-----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, WoJfvQJWUTiNdyI0VXkEuGxrqptkiE/Ato9oqHf/HZPPeZTOvuTEf0YqRG/kfekX Pbct2X0xDQN51PNuw5PcIw== 0000850309-96-000005.txt : 19960402 0000850309-96-000005.hdr.sgml : 19960402 ACCESSION NUMBER: 0000850309-96-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19951230 FILED AS OF DATE: 19960329 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMITHS FOOD & DRUG CENTERS INC CENTRAL INDEX KEY: 0000850309 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-GROCERY STORES [5411] IRS NUMBER: 870258768 STATE OF INCORPORATION: DE FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10252 FILM NUMBER: 96542053 BUSINESS ADDRESS: STREET 1: 1550 S REDWOOD RD CITY: SALT LAKE CITY STATE: UT ZIP: 84104 BUSINESS PHONE: 8019741400 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 30, 1995 (fifty-two weeks) Commission File Number: 001-10252 SMITH'S FOOD & DRUG CENTERS, INC. (Exact name of registrant as specified in its charter) Delaware 87-0258768 (State of incorporation) (I.R.S. Employer Identification No.) 1550 South Redwood Road, Salt Lake City, UT 84104 (Address of principal executive offices) (Zip Code) (801) 974-1400 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act Class B Common Stock, $.01 par value New York Stock Exchange (Title of each class) (Name of each exchange on which registered) 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 The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the last sale price of the Class B Common Stock on March 25, 1996: $381,675,455 Number of shares outstanding of each class of common stock as of March 25, 1996: Class A 11,366,532 Class B 13,705,191 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's Proxy Statement for its 1996 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Annual Report on Form 10-K or any amendment to this Annual Report on Form 10-K. [ ] TABLE OF CONTENTS PART I 1 Item 1. Business 1 Item 2. Properties 11 Item 3. Legal Proceedings 12 Item 4. Submission of Matters to a Vote of Security Holders 12 PART II 13 Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters 13 Item 6. Selected Financial Data 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 8. Financial Statements and Supplementary Data 21 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 21 PART III 21 Item 10. Directors and Executive Officers of the Registrant 21 Item 11. Executive Compensation 22 Item 12. Security Ownership of Certain Beneficial Owners and Management 22 Item 13. Certain Relationships and Related Transactions 22 PART IV 22 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 22 INDEX TO FINANCIAL STATEMENTS F-1 SIGNATURES S-1 INDEX TO EXHIBITS E-1 PART I Item 1. Business Smith's Food & Drug Centers, Inc. (the "Company") is a leading supermarket company in the Intermountain and Southwestern regions of the United States, operating 120 stores located in Utah (35), Arizona (30), Nevada (22), New Mexico (19) and Idaho, Texas and Wyoming (collectively, 14). Substantially all of the Company's stores offer one-stop shopping convenience through a food and drug combination format which features a full-line supermarket with drug and pharmacy departments and some or all of the following specialty departments: delicatessens, hot prepared food sections, in-store bakeries, video rental shops, floral shops, one-hour photo processing labs, full-service banking and frozen yogurt shops. The Company's 114 food and drug combination stores averaged approximately 63,000 square feet and $420,000 per week in sales volume in fiscal 1995. The Company has recently opened four price impact warehouse stores and also operates two conventional supermarkets. The Company has substantially completed the sale, lease or closure of its Southern California regional operations. The Company entered into agreements to sell or lease 16 stores and related equipment and three non-operating properties to various supermarket companies and others and has closed its remaining 18 stores (the "California Divestiture"). Management determined that because of the attractive growth prospects in the Company's other principal markets and the competitive environment in Southern California, it would redeploy Company resources from California into such other markets. See "_ California Divestiture." Except as otherwise stated, references to the number of stores operated by the Company give effect to the California Divestiture. The Company was founded in 1948 and reincorporated under Delaware law in 1989. The Company's Class B Common Stock is traded on the New York Stock Exchange under the symbol "SFD". Recent Developments The Company and Cactus Acquisition, Inc., a Delaware corporation and wholly owned subsidiary of the Company ("Acquisition"), entered into a Recapitalization Agreement and Plan of Merger, dated as of January 29, 1996 (the "Recapitalization Agreement"), with Smitty's Supermarkets, Inc. ("Smitty's"), a regional supermarket operator with 28 supermarkets in the Phoenix and Tucson areas, and The Yucaipa Companies ("Yucaipa"), a private investment group specializing in the supermarket industry. In the Recapitalization Agreement, the Company has agreed, subject to the terms and conditions described therein to: (i) commence a tender offer (the "Offer") to purchase 50% of the Company's outstanding Class A Common Stock, par value $.01 per share ("Class A Common Stock"), and Class B Common Stock, par value $.01 per share ("Class B Common Stock"; and, together with the Class A Common Stock, the "Common Stock") (excluding shares issuable in the Merger referred to below), for $36.00 in cash per share; and (ii) consummate the merger of Smitty's with Acquisition, pursuant to which Smitty's will become a wholly owned subsidiary of the Company and the stockholders of Smitty's will receive 3,038,888 shares of Class B Common Stock of the Company (the "Merger"). The Merger will significantly enhance the Company's market position in Arizona. Following the Merger, the Company will consolidate its Arizona operations with those of Smitty's. See "_ Operating Strategy Following the Consummation of the Transactions." It is anticipated that the Offer and the Merger will close simultaneously, except in certain limited circumstances. As part of the Recapitalization (as defined below) and Merger (collectively, the "Transactions"), the Company intends to: (i) purchase 50% of its outstanding Common Stock for approximately $451.4 million; (ii) repay approximately $667.9 million of indebtedness of the Company and approximately $101.9 million of indebtedness of Smitty's; (iii) purchase up to half of the outstanding management stock options of the Company for approximately $13.7 million; and (iv) purchase approximately $1 million of its Series I Preferred Stock, par value $.01 per share (the "Series I Preferred Stock"). In addition, the Company will pay related debt refinancing premiums, accrued interest and fees and expenses in connection with the Transactions. As part of the Recapitalization, the Company will enter into a management services agreement (the "Management Services Agreement") with Yucaipa and will issue warrants to Yucaipa pursuant to a warrant agreement (the "Warrant Agreement") to purchase shares of a new non-voting Class C Common Stock, par value $.01 per share ("Class C Common Stock"), of the Company, representing 10% of the aggregate common shares on a fully diluted basis, for an initial exercise price of $50 per share, subject to certain conditions and exceptions. Under the Management Services Agreement, Yucaipa will provide certain management consulting services and Ronald W. Burkle, the managing general partner of Yucaipa, will become Chief Executive Officer of the Company. Mr. Burkle, along with another designee of Yucaipa, will be nominated to become a member of the Company's Board of Directors. To consummate the Transactions, the Company will require approximately $1,432.7 million of financing to repay certain outstanding indebtedness of the Company and Smitty's, purchase Common Stock in the Offer, purchase shares of Series I Preferred Stock, purchase management stock options, and pay related fees and expenses. The Company plans to obtain the necessary funds by (a) borrowings of approximately $707.7 million aggregate principal amount under a new senior credit facility (the "New Credit Facility"); (b) the issuance of up to $250 million of new senior notes (the "New Senior Notes"); (c) the issuance of up to $400 million of new senior subordinated notes (the "New Senior Subordinated Notes"); and (d) the issuance of new cumulative redeemable exchangeable preferred stock (the "New Preferred Stock") by the Company for gross proceeds of $75 million. In addition, the Company will assume approximately $43.2 million of existing indebtedness of Smitty's upon consummation of the Merger. The "Recapitalization" as defined in the Recapitalization Agreement refers collectively to: (i) the execution, delivery and receipt of the proceeds under the financing agreements to be entered into by the Company; (ii) the making and consummation of the Offer; (iii) the execution and delivery of the Management Services Agreement; (iv) the execution and delivery of, and the issuance of the warrants provided for under, the Warrant Agreement; (v) the completion of certain transactions contemplated by the Recapitalization Agreement regarding the composition of the Company's Board of Directors, the election of Ronald Burkle as Chief Executive Officer, the cash payment for a portion of, and the reduction of the exercise price for a portion of, the Company's management stock options and the amendment of the Company's deferred compensation agreements; and (vi) the filing of the Amended and Restated Certificate of Incorporation for the Company. Principal Markets The Company's stores are located predominantly in Utah, Arizona, Nevada and New Mexico, which are among the fastest growing states in terms of population and employment. According to the U.S. Bureau of the Census, the population of those four states has increased at a compound annual growth rate of 3.0% since 1990, compared to the national average of 1.1% over the same period. According to the U.S. Bureau of Labor Statistics, employment in the same four states has increased at a compound annual growth rate of 4.0% since 1990, compared to the national average of 1.3% over the same period. In addition, management believes that operating in distinct markets in several states provides advantages due to the differences in economic cycles, demographics and competitive conditions among such markets. The Company has achieved strong competitive positions in each of its principal markets. The Company currently has leading market shares in Salt Lake City (31%), Las Vegas (24%) and Albuquerque (23%) and, after giving effect to the Merger, the Company will also have a leading market share in Phoenix (24%). The Company believes its reputation for offering a broad product selection and low pricing combined with quality customer service has created a valuable franchise with strong name recognition and customer loyalty. Store Formats The Company operates three types of retail stores: (i) 114 food and drug combination stores; (ii) four warehouse stores; and (iii) two conventional supermarkets. The food and drug combination stores range in size from 30,000 to 88,000 square feet (with an average size of 63,000 square feet) and offer an extensive line of supermarket, non-food and drug products. The Company's typical food and drug combination store offers approximately 50,000 SKUs, in comparison to approximately 20,000 SKUs offered at the average conventional supermarket nationwide. All stores carry a full line of supermarket products, including groceries, meat, poultry, produce, dairy products, bakery goods, frozen foods and health and beauty aids. In addition, combination stores carry a wide variety of general merchandise, including drugs, toys, hardware, giftware and small appliances. Within each category of merchandise, the stores offer multiple selections of nationally advertised brand name items. In addition, the stores carry an extensive selection of private label merchandise, which provides comparable quality products priced lower than national brands. The Company also carries a variety of bulk merchandise and generic brand products which enhance the Company's low price image. These stores feature modern layouts with wide aisles and well-lighted spaces to facilitate convenient shopping, a variety of specialty departments along the periphery and centralized checkout facilities. The Company's four price impact warehouse stores operating under the PriceRite Grocery Warehouse name, average 55,000 square feet in size, and are targeted to price-conscious consumers rather than conventional supermarket consumers. The PriceRite stores offer lower prices, fewer SKUs and fewer service departments than the Company's food and drug combination stores and conventional stores. The Company's conventional stores average 26,000 square feet in size and have the appearance of traditional supermarkets. Store Development and Expansion The following table sets forth information concerning changes in the store base of the Company over the last five years. 1991 1992 1993 1994 1995 Stores Opened (Net): Intermountain and Southwest 5 1 2 2 15 California 9 9 8 6 2 Total Number of Stores (end of period): Intermountain and Southwest 100 101 103 105 120 California 9 18 26 32 34 Not including California operations, approximately 80% of the Company's stores have been opened or remodeled within the last seven years. Over the past five fiscal years, the Company's capital expenditures for the construction of new and remodeled stores (not including California operations) totaled approximately $414.0 million. In addition, during the same period the Company invested approximately $163.0 million in distribution, processing and other support facilities (not including California operations). The Company's real estate department locates, acquires and develops sites for future stores. The Company's 48 years of operation have allowed it to choose its store locations selectively as new residential areas have been developed. The Company believes that many of its stores are in developed areas where land values and the difficulties in locating suitable parcels would make it difficult to replicate the Company's existing store base. The Company has historically sought to purchase the best potential new store locations available in any target market. If the Company cannot purchase the best potential locations, however, it will consider leasing a location from its owner or a local developer. As a result of this strategy, giving effect to the California Divestiture, the Company owned 95 of its 120 stores, including the underlying land with respect to 86 of such owned stores, as of December 30, 1995. See "Item 2. Properties." In order to maximize its future capital expenditure resources, the Company intends to place a greater emphasis on leasing new stores following the consummation of the Transactions. Merchandising The Company's merchandising strategy is to offer customers the ability to fulfill a significant portion of their daily and weekly shopping needs at one convenient location and to establish and promote its reputation as a low price leader in the trade area of each of its stores. The cornerstones of this strategy include: Everyday Low Pricing. The Company offers its products on an everyday low pricing ("EDLP") basis in all markets other than Phoenix and Tucson, where the Company offers a combination of EDLP and promotional pricing. The Company offers an EDLP program in most markets because the Company believes that it generally allows for higher overall profitability than a promotional pricing program. An EDLP program allows for more consistent prices over time than a promotional program, which entails variable pricing and higher levels of demand for sale products. As a result, EDLP simplifies inventory management and lowers operating costs. Quality Customer Service. The Company believes a key to its success is its emphasis on quality customer service. The Company provides courteous and efficient customer service by placing a high degree of emphasis on employee training. Most stores have a customer service counter located near the store entrance to answer questions and to assist customers in locating merchandise. The Company also provides rapid in-store checkout services, aided by the use of computerized scanning devices and the bagging of groceries at checkout. In most locations, stores are open 24 hours each day. Advertising and Promotion. The Company reinforces its low price image through extensive television advertising and through print advertising in newspapers and circulars. The Company divides its advertising budgets in a similar manner across its markets, with approximately 80% committed to print advertising and approximately 20% committed to radio and television advertising. The Company also takes an active interest in the communities in which its stores are located and maintains programs designed to contribute funds, products and manpower to local charities and civic groups. Specialty Departments. Each combination store provides certain specialty departments designed to provide one-stop shopping convenience to customers and to increase the frequency with which customers return to the store. The specialty departments, which vary depending upon store size and location, include delicatessens with prepared foods, full-service fresh fish and meat departments, bakeries, dry cleaning drop-off facilities, U.S. Post Office branches, pharmacies, video rental departments, take-out food counters, camera and photo departments with on-site film processing, floral departments and in-store banking provided by a regional or local bank. Private Label Program. Through its private label program, the Company offers in excess of one thousand items under the "Smith's," "Mountain Dairy," "Creek View" and other brand names. These products provide customers with quality comparable to that of national brands but at lower prices. Management believes that the Company's private label program is one of the most successful programs in the industry. The Company's owned manufacturing and processing facilities, including its milk and beverage plants, cultured dairy products plant, ice cream processing plant and frozen dough plant, supply the Company's stores with private label milk, milk products, fruit punches, sour cream, yogurt, cottage cheese, chip dip products, ice cream and novelty items, baked goods and other products and allow the Company to generate gross margins on such private label items that are generally higher than on national brands. Operations The Company is divided into two major operating regions, the Intermountain Region and the Southwest Region, which are segmented into eight geographic districts. The Intermountain Region consists of stores in Utah, Idaho, Nevada and Wyoming. The Southwest Region consists of stores in Arizona, New Mexico and Texas. The districts are staffed with operational managers who are given as much autonomy as possible while retaining the advantages of central control over accounting, real estate, legal, data processing and other functions at the Company's headquarters. This operational autonomy enables management to react quickly to changes in local markets. District and store managers are responsible for store operations, local advertising formats, employee relations and development, customer relations, community affairs and other functions relating to local operations. The regional staff includes supervisors responsible for the meat, produce, bakery, non-food, pharmacy, one-hour photo, deli and prepared foods departments, who help each regional manager. Purchasing, Distribution and Processing The Company's purchasing activities are regionally centralized, with most food products and all general merchandise being purchased in volume through regional buyers supervised by headquarter's management. Certain specialized or perishable products are purchased at regional warehouse levels. The Company owns and operates one of the most modern and efficient backstage operations in the industry. The Company's warehousing, distribution and processing facilities, which comprise approximately 3,000,000 square feet, have all been built, expanded or remodeled in the last five years. Central distribution facilities in Salt Lake City and Layton, Utah supply products to all stores in the Intermountain Region and distribute the majority of non-food merchandise, pharmaceutical products and certain bulk products to stores in the Southwest Region. An integrated distribution and processing center in Tolleson, Arizona includes complete warehousing operations and a dairy processing plant. The facility supplies products to all stores in the Southwest Region and Las Vegas. The Company also operates two produce warehouses, one in Ontario, California and the other in Albuquerque, New Mexico. See "Item 2. Properties." Approximately 80% of products sold in 1995 were shipped through the Company's distribution network. The Company transports food and merchandise from its distribution centers primarily through a Company-owned fleet of tractors and trailers which primarily serve nearby stores and through common carriers for stores located at greater distances. As of December 30, 1995, the Company's owned fleet included 158 tractors and 406 trailers. The Company seeks to lower costs on shipments by taking advantage of backhauling opportunities where available. The Company's processing facilities located in Tolleson, Arizona and Layton, Utah produce a variety of products under the Company's private label for distribution to Company stores. The Company's dairy plants process a variety of milk, milk products and fruit punches. The Company's automated frozen dough plant produces frozen bakery goods for final baking at in-store bakeries. The Company's cultured dairy products plant produces sour cream, yogurt, cottage cheese and chip dip products. The Company's ice cream processing plant supplies all stores with the Company's private label ice cream and novelty items. The Company believes that its central distribution facilities provide several advantages. Management is able to control inventory levels throughout its system in order to maximize the Company's in-stock position, while at the same time optimizing the use of store shelf space. Costs of products are reduced through centralized volume purchases and effective management of per- item transportation costs. Stores are also served more efficiently through central control of delivery schedules. By managing overall inventory levels, the Company seeks to maximize inventory turns and minimize investments in inventory. Management believes the Company's backstage operations will be able to accommodate the increased volume resulting from the integration of the Smitty's operations in Arizona following the Merger and to support anticipated future growth. Information Systems and Technology The Company is currently supported by a full range of advanced management systems. The Company has implemented store-level inventory and item management systems developed on UNIX in-store processors using the Informix relational database. This application includes direct store delivery store receiving, which allows goods to be scanned electronically upon arrival at each store receiving dock. This system also includes price verification and order entry using hand-held personal computers. Store checkout is supported by NCR point- of-sale scanning. The Company's stores are supported by pharmacy, video rental, labor scheduling and time and attendance systems which help the Company facilitate customer service while managing labor costs. The Company's buying operations are supported by the AS/400-based E3 forecasting and purchasing system which uses statistical models of seasonality, promotions and buying behavior to optimize inventory levels. The Company's distribution centers operate utilizing leading software of the Dallas Systems Company. The key components are the Distribution Center Management Control System, which is used for all inventory processing, and the Distribution Center Assignment Monitoring System (DCAMS), which is used for labor standards management. To increase operating efficiency and decrease labor costs, the DCAMS system transmits work assignments to lift drivers and order selectors through a radio-frequency terminal. The Company is currently