreement would be unable to fulfill their commitments. However, given the current economic environment and credit risk market crisis, there is no assurance that this may not change in the foreseeable future. Various factors could have a negative effect on our Company's financial position and results of operations. These include, among others, the following: o Our retail food business and the grocery retailing industry continues to experience aggressive competition from mass merchandisers, warehouse clubs, drug stores, convenience stores, discount merchandisers, dollar stores, restaurants, other retail chains, nontraditional competitors and emerging alternative formats in the markets where we have retail operations. Competition with these outlets is based on price, store location, advertising and promotion, product mix, quality and service. Some of these competitors may have greater financial resources, lower merchandise acquisition costs and lower operating expenses than we do, and we may be unable to compete successfully in the future. Price-based competition has also, from time to time, adversely affected our operating margins. Competitors' greater financial strengths enable them to participate in aggressive pricing strategies selling inventory below costs to drive overall increased sales. Our continued success is dependent upon our ability to effectively compete in this industry and to reduce operating expenses, including managing health care and pension costs contained in our collective bargaining agreements. The competitive practices and pricing in the food industry generally and particularly in our principal markets may cause us to reduce our prices in order to gain or maintain our market share of sales, thus reducing margins. 43 o Our in-store pharmacy business is also subject to intense competition. In particular, an adverse trend for drug retailing has been significant growth in mail-order and internet-based prescription processors. Pharmacies are exposed to risks inherent in the packaging and distribution of pharmaceuticals and other healthcare products. In addition, the conversion of various prescription drugs to over-the-counter medications, the withdrawal of certain drugs from the market and changes in third party reimbursement levels for prescription drugs, including changes in Medicare Part D or state Medicaid programs, may have a material adverse effect on our business. Failure to properly adhere to Federal, State and local government rules and regulations, applicable Medicare and Medicaid regulations could result in the imposition of civil as well as criminal penalties. o The retail food and food distribution industries, and the operation of our businesses, specifically in the New York -- New Jersey and Philadelphia regions, are sensitive to a number of economic conditions and other factors such as (i.) food price deflation or inflation, (ii.) softness in local and national economies, (iii.) increases in commodity prices, (iv.) the availability of favorable credit and trade terms, (v.) changes in business plans, operations, results and prospects, (vi.) potential delays in the development, construction or start-up of planned projects, and (vii.) other economic conditions that may affect consumer buying habits. Any one or more of these economic conditions can affect our retail sales, the demand for products we distribute to our retail customers, our operating costs and other aspects of our business. o Acts of war, threats of terror, acts of terror or other criminal activity directed at the grocery or drug store industry, the transportation industry, or computer or communications systems, could increase security costs, adversely affect our operations, or impact consumer behavior and spending as well as customer orders. Other events that give rise to actual or potential food contamination, drug contamination, or food-borne illness could have an adverse effect on our operating results. o We could be adversely affected if consumers lose confidence in the safety and quality of the food supply chain. Adverse publicity about these types of concerns, whether or not valid, could discourage consumers from buying products in our stores. The real or perceived sale of contaminated food products by us could result in a loss of consumer confidence and product liability claims, which could have a material adverse effect on our sales and operations. o Our operations subject us to various laws and regulations relating to the protection of the environment, including those governing the management and disposal of hazardous materials and the cleanup of contaminated sites. Under some environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, also known as CERCLA or the Superfund law, and similar state statues, responsibility for the entire cost of cleanup of a contaminated site can be imposed upon any current or former site owners or operators, or upon any party who sent waste to the site, regardless of the lawfulness of the original activities that led to the contamination. From time to time we have been named as one of many potentially responsible parties at Superfund sites, although our share of liability has typically been de minimis. Although we believe that we are currently in substantial compliance with applicable environmental requirements, future developments such as more aggressive enforcement policies, new laws or discoveries of unknown conditions may require expenditures that may have a material adverse effect on our business and financial condition. 44 o Our capital expenditures could differ from our estimate if development and remodel costs vary from those budgeted, or if performance varies significantly from expectations or if we are unsuccessful in acquiring suitable sites for new stores. o Our ability to achieve our profit goals will be affected by (i.) our success in executing category management and purchasing programs that we have underway, which are designed to improve our gross margins and reduce product costs while making our product selection more attractive to consumers, (ii.) our ability to achieve productivity improvements and reduce shrink in our stores, (iii.) our success in generating efficiencies in our supporting activities, and (iv.) our ability to eliminate or maintain a minimum level of supply and/or quality control problems with our vendors. o The majority of our employees are members of labor unions. While we believe that our relationships with union leaderships and our employees are satisfactory, we operate under collective bargaining agreements which periodically must be renegotiated. In the coming year, we have some contracts expiring and under negotiation. In each of these negotiations, rising health care and pension costs will be an important issue, as will the nature and structure of work rules. We are hopeful, but cannot be certain, that we can reach satisfactory agreements without work stoppages in these markets. However, the actual terms of the renegotiated collective bargaining agreements, our future relationships with our employees and/or a prolonged work stoppage affecting a substantial number of stores could have a material effect on our results. o The amount of contributions made to our pension and multi-employer plans will be affected by the performance of investments made by the plans and the extent to which trustees of the plans reduce the costs of future service benefits. o We are currently required to acquire a majority of our saleable inventory from one supplier, C&S Wholesale Grocers, Inc. Although there are a limited number of distributors that can supply our stores, we believe that other suppliers could provide similar product on reasonable terms. However, a change in suppliers could cause a delay in distribution and a possible loss of sales, which would affect operating results adversely. o We have estimated our exposure to claims, administrative proceedings and litigation and believe we have made adequate provisions for them, where appropriate. Unexpected outcomes in both the costs and effects of these matters could result in an adverse effect on our earnings. o Following the closing of the acquisition of Pathmark, Tengelmann, A&P's former majority stockholder, owned beneficially and of record a substantial percentage of our common stock on a fully diluted basis. As a result of this equity ownership and our stockholder agreement with Tengelmann, Tengelmann has the power to significantly influence the results of stockholder votes and the election of our board of directors, as well as transactions involving a potential change of control of our Company. Tengelmann may support strategies and directions for our Company which are in its best interests but which are opposed to other stockholder interests. o Our substantial indebtedness could impair our financial condition. Our indebtedness could make it more difficult for us to satisfy our obligations, which could in turn result in an event of default on our obligations, require us to dedicate a substantial portion of our cash flow from operations to debt service payments, thereby reducing the availability of cash for working capital, capital expenditures, 45 acquisitions, or other general corporate purposes, impair our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, or other general corporate purposes, diminish our ability to withstand a downturn in our business, the industry in which we operate or the economy generally, limit our flexibility in planning for, or reacting to, changes in the economy, our business and the industry in which we operate, and place us at a competitive disadvantage compared to competitors that have proportionately less debt. Our $675 million Credit Agreement contains restrictive covenants customary for facilities of that type which limit our ability to incur additional debt, pay dividends, grant additional liens, make investments and take other actions. These restrictions may limit our flexibility to undertake future financings and take other actions. If we are unable to meet our debt service obligations, we could be forced to repay our indebtedness prior to its scheduled maturity, restructure or refinance our indebtedness, seek additional equity capital or sell assets and may force liquidity issues. We may be unable to obtain debt and/or equity financing or sell assets on satisfactory terms, or at all. In addition, our Credit Agreement bears interest at a variable rate. If market interest rates increase, such variable-rate debt will have higher debt service requirements, which could adversely affect our cash flow. While we may enter into agreements limiting our exposure to higher interest rates, any such agreements may not offer complete protection from this risk. o We are the primary obligor for a significant number of closed stores and warehouses under long-term leases primarily located in the Midwest. Our ability to sublet or assign these leases depends on the economic conditions of the real estate markets in which these leases are located. We have estimated our obligation under these leases, net of expected subleases and we have reserved for them, where appropriate. Unexpected changes in the marketplace or with individual sublessors could result in an adverse effect on our cash flow and earnings. o