installing the OMI purchasing and forecasting system which will be used for distribution center replenishment. The installation is expected to be completed during 1996. The Company's computer operations and applications development activities were outsourced to Electronic Data Systems in 1992 under a ten-year outsourcing agreement. Competition The supermarket industry is highly competitive and characterized by narrow profit margins. The Company's competitors include national and regional supermarket chains, independent and specialty grocers, drug and convenience stores and the newer "alternative format" food stores, including warehouse club stores, deep discount drug stores and "supercenters." The Company's competitors continue to open new stores in the Company's existing markets. In addition, new competitors have entered the Company's markets in the past and could do so in the future. Supermarket chains generally compete on the basis of price, location, quality of products, service, product variety and store condition. The Company regularly monitors its competitors' prices and adjusts its prices and marketing strategy as management deems appropriate in light of existing conditions. Some of the Company's competitors have greater financial resources than the Company and could use those resources to take steps which could adversely affect the Company's competitive position. The Company's ability to respond to competitive pressures following the consummation of the Transactions could be adversely affected by its highly leveraged financial condition. The Company's principal supermarket competitors in the Salt Lake City market are Albertson's, Ream's Food Stores, Harmons, Fred Meyer, and Dan's Foods. In the Phoenix market, the Company's principal competitors include Fry's, Bashas Markets, Safeway, ABCO, Smitty's, Albertson's, Mega Foods and, prior to the Merger, Smitty's. In Albuquerque, the Company's principal competitors are Furr's, Jewel Osco and Albertson's, and in Las Vegas, the Company's main competitors are Lucky, Vons and Albertson's. The Company also competes with various drug chains and other non-food operators in each of its markets. Employees and Labor Relations The Company's policy is to train and develop its employees and promote from within. The Company generally prefers to promote its own employees to store manager positions. Management-level employees, including store department managers, participate in incentive compensation programs tied to profitability, and such compensation programs can represent a significant percentage of such managers' total compensation. The Company believes that its employee retention rate is high within the industry, especially at the store-manager level and above. Excluding California operations, as of December 30, 1995, the Company employed approximately 16,000 persons, approximately 53% of whom were full-time and 47% of whom were part-time. Approximately 50% of the Company's employees are unionized. The Company's unionized employees work under 15 collective bargaining agreements with local labor unions, primarily in Arizona, Nevada and New Mexico, which typically have three-year terms. Management of the Company believes that it will be able to renew existing agreements on terms satisfactory to the Company. If it is unable to do so, however, there could be a material adverse effect on the Company's operations. The wages and benefits provided in the Company's collective bargaining agreements are substantially similar to those of its supermarket competitors. The Company has not experienced a work stoppage in the past ten years and considers its relations with its employees and labor unions to be satisfactory. Environmental Matters The Company is subject to a variety of environmental laws, rules, regulations and investigative or enforcement activities, as are other companies in the same or similar business. The Company believes it is in substantial compliance with such laws, rules and regulations. These laws, rules, regulations and agency activities change from time to time, and such changes may affect the ongoing business and operations of the Company. The Company, from time to time, has or may in the future receive requests from environmental regulatory authorities to provide information or to conduct investigation or remediation activities. None of these requests is expected by management to have a material adverse effect on the Company's business. Governmental Regulation The Company is subject to regulation by a variety of governmental authorities, including federal, state and local agencies which regulate the distribution and sale of alcoholic beverages, pharmaceuticals, milk and other agricultural products, as well as various other food and drug items and also regulate trade practices, advertising, building standards, labor, health, safety and environmental matters. The Company from time to time receives inquiries from state and federal regulatory authorities with respect to its comparative advertising practices, pricing policies, employment practices and other trade practices. None of these inquiries, individually or in the aggregate, has resulted, or is expected by management to result, in any order, judgment, fine or other action that has, or would have, a material adverse effect on the business or financial position of the Company. Trade Names, Service Marks and Trademarks The Company uses a variety of trade names, service marks and trademarks in its business including "Smith's," "Smith's Food & Drug Centers," "Mountain Dairy," "Creek View," "PriceRite," and numerous others. While the Company believes its trademarks are important to its business, except for "Smith's," "Smith's Food & Drug Centers" and "PriceRite," the Company does not believe any of such trademarks are critical to its business. California Divestiture In late 1995, management determined that because of the attractive growth prospects of the Company's principal markets and the competitive environment in California, the Company would attempt to sell its California operations and redeploy its resources into its non-California markets. In December 1995, the Company entered into an agreement to sublease its Riverside, California distribution center to Ralphs Grocery Company ("Ralphs"), an affiliate of Yucaipa. On January 29, 1996, Ralphs commenced the sublease of the Riverside distribution center and dairy plant for an initial term of 23 years. Ralphs also purchased certain equipment and inventory for an aggregate purchase price (net of certain offsetting payments) of approximately $8.7 million. The sublease provides for a subrental of approximately $8.8 million per annum, which is substantially the same amount as is payable by the Company under the master lease, and requires Ralphs to fulfill substantially all of the other monetary obligations of the Company under the master lease. In January 1996, the Company entered into agreements to sell or lease 16 of its California stores and three non-operating properties. The Company has substantially completed the sale of these stores, including related equipment and inventory. Of the 16 sold stores, the Company has leased or subleased eight operating stores and one non-operating store to Ralphs. The non- operating store, located in Beaumont, California, is partially completed, and has been subleased by Ralphs in "as is" condition. The subleases to Ralphs are for terms, and at subrentals, that are substantially equivalent to the terms of, and the rentals payable under, the master store leases (except that Ralphs is not responsible for rent escalations in the master store lease of one of the subleased stores). The remaining eight stores were sold to other supermarket companies, four pursuant to outright sales, two pursuant to assignments of underlying leases and two pursuant to subleases. The two subleases are subject to early termination if the Company has not satisfied certain conditions within 18 months. The Company has substantially completed the California Divestiture transactions described above and, since December 30, 1995, has received net cash proceeds of approximately $67.2 million (excluding store inventory). The Company expects to receive approximately $10.6 million of additional cash proceeds shortly following the consummation of the Transactions. As of March 16, 1996, all of the unsold California stores have been closed. In connection with its decision to cease operations in California, the Company recorded pre- tax restructuring charges of $140 million for the year ended December 30, 1995 to reflect the anticipated cost to the Company of the California Divestiture. In connection with the California Divestiture, the Company entered into a settlement agreement with the California Attorney General (the "CAG") relating to the stores that were sold, leased, or closed. Under the settlement agreement, the Company agreed that, for a period of five years, it would not operate any of the closed stores as supermarkets without the permission of the CAG. In addition, for the same five-year period, the Company agreed not to (i) transfer the closed stores to third parties for supermarket use without the CAG's approval, (ii) transfer such stores for non-supermarket use without prior notice to the CAG, and (iii) sell any of such stores subject to restrictions as to future supermarket use. Description of Smitty's Business Smitty's is a leading regional supermarket operator based in Phoenix, Arizona which through its wholly owned subsidiary, Smitty's Super Valu, operates 25 stores in the Phoenix area and three stores in the Tucson area. Smitty's stores provide high quality fresh and prepared foods, groceries, general merchandise, restaurants and ancillary services in a shopping environment which emphasizes service, convenience, quality, selection and customer satisfaction. Smitty's Super Valu's 35-year presence in the Phoenix community has enabled it to locate its stores in strategic and convenient sites. These locations, together with Smitty's unique super combination store format, have provided it with high name recognition and customer loyalty. Store Formats. Smitty's, which will become a subsidiary of the Company upon consummation of the Merger, currently operates (i) 21 food and general merchandise "super combination" stores which average 105,000 square feet in size, (ii) six food and drug combination stores, which average 63,000 square feet in size, and (iii) one conventional supermarket. Smitty's "super combination" stores offer a full line of supermarket items, a broad range of drug store and pharmaceutical items and an expanded selection of general merchandise. These stores offer numerous services and specialty departments, including fresh produce, full-service fresh meat, delicatessen, seafood, bakery, prepared foods, fresh-cut flowers and video and photo departments, pharmacies, food courts, restaurants and full-service bank branches, family style hair salons and airline ticket counters. The food and drug combination stores offer a full selection of products and services, including full-service fresh meat, delicatessen, seafood and bakery departments, an expanded line of health care and beauty aids, a restaurant, snack bar or food court and full- service banking. Purchasing and Distribution. Smitty's currently makes approximately 60% of its annual purchases from the Arizona division of Fleming Foods West, Inc. ("Fleming"). Smitty's has reached an agreement in principle with Fleming to amend the supply agreements to make Fleming a back-up supplier to Smitty's through the end of 1997. Employees and Labor Relations. As of January 14, 1996, Smitty's employed 4,600 people, of whom approximately 36% were full-time and approximately 64% were part-time. Approximately 4,100 employees working in the stores, constituting approximately 89% of Smitty's employees, are covered by a collective bargaining agreement that expires in October 1997. Smitty's has not experienced a work stoppage in the past ten years and considers its relations with its employees and the unions to be satisfactory. Frequent Shopper Program. Smitty's has developed a proprietary information system that updates and maintains a comprehensive customer database used for its unique frequent shopper program, Shopper's Passport. Customers obtain a Shopper's Passport bar-coded scan readable card which entitles them to receive a number of benefits, including discounts on certain purchases, check cashing authorization and participation in special promotions held throughout the calendar year. Management believes that as a result of this program, Shopper's Passport has established one of the most comprehensive supermarket customer data bases in the country. The Company is evaluating plans to utilize the Shopper's Passport program in the Company's stores throughout the Phoenix and Tucson markets following the Merger. Trade Names, Service Marks and Trademarks. Smitty's uses a variety of trade names, service marks and trademarks. Except for "Smitty's" and "Shopper's Passport," the Company does not believe any of such tradenames, service marks or trademarks is material to Smitty's business. Operating Strategy Following Consummation of the Transactions Management, in conjunction with Yucaipa, has developed a strategic plan designed to: (i) expand operations in existing and adjacent markets, (ii) realize operating synergies and cost savings resulting from the Merger, (iii) improve working capital management, (iv) grow its recently introduced price impact warehouse stores and (v) dispose of remaining California real estate following consummation of the Transactions. Expand Operations in Existing and Adjacent Markets. Management believes that there are significant opportunities to increase the Company's sales and gain efficiencies in its existing markets through new store openings and store remodels. From 1991 through 1994, management primarily focused on the Southern California market, opening a net of 32 new stores in Southern California compa- red to a net of 10 new stores in its other markets. In 1995, the Company opened 19 new stores, only two of which were located in California. In an effort to more fully realize its market potential in its non-California markets, in 1995 the Company began opening smaller combination stores (54,000 to 60,000 square feet) in existing markets as part of a "fill-in" strategy. By pursuing a growth strategy which emphasizes opening new stores within its existing and adjacent markets, the Company believes it can increase its market share and improve its distribution and other efficiencies, while taking advantage of such markets' favorable growth prospects. Realize Operating Synergies and Cost Savings Resulting from the Merger. Management believes that approximately $25 million of net annual cost savings are achievable over a three-year period following the Merger. The majority of such cost savings opportunities relate to its Arizona operations and are believed to be achievable (on an annualized basis) by the end of the first full year of operations following the Merger. It is anticipated that approximately $17 million of capital expenditures and approximately $10 million of other expenses will be required to integrate the Arizona operations and realize such cost savings. The estimates of potential cost savings resulting from the Merger contained in this report are forward looking statements that involve risks and inherent uncertainties that could cause actual net annual cost savings to differ materially from those projected. See "_Ability to Achieve Anticipated Cost Savings" below. In connection with the Transactions, the Company and Smitty's are evaluating the format mix of the combined Arizona store base and are assessing the possibility of modifying the formats of certain stores. Improve Working Capital Management. Management believes that the Company can improve its working capital management. Under Yucaipa's management, other companies have achieved working capital improvements; however, there can be no assurance that similar improvements can be achieved by the Company. Grow Recently Introduced Price Impact Warehouse Format. The Company recently developed a price impact warehouse store format and during 1995 opened four of these stores in the Las Vegas area operating under the name "PriceRite Grocery Warehouse." Management believes that a number of the Company's markets are underserved by price impact warehouse stores and that there are substantial opportunities for expansion of the Company's PriceRite format through the conversion of existing stores and the opening of new stores. Yucaipa, through its management of other supermarket companies, has extensive experience in expanding and profitably operating price impact warehouse formats. Dispose of Remaining California Real Estate. Following the consummation of the Transactions, management, in conjunction with Yucaipa, anticipates that it will pursue a strategy to dispose of certain real estate assets in California, including leased and owned stores, non-operating, and excess land. The Company would use the net cash proceeds from the sale of these assets to either reinvest in the Company's business or reduce indebtedness incurred in connection with the Transactions. At December 30, 1995, the aggregate book value of such assets was approximately $260 million. If this strategy is adopted, as anticipated, the Company would record a charge to earnings, which could be substantial, to reflect the difference between the anticipated cash proceeds from the accelerated dispositions and the Company's existing book values and carrying costs for such assets. Ability to Achieve Anticipated Cost Savings Management of the Company has estimated that approximately $25 million of annualized net cost savings (as compared to such costs for the pro forma combined fiscal year ended December 30, 1995) can be achieved over a three-year period as a result of integrating the Arizona operations of the Company and Smitty's. These estimates of potential cost savings are forward looking statements that are inherently uncertain. Actual cost savings, if any, could differ materially from those projected. All of these forward looking statements are based on estimates and assumptions made by management of the Company, which although believed to be reasonable, are inherently uncertain and difficult to predict; therefore, undue reliance should not be placed upon such estimates. There can be no assurance that the savings anticipated in these forward looking statements will be achieved. The following important factors, among others, could cause the Company not to achieve the cost savings contemplated herein or otherwise cause the Company's results of operations to be adversely affected in future periods: (i) continued or increased competitive pressures from existing and new competitors and new entrants, including price-cutting strategies; (ii) unanticipated costs related to the Recapitalization and Merger and the operations of the Company and Smitty's; (iii) loss or retirement of key members of management or the termination of the Management Services Agreement with Yucaipa; (iv) inability to negotiate more favorable terms with suppliers or to improve working capital management; (v) increases in interest rates or the Company's cost of borrowing or a default under any material debt agreements; (vi) inability to develop new stores in advantageous locations or to successfully convert existing stores; (vii) prolonged labor disruption; (viii) deterioration in general or regional economic conditions; (ix) adverse state or federal legislation or regulation that increases the costs of compliance, or adverse findings by a regulator with respect to existing operations; (x) loss of customers as a result of the conversion of store formats; (xi) adverse determinations in connection with pending or future litigations or other material claims against the Company; (xii) inability to achieve future sales levels and other operating results that support the cost savings, and (xiii) the unavailability of funds for capital expenditures. Many of such factors are beyond the control of the Company. In addition, there can be no assurance that unforeseen costs and expenses or other factors will not offset the projected cost savings in whole or in part. Item 2. Properties As of December 30, 1995, giving effect to the California Divestiture, the Company would have owned 95 of its 120 operating stores, including the underlying land with respect to 86 of such owned stores. The Company's stores are located throughout a seven-state area as follows: State Stores Owned Stores Leased Total Arizona 27 3 30 Utah 30 5 35 Nevada 12 10 22 New Mexico 15 4 19 Idaho 4 1 5 Wyoming 3 2 5 Texas 4 0 4 -- -- --- Total 95 25 120 == == === The Company leases or subleases 25 of its operating stores from third parties under leases expiring between 1997 and 2023. Nine of the Company-owned stores are located on property which is ground-leased from third parties under leases expiring between 2007 and 2045. In most cases, such building and ground leases are subject to customary renewal options. The Company owns a 1,180,000 square-foot distribution and dairy processing center in Tolleson, Arizona, 573,000 square feet of grocery warehousing facilities and 348,000 square feet of processing plants in Layton, Utah and a 226,000 square foot non-food warehouse in Salt Lake City, Utah. The Company also leases a 40,000 square-foot produce and forward-purchasing warehouse in Albuquerque, New Mexico, a 408,000 square-foot non foods warehouse in Salt Lake City, Utah and a 205,000 square-foot produce warehouse in Ontario, California, under leases expiring in 1997, 1997 and 1999, respectively. The Company's corporate offices, data processing and records storage facilities are located in over 100,000 square feet of office and warehouse space owned by the Company in Salt Lake City, Utah. Item 3. Legal Proceedings The Company, in the ordinary course of its business, is party to various legal actions. Management believes these are routine in nature and incidental to the operations of the Company. Management believes that the outcome of any proceedings to which the Company is currently a party will not, individually or in the aggregate, have a material adverse effect on the operations or financial condition of the Company. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of fiscal 1995. PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters The Company's Class B Common Stock is listed on the New York Stock Exchange under the symbol "SFD". The following table shows the high and low sales prices per share for all quarters of fiscal 1994 and 1995: High Low ------- ------- Fiscal 1994 First Quarter $24 1/8 $20 1/8 Second Quarter 22 18 1/8 Third Quarter 24 3/4 18 1/2 Fourth Quarter 26 3/4 22 5/8 Fiscal 1995 First Quarter $27 5/8 $23 Second Quarter 24 19 1/4 Third Quarter 20 1/4 18 1/8 Fourth Quarter 27 3/4 19 3/8 As of March 25, 1996, there were 236 Class A Common Stockholders and 1,129 Class B Common Stockholders of record. There are numerous stockholders who hold their Class B Common Stock in the "street name" of their various stock brokerage houses. Cash dividends of $.15 per share of Class A Common Stock and Class B Common Stock were paid in each of the four quarters of fiscal 1995, totaling $.60 per common share for fiscal 1995. Cash dividends of $.13 per share of Class A Common Stock and Class B Common Stock were paid in each of the previous quarters of fiscal 1994, totaling $.52 per common share for fiscal 1994. The Company paid a quarterly cash dividend of $.15 per common share for the first quarter of fiscal 1996. However, as described under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation_Liquidity and Capital Resources," the Company intends to discontinue the payment of cash dividends on the Common Stock following the consummation of the Transactions and the payment of future dividends will be severely restricted by the terms of the financing agreements entered into by the Company in connection with the Transactions. Item 6. Selected Financial Data The following table sets forth selected consolidated historical financial and other data of the Company for the five fiscal years ended December 30, 1995, which have been derived from the financial statements of the Company audited by Ernst & Young LLP, independent auditors. The following information should be read in conjunction with the historical consolidated financial statements of the Company and related notes thereto included elsewhere herein.
52 Weeks 53 Weeks 52 Weeks 52 Weeks 52 Weeks Ended Ended Ended Ended Ended December 28, January 2, January 1, December 31, December 30, 1991 1993 1994 1994 1995 ------------ ---------- ----------- ------------ ------------ (dollars in millions, except per share data) Operating Data: Net sales $ 2,217.4 $ 2,649.9 $ 2,807.2 $ 2,981.4 $ 3,083.7 Gross profit 498.6 611.6 637.2 669.1 697.0 Operating, selling and administrative expenses 344.4 419.7 430.3 440.8 461.4 Depreciation and amortization 50.5 67.8 82.2 94.5 105.0 Interest expense 30.3 36.1 44.6 53.7 60.5 Restructuring charges(a) - - - - 140.0 Net income (loss) 45.1 53.7 45.8 48.8 (40.5) Net income (loss) per common share $ 1.65 $ 1.79 $ 1.52 $ 1.73 $ (1.62) Weighted average common shares outstanding 27,397,973 29,962,011 30,238,811 28,176,907 25,030,882 Balance Sheet Data (end of period): Working capital $ 30.7 $ 91.2 $ 160.4 $ 62.3 $ 162.7 Total assets 1,196.7 1,486.1 1,654.3 1,653.5 1,686.2 Total debt(b) 395.4 612.7 725.5 718.9 746.2 Redeemable preferred stock 8.5 7.5 6.5 5.4 4.3 Total stockholders'equity $ 474.4 $ 515.4 $ 542.2 $ 475.3 $ 416.7 Other Data: Stores open at end of 109 119 129 137 154 period(c) Capital expenditures $ 281.6 $ 208.0 $ 322.3 $ 146.7 $ 149.0 Ratio of earnings to fixed charges(d) 3.02x 3.06x 2.55x 2.18x 1.92x
_____________________ (a) Reflects charges in connection with the California Divestiture. See Note K to Notes to Consolidated Financial Statements of the Company included elsewhere herein. (b) Total debt includes long-term debt and current maturities of long-term debt. (c) After giving effect to the California Divestiture, the Company will operate 120 stores. See "Item 1. Business." (d) For purposes of computing the ratio of earnings to fixed charges, "earnings" consist of earnings before income taxes, restructuring charges and fixed charges. "Fixed charges" consist of interest expense, amortization of deferred debt issuance costs and one-third of rental expense (the portion deemed representative of the interest factor). For the five- year period ended December 30, 1995, the Company has not paid any preferred stock dividends. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Due to the Transactions and the California Divestiture, the Company believes that its future operating results may not be directly comparable to its historical operating results. Certain factors which are expected to affect the future operating results of the Company (or their comparability to prior periods) are discussed below. California Divestiture. The Company has historically focused on expansion into high growth markets, which led to its entrance into Southern California in 1991. During the period from 1991 through 1995, the Company opened 34 stores in Southern California and a 1,100,000 square foot distribution center and dairy plant in Riverside, California. Management determined that because of the attractive growth prospects in the Company's other principal markets and the competitive environment in Southern California, it would redeploy Company resources from California into such other markets. In December 1995 the Company executed a sublease with Ralphs pursuant to which Ralphs agreed to sublease the Riverside distribution center and dairy plant for the remaining 23- year term of the Company's lease. Ralphs also agreed to purchase certain related equipment and inventory. The sublease term commenced and the related purchases were consummated on January 29, 1996. In January 1996, the Company entered into agreements to sell or lease 16 of its California stores and related equipment and three non-operating properties to various supermarket companies (including Ralphs) and others and indicated that the remaining 18 stores would be closed as soon as practicable. Of the stores being sold or leased, four stores owned by the Company are being sold outright, two store leases are being assigned, three stores owned by the Company are being leased and seven leased stores are being subleased. Since December 30, 1995, the Company has received net cash proceeds of approximately $67.2 million from the store, equipment and property sales and expects to receive an additional approximately $10.6 million shortly after the consummation of the Transactions. As of March 16, 1996, all of the California stores have been closed. In connection with its decision to cease operations in California, the Company recorded pre-tax restructuring charges of $140 million for the year ended December 30, 1995 to reflect the anticipated cost to the Company of the California Divestiture. See Note K of the Notes to Consolidated Financial Statements of the Company. Certain information pertaining to the Company's California operations is summarized below:
52 Weeks 53 Weeks 52 Weeks 52 Weeks 52 Weeks Ended Ended Ended Ended Ended December 28, January 2, January 1, December 31, December 30, 1991 1993 1994 1994 1995 ------------ ---------- ---------- ----------- ------------ (dollars in millions) California stores at end of period 9 18 26 32 34 Net sales $ 35.9 $320.4 $472.8 $652.9 $674.6 Capital expenditures: Stores 118.4 160.0 136.1 53.0 23.4 Backstage facilities 1.1 33.8 80.6 2.7 1.3 ------ ------ ------ ------ ------ Total capital expenditures $119.5 $193.8 $216.7 $ 55.7 $ 24.7 ====== ====== ====== ====== ======
Remaining California Real Estate. After completion of the California Divestiture, the Company will continue to own real estate assets in California having an aggregate book value at December 30, 1995 of approximately $260 million. These assets include the stores leased or subleased as part of the California Divestiture (having an aggregate book value at December 30, 1995 of $42.5 million), the closed stores (aggregate book value_$115.3 million) and certain non-operating stores and other excess real estate (aggregate book value_$102.2 million). These properties have annual carrying costs of approximately $7 million (excluding depreciation and amortization). Management's present policy is to own and manage its real estate assets, including those in California, in order to maximize their long-term values, and, as a result, the Company maintains a fully staffed real estate, construction and property management capability. The Company believes that there are several viable strategies for maximizing the value of its California real estate assets over the next five years and that the implementation of these policies would not have any material negative impact on future earnings. Following the consummation of the Transactions, management, in conjunction with Yucaipa, anticipates that it will pursue a strategy to dispose of certain real estate assets in California on an accelerated basis, including leased stores, closed stores and excess land. The Company would use the net cash proceeds from the sales of these assets to either reinvest in the Company's business or reduce indebtedness incurred in connection with the Transactions. If this strategy is adopted, as anticipated, the Company would record a charge to earnings, which could be substantial, to reflect the difference between the anticipated cash proceeds from the accelerated dispositions and the Company's existing book values and carrying costs for such assets. This charge will cause a substantial decrease in the Company's earnings for such period and net worth, but is not otherwise anticipated to adversely affect the Company's liquidity or ongoing results of operations. Debt Refinancing and Recapitalization Charges. In connection with the anticipated consummation of the Transactions at May 1, 1996, the Company will refinance approximately $628.2 million of its existing mortgage notes and unsecured indebtedness as well as approximately $39.7 million of its revolving credit borrowings. The Company will also refinance approximately $101.9 million of existing indebtedness of Smitty's (assuming a 100% tender of the existing Senior Subordinated Notes due 2004 of Smitty's Super Valu, Inc. (the "Smitty's Notes") and the Senior Discount Debentures due 2006 of Smitty's (the "Smitty's Debentures")). In connection with such debt refinancings, the Company will pay make-whole and other premiums estimated at approximately $97.2 million. These refinancing premiums, together with approximately $11.7 million of debt issuance costs, will be written off upon the consummation of the Transactions and reflected as an extraordinary charge for the quarter in which the Transactions are consummated. It is estimated that this charge, net of taxes, will be approximately $66.4 million. The Company will also record approximately $12.5 million of pre-tax compensation expense in connection with the purchase of certain management stock options as part of the Recapitalization. Integration of Arizona Operations. Following the Merger, management of the Company has estimated that approximately $25 million of net annual cost savings (as compared to costs for the pro forma combined fiscal year ended December 30, 1995) are achievable by the end of the third year of combined operations. Management believes that approximately $17 million in Merger- related capital expenditures and approximately $10.0 million of other expenses will be required to integrate Arizona operations and realize such cost savings. Management anticipates that a charge related to such costs will be recorded in the quarter in which the Transactions are consummated. Purchase Accounting. The Merger will be accounted for as a purchase of Smitty's by the Company. As a result, the assets and liabilities of Smitty's will be recorded at their estimated fair value as of the date the Merger is consummated. The purchase price for Smitty's will be determined by reference to the trading price of the Company's Class B Common Stock following the consummation of the Merger. The purchase price in excess of the fair value of Smitty's assets will be recorded as goodwill and amortized over a 40-year period. The actual purchase accounting adjustments will be determined following the Merger. Results of Operations The Company's fiscal year ends on the Saturday closest to December 31. The following table sets forth the selected historical operating results of the Company for the three fiscal years ended December 30, 1995:
As a Percentage of Sales ------------------------------------ 52 Weeks 52 Weeks 52 Weeks 52 Weeks 52 Weeks 52 Weeks Ended Ended Ended Ended Ended Ended January 1, December 31, December 30, January 1, December 31, December 30, 1994 1994 1995 1994 1994 1995 ---------- ------------ ------------ ---------- ------------ ------------ (dollars in millions) Net sales $2,807.2 $2,981.4 $3,083.7 100.0% 100.0% 100.0% Gross profit 637.2 669.1 697.0 22.7% 22.4% 22.6% Operating, selling and administrative expenses 430.3 440.8 461.4 15.3% 14.8% 15.0% Depreciation and amortization 82.2 94.5 105.0 2.9% 3.2% 3.4% Operating income 124.7 133.8 130.7 4.4% 4.5% 4.2% Interest expense 44.6 53.7 60.5 1.6% 1.8% 2.0% Restructuring charges - - 140.0 -% -% 4.5% Income taxes (benefit) 34.3 31.3 (29.3) 1.2% 1.1% (1.0)% Net income (loss) 45.8 48.8 (40.5) 1.6% 1.6% (1.3)%
Comparison of Results of Operations for the 52 weeks ended December 30, 1995 with Results of Operations for the 52 weeks ended December 31, 1994 Net Sales. Net sales increased $102.3 million, or 3.4%, from $2,981.4 million in 1994 to $3,083.7 million in 1995. The sales increase in 1995 was attributable to a net increase of 17 stores as of the end of 1995, offset in part by a 3.4% decrease in same store sales. As adjusted to exclude the Company's California stores, net sales increased $80.7 million, or 3.5%, from $2,328.5 million in 1994 to $2,409.2 million in 1995. As adjusted to exclude the Company's California stores, same store sales decreased 3.2% in 1995, caused primarily by the Company's discontinuance of its "ad match" program in the Phoenix and Tucson markets and new stores opened by competitors in the Company's markets. Gross Profit. Gross profit increased $27.9 million, or 4.2%, from $669.1 million in 1994 to $697.0 million in 1995. Gross margins during 1995 and 1994 were 22.6% and 22.4%, respectively. The increase in 1995 is due primarily to less aggressive promotional activity in the Phoenix and Tucson markets following the discontinuance of the Company's "ad match" program, reduced charges for inventory shrinkage and improved competitive conditions in Utah, which were partially offset by the increase in the LIFO charge and increased new store openings. The pre-tax LIFO charge was $4.0 million in 1995 compared to $2.5 million in 1994. Newly opened stores apply pressure on gross margins until the stores become established in their respective markets. The Company opened 19 new stores during 1995 (including two in California) compared to eight stores in 1994 (including six in California). Operating, Selling and Administrative Expenses. Operating, selling and administrative expenses ("OS&A") increased $20.6 million, or 4.7%, from $440.8 million in 1994 to $461.4 million in 1995. As a percent of net sales, OS&A increased from 14.8% in 1994 to 15.0% in 1995. The increase was caused principally by the increase in new store opening costs compared to the prior year. The decrease in same store sales also contributed to the increase of OS&A as a percentage of net sales. Depreciation and Amortization Expenses. Depreciation and amortization expenses increased by $10.5 million, or 11.1%, from $94.5 million in 1994 to $105.0 million in 1995, primarily due to the addition of new combination stores and equipment replacements in remodeled stores. Interest Expense. Interest expense increased $6.8 million from $53.7 million in 1994 to $60.5 million in 1995 primarily as a result of net increases in the average debt amounts for each period. Restructuring Charges. As a result of the California Divestiture, the Company recorded $140 million of pre-tax restructuring charges to reflect the estimated costs associated with the sale, lease or closure of its Southern California stores and the Riverside distribution center. See Note K of the Notes to Consolidated Financial Statements of the Company included elsewhere herein. Income Taxes. The Company recorded a tax benefit of $29.3 million in 1995 compared to an expense of $31.3 million in 1994. The benefit recorded in 1995 reflects an adjustment (benefit) of $53.4 million of the Company's deferred taxes as a result of losses incurred in connection with the California Divestiture. Net Income (Loss). Income before restructuring charges decreased by $5.3 million, or 10.9%, from $48.8 million in 1994 to $43.5 million in 1995. Income per common share before restructuring charges decreased 0.6% from $1.73 in 1994 to $1.72 in 1995. Primarily as a result of the restructuring charges, the Company recorded a net loss of $40.5 million for 1995 ($1.62 per share) compared to net income of $48.8 million in 1994 ($1.73 per share). The weighted average number of common shares outstanding was 25,030,882 in 1995 and 28,176,907 in 1994. Comparison of Results of Operations for the 52 weeks ended December 31, 1994 with Results of Operations for the 52 weeks ended January 1, 1994 Net Sales. Net sales increased $174.2 million, or 6.2%, from $2,807.2 million in 1993 to $2,981.4 million in 1994. The sales increase in 1994 was attributable to a net increase of eight stores as of the end of 1994, offset in part by a 2.3% decrease in same store sales. As adjusted to exclude the Company's California stores, net sales decreased $5.9 million, or 0.3%, from $2,334.4 million in 1993 to $2,328.5 million in 1994. As adjusted to exclude the Company's California stores, same store sales decreased 1.3% in 1994. The decrease in same store sales (excluding California) in 1994 was caused primarily by competitive new store openings in the Company's principal market areas and increased overall price competition in Utah. Gross Profit. Gross profit increased $31.9 million, or 5.0%, from $637.2 million in 1993 to $669.1 million in 1994. Gross margins during 1994 and 1993 were 22.4% and 22.7%, respectively. The decrease in gross margin in 1994 was caused primarily by the Company's aggressive Utah pricing program which commenced in the second half of 1993 and continued through most of 1994. To reinforce the Company's everyday low price program, prices in Utah stores were lowered on more than 10,000 grocery, meat and produce items. The Company opened eight new stores during 1994 (including six in California) compared to ten new stores during 1993 (including eight in California). Operating, Selling and Administrative Expenses. OS&A increased $10.5 million, or 2.4%, from $430.3 million in 1993 to $440.8 million in 1994. As a percent of net sales, OS&A decreased from 15.3% in 1993 to 14.8% in 1994. The decrease in 1994, resulting primarily from the Company's program to reduce operating costs, was somewhat offset by the higher operating and labor costs associated with the expansion into Southern California. Depreciation and Amortization Expenses. Depreciation and amortization expenses increased by $12.3 million, or 15.0%, from $82.2 million in 1993 to $94.5 million in 1994, due to the addition of new food and drug combination stores and distribution and processing facilities. Interest Expense. Interest expense increased $9.1 million from $44.6 million in 1993 to $53.7 million in 1994 as a result of net increases in the average debt amounts for each period. Income Taxes. Income taxes as a percent of income before income taxes were 39.1% in 1994 and 42.8% in 1993. The Omnibus Budget Reconciliation Act of 1993 increased the Company's Federal tax rate from 34% to 35%. As a result of the increased tax rate, net income for 1993 was reduced by $2.75 million, or $0.09 per common share. This reduction consisted of $0.8 million, or $0.03 per common share, for the rate increase on income earned in 1993 and $1.95 million, or $.06 per common share, for the increase in recorded deferred taxes. Net Income. Net income increased 6.6% from $45.8 million in 1993 to $48.8 million in 1994. However, as a result of a reduction in the number of shares outstanding through the Company's buy-back programs, net income per common share increased 14% from $1.52 to $1.73. During 1994, the Company repurchased 4.9 million shares of Common Stock in the open market. The weighted average number of shares of Common Stock outstanding in 1994 was reduced by approximately 1.9 million shares, which increased net income per common share by $0.11. Liquidity and Capital Resources The Company's cash flow from operating activities was $140.6 million for fiscal 1995 and $203.6 million for fiscal 1994. The decrease in cash flow from operating activities was due primarily to balance fluctuations in operating assets and liabilities resulting from the execution of cash management policies based upon cash availability. Trade accounts payable decreased cash provided by operating activities by $21.7 million in 1995 and increased cash provided by operating activities by $50.6 million in 1994. One of the Company's principal uses of cash in its operating activities is inventory purchases. However, supermarket operators typically require small amounts of working capital since inventory is generally sold prior to the time that payments to suppliers are due. This reduces the need for short-term borrowings and allows cash from operations to be used for non-current purposes such as financing capital expenditures and other investing activities. The Company's cash used in investing activities was $146.3 million during fiscal 1995 and $127.4 million during fiscal 1994. Investing activities consisted primarily of additions to property and equipment for new stores, remodels and equipment purchases. The Company received approximately $7.5 million of cash from financing activities for fiscal 1995 and used approximately $123.9 million of cash in financing activities in fiscal 1994. The primary difference in financing activities from 1994 to 1995 of $131.4 million was the repurchase of Common Stock in 1994. In 1994, the Company purchased approximately $109.2 million of its Common Stock under its stock buy-back program. At December 30, 1995 and January 1, 1994, the Company had outstanding $725.2 million and $699.9 million, respectively, of long-term debt, principally borrowed from insurance companies and other institutional lenders. The Company has not experienced difficulty to date in obtaining financing at satisfactory terms. Assuming that the Transactions are not consummated, management believes that the financial resources available to it, including proceeds from sale/leaseback transactions, amounts available under existing and future bank lines of credit, additional long-term financings and internally generated funds, will be sufficient to meet planned capital expenditures and working capital requirements for the forseeable future, including debt and lease servicing requirements. Certain of the Company's existing debt agreements require the Company to comply with various financial covenants, including maintenance of certain levels of minimum net worth. The Company was in compliance with all such covenants at December 30, 1995. In order to consummate the Transactions, the Company expects to utilize total new financing proceeds in the amount of approximately $1.4 billion. The Company will enter into the New Credit Facility pursuant to which it will borrow up to $655 million of term loans (the "New Term Loans") and will have available a $190 million revolving credit facility (the "New Revolving Facility"), of which approximately $52.7 million is anticipated to be outstanding at the consummation of the Transactions. The Company will also issue $250 million principal amount of New Senior Notes, $400 million principal amount of New Senior Subordinated Notes and $75 million liquidation preference of New Preferred Stock. The proceeds from the New Credit Facility and the offerings of the Company's new securities will provide the sources of financing required to consummate the Transactions and pay related fees and expenses (including debt refinancing premiums). The Company will also assume certain existing indebtedness of Smitty's. The New Revolving Facility will be available, subject to the satisfaction of customary borrowing conditions, for working capital requirements and general corporate purposes. A portion of the New Revolving Facility may be used to support letters of credit, approximately $28 million of which are anticipated to be outstanding upon consummation of the Transactions. The New Revolving Facility will be non-amortizing and will have a six and one-quarter year term. The Company will be required to reduce loans outstanding under the New Revolving Facility to $85 million for a period of not less than 30 consecutive days during the first 12 months following the Merger and to $75 million for a period of