Fluctuating fuel costs may adversely affect our operating costs since we incur the cost of fuel in connection with the transportation of goods from our warehouse and distribution facilities to our stores. In addition, operations at our stores are sensitive to rising utility fuel costs due to the amount of electricity and gas required to operate our stores. In the event of rising fuel costs, we may not be able to recover rising utility and fuel costs through increased prices charged to our customers. Our profitability is particularly sensitive to the cost of oil. Oil prices directly affect our product transportation costs and fuel costs due to the amount of electricity and gas required to operate our stores as well as our utility and petroleum-based supply costs; including plastic bags. o We are subject to federal, state and local laws and regulations relating to zoning, land use, environmental protection, work place safety, public health, community right-to-know, beer and wine sales, pharmaceutical sales and gasoline station operations. A number of states and local jurisdictions regulate the licensing of supermarkets, including beer and wine license grants. In addition, under certain local regulations, we are prohibited from selling beer and wine in certain of our stores. Employers are also subject to laws governing their relationship with employees, including minimum wage requirements, overtime, working conditions, disabled access and work permit requirements. Compliance with these laws could reduce the revenue and profitability of our supermarkets and could otherwise adversely affect our business, financial condition or results of operations. In addition, any changes in these laws or regulations could significantly increase our compliance costs and adversely affect our results of operations, financial condition and liquidity. o We have large, complex information technology systems that are important to our business operations. We could encounter difficulties developing new systems and encounter difficulties maintaining, upgrading 46 or securing our existing systems. Such difficulties could lead to significant expenses or losses due to disruption in our business operations. o Our articles of incorporation permit our board of directors to issue preferred shares without first obtaining stockholder approval. If we issued preferred shares, these additional securities may have dividend or liquidation preferences senior to our common stock. If we issue convertible preferred shares, a subsequent conversion may dilute the current common stockholders' interest. Issuance of such preferred stock could adversely affect the price of our common stock. o Current economic conditions have been, and continue to be volatile. As a result of concern about the stability of the markets and the strength of counterparties, many financial institutions have reduced and, in some cases, ceased to provide funding to borrowers. Based on information available to us, as of our filing date, we have no indication that the financial institutions acting as lenders under our Credit Agreement would be unable to fulfill their commitments. Continued turbulence in the global credit markets and U.S. economy may adversely affect our results of operations, financial condition and liquidity. Other factors and assumptions not identified above could also cause actual results to differ materially from those set forth in the forward-looking information. Accordingly, actual events and results may vary significantly from those included in or contemplated or implied by forward-looking statements made by us or our representatives. RESULTS OF CONTINUING OPERATIONS AND LIQUIDITY AND CAPITAL RESOURCES - -------------------------------------------------------------------- Our consolidated financial information presents the results related to our operations of discontinued businesses separate from the results of our continuing operations. The discussion and analysis that follows focus on continuing operations. All amounts are in millions, except share and per share amounts. 12 WEEKS ENDED NOVEMBER 29, 2008 COMPARED TO THE 12 WEEKS ENDED DECEMBER 1, 2007 - -------------------------------------------------------------------------------- OVERALL - ------- Sales for the third quarter of fiscal 2008 were $2,120.9 million compared to $1,251.1 million for the third quarter of fiscal 2007 due primarily to the acquisition of Pathmark; comparable store sales, which include stores that have been in operation for two full fiscal years and replacement stores, increased 1.9%. Loss from continuing operations of $3.0 million for the third quarter of fiscal 2008 decreased from income from continuing operations of $73.1 million for the third quarter of fiscal 2007, due primarily to the gain on disposition of Metro, Inc. of $106.1 million. Loss from discontinued operations of $10.6 million for the third quarter of fiscal 2008 decreased from a loss from discontinued operations of $15.8 million for the third quarter of fiscal 2007. Net loss per share -- basic and diluted for the third quarter of fiscal 2008 was $0.26 and $1.61, respectively, compared to net income per share -- basic and diluted of $1.36 and $1.35, respectively, for the third quarter of fiscal 2007. 47
12 Weeks 12 Weeks Ended Ended Favorable / Nov. 29, 2008 Dec. 1, 2007 (Unfavorable) % Change ------------- ------------ ------------- ----------- Sales $ 2,120.9 $ 1,251.1 $ 869.8 69.5% Increase in comparable store sales 1.9% 3.1% NA NA (Loss) income from continuing operations (3.0) 73.1 (76.1) >100.0% Loss from discontinued operations (10.6) (15.8) 5.2 32.9% Net (loss) income (13.6) 57.3 (70.9) >100.0% Net (loss) income per share -- basic (0.26) 1.36 (1.62) >100.0% Net (loss) income per share -- diluted (1.61) 1.35 (2.96) >100.0%
Average weekly sales per supermarket were approximately $417,800 for the third quarter of fiscal 2008 versus $348,800 for the corresponding period of the prior year, an increase of 19.8% primarily due to the acquisition of Pathmark's larger supermarkets in the fourth quarter of fiscal 2007. SALES - -----
For the 12 weeks ended ----------------------------------- Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ Fresh $ 1,071.3 $ 1,103.4 Price Impact 924.4 32.6 Gourmet 67.1 63.0 Other 58.1 52.1 Investment in Metro, Inc. -- -- ---------- ---------- Total sales $ 2,120.9 $ 1,251.1 ========== ==========
Sales increased from $1,251.1 million for the 12 weeks ended December 1, 2007 to $2,120.9 million for the 12 weeks ended November 29, 2008 primarily due to an increase in the Price Impact segment of $891.8 million, as a result of the acquisition of Pathmark in the fourth quarter of fiscal 2007 as well as an increase in comparable stores sales of $24.3 million, offset by the absence of sales from store closures of $47.4 million. The decrease in sales in our Fresh segment of $32.1 million is primarily due to the absence of sales from store closures of $42.9 million, offset by an increase in comparable store sales of $10.8 million. The increase in sales in our Gourmet segment of $4.1 million is primarily due to comparable store sales increases. The sales increase of $6.0 million, or 11.5%, in our Other segment, representing Discount and Liquor, is primarily due to an increase in comparable store sales driven by our remodel program and our acquisition of Best Cellars, offset partially by store closures. GROSS MARGIN - ------------ Gross margin of $660.4 million increased 63 basis points as a percentage of sales to 31.14% for the third quarter of fiscal 2008 from gross margin of $381.7 million or 30.51% for the third quarter of fiscal 2007. Excluding the impact of the acquisition of Pathmark, which operates on lower gross margins, the increase is 156 basis points. This increase is primarily driven by the realization of lower net costs from buying synergies, improved stock loss results and overall improved margins, especially in the fresh departments. The following table details the dollar impact of several items affecting the gross margin dollar increase from the third quarter of fiscal 2007 to the third quarter of fiscal 2008:
Sales Volume Gross Margin Rate Total ------------- ----------------- ------------- Total Company $ 265.3 $ 13.4 $ 278.7
48 STORE OPERATING, GENERAL AND ADMINISTRATIVE EXPENSE - --------------------------------------------------- Store operating, general and administrative expense ("SG&A") was $648.5 million or 30.57% as a percentage of sales for the third quarter of fiscal 2008 compared to $402.8 million or 32.20% as a percentage of sales for the third quarter of fiscal 2007. Included in SG&A for the third quarter of fiscal 2008 were certain charges as follows: o costs relating to a voluntary labor buyout program of $3.0 million (14 basis points); o costs relating to our withdrawal of the Grocery Haulers, Inc. employees servicing Pathmark Stores from the Local 863 Union Multiemployer Pension Plan to our Company of $2.7 million (13 basis points), as discussed in Note 14 -- Retirement Plans and Benefits; o net real estate activity of $1.7 million (8 basis points); and o Pathmark acquisition related costs of $4.2 million (20 basis points). Partially offset by: o Recoveries from our VISA/Mastercard antitrust class action litigation as discussed in Note 20 -- Commitments and Contingencies of $2.2 million (11 basis points); and o a reversal of $5.2 million (25 basis points) for compensation expense related to restricted stock that had been previously recognized for performance targets that are no longer probable of being met, as discussed in Note 15 -- Stock Based Compensation. Included in SG&A for the third quarter of fiscal 2007 were certain charges as follows: o costs relating to the closing of our owned warehouses in Edison, New Jersey and Bronx, New York of $0.3 million (2 basis points) that were not sold as part of the sale of our U.S. distribution operations and some warehouse facilities and related assets to C&S Wholesale Grocers, Inc. as discussed in Note 9 -- Asset Disposition Initiatives; o net real estate activity of $4.3 million (35 basis points); and o Pathmark acquisition related costs of $4.4 million (35 basis points). Excluding the items listed above, SG&A as a percentage of sales decreased by 111 basis points during the third quarter of fiscal 2008 as compared to the third quarter of fiscal 2007 primarily due to the acquisition of Pathmark which contributed higher sales productivity. During the 12 weeks ended November 29, 2008 and December 1, 2007, we recorded impairment losses on long-lived assets due to closure or conversion in the normal course of business of $0.9 million and $2.5 million, respectively. The effects of changes in estimates of useful lives were not material to ongoing depreciation expense. If current operating levels do not continue to improve, there may be additional future impairments on long-lived assets, including the potential for impairment of assets that are held and used. 49 SEGMENT INCOME - --------------
For the 12 weeks ended ---------------------------------- Nov. 29, 2008 Dec. 1, 2007 ------------- ------------ Fresh $ 36.1 $ 9.5 Price Impact (1.9) (0.2) Gourmet 6.7 5.4 Other 0.5 (0.7) ------- ------- Total segment income $ 41.4 $ 14.0 ======= =======