not less than 30 consecutive days during each consecutive 12-month period thereafter. Assuming that the Merger closes on May 1, 1996, giving effect to currently anticipated borrowings and letter of credit issuances, the Company's remaining borrowing availability under the New Revolving Facility would be approximately $109.3 million. Pursuant to the New Credit Facility, the New Term Loans will be issued in four tranches: (i) Tranche A, in the amount of $330 million, will have a six and one-quarter year term; (ii) Tranche B, in the amount of $110 million, will have a seven and one-half year term; (iii) Tranche C, in the amount of $110 million, will have an eight and one-half year term; and (iv) Tranche D, in the amount of $105 million, will have a nine and one- quarter year term. The New Term Loans will require quarterly amortization payments. The New Credit Facility will be guaranteed by each of the Company's subsidiaries and secured by liens on substantially all of the unencumbered assets of the Company and its subsidiaries and by a pledge of the Company's stock in such subsidiaries. The Company will be subject to certain customary affirmative and negative covenants contained in the New Credit Facility, including, without limitation, covenants that restrict, subject to specified exceptions, (i) the incurrence of additional indebtedness and other obligations, (ii) mergers and acquisitions, (iii) asset sales, (iv) the granting of liens, (v) prepayment or repurchase of other indebtedness, (vi) engaging in transactions with affiliates, (vii) capital expenditures, (viii) the making of investments, (ix) dividends and other payments with respect to equity interests, or (x) rental payments. In addition, the New Credit Facility will require that the Company maintain certain specified financial covenants, including a minimum fixed charge coverage, a minimum operating cash flow, a maximum ratio of total debt to operating cash flow and a minimum net worth. The capital expenditures of the Company (excluding expenditures in California) were $91.0 million for fiscal 1994 and $124.3 million for fiscal 1995. The Company currently anticipates that its aggregate capital expenditures for fiscal 1996 will be approximately $100.0 million, excluding the approximately $17 million of capital expenditures which are estimated to be required in connection with the integration of Arizona operations. The Company intends to finance these capital expenditures primarily with cash provided by operations and other sources of liquidity including borrowings and leases. No assurance can be given that sources of financing for capital expenditures will be available or sufficient. However, the capital expenditure program has substantial flexibility and is subject to revision based on various factors. Management believes that if the Company were to substantially reduce or postpone these programs, there would be no substantial impact on short-term operating profitability. In the long term, however, if these programs were substantially reduced, management believes its operating businesses, and ultimately its cash flow, would be adversely affected. The capital expenditures discussed above do not include potential acquisitions which the Company could make to expand within its existing markets or to enter other markets. Future acquisitions may require the Company to seek additional debt or equity financing depending on the size of the transaction. With the exception of the Transactions, the Company is not currently engaged in discussions concerning any material acquisition which it considers probable. Following the consummation of the Transactions, the Company will be highly leveraged. Based upon current levels of operations and anticipated cost savings and future growth, the Company believes that its cash flow from operations, together with available borrowings under the New Revolving Facility and its other sources of liquidity (including leases), will be adequate to meet its anticipated requirements for working capital, capital expenditures, lease payments, interest payments and scheduled principal payments. There can be no assurance, however, that the Company's business will continue to generate cash flow at or above current levels or that estimated cost savings or growth can be achieved. Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long- lived Assets and for Long-lived Assets to be Disposed Of." The Company will be required to adopt this standard in the first quarter of 1996. The Company has not performed the complex analysis required to determine the effect of implementing this new standard. Management does not currently believe the adoption of SFAS No. 121 would have a significant impact on the Company's financial condition. Effects of Inflation The Company's primary costs, inventory and labor, are affected by a number of factors that are beyond its control, including availability and price of merchandise, the competitive climate and general and regional economic conditions. As is typical of the supermarket industry, the Company has generally been able to maintain gross profit margins by adjusting retail prices, but competitive conditions may from time to time render the Company unable to do so while maintaining its market share. Item 8. Financial Statements and Supplementary Data Audited Annual Financial Statements. The consolidated financial statements of the Company, including an index thereto and the report of Ernst & Young LLP, the Company's Independent Auditors, begin on page F-1 and are incorporated herein by reference. Quarterly Financial Data. (Dollar amounts in thousands, except per share data (unaudited)) First Second Third Fourth Total Fiscal 1995 Net sales $746,673 $770,405 $768,335 $798,324 $3,083,737 Gross profit 168,322 172,523 173,960 182,225 697,030 Net income (loss) 9,479 9,032 11,061 (70,084) (40,512) Net income (loss) per common share .37 .36 .44 (2.79) (1.62) Fiscal 1994 Net sales $753,780 $748,328 $725,360 $753,891 $2,981,359 Gross profit 164,180 166,176 164,965 173,810 669,131 Net income 9,354 11,887 13,341 14,199 48,781 Net income per common share .31 .41 .48 .53 1.73 Fiscal 1993 Net sales $688,239 $705,520 $686,747 $726,659 $2,807,165 Gross profit 161,552 163,770 152,445 159,411 637,178 Net income 14,007 13,999 7,911 9,903 45,820 Net income per common share .46 .46 .26 .34 1.52 All quarters presented are for 13 weeks Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. PART III Iten 10. Directors and Executive Officers of the Registrant Information concerning directors and executive officers of the Company is included in the Company's Proxy Statement for its 1996 Annual Meeting of Stockholders (the "Proxy Statement") under the captions "Management after Recapitalization and Merger," "Proposal No. 3_Election of Directors" and "Section 16(a) Reporting," which information is incorporated herein by reference. The Company's executive officers are appointed and serve, at the discretion of the Board of Directors, until their successors are appointed. Item 11. Executive Compensation Information concerning Executive Compensation is included in the Company's Proxy Statement under the caption "Executive Compensation," which information is incorporated herein by reference (other than information under the subcaptions "Compensation Committee Report on Executive Compensation" and "_Performance Graph," which shall not be deemed to be incorporated by reference herein). Item 12. Security Ownership of Certain Beneficial Owners and Management Information concerning Security Ownership of Certain Beneficial Owners and Management is included in the Company's Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management," which information is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions Information concerning Certain Relationships and Related Transactions is included in the Company's Proxy Statement under the captions "The Recapitalization and Merger_Interest of Certain Persons in the Transactions" and "Executive Compensation_Certain Transactions," which information is incorporated herein by reference. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Documents filed as part of this report: 1. Financial Statements: The following consolidated financial statements of the Company and its subsidiaries and the Report of Ernst & Young LLP, Independent Auditors, included herein on pages F-2 through F-17 are incorporated herein by reference: Report of Ernst & Young LLP, Independent Auditors Consolidated Balance Sheets--December 30, 1995 and December 31, 1994 Consolidated Statements of Income--fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994 Consolidated Statements of Common Stockholders' Equity--fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994 Consolidated Statements of Cash Flows--fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994 Notes to Consolidated Financial Statements 2. Financial Statement Schedules: None 3. Exhibits: The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference as part of the Form 10-K. (b) Reports on Form 8-K: There were no reports filed on Form 8-K during the fourth quarter of fiscal 1995. INDEX TO FINANCIAL STATEMENTS Report of Independent Auditors (Ernst & Young LLP) F-2 Consolidated Balance Sheets at December 30, 1995 and December 31, 1994 F-3 Consolidated Statements of Income for fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994 F-4 Consolidated Statements of Common Stockholders' Equity for fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994 F-5 Consolidated Statements of Cash Flows for fiscal years ended December 30, 1995, December 31, 1994 and January 1, 1994 F-6 Notes to Consolidated Financial Statements F-7 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Smith's Food & Drug Centers, Inc. We have audited the accompanying consolidated balance sheets of Smith's Food & Drug Centers, Inc. and subsidiaries as of December 30, 1995 and December 31, 1994, and the related consolidated statements of income, common stockholders' equity, and cash flows for each of the three fiscal years in the period ended December 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Smith's Food & Drug Centers, Inc. and subsidiaries at December 30, 1995 and December 31, 1994, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended December 30, 1995, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Salt Lake City, Utah January 29, 1996 SMITH'S FOOD & DRUG CENTERS, INC. CONSOLIDATED BALANCE SHEETS (dollar amounts in thousands) 1995 1994 -------- -------- ASSETS Current Assets Cash and cash equivalents $ 16,079 $ 14,188 Rebates and accounts receivable 23,802 25,596 Inventories 394,982 389,564 Prepaid expenses and deposits 21,255 15,858 Deferred tax assets 23,900 1,400 Assets held for sale 125,000 ------- ------- Total Current Assets 605,018 446,606 Property and Equipment Land 276,626 303,701 Buildings 610,049 619,056 Leasehold improvements 55,830 42,369 Fixtures and equipment 509,524 589,480 ------- ------- 1,452,029 1,554,606 Less allowances for depreciation and amortization 390,933 364,741 --------- --------- 1,061,096 1,189,865 Other Assets 20,066 16,996 --------- --------- $1,686,180 $1,653,467 ========= ========= LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Current Liabilities Trade accounts payable $ 214,152 $ 235,843 Accrued sales and other taxes 50,749 44,379 Accrued payroll and related benefits 97,455 84,083 Current maturities of long-term debt 20,932 19,011 Current maturities of Redeemable Preferred Stock 1,008 1,017 Accrued restructuring costs 58,000 ------- ------- Total Current Liabilities 442,296 384,333 Long-term debt, less current maturities 725,253 699,882 Accrued restructuring costs, less current portion 40,000 Deferred income taxes 58,600 89,500 Redeemable Preferred Stock, less current maturities 3,311 4,410 Common Stockholders' Equity Convertible Class A Common Stock (shares issued and outstanding, 11,613,043 in 1995 and 12,140,317 in 1994) 116 121 Class B Common Stock (shares issued, 18,348,968 in 1995 and 17,821,694 in 1994) 183 178 Additional paid-in capital 285,236 285,592 Retained earnings 238,027 293,456 ------- ------- 523,562 579,347 Less cost of Common Stock in the treasury (4,890,302 shares in 1995 and 4,772,822 shares in 1994) 106,842 104,005 ------- ------- 416,720 475,342 --------- --------- $1,686,180 $1,653,467 ========= ========= See notes to consolidated financial statements. SMITH'S FOOD & DRUG CENTERS, INC. CONSOLIDATED STATEMENTS OF INCOME (dollar amounts in thousands, except per share data) 1995 1994 1993 --------- --------- --------- Net sales $3,083,737 $2,981,359 $2,807,165 Cost of goods sold 2,386,707 2,312,228 2,169,987 --------- --------- --------- 697,030 669,131 637,178 Expenses: Operating, selling and administrative 461,401 440,844 430,258 Depreciation and amortization 104,963 94,491 82,173 Interest 60,478 53,715 44,627 Restructuring charges 140,000 ------- ------- ------- 766,842 589,050 557,058 ------- ------- ------- Income (loss) before income taxes (69,812) 80,081 80,120 Income taxes (29,300) 31,300 34,300 ------ ------ ------ Net income (loss) $ (40,512) $ 48,781 $ 45,820 ====== ====== ====== Net income (loss) per share of Common Stock $(1.62) $1.73 $1.52 ==== ==== ==== See notes to consolidated financial statements. SMITH'S FOOD & DRUG CENTERS, INC. CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (dollar amounts in thousands, except per share data)
Class A Common Stock Class B Common Stock -------------------- -------------------- Additional Number of Par Number of Par Paid-in Retained Treasury Total Shares Value Shares Value Capital Earnings Stock --------- ----- --------- ----- ------- -------- -------- -------- Balance at January 3, 1993 13,403,132 $134 16,558,879 $165 $285,980 $229,110 $515,389 Net income for 1993 45,820 45,820 Conversion of shares from Class A to Class B (785,687) (8) 785,687 8 Purchase of Class B Common Stock for the treasury $(11,074) (11,074) Shares sold to the Employee Stock Profit Sharing Plan (212) 3,237 3,025 Shares sold under the Employee Stock Purchase Plan (771) 4,853 4,082 Cash dividends-$.52 per share (15,530) (15,530) Other 485 485 ---------- --- ---------- --- ------- ------- ------ ------- Balance at January 1, 1994 12,617,445 126 17,344,566 173 285,482 259,400 (2,984) 542,197 Net income for 1994 48,781 48,781 Conversion of shares from Class A to Class B (477,128) (5) 477,128 5 Purchase of Class B Common Stock for the treasury (109,239) (109,239) Shares sold to the Employee Stock Profit Sharing Plan 143 1,505 1,648 Shares sold under the Employee Stock Purchase Plan (668) 6,713 6,045 Cash dividends-$.52 per share (14,725) (14,725) Other 635 635 ---------- --- ---------- --- ------- ------- -------- ------- Balance at December 31, 1994 12,140,317 121 17,821,694 178 285,592 293,456 (104,005) 475,342 Net loss for 1995 (40,512) (40,512) Conversion of shares from Class A to Class B (527,274) (5) 527,274 5 Purchase of Class B Common Stock for the treasury (9,039) (9,039) Shares sold to the Employee Stock Profit Sharing Plan 2 108 110 Shares sold under the Employee Stock Purchase Plan (926) 6,094 5,168 Cash dividends-$.60 per share (14,917) (14,917) Other 568 568 ---------- --- ---------- --- ------- ------- -------- ------- Balance at December 30, 1995 11,613,043 $116 18,348,968 $183 $285,236 $238,027 $(106,842) $416,720 ========== === ========== === ======= ======= ======== =======
See notes to consolidated financial statements. SMITH'S FOOD & DRUG CENTERS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (dollar amounts in thousands) 1995 1994 1993 ---- ---- ---- Operating Activities Net income (loss) $(40,512) $ 48,781 $ 45,820 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 104,963 94,491 82,173 Deferred income taxes (53,400) 10,500 15,400 Restructuring charges 140,000 Other 568 635 485 Changes in operating assets and liabilities: Rebates and accounts receivable 1,794 (4,758) (4,038) Inventories (5,418) (11,625) (36,523) Prepaid expenses and deposits (5,397) (1,324) (518) Trade accounts payable (21,691) 50,618 1,119 Accrued sales and other taxes 6,370 5,616 6,625 Accrued payroll and related benefits 13,372 10,616 8,007 ------- ------- ------- Cash provided by operating activities 140,649 203,550 118,550 Investing Activities Additions to property and equipment (149,035) (146,676) (322,301) Sale/leaseback arrangements and other property and equipment sales 5,841 20,949 159,137 Other (3,070) (1,649) (1,258) ------- ------- ------- Cash used in investing activities (146,264) (127,376) (164,422) Financing Activities Additions to long-term debt 45,978 27,000 262,000 Payments on long-term debt (18,686) (33,594) (149,197) Redemptions of Redeemable Preferred Stock (1,108) (1,042) (1,039) Purchases of Treasury Stock (9,039) (109,239) (11,074) Proceeds from sales of Treasury Stock 5,278 7,693 7,107 Payment of dividends (14,917) (14,725) (15,530) ------ ------- ------ Cash provided by (used in) financing activities 7,506 (123,907) 92,267 ------ ------- ------ Net increase (decrease) in cash and cash equivalents 1,891 (47,733) 46,395 Cash and cash equivalents at beginning of year 14,188 61,921 15,526 ------ ------ ------ Cash and cash equivalents at end of year $ 16,079 $ 14,188 $ 61,921 ====== ====== ====== See notes to consolidated financial statements. SMITH'S FOOD & DRUG CENTERS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of Smith's Food & Drug Centers, Inc. and its wholly-owned subsidiaries (the "Company"), after the elimination of significant intercompany transactions and accounts. The Company operates a regional supermarket and drug store chain in the Intermountain and Southwestern regions of the United States. Estimates and Assumptions The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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. Definition of Accounting Period The Company's fiscal year ends on the Saturday nearest to December 31. Fiscal year operating results include 52 weeks for each year. Cash and Cash Equivalents Cash and cash equivalents consist of cash and short-term investments with maturities less than three months. The amount reported in the balance sheet for cash and cash equivalents approximates its fair value. Inventories Inventories are valued at the lower of cost, determined on the last-in, first-out (LIFO) method, or market. Approximately 95% of inventories in 1995 and 1994 were valued using the LIFO method. Other inventories were valued using the first-in, first-out (FIFO) method. The FIFO cost exceeded the LIFO value of inventories by $8.1 million in 1995 and $4.1 million in 1994. The pretax LIFO charge was $4.0 million in 1995, $2.5 million in 1994, and $1.6 million in 1993. Property and Equipment Property and equipment are stated at cost. Depreciation and amortization are provided by the straight-line method based upon estimated useful lives. Improvements to leased property are amortized over their estimated useful lives or the remaining terms of the leases, whichever is shorter. Pre-Operating and Closing Costs Costs incurred in connection with the opening of new stores and distribution facilities are expensed as incurred. The remaining net investment in stores closed, less salvage value, is charged against earnings in the period of closing. For leased stores that are closed and subleased to third parties, a provision is made for the remaining lease liability, net of expected sublease rental. For leased stores that are closed but not yet subleased, a provision is made based on discounted lease payments through the estimated period until subleased. Interest Costs Interest costs are expensed as incurred, except for interest costs which have been capitalized as part of the cost of properties under development. The Company's cash payments for interest (net of capitalized interest of approximately $1.4 million in 1995, $5.8 million in 1994 and $14.5 million in 1993) amounted to $60.7 million in 1995, $54.0 million in 1994 and $39.8 million in 1993. Income Taxes The Company determines its deferred tax assets and liabilities based on differences between the financial reporting and tax basis of its assets and liabilities using the tax rates that will be in effect when the differences are expected to reverse. Net Income Per Share of Common Stock Net income per share of Common Stock is computed by dividing the net income by the weighted average number of shares of Common Stock outstanding of 25,030,882 in 1995, 28,176,907 in 1994 and 30,238,811 in 1993. Common Stock equivalents in the form of stock options are excluded from the weighted average number of common shares in 1995 due to the net loss. Adoption of Accounting Standard In March 1995, the Financial Accounting Standards Board issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", which requires impairment losses to be recorded on long- lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. Due to the nature of the Company's operations and the number of estimates required to assess the impact of Statement 121, the financial statement impact of adoption has not yet been determined. Litigation The Company is a party to certain legal actions arising out of the ordinary course of its business. Management believes that none of these actions, individually or in the aggregate, will have a material adverse effect on the Company's results of operations or financial position. Reclassifications Certain reclassifications have been made to the 1993 and 1994 financial statements to conform with the 1995 presentation. NOTE B - Property and Equipment The Company depreciates its buildings over 25 to 30 years and its fixtures and equipment over a period of 2 to 9 years and amortizes its leasehold improvements over their estimated useful lives or the life of the lease, whichever is shorter. Property and equipment consists of the following (dollar amounts in thousands):
Allowances for Current Year Depreciation Net Book Depreciation Cost and Amortization Value and Amortization --------- ---------------- --------- ---------------- 1995 Land $ 276,626 $ 276,626 Buildings 610,049 $108,985 501,064 $ 19,907 Leasehold improvements 55,830 12,556 43,274 2,970 Fixtures and Equipment 509,524 269,392 240,132 82,086 --------- -------- --------- ------- $1,452,029 $390,933 $1,061,096 $104,963 ========= ======= ========= ======= 1994 Land $ 303,701 $ 303,701 Buildings 619,056 $ 92,542 526,514 $ 18,334 Leasehold improvements 42,369 10,122 32,247 1,842 Fixtures and equipment 589,480 262,077 327,403 74,315 --------- ------- --------- ------- $1,554,606 $364,741 $1,189,865 $ 94,491 ========= ======= ========= =======