Segment income increased $27.4 million from $14.0 million for the 12 weeks ended December 1, 2007 to $41.4 million for the 12 weeks ended November 29, 2008. Third quarter of fiscal 2008 results include segment loss of $1.9 million from the Pathmark business acquired in the fourth quarter of fiscal 2007 and the third quarter conversion of Pathmark Sav-A-Center stores. Our Fresh segment experienced an increase in segment income of $26.6 million from improved gross margins as well as decreased store operating, general and administrative costs, mainly in labor and occupancy related costs. Segment income from our Gourmet business improved by $1.3 million primarily as a result of an improved gross margin rate partially offset by an increase in operating costs, mainly in labor. The increase in segment income of $1.2 million in our Other segment, representing Discount and Liquor, is primarily due to improving sales and margin rates in both businesses and our acquisition of Best Cellars. Refer to Note 17 - -- Operating Segments for further discussion of our reportable operating segments. GAIN ON DISPOSITION OF METRO, INC. - ---------------------------------- During the 12 weeks ended December 1, 2007, we sold the remaining shares of our holdings in Metro, Inc. resulting in a gain of $106.1 million. There were no such gains during the 12 weeks ended November 29, 2008. NONOPERATING INCOME - ------------------- During the third quarter of fiscal 2008, we recorded $22.8 million in fair value adjustments for our Series B warrants acquired in connection with our purchase of Pathmark. There were no such gains during the third quarter of fiscal 2007. INTEREST EXPENSE - ---------------- Interest expense of $36.7 million for the third quarter of 2008 increased from the prior year amount of $14.5 million due primarily to the higher level of indebtedness related to our acquisition of Pathmark, including the issuance of $165 million 5.125% convertible senior notes due 2011 and $255 million 6.75% convertible senior notes due 2012 resulting in an increase in interest expense of $8.7 million ($2.8 million of which were non-cash costs), increased borrowings on our Line of Credit and Credit Agreement resulting in interest expense of $6.8 million and an increase in interest expense related to Pathmark of $5.4 million primarily due to interest on capital leases. INCOME TAXES - ------------ The provision for income taxes from continuing operations for the third quarter of fiscal 2008 was $1.0 million compared to $1.8 million for the third quarter of fiscal 2007. Consistent with the prior year, we continue to record a valuation allowance in an amount that appropriately reduces our net deferred tax asset to reflect our assessment of its realizability. 50 The effective tax rate on continuing operations of 53.1% for the 12 weeks ended November 29, 2008 varied from the statutory rate of 35% primarily due to the recording of state and local income taxes, recording additional valuation allowance offset by a permanent difference related to nonoperating income from the fair value adjustments related to the conversion features, financing warrants and Series B warrants. The effective tax rate on continuing operations of 2.3% for the 12 weeks ended December 1, 2007 varied from the statutory rate of 35% primarily due to state and local income taxes and a decrease to our valuation allowance as a result of the utilization of loss carryforwards that were not previously tax benefited. DISCONTINUED OPERATIONS - ----------------------- Beginning in the fourth quarter of fiscal year 2002 and in the early part of the first quarter of fiscal 2003, we decided to sell our operations located in Northern New England and Wisconsin, as well as our Eight O'Clock Coffee business. These asset sales are now complete. However, our Company continues to pay occupancy costs for operating leases on closed locations. On April 24, 2007, based upon unsatisfactory operating trends and the need to devote resources to our expanding Northeast core business, our Company announced negotiations for the sale of our non-core stores within our Midwest operations, including inventory related to these stores. Our Company ceased sales operations in all stores as of July 7, 2007. Planned sale transactions for these stores have been completed. On May 30, 2007, our Company announced advanced negotiation for the sale of our non-core stores located within the Greater New Orleans area, including inventory related to these stores. Our Company ceased sales operations in all stores not sold as of November 1, 2007. Planned sale transactions for these stores have been completed. The loss from operations of discontinued businesses, net of tax, for the third quarter of fiscal 2008 of $12.5 million decreased from a loss from operations of discontinued businesses, net of tax, of $13.5 million for the third quarter of fiscal 2007 primarily due to changes of estimates in vacancy related costs due to the closure of stores in the Midwest and the Greater New Orleans area. The gain on disposal of discontinued operations of $1.8 million for the third quarter of fiscal 2008 relates to the sale of land in the Greater New Orleans area and the loss on disposal of discontinued operations in the prior year of $2.2 million primarily was due to impairment losses recorded on the property, plant and equipment in the Greater New Orleans area and Midwest as we recorded the assets' fair market value based upon proceeds received less costs to sell. 40 WEEKS ENDED NOVEMBER 29, 2008 COMPARED TO THE 40 WEEKS ENDED DECEMBER 1, 2007 - -------------------------------------------------------------------------------- OVERALL - ------- Sales for the 40 weeks ended November 29, 2008 were $7,226.3 million compared to $4,204.6 million for the 40 weeks ended December 1, 2007 due primarily to the acquisition of Pathmark; comparable store sales, which includes stores that have been in operation for two full fiscal years and replacement stores, increased 2.7%. Loss from continuing operations of $2.8 million for the 40 weeks ended November 29, 2008 decreased from income from continuing operations of $131.5 million for the 40 weeks ended December 1, 2007 primarily due to the absence of the gain on disposition of Metro, Inc. Loss from discontinued 51 operations of $230.7 million for the 40 weeks ended December 1, 2007 decreased to a loss from discontinued operations of $26.0 million for the 40 weeks ended November 29, 2008, due to the absence of the sale and closure of stores in the Midwest and the sale of our stores in the Greater New Orleans area. Net loss per share -- basic for the 40 weeks ended November 29, 2008 was $0.57 compared to net loss per share -- basic $2.37 for the 40 weeks ended December 1, 2007. Net loss per share -- diluted for the 40 weeks ended November 29, 2008 was $2.79 compared to a net loss per share -- diluted of $2.34 for the 40 weeks ended December 1, 2007.
40 weeks 40 weeks Ended Ended Favorable / Nov. 29, 2008 Dec. 1, 2007 (Unfavorable) % Change ------------- ------------ ------------- ---------- Sales $ 7,226.3 $ 4,204.6 $ 3,021.7 71.9% Increase in comparable store sales 2.7% 2.3% NA NA (Loss) income from continuing operations (2.8) 131.5 (134.3) >100.0% Loss from discontinued operations (26.0) (230.7) 204.7 88.7% Net (loss) income (28.8) (99.2) 70.4 71.0% Net loss per share -- basic (0.57) (2.37) 1.80 75.9% Net loss per share -- diluted (2.79) (2.34) (0.45) (19.2%)
Average weekly sales per supermarket were approximately $425,700 for the 40 weeks ended November 29, 2008 versus $350,200 for the corresponding period of the prior year, an increase of 21.6% primarily due to the acquisition of Pathmark's larger supermarkets in the fourth quarter of fiscal 2007. SALES - -----
For the 40 weeks ended -------------------------------- Nov. 29, 2008 Dec. 1, 2007 --------------- -------------- Fresh $ 3,658.3 $ 3,722.7 Price Impact 3,168.1 110.1 Gourmet 208.9 192.4 Other 191.0 173.6 Investment in Metro, Inc. -- 5.8 --------------- -------------- Total sales $ 7,226.3 $ 4,204.6 =============== ==============
Sales increased from $4,204.6 million for the 40 weeks ended December 1, 2007 to $7,226.3 million for the 40 weeks ended November 29, 2008 primarily due to an increase in the Price Impact segment of $3,058.0 million, as a result of the acquisition of Pathmark in the fourth quarter of fiscal 2007 as well as an increase in comparable stores sales of $118.6 million, offset by the absence of sales from store closures of $168.3 million. The decrease in sales in our Fresh segment of $64.4 million is primarily due to the absence of sales from store closures of $153.8 million, offset by an increase in comparable store sales of $77.7 million and an increase in sales related to the opening of new stores of $11.7 million. The increase in sales in our Gourmet segment of $16.5 million is primarily due to comparable store sales increases. The sales increase of $17.4 million, or 10.0%, in our Other segment, representing Discount and Liquor, is primarily due to an increase in comparable store sales driven by our remodel program and our acquisition of Best Cellars, offset partially by store closures. The decrease in sales of $5.8 million, or 100%, in our Metro segment is due to the expiration of our information technology agreement with Metro, Inc. during fiscal 2007. 52 GROSS MARGIN - ------------ Gross margin of $2,195.5 million decreased 62 basis points to 30.38% as a percentage of sales for the 40 weeks ended November 29, 2008 from $1,303.3 million or 31.00% as a percentage of sales for the 40 weeks ended December 1, 2007. Excluding the impact of the acquisition of Pathmark, which operates on lower gross margins, the gross margin rate increased 66 basis points. This increase is primarily driven by the realization of lower net costs from buying synergies as well as overall improved margins, especially in the fresh departments. The following table details the dollar impact of several items affecting the gross margin dollar increase (decrease) from the 40 weeks ended December 1, 2007 to the 40 weeks ended November 29, 2008:
Sales Volume Gross Margin Rate Total ------------- ----------------- -------------- Northeast $ 936.6 $ (44.4) $ 892.2