NOTE C - Long-Term Debt Long-term debt consists of the following (dollar amounts in thousands): 1995 1994 -------- -------- Mortgage notes, collateralized by property and equipment with a cost of $420.7 million in 1995 and $413.0 million in 1994, due through 2011 with interest at an average rate of 9.68% in 1995 and 9.73% in 1994 $254,385 $270,082 Unsecured notes, due in 2002 through 2015 with varying annual installments starting in 2000 which accrue interest at an average rate of 7.68% in 1995 and 1994 410,000 410,000 Revolving credit bank loans 68,000 27,000 Industrial revenue, bonds, collateralized by property and equipment with a cost of $11.7 million in 1995 and $11.6 million in 1994 due in 2000 through 2010 plus interest at an average rate of 7.44% in 1995 and 7.47% in 1994 6,308 6,597 Other 7,492 5,214 ------- ------- 746,185 718,893 Less current maturities 20,932 19,011 ------- ------- $725,253 $699,882 Interest rates on the revolving credit bank loans averaged 6.06% in 1995 and 5.89% in 1994. The agreements are reviewed annually with the banks, at which time the date each installment is due is generally extended one year. At December 30, 1995, the Company had unused lines of credit related to unsecured revolving credit bank loans of $60.0 million. The Company's loan agreements contain provisions which require the Company to maintain a specified level of consolidated net worth, fixed charge coverage and ratio of debt to net worth. Maturities of the Company's long-term debt for the five fiscal years succeeding December 30, 1995 are approximately $20.9 million in 1996, $22.1 million in 1997, $23.7 million in 1998, $45.4 million in 1999 and $28.9 million in 2000. The amounts classified as revolving credit bank loans approximate their fair value. The fair value of the Company's long-term debt was estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of debt arrangements. NOTE D - Redeemable Preferred Stock The Company has 85,000,000 shares of $.01 per share par value Preferred Stock authorized. The Company has designated 34,524,579 of these shares as Series I Preferred Stock, of which 12,956,747 shares and 16,281,777 shares were issued and outstanding in 1995 and 1994, respectively. The redeemable Series I Preferred Stock has no dividend requirement. All shares of the Company's redeemable Series I Preferred Stock are subject to redemption at any time at the option of the Board of Directors, in such numbers as the Board may determine, and at a redemption price of $.33 1/3 per share. The scheduled redemptions of the Company's redeemable Series I Preferred Stock are approximately $1.0 million each year until all outstanding shares are redeemed. Upon liquidation of the Company, each share of Series I Preferred Stock is entitled to a liquidation preference of $.33 1/3, on a pro rata basis with any other series of Preferred Stock, before any distribution to the holders of Class A Common Stock or Class B Common Stock. Each share of Series I Preferred Stock is entitled to ten votes. Series I Preferred Stock is stated at redemption value in the balance sheet. The amount included in the balance sheet for redeemable Series I Preferred Stock approximates its fair value. NOTE E - Common Stockholders' Equity The voting powers, preferences and relative rights of Class A Common Stock and Class B Common Stock are identical in all respects, except that the holders of Class A Common Stock have ten votes per share and the holders of Class B Common Stock have one vote per share. Each share of Class A Common Stock is convertible at any time at the option of the holder into one share of Class B Common Stock. The Company's Certificate of Incorporation also provides that each share of Class A Common Stock will be converted automatically into one share of Class B Common Stock if at any time the number of shares of Class A Common Stock issued and outstanding shall be less than 2,910,885. Future sales or transfers of the Company's Class A Common Stock are restricted to the Company or immediate family members of the original Class A Common Stockholders unless first presented to the Company for conversion into an equal number of Class B Common Stock shares. The Class B Common Stock has no conversion rights. At December 30, 1995 there were 20,000,000 shares of $.01 per share par value Class A Common Stock and 100,000,000 shares of $.01 per share par value Class B Common Stock authorized. NOTE F - Income Taxes Income tax expense (benefit) consists of the following (dollar amounts in thousands): 1995 1994 1993 ------- ------ ------ Current: Federal $ 20,220 $17,211 $15,715 State 3,880 3,589 3,185 ------ ------ ------ 24,100 20,800 18,900 Deferred: Federal (46,681) 9,247 13,012 State ( 6,719) 1,253 2,388 ------ ------ ------ (53,400) 10,500 15,400 ------ ------ ------ $(29,300) $31,300 $34,300 ====== ====== ====== Income tax expense included a charge of $1.95 million in 1993 resulting from applying the increased federal tax rate to deferred tax items. Cash disbursements for income taxes were $19.2 million in 1995, $21.7 million in 1994 and $17.3 million in 1993. The difference between income tax expense (benefit) and the tax computed by applying the statutory income tax rate to income before income taxes is as follows: 1995 1994 1993 ------ ------ ------ Statutory federal income tax rate (35.0%) 35.0% 35.0% State income tax rate, net of federal income tax effect (4.3) 4.7 5.2 Effect of income tax rate changes on deferred taxes (3.6) 2.4 Other .9 (.6) .2 ---- ---- ---- (42.0%) 39.1% 42.8% The effect of temporary differences that give rise to deferred tax balances are as follows (dollar amounts in thousands): 1995 1994 ------ ------ Deferred tax liabilities: Depreciation and amortization $81,008 $ 98,186 Other 13,572 11,935 ------ ------- 94,580 110,121 Deferred tax assets: Accrued restructuring costs (33,305) Accrued insurance claims (12,271) (10,126) Rent (8,138) (6,006) Other (6,166) (5,889) ------ ------ (59,880) (22,021) ------ ------ 34,700 88,100 Net current deferred tax assets 23,900 1,400 ------ ------ Net non-current deferred tax liabilities $58,600 $89,500 ====== ====== NOTE G - Fair Value of Financial Instruments The carrying amounts and related fair values of the Company's financial instruments are as follows (dollar amounts in thousands): 1995 1994 ------------------ ------------------ Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- -------- -------- Cash and cash equivalents $ 16,079 $ 16,079 $ 14,188 $ 14,188 Long-term debt 746,185 803,613 718,893 680,460 Redeemable Preferred Stock 4,319 4,319 5,427 5,427 The methods of determining the fair value of the Company's financial instruments are disclosed in the respective notes to the consolidated financial statements. NOTE H - Lease and Commitments The Company leases property and equipment under terms which include, in some cases, renewal options, escalation clauses or contingent rentals which are based on sales. Total rental expense for such leases amounted to the following (dollar amounts in thousands): 1995 1994 1993 ------- ------- ------- Minimun rentals $46,460 $39,852 $19,539 Contingent rentals 235 293 281 ------ ------ ------ 46,695 40,145 19,820 Less sublease rental income 7,334 5,953 5,506 ------ ------ ------ $39,361 $34,192 $14,314 ====== ====== ====== At December 30, 1995, future minimum rental payments and sublease rentals for all noncancellable leases with initial or remaining terms of one year or more consisted of the following (dollar amounts in thousands): Minimum Less Rental Sublease Payments Rentals Total -------- -------- -------- 1996 $ 48,781 $ 16,419 $ 32,362 1997 40,223 16,932 23,291 1998 43,759 16,934 26,825 1999 46,205 16,600 29,605 2000 45,998 16,433 29,565 Thereafter 697,832 201,864 495,968 ------- ------- ------- $922,798 $285,182 $637,616 ======= ======= ======= At December 30, 1995 the Company had contract commitments of approximately $3.6 million for future construction and a contract for information technology services requiring payments of approximately $19.6 million in 1996, $21.3 million in 1997, $24.1 million in 1998, $26.7 million in 1999 and $35.0 million in 2000. NOTE I - Employee Stock Plans In 1993 the Company established a stock profit sharing plan under which year end employees who are compensated for more than 1,000 hours during the year are participants. Eligible employees are allocated shares of the Company's Class B Common Stock based on hours of service up to 2,080 hours. Contributions are made at the sole discretion of the Company based on its profitability. The contribution expense was $1.4 million in 1995, $1.6 million in 1994 and $3.0 million in 1993. In 1993 the Company established a stock purchase plan which permits employees to purchase shares of the Company's Class B Common Stock through payroll deductions at 85% of fair market value at the time of purchase. Employees purchased 282,485 shares, 309,553 shares and 180,950 shares from the Treasury during 1995, 1994 and 1993, respectively. The Company has a Stock Option Plan which authorizes the Compensation Committee of the Board of Directors to grant options to key employees for the purchase of Class B Common Stock. The aggregate number of shares available for grant under the plan is equal to 10% of the number of shares of Class B Common Stock authorized. However, the number of outstanding and unexercised options shall not exceed 10% of the number of shares of Class A and Class B Common Stock outstanding. The number of unoptioned shares of Class B Common Stock available for grant was 890,671 shares and 973,419 shares at the end of 1995 and 1994, respectively. The options may be either incentive stock options or non- qualified stock options. Stock options granted to key employees and options outstanding are as follows: Option Price Number of per Share Shares ------------ --------- Balance at January 3, 1993 $19.00 1,107,500 Granted 19.00 622,000 Forfeited 19.00 (232,000) ----- --------- Balance at January 1, 1994 19.00 1,497,500 Granted 19.00 81,000 Forfeited 19.00 (33,000) ----- --------- Balance at December 31, 1994 19.00 1,545,500 Granted 19.00 317,000 Forfeited 19.00 (246,000) ----- --------- Balance at December 30, 1995 $19.00 1,616,500 ===== ========= The options are exercisable as follows: Number of Shares --------- Options exercisable in the future 1997 25,000 1999 453,000 2000 130,000 2001 207,000 2002 64,500 2003 528,000 2004 11,000 2005 138,000 --------- 1,556,500 Options currently exercisable 60,000 --------- 1,616,500 ========= Compensation expense for the difference between the market value of the options on the grant date and the grant price is recognized on a straight-line basis over the vesting period of the options. The amount charged to operations in 1995, 1994 and 1993 was immaterial. NOTE J - Pension Plans Employees whose terms of employment are determined by negotiations with recognized collective bargaining units are covered by their respective multi-employer defined benefit pension plans to which the Company contributes. The costs charged to operations for these plans amounted to approximately $4.6 million in 1995, $4.2 million in 1994 and $3.3 million in 1993. Other information for these multi- employer plans is not available to the Company. The Company maintains a defined benefit pension plan for all other permanent employees which provides for normal retirement at age 65. Employees are eligible to join when they complete at least one year of service and have reached age 21. The benefits are based on years of service and stated amounts associated with those years of service. The Company's funding policy is to contribute annually up to the maximum amount deductible for federal income tax purposes. Net pension cost includes the following components (dollar amounts in thousands): 1995 1994 1993 ---- ---- ---- Service cost - present value of benefits earned during the period $2,119 $2,326 $1,869 Interest cost on projected benefit obligation 1,966 1,725 1,350 Actual return on plan assets (9,692) 237 (1,053) Net amortization and deferral 7,598 (1,615) (304) ----- ----- ----- $1,991 $2,673 $1,862 ===== ===== ===== The following table presents the plan's funded status and amounts recognized in the Company's consolidated balance sheets (dollar amounts in thousands): 1995 1994 ---- ---- Actuarial present value of accumulated benefits based on service rendered to date: Vested $29,649 $16,965 Non-vested 3,482 3,438 ------ ------ 33,131 20,403 Fair value of plan assets (primarily in equity and fixed income funds and real estate) 37,934 20,993 ------ ------ Fair value of plan assets in excess of projected benefit obligation 4,803 590 Unrecognized net loss 7,473 5,737 Prior service cost 133 160 Unrecognized net asset (978) (1,141) ------ ----- Net prepaid pension cost $11,431 $5,346 ====== ===== The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 7.25% in 1995 and 8.5% in 1994. The expected long-term rate of return on plan assets was 8.5% in 1995 and 1994, and 9.5% in 1993. The Company provides a 401(k) plan for virtually all employees. The plan is entirely funded by employee contributions which are based on employee compensation not to exceed certain limits. NOTE K - Restructuring Charges In December 1995, the Company recorded restructuring charges amounting to $140 million related to its decision to sell, lease or close all 34 stores and the distribution center comprising its Southern California Region. The Southern California Region contributed sales of approximately $675 million, $653 million and $473 million in 1995, 1994 and 1993, respectively, and recognized operating losses of $41.1 million, $49.5 million and $40.0 million in 1995, 1994 and 1993, respectively. These losses include corporate allocations such as benefits of corporate buying, distribution and manufacturing operations; interest expense and corporate overhead. The restructuring charges include the following components. Total Adjustments Accrued Restructuring Restructuring to Costs Charges Carrying --------------------- Value Current Long-term ------------- ----------- --------- ----------- Charges for lease obligations $ 65,600 $25,600 $40,000 Asset valuation adjustments: Closed stores 21,700 $21,700 Assets sold 20,300 20,300 Inventory 16,000 16,000 Termination payments 10,000 10,000 Other 6,400 6,400 ------- ------ ------ ------ $140,000 $42,000 $58,000 $40,000 ======= ====== ====== ====== The lease rental obligations primarily relate to closed stores and consist of average annual lease expense over a five-year period net of any sublease income, discounted at a rate of 9%. Also included is a $15 million charge for certain fees associated with the sublease of the distribution center which is expected to be paid by March 1996. The distribution center and nine stores have been leased or subleased to another supermarket company controlled by the same group of investors that controls Smitty's Supermarkets, Inc., with whom the Company has entered into a definitive merger agreement (see Note L). The charges for store and distribution center inventories represent incremental losses for shrinkage, damage and liquidation sales expected to be incurred during the closing process. The termination payments relate to substantially all of the Company's 3,900 store and distribution center employees in the Southern California Region. The termination payments are expected to be made by the end of March 1996 and have been estimated based on existing employment contracts and involuntary termination statutes. The other costs represent charges for taxes, fees, contractual obligations, and other costs associated with closing the region. The restructuring charges include management's best estimates of the amounts expected to be realized on the disposal of the remaining stores and closure of the region. At December 30, 1995, the Company's carrying value of closed stores and excess land was approximately $260 million. The Company's current management has not determined the ultimate disposition or use of these real estate assets and believes that their disposal in the ordinary course of business would not result in a significant impact on carrying values. However, should the Company complete the subsequent event (see Note L), management may decide to pursue the sale of these assets. The amounts the Company may realize on disposal could differ significantly in the near term from the carrying values. NOTE L - Subsequent Event On January 29, 1996, the Company announced it had entered into a definitive merger agreement with Smitty's Supermarkets, Inc. ("Smitty's") in which Smitty's will become a wholly owned subsidiary of the Company. The merger will be completed by issuing 3,038,888 shares of the Company's Class B Common Stock for all of Smitty's outstanding common stock, subject to adjustment under certain circumstances. The Company will assume or refinance approximately $148 million of Smitty's debt. The Company also announced it will commence a self tender offer to purchase 50% of its outstanding Class A and Class B Common Stock for $36 per share, excluding shares to be issued in connection with the Smitty's merger. Debt of approximately $1.4 billion is expected to be issued at various interest rates to finance the stock purchase, repay certain existing indebtedness, and premiums related to early repayment. In addition, the Company plans to offer preferred stock to raise approximately $75 million. Completion of the tender offer will be subject to the tender of at least 50% of the Company's outstanding Common Stock, the receipt of adequate financing and various other conditions. Completion of the merger with Smitty's will be conditioned on the Company's purchase of shares pursuant to the self tender offer, receipt of adequate financing, regulatory approvals, approval by the Company's stockholders and various other conditions. The tender offer is expected to commence in April 1996 and be consummated in May 1996. The merger with Smitty's is expected to be consummated concurrently with the closing of the tender offer. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. SMITH'S FOOD & DRUG CENTERS, INC. /s/Jeffrey P. Smith Jeffrey P. Smith Chairman of the Board of Directors Date: March 29, 1996 and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/Jeffrey P. Smith Chairman of the Board and March 29, 1996 Jeffrey P. Smith Chief Executive Officer /s/Allen R. Rowland President and Chief March 29, 1996 Allen R. Rowland Operating Officer /s/Matthew G. Tezak Senior Vice President and March 29, 1996 Matthew G. Tezak Chief Financial Officer (Principal Financial Officer) /s/DeLonne Anderson Director March 29, 1996 DeLonne Anderson /s/Robert D. Bolinder Director March 29, 1996 Robert D. Bolinder /s/Allen P. Martindale Director March 29, 1996 Allen P. Martindale /s/Nicole Miller Director March 29, 1996 Nicole Miller /s/Duane Peters Director March 29, 1996 Duane Peters Director March 29, 1996 Ray V. Rose /s/Fred L. Smith Director March 29, 1996 Fred L. Smith /s/Richard D. Smith Director March 29, 1996 Richard D. Smith /s/Sean D. Smith Director March 29, 1996 Sean D. Smith /s/Douglas John Tigert Director March 29, 1996 Douglas John Tigert /s/Kenneth A. White Director March 29, 1996 Kenneth A. White INDEX TO EXHIBITS Exhibit Number Document 2.1 Recapitalization Agreement and Plan of Merger dated as of January 29, 1996 by and among Smith's Food & Drug Centers, Inc., Cactus Acquisition, Inc., Smitty's Supermarkets, Inc. and The Yucaipa Companies. 3.1 Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 in the Company's Registration Statement on Form S-1 (Commission File No. 33- 28698) which became effective on June 21, 1989). 3.2 By-laws of the Company (incorporated by reference to Exhibit 3.2 in the Company's Registration Statement on Form S-1 (Commission File No. 33-28698) which became effective on June 21, 1989). 4.1 Article IV of Restated Certificate of Incorporation of the Company (see Exhibit 3.1). 4.2 Certain instruments which define the rights of holders of long-term debt of the Company and its subsidiaries are not being filed because the total amount of securities authorized under each such instrument does not exceed 10% of the total consolidated assets of the Company and its subsidiaries. The Company hereby agrees to furnish a copy of each such instrument to the Commission upon request. 4.3 Form of Pass Through Trust Agreement between the Company and the Pass Through Trustee Company (incorporated by reference to Exhibit 4.1 in the Company's Registration Statement on Form S- 3 (Commission File No. 33-51097) which became effective on January 26, 1994). 4.4 Form of Pass Through Certificate (included in Exhibit 4.3). *10.1 Amended and Restated 1989 Stock Option Plan (incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 1991). *10.2 First Amendment to the Amended and Restated 1989 Stock Option Plan (Exhibit 10.1) dated as of February 7, 1995 (incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). *10.3 1993 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.2 of the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 1993). *10.4 First Amendment to the 1993 Employee Stock Purchase Plan (Exhibit 10.3) dated as of August 2, 1993 (incorporated by reference to Exhibit 10.3 of the Company's Annual Report on Form 10-K for the fiscal year ended January 1, 1994). *10.5 Employees' Profit Sharing Plan and Trust, as amended and restated as of July 27, 1982 (incorporated by reference to Exhibit 10.4 of the Company's Registration Statement on Form S-1 (Commission File No. 33-28698) which became effective June 21, 1989). *10.6 Pension Plan of Employees, as amended and restated as of July 27, 1982 (incorporated by reference to Exhibit 10.5 of the Company's Registration Statement on Form S-1 (Commission File No. 33-28698) which became effective on June 21, 1989). 10.7 Employee Profit Sharing Plan dated as of January 3, 1993, First Amendment dated as of August 2, 1993 and Second Amendment dated as of January 27, 1994 (incorporated by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the fiscal year ended January 1, 1994). 10.8 Third Amendment to the Employee Profit Sharing Plan (Exhibit 10.7) dated as of November 1, 1994 (incorporated by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). *10.9 Forms of Supplemental Compensation Agreements dated as of January 2, 1985, and amended as of March 14, 1985, between the Company and certain executive officers (incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1 (Commission File No. 33-28698) which became effective on June 21, 1989). 10.10 Revolving Credit Agreement, dated as of January 31, 1995, between the Company and Banco di Roma (incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994). 10.11 Revolving Credit Agreement, dated as of November 28, 1995, between the Company and Credit Suisse. 10.12 Loan Agreement Between the Company and a consortium of lenders dated May 1, 1992 (incorporated by reference to Exhibit 10.11 of the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 1993). 