STORE OPERATING, GENERAL AND ADMINISTRATIVE EXPENSE - --------------------------------------------------- SG&A expense was $2,193.0 million or 30.35% as a percentage of sales for the 40 weeks ended November 29, 2008 as compared to $1,323.4 million or 31.48% as a percentage of sales for the 40 weeks ended December 1, 2007. Included in SG&A for the 40 weeks ended November 29, 2008 were certain charges as follows: o net losses on restructuring activity of $0.4 million (1 basis point); o costs relating to a voluntary labor buyout program of $3.0 million (4 basis points); o costs relating to our withdrawal of the Grocery Haulers, Inc. employees servicing Pathmark Stores from the Local 863 Union Multiemployer Pension Plan to our Company of $2.7 million (4 basis points), as discussed in Note 14 -- Retirement Plans and Benefits; o net real estate activity of $8.1 million (11 basis points); and o Pathmark acquisition related costs of $28.9 million (40 basis points). Partially offset by: o Recoveries from our VISA/Mastercard antitrust class action litigation as discussed in Note 20 -- Commitments and Contingencies of $2.2 million (3 basis points); and o a reversal of $5.2 million (7 basis points) for compensation expense related to restricted stock that had been previously recognized for performance targets that are no longer probable of being met, as discussed in Note 15 -- Stock Based Compensation. Included in SG&A for the 40 weeks ended December 1, 2007 were certain charges as follows: o costs relating to a voluntary retirement buyout program of $0.5 million (1 basis point); o net real estate activity of $7.3 million (17 basis points); and o Pathmark acquisition related costs of $6.8 million (16 basis points). 53 Partially offset by: o reversal of costs relating to the consolidation of our operating offices in line with our smaller operations of $0.9 million (2 basis points); o gain on the sale of our owned warehouse in Edison, New Jersey of $13.2 million (31 basis points) that was closed and not sold as part of the sale of our U.S. distribution operations and some warehouse facilities and related assets to C&S Wholesale Grocers, Inc. as discussed in Note 9 -- Asset Disposition Initiatives; and o reversal of occupancy related costs of $1.4 million (3 basis points) due to changes in our estimates of future costs for stores closed as part of our asset disposition initiatives as discussed in Note 9 -- Asset Disposition Initiatives. Excluding the items listed above, SG&A as a percentage of sales decreased 164 basis points during the 40 weeks ended November 29, 2008 as compared to the 40 weeks ended December 1, 2007 primarily due to the acquisition of Pathmark which contributed higher sales productivity. During the 40 weeks ended November 29, 2008 and December 1, 2007, we recorded impairment losses on long-lived assets for impairments due to expected closure, closure or conversion of stores in the normal course of business of $2.7 million and $3.6 million, respectively. The effects of changes in estimates of useful lives were not material to ongoing depreciation expense. If current operating levels do not continue to improve, there may be additional future impairments on long-lived assets, including the potential for impairment of assets that are held and used. SEGMENT INCOME - --------------
For the 40 weeks ended --------------------------------- Nov. 29, 2008 Dec. 1, 2007 --------------- ------------- Fresh $ 100.1 $ 60.9 Price Impact 16.1 -- Gourmet 16.6 11.0 Other 1.8 (2.3) --------------- ------------- Total segment income $ 134.6 $ 69.6 =============== ==============
Segment income increased $65.0 million from $69.6 million for the 40 weeks ended December 1, 2007 to $134.6 million for the 40 weeks ended November 29, 2008. Third quarter of fiscal 2008 results include segment income of $16.1 million from the Pathmark business acquired in the fourth quarter of fiscal 2007 and the third quarter conversion of Pathmark Sav-A-Center stores. Our Fresh segment experienced an increase in segment income of $39.2 million from decreased costs, mainly in labor and occupancy related costs. Segment income from our Gourmet business improved by $5.6 million primarily as a result of an improved gross margin rate partially offset by additional operating costs, mainly in labor and occupancy related costs. The increase in segment income of $4.1 million in our Other segment, representing Discount and Liquor, is primarily due to improving sales and margin rates in both businesses and our acquisition of Best Cellars. Refer to Note 17 - Operating Segments for further discussion of our reportable operating segments. 54 GAIN ON DISPOSITION OF METRO, INC. - ---------------------------------- During the 40 weeks ended December 1, 2007, we sold all shares of our holdings in Metro, Inc. resulting in a gain of $184.5 million. There were no such gains during the 40 weeks ended November 29, 2008. NONOPERATING INCOME - ------------------- During the 40 weeks ended November 29, 2008, we recorded $114.3 million in fair value adjustments for (i.) our Series A and Series B warrants acquired in connection with our purchase of Pathmark, (ii.) our conversion feature of the 5.125% convertible senior notes and the 6.75% convertible senior notes, and (iii.) our financing warrants issued in connection with the issuance of our convertible senior notes. There were no such gains during the 40 weeks ended December 1, 2007. INTEREST EXPENSE - ---------------- Interest expense of $116.6 million for the 40 weeks ended November 29, 2008 increased from the prior year amount of $48.8 million due primarily to the higher level of indebtedness related to our acquisition of Pathmark, including the issuance of $165 million 5.125% convertible senior notes due 2011 and $255 million 6.75% convertible senior notes due 2012 resulting in an increase in interest expense of $28.9 million ($9.3 million of which were non-cash costs), increased borrowings on our Line of Credit and Credit Agreement resulting in an increase in interest expense of $18.1 million and an increase in interest expense related to Pathmark of $16.7 million primarily due to interest on capital leases. EQUITY IN EARNINGS OF METRO, INC. - --------------------------------- We used the equity method of accounting to account for our investment in Metro, Inc., through March 13, 2007, because we exerted significant influence over substantive operating decisions made by Metro, Inc. through our membership on Metro, Inc.'s Board of Directors and its committees and through an information technology services agreement with Metro, Inc. During the 40 weeks ended December 1, 2007, we recorded $7.9 million in equity earnings relating to our equity investment in Metro, Inc. During fiscal 2007, we sold all of our holdings in Metro, Inc. Thus, there were no such equity earnings during the 40 weeks ended November 29, 2008. INCOME TAXES - ------------ The provision for income taxes from continuing operations for the 40 weeks ended November 29, 2008 was $3.5 million compared to $4.3 million for the 40 weeks ended December 1, 2007. Consistent with prior year, we continue to record a valuation allowance against our net deferred tax assets. The effective tax rate on continuing operations of 510.3% for the 40 weeks ended November 29, 2008 varied from the statutory rate of 35% primarily due to the recording of state and local income taxes, recording additional valuation allowance offset by a permanent difference related to nonoperating income from the fair value adjustments related to the conversion features, financing warrants and Series A and B warrants. The effective tax rate on continuing operations of 3.2% for the 40 weeks ended December 1, 2007 varied from the statutory rate of 35% primarily due to state and local income taxes and a decrease to our valuation allowance as a result of the utilization of loss carryforwards that were not previously tax benefited. 55 DISCONTINUED OPERATIONS - ----------------------- Beginning in the fourth quarter of fiscal year 2002 and in the early part of the first quarter of fiscal 2003, we decided to sell our operations located in Northern New England and Wisconsin, as well as our Eight O'Clock Coffee business. These asset sales are now complete. However, our Company continues to pay occupancy costs for operating leases on closed locations. On April 24, 2007, based upon unsatisfactory operating trends and the need to devote resources to our expanding Northeast core business, our Company announced negotiations for the sale of our non-core stores within our Midwest operations, including inventory related to these stores. Our Company ceased sales operations in all stores as of July 7, 2007. Planned sale transactions for these stores have been completed. On May 30, 2007, our Company announced advanced negotiation for the sale of our non-core stores located within the Greater New Orleans area, including inventory related to these stores. Our Company ceased sales operations in all stores not sold as of November 1, 2007. Planned sale transactions for these stores have been completed. The loss from operations of discontinued businesses, net of tax, for the 40 weeks ended November 29, 2008 of $30.6 million decreased from a loss from operations of discontinued businesses, net of tax, of $179.7 million for the 40 weeks ended December 1, 2007 primarily due to a decrease in vacancy related costs that were recorded during fiscal 2007 due to the closure of stores in the Midwest and the Greater New Orleans area. The gain on disposal of discontinued operations of $4.7 million for the 40 weeks ended November 29, 2008 increased from the loss on disposal of discontinued operations in the prior year of $51.0 million primarily due to the absence of impairment losses recorded on the property, plant and equipment in the Greater New Orleans area and Midwest as we recorded the assets' fair market value based upon proceeds received and expected proceeds less costs to sell. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- CASH FLOWS - ---------- The following table presents excerpts from our Consolidated Statements of Cash Flows:
40 weeks Ended ------------------------------------------- Nov. 29, 2008 Dec. 1, 2007 ----------------- ----------------- Net cash used in operating activities $ (48,214) $ (25,260) ----------------- ----------------- Net cash (used in) provided by investing activities $ (56,999) $ 84,059 ----------------- ----------------- Net cash provided by (used in) financing activities $ 165,427 $ (75,603) ----------------- -----------------
Net cash used in operating activities of $48.2 million for the 40 weeks ended November 29, 2008 primarily reflected our net loss of $28.8 million, adjusted for non-cash charges for (i.) depreciation and amortization of $201.4 million, (ii.) charges related to our asset disposition initiatives of $9.8 million, (iii.) other share based awards of $3.6 million, partially offset by (iv.) gain on disposal of discontinued operations of $4.7 million, and (v.) nonoperating income related to marked to market adjustments for financial instruments of $114.3 million. Further, cash was provided by an increase in accounts payable of $21.7 million mainly due to the timing of payments partially offset by an increase in inventories of $49.1 million, an increase in other assets of $11.8 million, a decrease in accrued salaries, wages, benefits and taxes of $30.3 million and a decrease in other 56 non-current liabilities of $49.0 million primarily due to payments on closed locations. Refer to Working Capital below for discussion of changes in working capital items. Net cash used in operating activities of $25.3 million for the 40 weeks ended December 1, 2007 primarily reflected our net loss of $99.2 million, adjusted for non-cash charges for (i.) depreciation and amortization of $122.6 million, (ii.) asset disposition initiatives of $120.4 million, (iii.) losses on the disposal of owned property of $2.5 million, (iv.) loss on disposal of discontinued operations of $51.0 million, (v.) other property impairments of $3.6 million, (vi.) other share based awards of $7.3 million, partially offset by (vii.) our equity in earnings of Metro, Inc. of $7.9 million, and (viii.) the gain on disposition of Metro, Inc. of $184.5 million. Further, cash