10.13 Loan Agreement between the Company and a consortium of lenders dated December 15, 1992 (incorporated by reference to Exhibit 10.12 of the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 1993). *10.14 Form of Additional Retirement Benefit Agreement between the Company and certain of its executive officers (incorporated by reference to Exhibit 10.13 of the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 1993). *10.15 Form of Indemnification Agreement between the Company and its directors and officers (incorporated by reference to Exhibit 10.14 of the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 1993). 10.16 Revolving Credit Agreement, dated as of June 28, 1993, between the Company and Bank of America (incorporated by reference to Exhibit 10.15 of the Company's Form 10-Q for the second quarter ended July 3, 1993). 10.17 Amendment 1, dated as of September 16, 1994, to Revolving Credit Agreement, dated as of June 28, 1993, between the Company and Bank of America (incorporated by reference to Exhibit 10.19 of the Company's Form 10-Q for the third quarter ended October 1, 1994). 10.18 Loan Agreement between the Company and a consortium of lenders dated November 1, 1993 (incorporated by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the fiscal year ended January 1, 1994). 10.19 Committed Credit Line Agreement, dated as of March 31, 1995, between the Company and Wachovia Bank of Georgia, N.A. (incorporated by reference to Exhibit 10.20 of the Company's Form 10-Q for the first quarter ended April 1, 1995). 10.20 Committed Credit Line Agreement, dated as of May 31, 1995, between the Company and Banque National de Paris (incorporated by reference to Exhibit 10.21 of the Company's Form 10-Q for the second quater ended July 1, 1995). 10.21 Amendment 2, dated as of May 9, 1995, to Revolving Credit Agreement, dated as of June 28, 1993, between the Company and Bank of America (incorporated by reference to Exhibit 10.22 of the Company's Form 10-Q for the second quater ended July 1, 1995). 12.1 Statement regarding computation of ratio of earnings to fixed charges. 21.1 Subsidiaries of the Company (incorporated by reference to Exhibit 22.1 of the Company's Annual Report on Form 10-K for the fiscal year ended January 1, 1994). 23.1 Consent of Ernst & Young LLP, Independent Auditors. * Indicates management contract or compensatory plan or arrangement. EX-2.1 2 RECAPITALIZATION AGREEMENT AND PLAN OF MERGER by and among SMITH'S FOOD & DRUG CENTERS, INC. CACTUS ACQUISITION, INC. SMITTY'S SUPERMARKETS, INC. and THE YUCAIPA COMPANIES Dated as of January 29, 1996 TABLE OF CONTENTS Page ---- ARTICLE 1. THE MERGER AND EFFECT OF THE MERGER ON THE CAPITAL STOCK OF THE CONSTITUENT CORPORATIONS 2 1.1 The Merger 2 1.2 Effective Time of the Merger 2 1.3 Effects of the Merger 2 1.4 Certificate of Incorporation and Bylaws 2 1.5 Directors and Officers 3 1.6 Tax Consequences 3 1.7 Stockholders' Agreements 3 1.8 Tax Matters Certificates and Opinions 3 1.9 Specified Smitty's Indebtedness 3 1.10 Effect on Capital Stock 4 1.11 Dissenting Shares 4 1.12 Exchange of Certificates 5 ARTICLE 2. RECAPITALIZATION OF THE COMPANY 6 2.1 Offer by the Company 6 2.2 Financing Arrangements by Yucaipa 7 2.3 Definitive Financing Agreements 8 2.4 Execution of Related Agreements 8 2.5 Redemption of the Company's Preferred Stock 8 2.6 Board of Directors; Officers 8 2.7 Company's Options and Deferred Compensation Plans 9 2.8 Recapitalization 9 ARTICLE 3. THE CLOSINGS 10 3.1 Merger Closing 10 3.2 Offer Closing 11 ARTICLE 4. REPRESENTATIONS OF THE COMPANY AND ACQUISITION 11 4.1 Organization 11 4.2 Capitalization 11 4.3 Authorization 12 4.4 Absence of Certain Changes or Events 12 4.5 No Conflict or Violation 13 4.6 Consents and Approvals 13 4.7 Litigation 13 4.8 Compliance with Law 14 4.9 Company SEC Reports 14 4.10 ERISA 14 4.11 Taxes 15 4.12 Absence of Breaches or Defaults 16 4.13 Environmental Matters 16 4.14 No Brokers 17 4.15 Opinion of Financial Advisor 17 4.16 No Other Agreements to Sell the Company or its Assets 17 4.17 Transactions with Affiliates 17 4.18 Vote Required 17 4.19 Registration Rights 17 4.20 Information in Proxy Statement 17 4.21 Information in the Financing Registration Statements 18 ARTICLE 5. REPRESENTATIONS OF SMITTY'S 18 5.1 Organization of Smitty's 18 5.2 Subsidiaries 18 5.3 Capitalization 19 5.4 Authorization 19 5.5 Absence of Certain Changes or Events 19 5.6 Assets 20 5.7 Contracts and Commitments 21 5.8 Absence of Breaches or Defaults 22 5.9 No Conflict or Violation 22 5.10 Consents and Approvals 23 5.11 Litigation 23 5.12 Compliance with Law 23 5.13 Labor Matters 23 5.14 Smitty's SEC Reports 24 5.15 No Brokers 25 5.16 No Other Agreements to Sell Smitty's or its Assets 25 5.17 Proprietary Rights 25 5.18 Employee Benefit Plans 25 5.19 Insurance 26 5.20 Affiliate Transactions 26 5.21 Environmental Matters 27 5.22 Taxes 27 5.23 Bank Accounts 28 5.24 Information in Proxy Statement and Financing Registration Statements 28 ARTICLE 6. REPRESENTATIONS OF YUCAIPA 29 6.1 Organization; Authorization; etc. 29 6.2 Ownership of Shares 29 6.3 Consents and Approvals; No Violations 29 6.4 Agreement to Sell Smitty's and Other Matters 30 ARTICLE 7. CONDUCT OF BUSINESS PENDING THE MERGER CLOSING 30 7.1 The Company 30 7.2 Smitty's 31 ARTICLE 8. ADDITIONAL COVENANTS 34 8.1 Further Assurances and Cooperation 34 8.2 Certain Filings and Consents 34 8.3 Access to Information; Confidentiality 35 8.4 Notification of Certain Matters 35 8.5 Alternative Proposals 36 8.6 Public Statements and Press Releases 37 8.7 Directors' and Officers' Insurance and Indemnification 37 8.8 Financial Information 39 8.9 Smitty's Stockholders' Approval 39 8.10 Proxy Statement; Company Stockholders' Meeting 39 8.11 Stockholders' Representative 40 8.12 Termination of Consulting Agreement 40 ARTICLE 9. CONDITIONS PRECEDENT TO THE MERGER 40 9.1 Conditions Precedent to the Company's and Acquisition's Obligations 40 9.2 Conditions Precedent to Smitty's' Obligations 42 ARTICLE 10. TERMINATION, AMENDMENT AND WAIVER 43 10.1 Termination of the Agreement 43 10.2 Termination of Recapitalization 44 10.3 Procedure and Effect of Termination 44 10.4 Fees and Expenses 45 10.5 Amendments 45 10.6 Waivers 45 ARTICLE 11. DEFINITIONS 45 11.1 Defined Terms 45 11.2 Other Defined Terms 50 ARTICLE 12. MISCELLANEOUS 52 12.1 Non-survival of Representations and Warranties 52 12.2 Assignment 52 12.3 Notices 52 12.4 Payment to Yucaipa 53 12.5 Choice of Law 53 12.6 Counterparts 53 12.7 No Third Party Beneficiaries 53 12.8 Invalidity 53 12.9 Headings 53 12.10 Gender 54 12.11 Delivery of Company Disclosure Schedule 54 SCHEDULE I- Specified Company Indebtedness ANNEXES Annex A - Certificate of Incorporation of the Surviving Corporation Annex B - Legal Opinion to be Delivered by Counsel to the Company Annex C - Legal Opinion to be Delivered by Counsel to Smitty's Annex D - Form of Amended and Restated Certificate of Incorporation of the Company Annex E - Form of Registration Rights Agreement Annex F - Form of Smitty's Stockholders' Agreement Annex G - Form of Continuity-of-Interest Letter Annex H - Form of Investment Letter Annex I - Form of Company Tax Matters Certificate Annex J - Form of Smitty's Tax Matters Certificate Annex K - Form of Standstill Agreement Annex L - Form of Management Agreement Annex M - Form of Warrant Agreement Annex N - Conditions to Offer Annex O - Smith's Shareholder Agreement RECAPITALIZATION AGREEMENT AND PLAN OF MERGER RECAPITALIZATION AGREEMENT AND PLAN OF MERGER (this "Agreement"), dated as of January 29, 1996, by and among Smith's Food & Drug Centers, Inc., a Delaware corporation (the "Company"), Cactus Acquisition, Inc., a Delaware corporation and a wholly owned subsidiary of the Company ("Acquisition"), Smitty's Supermarkets, Inc., a Delaware corporation ("Smitty's"), and The Yucaipa Companies, a California general partnership ("Yucaipa"). Acquisition and Smitty's are hereinafter collectively referred to as the "Constituent Corporations". Definitions of capitalized terms used herein are contained or referenced in Article 11 hereof. WHEREAS, the parties hereto desire to effect a series of transactions as described herein which, collectively, will constitute the Recapitalization of the Company; WHEREAS, the respective Boards of Directors of the Company, Acquisition and Smitty's have determined that the merger of Acquisition with and into Smitty's (the "Merger") in accordance with the Delaware General Corporation Law (the "Delaware Law") and upon the terms and subject to the conditions set forth in this Agreement, would be fair and in the best interests of their respective stockholders, and such Boards of Directors have approved such Merger upon the terms and conditions contained in this Agreement; WHEREAS, it is intended that the Merger qualify as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended; WHEREAS, as part of the Recapitalization, the Company will make an offer to repurchase for $36.00 per share (the "Offer Price") 50% of its outstanding Class A Common Stock, par value $.01 per share (the "Class A Common Stock") and its outstanding Class B Common Stock, par value $.01 per share (the "Class B Common Stock; together with the Class A Common Stock, the "Common Stock"), pursuant to a tender offer as further described herein (the "Offer"); WHEREAS, as part of the Recapitalization, the Company will enter into a Management Services Agreement, in the form of Annex L hereto (the "Management Agreement"), with Yucaipa pursuant to which Yucaipa will undertake and perform various managerial obligations in respect of the Company's operations, subject to the terms and conditions contained in such agreement; and WHEREAS, as part of the Recapitalization, the Company will redeem a portion of its outstanding Series I Preferred Stock, par value $.01 per share (the "Series I Preferred Stock"), from certain holders thereof in accordance with the redemption provisions contained in the Company's certificate of incorporation; NOW, THEREFORE, in consideration of the mutual covenants and premises contained herein and for other good and valuable consideration the receipt and adequacy of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE 1. THE MERGER AND EFFECT OF THE MERGER ON THE CAPITAL STOCK OF THE CONSTITUENT CORPORATIONS 1.1 The Merger. Subject to the terms and conditions hereof, at the Effective Time, Acquisition shall be merged with and into Smitty's in accordance with the applicable provisions of the Delaware Law. Upon the consummation of the Merger, the separate existence of Acquisition shall cease and Smitty's, as the surviving corporation in the Merger (the "Surviving Corporation"), shall continue its corporate existence under the laws of the State of Delaware as a wholly owned subsidiary of the Company. 1.2 Effective Time of the Merger. On the Merger Closing Date, the parties hereto shall cause the Merger to be consummated by duly filing an appropriate certificate of merger (the "Certificate of Merger") in such form as is required by, and executed in accordance with, the relevant provisions of the Delaware Law. The Merger shall be effective at such time as the Certificate of Merger is filed with the Secretary of State of Delaware in accordance with the Delaware Law or at such later time as is specified in the Certificate of Merger (the "Effective Time"). 1.3 Effects of the Merger. The Merger shall have all of the effects provided for under the Delaware Law, including, without limitation, that upon the effectiveness of the Merger, the Surviving Corporation shall thereupon and thereafter possess all the rights, privileges, powers and franchises, of a public as well as of a private nature, of the Constituent Corporations, and shall become subject to all the restrictions, disabilities and duties of each of the Constituent Corporations; and, all and singular, the rights, privileges, powers and franchises of each of the Constituent Corporations, and all property, real, personal and mixed, and all debts due to any of such Constituent Corporations, on whatever account, as well for stock subscriptions as all other choses in action belonging to each of such corporations, shall become vested in the Surviving Corporation; and all property, rights, privileges, powers and franchises, and all and every other interest shall become thereafter as effectually the property of the Surviving Corporation as they were of the Constituent Corporations; and the title to any real estate vested by deed or otherwise or any other interest in real estate vested by any instrument or otherwise in either of such Constituent Corporations shall not revert or become in any way impaired by reason of the Merger; but all liens upon any property of either of the Constituent Corporations shall thenceforth attach to the Surviving Corporation, and shall be enforceable against it to the same extent as if such debts, liabilities and duties had been incurred or contracted by it; all of the foregoing in accordance with the applicable provisions of the Delaware Law. 1.4 Certificate of Incorporation and Bylaws. (a) The certificate of incorporation of Smitty's, as in effect immediately prior to the Effective Time, shall be amended so as to read in its entirety in the form set forth as Annex A hereto, and, as so amended, until thereafter further amended as provided therein and under the Delaware Law, it shall be the certificate of incorporation of the Surviving Corporation following the Merger. (b) The bylaws of Smitty's as in effect at the Effective Time shall be the bylaws of the Surviving Corporation following the Merger until thereafter changed or amended as provided therein or under the Delaware Law. 1.5 Directors and Officers. The directors and officers of the Surviving Corporation following the Merger shall be the directors and officers, respectively, of Acquisition at the Merger Closing Date, until the earlier of their resignation or removal or until their respective successors are duly elected and qualified, as the case may be. Smitty's shall cause to be delivered to the Company on the Merger Closing Date the resignations of such officers and directors as the Company shall designate, in such capacities, of itself and its subsidiaries. 1.6 Tax Consequences. For federal income tax purposes, the Merger is intended to constitute a reorganization within the meaning of Section 368(a) of the Code. Neither the Company, Acquisition, Smitty's nor the Surviving Corporation shall take a position inconsistent with this Section 1.6 on any tax return or otherwise. 1.7 Stockholders' Agreements. As of the date hereof, each of the Smitty's Principal Stockholders shall have entered into, and Smitty's and Yucaipa shall use their respective best efforts to cause each other Smitty's Stockholder, to enter into a stockholders' agreement (each a "Smitty's Stockholders' Agreement") with the Company in substantially the form attached hereto as Annex F and to execute a Continuity-of-Interest Letter and an Investment Letter in the forms attached hereto as Annexes G and H, respectively. 1.8 Tax Matters Certificates and Opinions. At the Merger Closing, the Company and Smitty's shall deliver Tax Matters Certificates to their respective counsel, which certificates shall be in substantially the form of Annexes I and J attached hereto, respectively. At the Merger Closing, each of the Company and Smitty's shall have requested and received written opinions from their respective counsel, dated the Merger Closing Date, to the effect that the Merger will constitute a reorganization within the meaning of Section 368(a) of the Code, which opinions will be substantially identical in form and substance. Such counsel shall, in rendering such opinions, be entitled to rely on (and to the extent reasonably required, the parties and the Smitty's Principal Stockholders shall make) reasonable representations related thereto. 1.9 Specified Smitty's Indebtedness. On the Merger Closing Date, the Company shall repay, or cause to be repaid, all outstanding principal and interest, and other amounts payable, under the Specified Smitty's Indebtedness. In furtherance of the foregoing, substantially concurrently with the commencement of the Offer (or in the event that the Recapitalization is terminated prior to the commencement of the Offer in accordance with the provisions of Section 10.2 hereof, as soon as practicable following such termination), Smitty's shall commence offers (the "Debt Offers") to purchase for cash all of the issued and outstanding 12 3/4% Senior Subordinated Notes due 2004 of Smitty's Super Valu, Inc. (the "Smitty's Notes") and the 13 3/4% Senior Discount Debentures due 2006 of Smitty's (the "Smitty's Debentures" and, together with the Smitty's Notes, the "Smitty's Securities"), at such prices as may be recommended by the Company's financial advisors, net to the sellers in cash (such prices, or such higher prices as may be paid in the Debt Offers, being referred to herein as the "Debt Offer Prices"). The Debt Offers shall be subject to there being validly tendered and not withdrawn prior to the expiration of the Debt Offers, at least 50.1% of the outstanding Smitty's Notes and Smitty's Debentures as of the expiration of the Debt Offers (the "Minimum Debt Condition") and to such other conditions as are reasonably determined by Smitty's. Smitty's shall, on the terms and subject to the prior satisfaction or waiver of the conditions of the Debt Offers, accept for payment and pay for Smitty's Securities tendered as soon as practicable after the later of the satisfaction of the conditions to the Debt Offers and the expiration of the Debt Offers. The Debt Offers shall be made by means of an offer to purchase (the "Debt Offer to Purchase") containing the terms contemplated by this Agreement. Without the written consent of the Company, Smitty's shall not amend or waive the Minimum Debt Condition, change the Debt Offer Prices, change the number of Smitty's Securities sought to an amount less than all of the outstanding Smitty's Securities, change the form of consideration to be paid pursuant to the Debt Offers or amend any other term or condition of the Debt Offers in any manner which is adverse to the holders of the Smitty's Securities; provided, however, that if on the initial scheduled expiration date of the Debt Offers (as they may be extended in accordance with the terms thereof), all conditions to the Debt Offers shall not have been satisfied or waived, the Debt Offers may be extended from time to time without the consent of the Company for such period of time as is reasonably expected to be necessary to satisfy such unsatisfied conditions. In addition, the Debt Offer Prices may be increased with the consent of the Company as specified above, in which case the Debt Offers may be extended to the extent required by law in connection with such increase without any further consent of the Company. 1.10 Effect on Capital Stock. As of the Effective Time, by virtue of the Merger and without any action on the part of the holder of any shares of common stock, par value $.01 per share, without distinction as to class, of Smitty's (the "Smitty's Common Stock") or any shares of capital stock of Acquisition or the Company: (a) Common Stock of Acquisition. Each share of common stock of Acquisition issued and outstanding immediately prior to the Effective Time shall be converted into one share of common stock, par value $.01 per share, of the Surviving Corporation. (b) Cancellation of Treasury Stock of Acquisition. Each share of capital stock of Acquisition that is owned by Acquisition or by any subsidiary of the Company or Acquisition shall automatically be cancelled and retired and shall cease to exist, and no consideration shall be delivered or deliverable in exchange therefor. (c) Smitty's Common Stock. Each share of Smitty's Common Stock, without distinction as to class, outstanding immediately prior to the Effective Time (other than shares of Smitty's Common Stock to be cancelled pursuant to Section 1.10(d) below), shall be converted into 3.011803 shares of the Company's Class B Common Stock (the "Merger Consideration"). (d) Cancellation of Treasury Stock of Smitty's. Each share of capital stock of Smitty's that is owned by Smitty's or by any subsidiary of Smitty's shall automatically be cancelled and retired and shall cease to exist, and no consideration shall be delivered or deliverable in exchange therefor. 1.11 Dissenting Shares. Each Smitty's Stockholder delivering a Smitty's Stockholders' Agreement will agree, pursuant to its respective Smitty's Stockholders' Agreement, to waive any appraisal rights granted pursuant to Section 262 of the Delaware Law (or any successor provision) to which it may otherwise be entitled as a result of the transactions resulting from the Merger. Notwithstanding anything in this Agreement to the contrary, shares of Smitty's Common Stock outstanding immediately prior to the Effective Time held by a holder (other than any Smitty's Stockholder who has delivered a Smitty's Stockholders' Agreement) who has the right to demand payment for and an appraisal of such shares in accordance with Section 262 of the Delaware Law (or any successor provision) ("Dissenting Shares") shall not be converted into the Merger Consideration or any cash in lieu of fractional shares of Smitty's Common Stock unless such holder fails to perfect or otherwise loses such holder's right to such payment or appraisal, if any. If, after the Effective Time, such holder fails to perfect or loses any such right to appraisal, each such share of Smitty's Common Stock of such holder shall be treated as a share that had been converted as of the Effective Time into the Merger Consideration in accordance with Section 1.10. Smitty's shall give prompt notice to the Company of any demands received by Smitty's for appraisal of shares of Smitty's Common Stock, and the Company (or its designee) shall have the right to participate in and direct all negotiations and proceedings with respect to such demands. Smitty's shall not, except with the prior written consent of the Company (or its designee), make any payment with respect to, or settle or offer to settle, any such demands. 