was provided by a decrease in accounts receivable of $31.9 million, a decrease in inventories of $72.7 million primarily due to the sale of our Midwest and the Greater New Orleans area operations offset by an increase in prepaid expenses and other current assets of $14.2 million, an increase in other assets of $3.1 million, a decrease in accrued salaries, wages, benefits and taxes of $52.8 million, a decrease in other non-current liabilities of $42.6 million and a decrease in accounts payable of $27.3 million mainly due to the timing of payments. Net cash used in investing activities of $57.0 million for the 40 weeks ended November 29, 2008 primarily reflected property expenditures totaling $85.7 million, which included 3 new liquor stores, 1 new Gourmet store, 13 major remodels, 1 major enlargement, 2 conversions, 7 Pathmark Price Impact remodels and 3 Starbucks remodels partially offset by proceeds from disposal of property of $17.7 million and proceeds from maturities of restricted marketable securities of $9.9 million. For fiscal 2008, we have reduced our planned capital expenditures from approximately $200 million to an approximate range of $100 to $125 million mainly due to a shift to lower cost Pathmark Price Impact remodels as well as our intention to limit capital expenditures in light of the difficult economic environment. Net cash provided by investing activities of $84.1 million for the 40 weeks ended December 1, 2007 primarily reflected proceeds from the sale of assets of $121.6 million ($23.7 million in the Northeast, $53.3 million in the Midwest and $44.6 million in the Greater New Orleans area), cash received from the sale of shares of Metro, Inc. of $551.2 million, and net sales of marketable securities of $20.4 million partially offset by acquisition related expenditures for the purchase of Pathmark Stores, Inc. of $18.7 million, an increase in restricted cash of $490.9 million and property expenditures totaling $98.4 million, which included 4 new supermarkets, 9 major remodels and 2 minor remodels. Net cash provided by financing activities of $165.4 million for the 40 weeks ended November 29, 2008 primarily reflected net proceeds under our revolving lines of credit of $191.9 million, proceeds from a promissory note of $10.0 million, an increase in book overdrafts of $14.5 million, partially offset by the settlement of Series A warrants of $45.7 million and principal payments on capital leases of $5.6 million. Net cash used in financing activities of $75.6 million for the 40 weeks ended December 1, 2007 primarily reflected principal payments on long-term borrowings of $32.0 million and net principal payments on revolving lines of credit of $58.7 million offset by net proceeds from long term real estate liabilities of $6.4 million and proceeds from the exercise of stock options of $6.2 million. We operate under an annual operating plan which is reviewed and approved by our Board of Directors and incorporates the specific operating initiatives we expect to pursue and our anticipated financial results. We are in the process of planning for fiscal 2009 and beyond at this time and we believe that our present cash resources, including invested cash on hand, available borrowings under our Credit Agreement and other sources, are sufficient to meet our needs. Based on current information available to us, as of our filing date, we have no indication that the financial institutions acting as lenders under our $675 million Credit Agreement would be unable to fulfill their commitments as of our filing date. However, given the current 57 economic environment and credit risk market crisis, we can not assure you that this may not change in the foreseeable future. Profitability, cash flow, asset sale proceeds and timing can be impacted by certain external factors such as unfavorable economic conditions, competition, labor relations and fuel and utility costs which could have a significant impact on cash generation. If our profitability and cash flow do not improve in line with our plans or if they do not otherwise provide sufficient resources to operate effectively, we anticipate that we would be able to modify the operating plan, by reducing capital investments and through other contingency actions. We may also look to raise capital through the issuance of additional debt or equity in order to ensure that we have appropriate resources. However, there is no assurance that we will pursue such actions or that they will be successful in generating resources necessary to operate the business. WORKING CAPITAL - --------------- We had working capital of $234.2 million at November 29, 2008 compared to working capital of $112.6 million at February 23, 2008. We had cash and cash equivalents aggregating $160.9 million at November 29, 2008 compared to $100.7 million at February 23, 2008. The increase in working capital was attributable primarily to the following: o An increase in cash and cash equivalents as detailed in the Consolidated Statements of Cash Flows; o An increase in inventories due to seasonality; o A decrease in current portion of other financial liabilities due to the exercise of Series A warrants by Yucaipa Corporate Initiatives Fund I, L.P., Yucaipa American Alliance Fund I, L.P. and Yucaipa American Alliance (Parallel) Fund I, L.P., and o A decrease in accrued salaries, wages and benefits primarily due to payments made in connection with our annual incentive programs. Partially offset by the following: o A decrease in prepaid expenses and other current assets mainly due to the timing of payments; and o An increase in accounts payable (inclusive of book overdrafts) due to the timing of payments. LINE OF CREDIT - -------------- On January 16, 2008, we entered into a secured line of credit agreement with Blue Ridge Investments, L.L.C. This agreement enables us to borrow funds on a revolving basis subject to invested cash balances. Each borrowing bears interest at a rate per annum equal to the BBA Libor Daily Floating Rate plus 0.10%. At November 29, 2008 and February 23, 2008, we had borrowings outstanding under this line of credit agreement of $7.9 million and $11.6 million, respectively. This agreement had an original expiration date of December 31, 2008; however, on November 26, 2008 this agreement was extended to expire on December 31, 2009. These loans are collateralized by a first priority perfected security interest in our ownership interest in the Columbia Fund. See Note 5 -- Cash, Cash Equivalents, Restricted Cash and Restricted Marketable Securities, for further discussion on the Columbia Fund. 58 CREDIT AGREEMENT - ---------------- On December 3, 2007, the 2005 Revolving Credit Agreement and Letter of Credit Agreement were refinanced pursuant to a new $675 million Credit Agreement. Our Credit Agreement is syndicated with various financial institutions, with Banc of America Securities LLC and Bank of America, N.A. as the co-lead arranger. Subject to borrowing base requirements, the Credit Agreement provides for a five-year term loan in the aggregate amount of $82.9 million and a five-year revolving credit facility of $592.1 million enabling us to borrow funds and issue letters of credit on a revolving basis. The Credit Agreement includes a $100 million accordion feature which gives us the ability to request increases in the lending commitments from $675 million to up to $775 million, but such increases would become effective only if and to the extent that existing and new lenders agree to provide such increases. Our obligations under the Credit Agreement are secured by substantially all assets of the company, including, but not limited to, inventory, certain accounts receivable, pharmacy scripts, owned real estate and certain Pathmark leaseholds. Borrowings under the Credit Agreement bear interest based on LIBOR or Prime interest rate pricing. Subject to certain conditions, we are permitted to pay cumulative cash dividends on common shares as well as make bond repurchases. At November 29, 2008, there were $361.8 million of loans and $228.7 million in letters of credit outstanding under this agreement. As of November 29, 2008, after reducing availability for borrowing base requirements, we had $77.6 million available under the Credit Agreement. In addition, we have invested cash available to reduce borrowings under this Credit Agreement or to use for future operations of $46 million as of November 29, 2008. On December 27, 2007, in order to facilitate the syndication of the Credit Agreement under current market conditions, we entered into an Amended and Restated Credit Agreement, whereby a portion of the revolving commitment was converted into a $50 million term loan tranche which was collateralized by certain real estate assets at an increased margin rate. This agreement expires on December 3, 2012. Based on information available to us, as of our filing date, we have no indication that the financial institutions acting as lenders under our Credit Agreement would be unable to fulfill their commitments. PROMISSORY NOTE - --------------- On September 2, 2008, our Company issued a three year, unsecured promissory note in the amount of $10 million to Erivan Karl Haub. Erivan Haub is the father of Christian W. E. Haub, our Executive Chairman, and is a limited partner of Tengelmann which owns an interest in our Company's stock. The principal is due in a lump sum payment on August 18, 2011 and will bear interest at a rate of 6% per year, payable in twelve equal payments of $0.15 million over the term of the note. SERIES A AND SERIES B WARRANTS - ------------------------------ As part of the acquisition of Pathmark on December 3, 2007, we issued 4,657,378 and 6,965,858 roll-over stock warrants in exchange for Pathmark's 2005 Series A and Series B warrants, respectively. The number of warrants issued was computed based on the conversion factor of 0.46296. The Series A warrants were exercisable at $18.36 and expired on June 9, 2008 and the Series B warrants are exercisable at $32.40 and expire on June 9, 2015. These warrants were originally valued using the price of A&P common stock of $30.05 per common share, the quoted market price of A&P common stock on November 30, 2007, the last trading day before the transaction closing date. The Tengelmann stockholders have the right to approve any issuance of common stock under these warrants upon exercise (assuming Tengelmann's outstanding interest is at least 25% and subject to liquidity impairments defined within the Tengelmann Stockholder Agreement). In addition, Tengelmann has the ability to exercise a "Put Right" whereby it has the ability to require A&P to 59 purchase A&P stock held by Tengelmann to settle these warrants. Based on the rights provided to Tengelmann, A&P does not have sole discretion to determine whether the payment upon exercise of these warrants will be settled in cash or through issuance of an equivalent portion of A&P shares. Therefore, these warrants are recorded as liabilities and marked-to-market each reporting period based on A&P's current stock price. On May 7, 2008, the 4,657,378 Series A warrants were exercised by Yucaipa Corporate Initiatives Fund I, L.P., Yucaipa American Alliance Fund I, L.P. and Yucaipa American Alliance (Parallel) Fund I, L.P. We opted to settle the Series A warrants in cash totaling $45.7 million rather than issuing additional common shares. Included in "Nonoperating Income" on our Consolidated Statements of Operations for the 12 and 40 weeks ended November 29, 2008, is a loss of nil and $1.2 million, respectively, for the Series A warrants through the settlement date of May 7, 2008 and a gain of $22.8 million and $98.7 million, respectively, for the Series B warrants market value adjustment. The value of the Series B warrants were $7.4 million as of November 29, 2008 and is included in "Other financial liabilities" on our Consolidated Balance Sheets. The following assumptions and estimates were used in the Black-Scholes model for the Series B warrants:
For the 40 weeks ended November 29, 2008 ----------------- Expected life 6.5 years Volatility 59.9% Dividend yield 0% Risk-free interest rate 2.35%
PUBLIC DEBT OBLIGATIONS - ----------------------- Outstanding notes totaling $596.0 million at November 29, 2008 consisted of $12.8 million aggregate principal amount of 9.125% Senior Notes due December 15, 2011, $146.0 million aggregate principal amount of 5.125% Convertible Senior Notes due June 15, 2011, $237.2 million aggregate principal amount of 6.75% Convertible Senior Notes due December 15, 2012 and $200.0 million aggregate principal amount of 9.375% Notes due August 1, 2039. Interest is payable quarterly on the 9.375% Notes and semi-annually on the 9.125%, 5.125% and 6.75% Notes. The 9.375% Notes are now callable at par ($25 per bond) and the 9.125% Notes are callable at a premium to par (103.042%). The 9.375% Notes are unsecured obligations and were issued under the terms of our senior debt securities indenture, which contains among other provisions, covenants restricting the incurrence of secured debt. The 9.375% Notes are effectively subordinate to the Credit Agreement and do not contain cross default provisions. All covenants and restrictions for the 9.125% Senior Notes have been eliminated in connection with the cash tender offer in fiscal 2005. Our notes are not guaranteed by any of our subsidiaries. During the 40 weeks ended December 1, 2007, the outstanding principal amount of our 7.75% Notes of $31.9 million due April 15, 2007 matured and was paid in full. On December 18, 2007, we completed a public offering and issued $165 million 5.125% convertible senior notes due 2011 and $255 million 6.75% convertible senior notes due 2012. The 2011 notes are not redeemable at our option at any time. The 2012 notes are redeemable at our option on or after December 15, 2010, at a redemption price of 102.70% and on or after December 15, 2011, at a redemption price of 60 101.35%. The initial conversion price of the 2011 notes is $36.40 representing a 30.0% premium to the offering price of $28.00 and the initial conversion price of the 2012 notes is $37.80 representing a 35.0% premium to the offering price of $28.00 at maturity, and at our option, the notes are convertible into shares of our stock, cash, or a combination of stock and cash. Concurrent with this offering, we entered into call options and financing warrant transactions with financial institutions that are affiliates of the underwriters of the notes to effectively increase the conversion price of these notes and to reduce the potential dilution upon future conversion. Conversion prices were effectively increased to $46.20 or a 65% premium and $49.00 or a 75% premium for the 2011 and 2012 notes, respectively. We understand that on or about October 3, 2008, Lehman Brothers OTC Derivatives, Inc. or "LBOTC" who accounts for 50% of the call option and financing warrant transactions filed for bankruptcy protection, which is an event of default under such transactions. We are carefully monitoring the developments affecting LBOTC, noting the impact of the LBOTC bankruptcy effectively reduced conversion prices for 50% of our Notes to their stated prices of $36.40 for the 2011 notes and $37.80 for the 2012 notes. As of December 18, 2007, our Company did not have sufficient authorized shares to provide for all potential issuances of common stock. Therefore, in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," our Company accounted for the conversion features as freestanding instruments. The notes were recorded with a discount equal to the value of the conversion features at the transaction date and will be accreted to the par value of the notes over the life of the notes. The value of the conversion features were determined utilizing the Black-Scholes option pricing model and recorded as a long term liability. The portion of the conversion features for which there was not shares available for settlement of conversions were marked to market each balance sheet date. On June 26, 2008, at a special meeting of shareholders, the number of shares of common stock we have the authority to issue was increased to 160,000,000 based on a majority vote by our shareholders. During the 12 and 40 weeks ended November 29, 2008, we recorded a gain of nil and $9.4 million, respectively, in "Nonoperating Income" on our Consolidated Statements of Operations for the conversion features of the 5.125% convertible senior notes. During the 12 and 40 weeks ended November 29, 2008, the gain that was recorded in "Nonoperating Income" on our Consolidated Statements of Operations for the conversion features of the 6.75% convertible senior notes was nil and $5.1 million, respectively. Based on an increase in available shares primarily due to the exercise of our Series A warrants during the first quarter of fiscal 2008 and the increase in authorized shares during the second quarter of fiscal 2008, the fair value of the conversion features of the 5.125% and 6.75% convertible senior notes of $13.8 million and $14.7 million as of June 26, 2008, respectively, were reclassified to "Additional paid-in-capital" on our Consolidated Statements of Stockholder's Equity and Comprehensive (Loss) Income. Thus, the fair value of the conversion features for the 5.125% and 6.75% convertible notes are no longer classified as a liability at November 29, 2008. The following assumptions and estimates were used in the Black-Scholes model:
As of June 26, 2008 ------------- Expected life 3.0 years Volatility 33.4% Dividend yield 0% Risk-free interest rate 3.11%
61 SHARE LENDING AGREEMENTS - ------------------------ We have entered into share lending agreements, dated December 12, 2007, with certain financial institutions, under which we have agreed to loan up to 11,278,988 shares of our common stock (subject to certain adjustments set forth in the share lending agreements). These borrowed shares must be returned to us no later than December 15, 2012 or sooner if certain conditions are met. If an event of default should occur under the stock lending agreement and a legal obstacle exists that prevents the Borrower from returning the shares, the Borrower shall, upon written request of our Company, pay our Company, using available funds, in lieu of the delivery of loaned shares, to settle its obligation. On June 26, 2008, our shareholders approved to loan up to an additional 1,577,569 shares of our Company's common stock pursuant to the share lending agreement. These financial institutions will sell the "borrowed shares" to investors to facilitate hedging transactions relating to the issuance of our 5.125% and 6.75% Convertible Notes. Pursuant to these agreements, we loaned 8,134,002 shares of our stock of which 6,300,752 shares were sold to the public on December 18, 2007 in a public offering. We did not receive any proceeds from the sale of the borrowed shares. We received a nominal lending fee from the financial institutions pursuant to the share lending agreements. Any shares we loan will be issued and outstanding. Investors that purchase borrowed shares will be entitled to the same voting and dividend rights as any other holders of our common stock; however, the financial institutions will not have such rights pursuant to the share lending agreements. The obligation of the financial institutions to return the borrowed shares has been accounted for as a prepaid forward contract and, accordingly, shares underlying this contract, except as described below, are removed from the computation of basic and dilutive earnings per share. On a net basis, this transaction will have no impact on earnings per share. On September 15, 2008, Lehman and certain of its subsidiaries, including, Lehman Europe filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court. Lehman Europe is party to a 3,206,058 share lending agreement with our Company. Due to the circumstances of the Lehman bankruptcy, we have recorded these loaned shares as issued and outstanding effective September 15, 2008, for purposes of computing and reporting our Company's basic and diluted weighted average shares and earnings per share. CALL OPTION AND FINANCING WARRANT - --------------------------------- Concurrent with the issuance of the convertible senior notes, our Company issued financing warrants in conjunction with the call options recorded as equity in the Consolidated Balance Sheet to effectively increase the conversion price of these notes and reduce the potential dilution upon future conversion. The financing warrants allow holders to purchase common shares at $46.20 with respect to the 5.125% notes and $49.00 with respect to the 6.75% notes. The financing warrants were valued at $36.8 million at the issuance date. At the issuance date, we did not have sufficient authorized shares to provide all potential issuances of common stock. Therefore, the financing warrants were accounted for as freestanding derivatives, required to be settled in cash until sufficient shares were available and were recorded as a long-term liability in the Consolidated Balance Sheet. On June 26, 2008, at a special meeting of shareholders, the number of shares of common stock we have the authority to issue was increased to 160,000,000 based on a majority vote by our shareholders. Thus, the financing warrants were marked to market through June 26, 2008 utilizing the Black-Scholes option pricing model and $28.9 million was reclassified to "Additional paid-in-capital" on our Consolidated Statements of Stockholder's Equity and Comprehensive (Loss) Income as of June 26, 2008. These financing warrants are no longer classified as a liability at November 29, 2008. During the 12 and 40 weeks ended November 29, 2008, we recorded a gain of nil and $2.3 million, respectively, relating to 62 these warrants, which is included in "Nonoperating income" on our Consolidated Statements of Operations. The following assumptions and estimates were used in the Black-Scholes model:
As of June 26, 2008 --------------------- Expected life 3.3 years - 4.8 years Volatility 33.4% Dividend yield 0% Risk-free interest rate range 3.11% - 3.54%