1.12 Exchange of Certificates. (a) Exchange Procedures. As soon as practicable after the Effective Time, each holder of an outstanding certificate or certificates which prior thereto represented shares of Smitty's Common Stock shall, upon surrender to the Surviving Corporation, duly endorsed, as the Surviving Corporation may require, be entitled to a certificate or certificates representing the number of full shares of Class B Common Stock into which the number of shares of Smitty's Common Stock previously represented by such certificate or certificates surrendered shall have been converted pursuant to this Agreement. Certificates for the newly issued Class B Common Stock shall bear the legend contemplated by the Investment Letters. After the Effective Time, there shall be no further transfer on the records of Smitty's or its transfer agent of certificates representing shares of Smitty's Common Stock which have been converted pursuant to this Agreement into the Merger Consideration, and if such certificates are presented to Smitty's for transfer, they shall be cancelled against delivery of the certificates representing the Merger Consideration, as well as any cash in lieu of fractional shares thereof. If any certificate for Class B Common Stock is to be issued in, or if cash in lieu of fractional shares is to be remitted to, a name other than that in which the certificate for Smitty's Common Stock surrendered for exchange is registered, it shall be a condition of such exchange that the certificate so surrendered shall be properly endorsed, with signature guaranteed, or otherwise in proper form for transfer and that the person requesting such exchange shall pay to the Company or its transfer agent any transfer or other taxes required by reason of the issuance of certificates for such Class B Common Stock in a name other than that of the registered holder of the Smitty's Common Stock certificate surrendered, or establish to the satisfaction of Smitty's or its transfer agent that such tax has been paid or is not applicable. Until surrendered as contemplated by this Section, each certificate for shares of Smitty's Common Stock shall be deemed at any time after the Effective Time to represent the Merger Consideration as contemplated by Section 1.10. No interest will be paid or will accrue on any cash payable as Merger Consideration or in lieu of any fractional shares of Class B Common Stock issued hereby. (b) Distributions. No dividends or other distributions with respect to Class B Common Stock issued hereby with a record date after the Effective Time shall be paid to the holder of any unsurrendered certificate for shares of Smitty's Common Stock with respect to the shares of Class B Common Stock represented thereby and no cash payment in lieu of fractional shares shall be paid to any such holder until the surrender of such certificate in accordance with this Article 1. Subject to the effect of applicable laws, following surrender of any such certificate, there shall be paid to the holder of the certificates representing whole shares of Class B Common Stock issued in connection therewith, without interest, (i) at the time of such surrender the amount of any cash payable in lieu of a fractional share of Class B Common Stock to which such holder is entitled pursuant to Section 1.11(c), and (ii) at the appropriate payment date, the proportionate amount of dividends or other distributions with a record date after the Effective Time but prior to such surrender with respect to such whole shares of Class B Common Stock. (c) No Fractional Shares. (i) No certificates or scrip representing fractional shares of Class B Common Stock shall be issued in connection with the Merger. (ii) Notwithstanding any other provision of this Agreement, each holder of shares of Smitty's Common Stock exchanged pursuant to the Merger who would otherwise have been entitled to receive a fraction of a share of Class B Common Stock (after taking into account all shares of Smitty's Common Stock delivered by such holder) shall receive, in lieu thereof, a cash payment (without interest) representing such holder's proportionate interest in a share of Class B Common Stock which shall be deemed to have a value equal to the average closing price of the Class B Common Stock on the New York Stock Exchange for the five trading days following the Merger Closing Date. ARTICLE 2. RECAPITALIZATION OF THE COMPANY 2.1 Offer by the Company. (a) The Company shall commence the Offer as soon as practicable following the mailing of the Proxy Statement by the Company to its stockholders. The Company agrees that the terms of the Offer will provide that the Company will purchase, subject to the satisfaction or waiver of the conditions to the Offer set forth in Annex N hereto, 50% of its outstanding shares of Common Stock, which shares have been validly tendered and not withdrawn in the Offer, at a price per share equal to the Offer Price. Notwithstanding the foregoing, however, the parties agree that in the event the financing described in paragraph (b) of Annex N has been obtained, the Company agrees that it will, if so requested in writing by Yucaipa, waive the condition set forth in paragraph (f) of Annex N. Upon the Company's acceptance of, and payment for, shares of Common Stock, such shares shall cease to be outstanding for all purposes. The Offer shall provide that if there are validly tendered and not withdrawn more than 50% of the shares of outstanding Common Stock, then the number of shares that the Company is obligated to purchase shall be reduced pro rata on the basis of the total number of shares tendered. (b) On the date the Offer is commenced, the Company shall file with the SEC an Offer Statement on Schedule 13E-4 with respect to the Offer. The Offer Statement shall contain the offer to purchase and forms of the related letter of transmittal and summary advertisement, as well as all other information and exhibits required by law. The Company agrees promptly to correct any information in the Offer Statement that shall be or shall have become false or misleading in any material respect and the Company further agrees to take all steps necessary to cause the Offer Statement as so corrected to be filed with the SEC and disseminated to the stockholders of the Company as and to the extent required by applicable federal securities laws. Smitty's and its counsel shall be given an opportunity to participate in the preparation of the Offer Statement prior to its being filed with the SEC. The Company agrees to provide Smitty's and its counsel with any written comments the Company or its counsel may receive from the SEC with respect to the Offer Statement promptly after the receipt of such comments. The form and substance of the Offer Statement and any amendments, modifications or supplements to the Offer Statement shall be determined by the Company in its reasonable discretion; provided, however, that the Company will provide Smitty's a reasonable opportunity to review and comment on any such amendment, modification or supplement prior to filing or distribution. 2.2 Financing Arrangements by Yucaipa. (a) On or prior to the date hereof, Yucaipa has caused to be delivered to the Company, and the Company has accepted, one or more bank commitment letters and one or more highly confident letters (collectively, the "Commitment Letters") containing indicative terms and conditions which are reasonably satisfactory to the Company providing for (i) borrowings by the Company in an aggregate principal amount of approximately $850 million under one or more senior bank facilities, (ii) the issuance and sale by the Company of senior notes and senior subordinated notes in an aggregate principal amount of approximately $650 million (the "New Debt Securities"), (iii) the issuance and sale of shares of a newly designated series of the Company's pay-in-kind preferred stock with aggregate gross proceeds of approximately $75 million (the "PIK Preferred Stock") and shares of the Company's Class B Common Stock (the financings referred to in clauses (i), (ii) and (iii) are collectively referred to as the "Financings"). (b) At all times prior to the Offer Closing Date, Yucaipa agrees to use all reasonable efforts to consult with the Company concerning and, as appropriate, assist the Company in arranging for the Company to enter into one or more agreements providing for financing (collectively, the "Financing Agreements"), with terms and conditions which are consistent with the related Commitment Letters for such Financing Agreements and are otherwise reasonably satisfactory to the Company. (c) On or prior to the Offer Closing Date, the Company agrees to effect borrowings and issuances and sales, as applicable, under the Financing Agreements, the funds of which shall be used upon expiration of the Offer, together with other funds available to the Company, to (x) purchase 50% of its outstanding Common Stock, (y) repay all outstanding principal and interest, and other amounts payable, under the Specified Company Indebtedness and the Specified Smitty's Indebtedness and (z) pay certain fees and expenses incurred in connection with the Recapitalization and the other transactions contemplated hereby. 2.3 Definitive Financing Agreements. The Company shall use all reasonable efforts to negotiate, prepare and enter into definitive Financing Agreements to provide for the Financings on terms and conditions which are consistent with those contained in the related Commitment Letters and are otherwise reasonably satisfactory to the Company. Each of the parties hereto shall use all reasonable efforts to satisfy, on or before the Offer Closing Date, all requirements of the Financing Agreements which are conditions to closing the transactions constituting the Financings. Without limitation of the foregoing, the Company will prepare registration statements (the "Financing Registration Statements") for filing pursuant to the Securities Act on such forms as may be appropriate in order to permit the public offering of the New Debt Securities and the PIK Preferred Stock and to take such other actions in connection therewith as may be appropriate to complete such public offerings. Smitty's and its counsel shall be given an opportunity to participate in the preparation of each Financing Registration Statement prior to its being filed with the SEC. The Company agrees to provide Smitty's and its counsel with any written comments the Company or its counsel may receive from the SEC with respect to any Financing Registration Statement promptly after the receipt of such comments. The form and substance of the Financing Registration Statements and any amendments, modifications or supplements to the Financing Registration Statements shall be determined by the Company in its reasonable discretion; provided, however, that the Company will provide Smitty's and its counsel a reasonable opportunity to review and comment on any such amendment, modification or supplement prior to filing or distribution. 2.4 Execution of Related Agreements. (a) Simultaneously with the execution of this Agreement, the Company, Yucaipa, the Smitty's Principal Stockholders and the Company stockholders named therein shall enter into a Standstill Agreement (the "Standstill Agreement"), in the form of Annex K hereto. (b) On the Offer Closing Date, the Company and Yucaipa shall enter into the Management Agreement, in the form of Annex L hereto. (c) On the Offer Closing Date, the Company and Yucaipa shall enter into a Warrant Agreement (the "Warrant Agreement"), in the form of Annex M hereto. (d) Simultaneously with the execution of this Agreement, Smitty's, Jeffrey P. Smith, Richard D. Smith, Fred L. Smith, Ida Smith, the Dee Glenn Smith Marital Trust, Trust for the Children of Jeffrey Paul Smith, Trust for the Children of Richard Dee Smith, and Trust for the Children of Fred Lorenzo Smith shall each enter into a stockholders' agreement (the "Smith's Shareholder Agreement"), in the form of Annex O hereto. 2.5 Redemption of the Company's Preferred Stock. On or prior to the Offer Closing Date, the Company agrees, subject to the provisions of the Company's certificate of incorporation, to redeem outstanding shares of Series I Preferred Stock from certain holders in an amount and on terms reasonably acceptable to the Company and Smitty's. 2.6 Board of Directors; Officers. Effective on the Offer Closing Date, the Company agrees to use all reasonable efforts, subject to the provisions of the certificate of incorporation and bylaws of the Company and the approval of the Company's stockholders at the Company Stockholders' Meeting, to: (a) cause the Company's Board of Directors to be reduced to seven directors and have nominated and elected as directors two designees of Yucaipa, two independent directors, the individual selected by the Company to become the Chief Operating Officer of the Company and two nominees designated by the Chairman of the Company; and (b) cause the Company's Board of Directors to elect Ronald W. Burkle as the Chief Executive Officer of the Company. 2.7 Company's Options and Deferred Compensation Plans. (a) The Company shall, consistent with applicable law, offer those employees who hold, immediately prior to the Offer Closing Date, options to purchase Common Stock under the Company's 1989 Stock Option Plan (the "Options"), the opportunity to elect either: (A) to receive (on the Offer Closing Date) cash payments with respect to one-half of the shares subject to the Options in an amount equal to (1) the number of shares of Company Common Stock that would be received by such holder upon exercise of such Options multiplied by the Offer Price minus (2) the aggregate exercise price of such Options, and, in consideration of such payments, to execute amendments to each existing option agreement such that the remaining one-half of the shares subject to the Options shall not be exercisable prior to the exercise date stated therein (without regard to the transactions contemplated hereby) and shall have a reduced exercise price of $15.00 per share of Company Common Stock; or (B) have the vesting of all of such holder's Options accelerate in accordance with the stated terms of the options as in effect as of the date of this Agreement. (b) The Company shall use all reasonable efforts to amend its deferred compensation agreements in effect as of the date of this Agreement with each of Frederick F. Urbanek, James A. Acton, Richard C. Bylski, Larry R. McNeill, Kenneth A. White, Matthew G. Tezak, Paul D. Tezak, James W. Hallsey, Michael C. Frei, Harry M. Moskal, Robert C. Bolinder and Thomas K. Welch, to provide that if within two years after the Closing Date the Company terminates such officer's employment without cause (as such term will be defined in such amendments to the reasonable satisfaction of such officers, the Company and Yucaipa), all of such officer's unvested benefits under such deferred compensation agreement shall become immediately and fully vested. 2.8 Recapitalization. As used herein, the "Recapitalization" refers collectively to the execution, delivery and performance of this Agreement with respect to the following: (i) the execution and delivery of, and receipt of the proceeds under, the Financing Agreements, (ii) the making and consummation of the Offer, (iii) the execution and delivery of the Management Agreement; (iv) the execution and delivery of, and the issuance of the warrants provided for under, the Warrant Agreement, (v) the completion of the transactions contemplated by Sections 2.6 and 2.7 hereof, and (vi) the filing of the restated certificate of incorporation of the Company in the form attached hereto as Annex D. ARTICLE 3. THE CLOSINGS 3.1 Merger Closing. (a) The closing of the Merger (the "Merger Closing") shall take place at 10:00 a.m. local time on the fifth Business Day following the day on which the last to be fulfilled or waived of the conditions set forth in Article 9 hereof shall be fulfilled or waived in accordance with this Agreement, at the offices of Latham & Watkins, 633 West Fifth Street, Sixth Floor, Los Angeles, California 90071, or at such other time and place and on such other date as the parties hereto shall agree (the "Merger Closing Date"). (b) In connection with the Merger Closing, the filing required under Section 1.2 shall be made and all actions, payments and deliveries then required hereunder shall be completed. The Merger Closing shall be deemed to have occurred only when (i) the matters provided for in Section 1.2 shall have occurred and (ii) all of the opinions, certificates and other documents required to be delivered at the Merger Closing, as specified in the following sentence, have been delivered (or the requirement therefor waived). (c) At the Merger Closing, (i) the Company shall deliver to the Smitty's Stockholders, in the case of clause (A), and to Yucaipa (with copies to Smitty's) as representative of the Smitty's Stockholders, in the case of clauses (B) through (G), (A) the Merger Consideration as specified in Section 1.10, (B) a certificate of the Company (signed on behalf of the Company by its President or a Vice President) that the conditions set forth in Section 9.1 have been satisfied (except as waived by Smitty's), (C) the certificate of incorporation of each of the Company and Acquisition, certified by the Secretary of State of Delaware and certificates of good standing of the Company and Acquisition in Delaware and Arizona, (D) an incumbency certificate with respect to the officers of the Company and Acquisition, (E) the Registration Rights Agreement, in the form of Annex E hereto, duly executed by the Company, (F) a favorable opinion of counsel to the Company (which counsel may include in-house counsel to the Company and shall be reasonably satisfactory to Smitty's) as to the matters set forth in the Annex B hereto and such other matters as are customary in acquisition transactions and as may be reasonably requested by Smitty's and Yucaipa, and (G) such other certificates, instruments or other documents as Smitty's may reasonably request, in each case in form and substance reasonably satisfactory to Smitty's; and (ii) Smitty's and Yucaipa, as applicable, shall deliver, or cause to be delivered, to the Company (A) the corporate minute books, stock transfer books and bylaws of Smitty's, (B) a certificate of Smitty's and Yucaipa (signed, in the case of Smitty's, by its President or a Vice President) that the conditions set forth in Section 9.2 have been satisfied (except as waived by the Company), (C) the certificate of incorporation of Smitty's certified by the Secretary of State of Delaware and certificates of good standing of Smitty's in Delaware and Arizona, (D) incumbency certificates with respect to the officers of Smitty's and, as appropriate, its subsidiaries, and Yucaipa, (E) a favorable opinion of counsel to Smitty's (which counsel may include in-house counsel to Smitty's and shall be reasonably satisfactory to the Company) as to the matters set forth in Annex C hereto and such other matters as are customary in acquisition transactions and as may be reasonably requested by the Company, and (F) such other certificates, instruments or other documents as the Company may reasonably request, in each case in form and substance reasonably satisfactory to the Company. 3.2 Offer Closing. Unless the Recapitalization has been terminated in accordance with Section 10.2 hereof, the closing of the Offer (the "Offer Closing"; and together with the Merger Closing, the "Closing") shall take place on the Merger Closing Date (the "Offer Closing Date"; and together with the Merger Closing Date, the "Closing Date"). At the Offer Closing, each of the parties hereto shall have executed and delivered, to the extent they are parties thereto, each of the Management Agreement and the Warrant Agreement. ARTICLE 4. REPRESENTATIONS OF THE COMPANY AND ACQUISITION The Company and Acquisition hereby represent and warrant to Smitty's as follows: 4.1 Organization. Each of the Company, Acquisition and the Company's other subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, with the corporate power and authority to own and operate its businesses as presently conducted. Each of the Company, Acquisition and the Company's other subsidiaries is duly qualified as a foreign corporation to do business, and is in good standing, in each jurisdiction where the character of its properties owned or held under lease or the nature of its activities makes such qualification necessary, except where the failure of the Company or any of its subsidiaries to be so qualified would not have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. The Company has previously provided Smitty's with true and correct copies of the certificate of incorporation and bylaws, as currently in effect, of the Company and each of the Company's subsidiaries. Except as disclosed in Section 4.1 of the Disclosure Schedule, all of the outstanding shares of capital stock of each of the Company's subsidiaries are beneficially owned by the Company, directly or indirectly, free and clear of all liens, charges, security interests, options, claims or encumbrances of any nature whatsoever, and all such shares have been validly issued and are fully paid and non-assessable. 4.2 Capitalization. (a) The authorized capital stock of the Company consists of 20,000,000 shares of Class A Common Stock, 100,000,000 shares of Class B Common Stock and 85,000,000 shares of preferred stock, 34,524,579 shares of which have been designated as Series I Preferred Stock. As of January 25, 1996, 11,598,086 shares of Class A Common Stock, 18,363,925 shares of Class B Common Stock (4,890,288 of which are held in the Company's treasury) and 12,956,747 shares of Series I Preferred Stock are issued and outstanding. All of the issued and outstanding shares of Common Stock are validly issued, fully paid and non-assessable. As of the date hereof, except as otherwise disclosed in Section 4.2 of the Disclosure Schedule, there are no existing options, warrants, calls, subscriptions, convertible securities or other securities, agreements, commitments, or obligations which would require the Company to issue or sell shares of Common Stock or any other equity securities, or securities convertible into or exchangeable or exercisable for shares of Common Stock or any other equity securities of the Company or any of its subsidiaries. The Company has no commitments or obligations to purchase or redeem any shares of its Common Stock or, except as specified in the Company's certificate of incorporation, its Series I Preferred Stock. (b) The authorized capital stock of Acquisition consists of (i) 1,000 shares of common stock, 100 shares of which are issued and outstanding as of the date hereof. All of the issued and outstanding shares of Acquisition's common stock are validly issued, fully paid and non-assessable and owned by the Company. There are no existing options, warrants, calls, subscriptions, convertible securities or other securities, agreements, commitments, or obligations which would require Acquisition to issue or sell shares of its common stock or any other equity securities, or securities convertible into or exchangeable or exercisable for shares of its common stock or any other equity securities. Acquisition has no commitments or obligations to purchase or redeem any shares of its common stock. (c) Upon issuance in connection with the Merger, the shares of Class B Common Stock to be delivered to the Smitty's Stockholders as Merger Consideration will be validly issued, fully paid and non-assessable. 