We understand that on or about October 3, 2008, Lehman Brothers OTC Derivatives, Inc. or "LBOTC" who accounts for 50% of the call option and financing warrant transactions filed for bankruptcy protection, which is an event of default under such transactions. We are carefully monitoring the developments affecting LBOTC. In the event we terminate these transactions, we would have the right to monetary damages from LBOTC in an amount equal to the present value of our cost to replace the transactions with another party for the same period and on the same terms. OTHER - ----- We are the guarantor of a loan of $1.1 million related to a shopping center, which will expire in 2011. In the normal course of business, we have assigned to third parties various leases related to former operating stores (the "Assigned Leases"). When the Assigned Leases were assigned, we generally remained secondarily liable with respect to these lease obligations. As such, if any of the assignees were to become unable to continue making payments under the Assigned Leases, we could be required to assume the lease obligation. As of November 29, 2008, 227 Assigned Leases remain in place. Assuming that each respective assignee became unable to continue to make payments under an Assigned Lease, an event we believe to be remote, we estimate our maximum potential obligation with respect to the Assigned Leases to be approximately $684.9 million, which could be partially or totally offset by reassigning or subletting such leases. Our existing senior debt rating was Caa1 with stable outlook with Moody's Investors Service ("Moody's") as of November 29, 2008. Our existing senior debt rating was B with positive outlook with Standard & Poor's Ratings Group ("S&P") as of November 29, 2008. Also, S&P assigned B- ratings to our $165 million 5.125% convertible senior notes due 2011 and our $255 million 6.75% convertible senior notes due 2012. Moody's assigned a Caa1 rating to our $165 million 5.125% convertible senior notes due 2011 and our $255 million 6.75% convertible senior notes due 2012. Our liquidity rating was SGL3 with Moody's as of November 29, 2008. Our recovery rating was 5 with S&P as of November 29, 2008 indicating a modest expectation of 10%-30% recovery of our senior debt to our lenders. Future rating changes could affect the availability and cost of financing to our Company. CRITICAL ACCOUNTING ESTIMATES - ----------------------------- Critical accounting estimates are those accounting estimates that we believe are important to the portrayal of our financial condition and results of operations and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. 63 The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Self-Insurance Reserves Our Consolidated Balance Sheets include liabilities with respect to self-insured workers' compensation and general liability claims. We estimate the required liability of such claims on a discounted basis, utilizing an actuarial method, which is based upon various assumptions, which include, but are not limited to, our historical loss experience, projected loss development factors, actual payroll, legal costs and other data. Legal expenses incurred in connection with workers' compensation and general liability claims are charged to the specific claim to which costs pertain. The required liability is also subject to adjustment in the future based upon the changes in claims experience, including changes in the number of incidents (frequency) and changes in the ultimate cost per incident (severity). Long-Lived Assets We review assets in stores planned for closure or conversion for impairment upon determination that such assets will not be used for their intended useful life. The value of the assets is determined based on estimates of future cash flows. Any impairment amounts are included in SG&A in our Consolidated Statements of Operations. The effects of changes in estimates of useful lives were not material to ongoing depreciation expense. If current operating levels do not improve, there may be a need to take further actions which may result in future impairments on long-lived assets, including the potential for impairment of assets that are held and used. Goodwill and Other Intangible Assets In accordance with SFAS 142 "Goodwill and Other Intangible Assets," goodwill and intangibles with indefinite useful lives are no longer required to be amortized, but tested for impairment at least annually. Our Company tests for impairment in the fourth quarter of each fiscal year, unless events or changes in circumstances indicate that impairment may have occurred in an interim period. The first step of the impairment analysis is performed by comparing the estimated fair value of each reporting unit to the related carrying value. If the carrying value exceeds the fair market value, an impairment is indicated. The estimated fair value of a reporting unit is determined by using discounted cash flow analyses or by using market multiples, as appropriate. In determining fair value, we make various assumptions, including projections of future cash flows. Impairment testing results could differ if actual results are lower than our expectations or if different methodology was utilized to perform the impairment analysis. The current economic environment has led to an overall decline in the stock market which has negatively impacted our stock price. We do not believe the decline in our stock price reflects changes in the fundamentals of our business. Our current expectations are that projected future results of our reporting units would not indicate an impairment of our goodwill or intangibles. However, there can be no assurance that there is not an impairment until a full analysis is completed. Our annual impairment test is performed in the fourth quarter of our fiscal year and it is possible that the estimated fair value of one or more of our reporting units may be less than their carrying amounts. If so, we may be required to record a non-cash impairment charge during our fourth quarter of fiscal 2008. Closed Store and Closed Warehouse Reserves For closed stores and warehouses that are under long-term leases, we adjust the charges originally accrued for these events for 1) interest accretion, 2) settlements on leases or sold properties, and 3) changes in estimates in future sublease rental assumptions. Net adjustments, all of which have been disclosed in the Notes to the Consolidated Financial Statements, for changes have been cumulatively approximately 4% from the date of inception, with the most significant adjustments being made prior to 2000. Adjustments are predominantly due to fluctuations in the real estate market from the time the original charges are incurred until the properties are actually settled. 64 As of November 29, 2008, we had recorded liabilities for estimated probable obligations of $178 million. Of this amount, $17 million relates to stores closed in the normal course of business, $25 million relates to stores and warehouses closed as part of the asset disposition initiatives (see Note 9 of our Consolidated Financial Statements), and $136 million relates to stores closed as part of our discontinued operations (see Note 8 of our Consolidated Financial Statements). Due to the long-term nature of the lease commitments, it is possible that current accruals, which are based on estimates of vacancy costs and sublease income, will change in the future as economic conditions change in the real estate market; however, we are unable to estimate the impact of such changes at this time and the existing obligations are management's best estimate of these obligations at this time. Warrant Liability We have warrants which are recorded as liabilities in our financial statements and marked to market each reporting period using the Black-Scholes option pricing model. The value of these liabilities may change as a result of changes in A&P's stock price, the remaining time until maturity, and the current interest rate. Employee Benefit Plans The determination of our obligation and expense for pension and other postretirement benefits is dependent, in part, on our selection of certain assumptions used by our actuaries in calculating these amounts. These assumptions include the weighted average discount rate at which obligations can be effectively settled, the anticipated rate of future increases in compensation levels, the expected long-term rate of return on assets, increases or trends in health care cost, and certain employee related factors, such as turnover, retirement age and mortality. The discount rate is determined by taking into account the actual pattern of maturity of the benefit obligations. To generate the year-end discount rate, a single rate is developed using a yield curve which is derived from multiple high quality corporate bonds, discounting each future year's projected cash flow, and determining the equivalent single discount rate. A discount rate of 5.75% was selected for the February 23, 2008 disclosures. We use independent actuaries to assist us in determining the discount rate assumption and measuring our plans' obligations. The rate of compensation increase is determined based upon a scale of merit and promotional increases according to duration plus an economic increase per year. Our long-term rate of return is developed by taking into account the target allocations contained in each plan's investment policy, as of the beginning of the year, and reflecting long term historical data, with greater weight given to recent years. Under this approach, separate analyses are performed to determine the expected long-term rate of inflation, real rates of return for each asset class, and the correlations among the returns for the various asset classes. We use independent actuaries to assist us in determining our long-term rate of return assumptions. We believe that our current assumptions used to estimate plan obligations and annual expense are appropriate in the current economic environment. However, if economic conditions change, we may need to change some of our assumptions, and the resulting changes may materially affect our pension and other postretirement obligations in the Consolidated Balance Sheets and our future expense in the Consolidated Statement of Operations. Actual results that differ from our Company's assumptions are accumulated and amortized over future periods into the Consolidated Statement of Operations. 65 Inventories We evaluate inventory shrinkage throughout the year based on actual physical counts and record reserves based on the results of these counts to provide for estimated shrinkage between the store's last inventory and the balance sheet date. Physical inventory counts are taken every period for fresh inventory, approximately twice per fiscal year on a staggered basis for the remaining merchandise inventory in stores, and annually for inventory in distribution centers and supplies. The average shrinkage rate resulting from the physical inventory counts is applied to the ending inventory balance in each store as of the balance sheet date to provide for estimated shrinkage from the date of the last physical inventory count for that location. Adjustments to the stock loss reserve based on physical inventories have not been material. Income Taxes As discussed in Note 16 of the Consolidated Financial Statements, we recorded a valuation allowance for the entire U.S. net deferred tax asset since, in accordance with SFAS 109, it was more likely than not that the net deferred tax asset would not be utilized based on historical cumulative losses. Under SFAS 109, this valuation allowance could be reversed in future periods if we experience improvement in our U.S. operations. We adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an Interpretation of FASB Statement 109 ("FIN 48") as of February 25, 2007. The cumulative effect of the adoption of the recognition and measurement provisions of FIN 48 resulted in a $24.4 million increase to the February 25, 2007 balance of retained earnings. Results of prior periods have not been restated. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 requires that we determine whether the benefits of our tax positions are more likely than not of being sustained upon audit based on the technical merits of the tax position. For tax positions that are more likely than not of being sustained upon audit, we recognize the largest amount of the benefit that is more likely than not of being sustained in our Consolidated Financial Statements. For tax positions that are not more likely than not of being sustained upon audit, we do not recognize any portion of the benefit in our Consolidated Financial Statements. Our policy for interest and penalties under FIN 48 related to income tax exposures was not impacted as a result of the adoption of the recognition and measurement provisions of FIN 48. Therefore, we continue to recognize interest and penalties as incurred within "(Provision for) benefit from income taxes" in our Consolidated Statements of Operations. Our Company makes estimates of the potential liability based on its assessment of all potential tax exposures. In addition, we use factors such as applicable tax laws and regulations, current information and past experience with similar issues to make these adjustments. The increase in our liabilities for unrecognized tax benefits as of the date of adoption of approximately $165 million was due mostly to our assessment of potential exposure concerning a deduction taken in the Company's fiscal 2005 federal income tax return. Despite the Company's belief that its tax return position is supportable, the Company believes that the position may not be fully sustained upon review by tax authorities. Such amount was adjusted to approximately $154 million in the fourth quarter of fiscal 2007 in connection with the Company's fiscal 2006 tax return to provision reconciliation. As we were in a full valuation allowance position, the approximate $11 million adjustment had no effect on the Company's earnings. In addition, the acquisition of Pathmark Stores Inc. increased this balance to the current $164 million. Our Consolidated Balance Sheet has been adjusted to reflect the liabilities for uncertain tax positions and deferred tax assets for net operating losses, since such losses are available to absorb the taxable income attributable to the unrecognized tax 66 benefits. Thus, there was no impact on the Company's retained earnings resulting from the increase in the liability for unrecognized tax benefits. ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk MARKET RISK - ----------- Market risk represents the risk of loss from adverse market changes that may impact our consolidated financial position, results of operations or cash flows. Among other possible market risks, we are exposed to such risk in the areas of interest rates and foreign currency exchange rates. From time to time, we may enter hedging agreements in order to manage risks incurred in the normal course of business including forward exchange contracts to manage our exposure to fluctuations in foreign exchange rates. Interest Rates - -------------- Our exposure to market risk for changes in interest rates relates primarily to our debt obligations. We do not have cash flow exposure due to rate changes on all of our Notes as of November 29, 2008 of $608.3 million because they are at fixed interest rates ranging from 2.0% to 9.375%. However, we do have cash flow exposure on our committed bank lines of credit of $369.7 million due to our variable floating rate pricing. Accordingly, during the 12 and 40 weeks ended November 29, 2008, a presumed 1% change in the variable floating rate would have impacted interest expense by $0.8 million and $2.1 million, respectively. A presumed 1% change in the variable floating rate during the 12 and 40 weeks ended December 1, 2007, would have impacted interest expense by $0.06 million and $0.15 million, respectively. Foreign Exchange Risk - --------------------- We are exposed to foreign exchange risk to the extent of adverse fluctuations in the Canadian dollar. As we have approximately $1.0 million in assets denominated in foreign currency, we do not believe that a change in the Canadian currency of 10% will have a material effect on our Consolidated Statements of Operations or Cash Flows. On November 6, 2007, we entered into a currency exchange forward contract to purchase $380 million United States dollars to hedge the value of our shares in Metro, Inc. against adverse movements in exchange rates. We measure ineffectiveness based upon the change in forward exchange rates. In the third quarter of fiscal 2007 and upon completion of the sale of our shares of Metro, Inc., this forward contract was settled. ITEM 4 - Controls and Procedures We have established and maintained disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Company's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our Company's management, including our President and Chief Executive Officer and Senior Vice President, Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. 67 We carried out an evaluation, under the supervision and with the participation of our Company's management, including our Company's President and Chief Executive Officer along with our Company's Senior Vice President, Chief Financial Officer, of the effectiveness of the design and operation of our Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon the foregoing, our Company's President and Chief Executive Officer along with our Company's Senior Vice President, Chief Financial Officer, concluded that our Company's disclosure controls and procedures were effective as of the period covered by this report. There have been no changes during our Company's fiscal quarter ended November 29, 2008 in our Company's internal control over financial reporting that has materially affected, or are reasonably likely to materially affect, our Company's internal control over financial reporting. CAUTIONARY NOTE - --------------- This presentation may contain forward-looking statements about the future performance of our Company, and is based on our assumptions and beliefs in light of information currently available. We assume no obligation to update this information. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements including but not limited to: competitive practices and pricing in the food industry generally and particularly in our principal markets; our relationships with our employees; the terms of future collective bargaining agreements; the costs and other effects of lawsuits and administrative proceedings; the nature and extent of continued consolidation in the food industry; changes in the financial markets which may affect our cost of capital or the ability to access capital; supply or quality control problems with our vendors; and changes in economic conditions, which may affect the buying patterns of our customers. PART II. OTHER INFORMATION ITEM 1 - Legal Proceedings Refer to Note 20 - Commitments and Contingencies for discussion of our legal proceedings. ITEM 1A - Risk Factors Refer to Item 1A - Risk Factors in our Fiscal 2007 Form 10-K. In addition to the risk factors disclosed in our Fiscal 2007 Form 10-K, the following risk factors have been added to update current year events that could have a negative effect on our Company's financial position and results of operations. o Current economic conditions have been, and continue to be volatile. As a result of concern about the stability of the markets and the strength of counterparties, many financial institutions have reduced and, in some cases, ceased to provide funding to borrowers. Based on information available to us, as of our filing date, we have no indication that the financial institutions acting as lenders under our Credit Agreement would be unable to fulfill their commitments. Continued turbulence in the global credit markets and U.S. economy may adversely affect our results of operations, financial condition and liquidity. 68 ITEM 2 - Unregistered Sales of Equity Securities and Use of Proceeds None ITEM 3 - Defaults Upon Senior Securities None ITEM 4 - Submission of Matters to a Vote of Security Holders None ITEM 5 - Other Information None ITEM 6 - Exhibits (a) Exhibits required by Item 601 of Regulation S-K EXHIBIT NO. DESCRIPTION 10.50 Warehousing, Distribution and Related Services Agreement dated March 7, 2008 by and between our Company and C&S Wholesale Grocers, Inc. (incorporated herein by reference to Exhibit 10.50 to Form 10-Q filed on July 21, 2008) 31.1* Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2* Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * Filed with this 10-Q 69 The Great Atlantic & Pacific Tea Company, Inc. SIGNATURES - ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC. Dated: January 8, 2009 By: /s/ Melissa E. Sungela ----------------------------------------------- Melissa E. Sungela, Vice President, Corporate Controller (Chief Accounting Officer) 70 EX-31 2 ex311f10q32008.txt EXHIBIT 31.1 - ERIC CLAUS CERTIFICATION Exhibit 31.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER Section 302 Certification I, Eric Claus, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Great Atlantic & Pacific Tea Company, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusion about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Eric Claus Date: January 8, 2009 - -------------- Eric Claus President and Chief Executive Officer 71 EX-31 3 ex312f10q32008.txt EXHIBIT 31.2 - BRENDA M. GALGANO CERTIFICATION Exhibit 31.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER Section 302 Certification I, Brenda M. Galgano, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Great Atlantic & Pacific Tea Company, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusion about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Brenda M. Galgano Date: January 8, 2009 - --------------------- Brenda M. Galgano Senior Vice President, Chief Financial Officer 72 EX-32 4 ex32f10q32008.txt EXHIBIT 32 - ERIC CLAUS AND BRENDA M. GALGANO CERTIFICATION Exhibit 32 Certification Accompanying Periodic Report Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. ss. 1350) The undersigned, Eric Claus, President and Chief Executive Officer of The Great Atlantic & Pacific Tea Company, Inc. ("Company"), and Brenda M. Galgano, Senior Vice President, Chief Financial Officer of the Company, each hereby certifies that (1) the Quarterly Report of the Company on Form 10-Q for the period ended November 29, 2008 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and the results of operations of the Company. Dated: January 8, 2009 /s/ Eric Claus -------------- Eric Claus President and Chief Executive Officer Dated: January 8, 2009 /s/ Brenda M. Galgano --------------------- Brenda M. Galgano Senior Vice President, Chief Financial Officer 73 -----END PRIVACY-ENHANCED MESSAGE-----