4.3 Authorization. Each of the Company and Acquisition has the requisite corporate power and authority to execute, deliver and perform this Agreement and the other Transaction Documents to which it is a party and the transactions contemplated hereby and thereby. The execution and delivery of this Agreement by each of the Company and Acquisition, the performance by each of the Company and Acquisition of their respective obligations hereunder and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of the Company and Acquisition, as applicable, except for the authorization and performance of the Financing Agreements and the requisite approval of the Company's stockholders, all of which action will be taken prior to the Closing Date. The execution, delivery and performance of the other Transaction Documents and the consummation of the transactions contemplated thereby will have been duly authorized by all necessary corporate action on the part of the Company or Acquisition, as applicable, prior to the Closing Date. Each of this Agreement and the Standstill Agreement has been duly and validly executed and delivered by each of the Company and Acquisition, as applicable, and constitutes a legally valid and binding obligation of each of the Company and Acquisition, as the case may be, enforceable against them in accordance with its terms except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally or by general principles of equity. The other Transaction Documents will have been, as of the Closing Date, duly and validly executed and delivered by the Company and will constitute, as of such time, legally valid and binding obligations of the Company, enforceable against them in accordance with their respective terms, except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally or by general principles of equity. The Certificate of Merger will have been, as of the Effective Time, duly and validly executed and delivered by Acquisition and will constitute as of such time legally valid and binding obligation of Acquisition, enforceable against it in accordance with its terms except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally or by general principles of equity. 4.4 Absence of Certain Changes or Events. Except as set forth in Section 4.4 of the Disclosure Schedule or in the Company SEC Reports and except for the transactions contemplated hereby, since December 31, 1994, (i) the Company and its subsidiaries have conducted their respective businesses only in the ordinary and usual course consistent with past practices, and (ii) there has not been any materially adverse change in the business, operations, condition (financial or otherwise), results of operations, prospects, assets, liabilities, working capital or reserves of the Company and its subsidiaries taken as a whole. Except as set forth in Section 4.4 of the Disclosure Schedule or the Company SEC Reports, from December 31, 1994 through the date of this Agreement, neither the Company nor any of its subsidiaries has taken any of the actions prohibited by Section 7.1 hereof. 4.5 No Conflict or Violation. Except as set forth in Section 4.5 of the Disclosure Schedule, neither the execution and delivery of this Agreement or the other Transaction Documents, nor the performance by each of the Company and Acquisition of their respective obligations hereunder and thereunder, nor the consummation of the transactions contemplated hereby or thereby, will (i) conflict with the Company's or Acquisition's certificate of incorporation or bylaws; (ii) assuming satisfaction of the requirements set forth in Section 4.6 below, violate any statute, law, ordinance, rule or regulation applicable to the Company or Acquisition or any of their respective properties or assets; or (iii) violate, breach, be in conflict with or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or permit the termination of any provision of, or result in the termination of, the acceleration of the maturity of, or the acceleration of the performance of any obligation of the Company or any of its subsidiaries, or result in the creation or imposition of any lien upon any properties, assets or business of the Company or any of its subsidiaries under, any note, bond, indenture, mortgage, deed of trust, lease, franchise, permit, authorization, license, contract, instrument or other agreement or commitment, or any order, judgment or decree to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or any of their respective assets or properties is bound or encumbered, except, in each case, for such violations, conflicts, defaults or other occurrences which, in the aggregate, would not have a Material Adverse Effect on the Company and its subsidiaries taken as a whole and would not prevent or delay the Merger or the Recapitalization or otherwise prevent the Company from performing its obligations under this Agreement and the other Transaction Documents. 4.6 Consents and Approvals. Except (i) pursuant to applicable requirements of the HSR Act, (ii) for filing of the Certificate of Merger in accordance with the Delaware Law, (iii) with respect to matters set forth in Section 4.6 of the Disclosure Schedule, no consent, approval or authorization of, permit from, or declaration, filing or registration with, any governmental or regulatory authority, or any other person or entity, is required to be made or obtained by the Company or Acquisition in connection with the execution, delivery and performance of this Agreement or the other Transaction Documents and the consummation of the transactions contemplated hereby and thereby. 4.7 Litigation. Except as set forth in Section 4.7 of the Disclosure Schedule or in the Company SEC Reports, there are no Actions instituted, pending or, to the best knowledge of the Company or Acquisition, threatened, which can reasonably be expected, individually or in the aggregate, directly or indirectly, to have a Material Adverse Effect on the Company and its subsidiaries taken as a whole, or to prevent or delay the Merger or the Recapitalization or otherwise prevent the Company or Acquisition from performing their respective obligations under this Agreement and the other Transaction Documents, nor is there any outstanding judgment, decree, or injunction or any statute, rule or order of any domestic or foreign court, governmental department, commission or agency which has or will have, individually or in the aggregate, any such Material Adverse Effect. 4.8 Compliance with Law. Except as set forth in Section 4.8 of the Disclosure Schedule, the Company and each of its subsidiaries is in compliance with all foreign, federal, state and local laws and regulations applicable to its operations or with respect to which compliance is a condition of engaging in the business thereof (including, without limitation, all Environmental Laws), except to the extent that failure to comply would not have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. Except as set forth in Section 4.8 of the Disclosure Schedule, to the best knowledge of the Company, neither the Company nor any of its subsidiaries has received any notice asserting a failure, or possible failure, to comply with any such law or regulation, the subject of which notice has not been resolved as required thereby or otherwise to the satisfaction of the party sending the notice, except for such failure as would not have a Material Adverse Effect on the Company and its subsidiaries taken as a whole or the transactions contemplated hereby. 4.9 Company SEC Reports. The Company has delivered to Smitty's true and complete copies of each registration statement, report and proxy or information statement, including without limitation, its annual reports to stockholders incorporated in material part by reference in certain of such reports, in the form (including exhibits (including all material contracts) and any amendments thereto) required to be filed with the SEC since December 31, 1993 (collectively, the "Company SEC Reports"). As of the respective dates such Company SEC Reports were filed, or if any Company SEC Reports were amended, as of the date such amendment was filed, each of the Company SEC Reports (i) complied in all material respects with all applicable requirements of the Securities Act and the Exchange Act and the rules and regulations promulgated thereunder, and (ii) did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Each of the audited consolidated financial statements and unaudited consolidated interim financial statements of the Company (including any related notes and schedules) included or incorporated by reference in its Annual Reports on Form 10-K for each of the three fiscal years ended on the Saturday nearest to December 31 in 1992, 1993 and 1994 and Quarterly Reports on Form 10-Q for all interim periods subsequent thereto fairly present, in conformity with GAAP applied on a consistent basis (except as may be indicated in the notes thereto), the consolidated financial position of the Company and its subsidiaries as of its date and the consolidated results of operations and changes in financial position for the period then ended (subject to normal year-end adjustments in the case of any unaudited interim financial statements). 4.10 ERISA. (a) Section 4.10 of the Disclosure Schedule contains a complete list of the Company's Employee Plans. Copies or descriptions of the Company's Employee Plans have been or will be furnished or made available to Smitty's and Yucaipa and their counsel within 10 Business Days of the date of this Agreement. (b) Except as described in Section 4.10 of the Disclosure Schedule, each of the Company's Employee Plans (other than any Multiemployer Plan) has been administered and is in compliance with the terms of such Plan and all applicable laws, rules and regulations where the failure thereof would have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. (c) No "reportable event" (as such term is used in section 4043 of ERISA), "prohibited transaction" (as such term is used in section 406 of ERISA or section 4975 of the Code) or "accumulated funding deficiency" (as such term is used in section 412 or 4971 of the Code) has heretofore occurred with respect to any of the Company's Employee Plans (other than any Multiemployer Plan) which would have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. (d) No litigation or administrative or other proceeding involving any of the Company's Employee Plans (other than any Multiemployer Plan) has occurred or are threatened where an adverse determination would have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. (e) Except as set forth in Section 4.10 of the Disclosure Schedule, neither the Company nor any ERISA Affiliate of the Company has incurred any withdrawal liability with respect to any Multiemployer Plan under Title IV of ERISA which remains unsatisfied in an amount which would have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. (f) Any termination of, or withdrawal from, any of the Company's Employee Plans or Multiemployer Plans, on or prior to the Closing Date, would not subject the Company to any material liability under Title IV of ERISA. 4.11 Taxes. As of the date of this Agreement, except as set forth in Section 4.12 of the Disclosure Schedule: (i) the Company and its subsidiaries have (A) duly filed (or there have been filed on their behalf) with the appropriate governmental authorities all Tax Returns required to be filed by them and such Tax Returns are true, correct and complete in all material respects, and (B) duly paid in full or made provision in accordance with GAAP (or there has been paid or provision has been made on their behalf) for the payment of all Taxes for all periods (or portions thereof) ending on or prior to the Merger Closing Date; (ii) the Company and its subsidiaries have complied in all material respects with all applicable laws, rules and regulations relating to the payment and withholding of Taxes and have, within the time and the manner prescribed by law, withheld and paid over to the proper governmental authorities all amounts required to be so withheld and paid over under applicable laws; (iii) no federal, state, local or foreign audits or other administrative proceedings or court proceedings are presently pending with regard to any Taxes or Tax Returns of the Company or its subsidiaries and neither the Company nor its subsidiaries has received a written notice of any pending audits or proceedings; (iv) neither the Service nor any other taxing authority (whether domestic or foreign) has asserted, or to the best knowledge of the Company, is threatening to assert, against the Company or any of its subsidiaries any deficiency or claim for Taxes; and (v) there are no material liens for Taxes upon any property or assets of the Company or any subsidiary thereof, except for liens for Taxes not yet due and payable and liens for Taxes that are being contested in good faith by appropriate proceedings. 4.12 Absence of Breaches or Defaults. Except as set forth in Section 4.12 of the Disclosure Schedule, to the best of the Company's knowledge, neither the Company nor any of its subsidiaries is in default under, or in breach or violation of, any material Contract. No event has occurred which either entitles, or would, on notice or lapse of time or both, entitle the holder of any indebtedness affecting the Company or any of its subsidiaries (except for the execution of this Agreement) to accelerate, or which does accelerate, the maturity of any indebtedness affecting the Company or any of its subsidiaries, except as set forth in Section 4.12 of the Disclosure Schedule. 4.13 Environmental Matters. Except as set forth in Section 4.13 of the Disclosure Schedule, each of the Properties of the Company or any of its subsidiaries is maintained in compliance with all Environmental Laws, except where the failure to so comply, or any aggregation of such failures, would not have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. Except as set forth in Section 4.13 of the Disclosure Schedule, no conditions exist with respect to the soil, surface waters, groundwaters, land, stream sediments, surface or subsurface strata, ambient air, and any other environmental medium on or off the Company's Properties, which, individually or in the aggregate, could result in any damage, claim, or liability to or against the Company or any of its subsidiaries by any third party (including, without limitation, any government entity), including, without limitation, any condition resulting from the operation of the Company's business and/or operator in the vicinity of any of the Company's Properties and/or any activity or operation formerly conducted by any Person on the Company's Properties, except in any such case which would not be reasonably expected to have a Material Adverse Effect on the Company and its subsidiaries taken as a whole. With the exception of retail consumer products sold in the ordinary course of business and supplies used in the ordinary course of business, and except as set forth in Section 4.13 of the Disclosure Schedule, the Company and any other Person for whose conduct the Company is or may be held responsible, has not generated, manufactured, refined, transported, treated, stored, handled, disposed, transferred, produced, or processed any Hazardous Materials. Except as set forth in Section 4.13 of the Disclosure Schedule, (i) there are no existing uncured notices of violation, administrative actions, or lawsuits against the Company or any of its subsidiaries arising under Environmental Laws or relating to the use, handling, storage, treatment, recycling, generation, or release of Hazardous Materials at any of the Company's Properties, nor has the Company received any uncured notification of any allegation of any responsibility for any disposal, release, or threatened release at any location of any Hazardous Materials; (ii) there have been no spills or releases of Hazardous Materials at any of the Company's Properties in excess of quantities reportable under Environmental Laws, except in any such case which would not be reasonably expected to have a Material Adverse Effect on the Company and its subsidiaries taken as a whole; and (iii) there are no consent decrees, consent orders, judgments, judicial or administrative orders, or liens by any governmental authority relating to any Environmental Law which regulate, obligate, or bind the Company or any of its subsidiaries. 4.14 No Brokers. Except for fees to be paid to Goldman, Sachs & Co. by the Company, no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the Merger or the Recapitalization or in connection with any proposed sale of the Company or any of its assets, or a restructuring of or merger or similar transaction involving the Company based upon arrangements made by or on behalf of Company and its subsidiaries. 4.15 Opinion of Financial Advisor. The Company has received an opinion from Goldman, Sachs & Co. dated as of a date which is on or prior to the date of this Agreement to the effect that, as of such date, the Merger Consideration to be paid by the Company in the Merger is fair to the Company (the "Fairness Opinion"). The Company has delivered to each of Smitty's and Yucaipa a true, complete and correct copy of the Fairness Opinion. 4.16 No Other Agreements to Sell the Company or its Assets. Except as set forth in Section 4.16 of the Disclosure Schedule, the Company has no legal obligation, absolute or contingent, to any other person or firm to sell any material portion of the Assets of the Company, to sell the capital stock of the Company or any of its subsidiaries, or to effect any merger, consolidation or other reorganization of the Company or any of its subsidiaries or to enter into any agreement with respect thereto. 4.17 Transactions with Affiliates. Except to the extent disclosed in the Company SEC Reports filed prior the date of this Agreement, from December 31, 1994 through the date of this Agreement, there have been no transactions, agreements, arrangements or understandings between the Company or its subsidiaries, on the one hand, and the Company's affiliates (other than wholly owned subsidiaries of the Company) or other Persons, on the other hand, that would be required to be disclosed under Item 404 of Regulation S-K under the Securities Act. 4.18 Vote Required. The approval by a majority of the votes cast by the holders of the outstanding shares of Company Common Stock and Series I Preferred Stock (taking into account the special voting rights attributable to the Class A Common Stock and the Series I Preferred Stock) is the only vote of the holders of any class or series of the Company's capital stock necessary to approve the Merger and the Recapitalization; provided that the total vote cast represents over 50% in interest of all securities of the Company entitled to vote on such matters. 4.19 Registration Rights. Except as set forth in Section 4.19 of the Disclosure Schedule, neither the Company nor any of its subsidiaries has previously entered into any agreement granting any registration rights to any Person, whether consistent or inconsistent with the rights to be granted to the Smitty's Stockholders in the Registration Rights Agreement. 4.20 Information in Proxy Statement. The Proxy Statement (or any amendment thereof or supplement thereto), at the date mailed to the Company's stockholders and at the time of the Company Stockholders' Meeting, will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading; provided, however, that no representation is made by the Company with respect to statements made therein based on information supplied by Smitty's, Yucaipa or any of their respective affiliates for inclusion in the Proxy Statement. Subject to the proviso set forth in the preceding sentence, the Proxy Statement will comply in all material respects with the provisions of the Exchange Act and the rules and regulations thereunder. 4.21 Information in the Financing Registration Statements. The Financing Registration Statements (or any amendments thereof or supplements thereto), on the date declared effective by the SEC, will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading; provided, however, that no representation is made by the Company with respect to statements made therein based on information supplied by Smitty's, Yucaipa or any of their respective affiliates for inclusion in the Financing Registration Statements. Subject to the proviso set forth in the preceding sentence, the Financing Registration Statements will comply in all material respects with the provisions of the Securities Act and the rules and regulations thereunder. ARTICLE 5. REPRESENTATIONS OF SMITTY'S Smitty's hereby represents and warrants to the Company and Acquisition as follows: 5.1 Organization of Smitty's. Smitty's and each of its subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation, with the corporate power and authority to own and operate its businesses as presently conducted. Smitty's and each of its subsidiaries is duly qualified as a foreign corporation to do business and is in good standing in each jurisdiction where the character of its properties owned or held under lease or the nature of its activities makes such qualification necessary, except where the failure of Smitty's or any of its subsidiaries to be so qualified would not have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. The jurisdictions in which Smitty's and each of its subsidiaries are qualified to do business are set forth in Section 5.1 of the Disclosure Schedule. Smitty's has previously provided the Company with true and correct copies of its certificate of incorporation and bylaws and the charter documents and bylaws of each of its subsidiaries, as currently in effect. 5.2 Subsidiaries. The only subsidiaries of Smitty's are those set forth in Section 5.2 of the Disclosure Schedule. All of the outstanding shares of capital stock of each of Smitty's' subsidiaries are validly issued, fully paid, non-assessable and free of preemptive rights or rights of first refusal. Except as set forth in Section 5.2 of the Disclosure Schedule, Smitty's owns, directly or indirectly, all of the issued and outstanding capital stock of each of its subsidiaries, free and clear of all Encumbrances, and there are no existing options, warrants, calls, subscriptions, convertible securities or other securities, agreements, commitments or obligations of any character relating to the outstanding capital stock or other securities of any subsidiary of Smitty's or which would require any subsidiary of Smitty's to issue or sell any shares of its capital stock or securities convertible into or exchangeable for shares of its capital stock. Except as set forth in Section 5.2 of the Disclosure Schedule, neither Smitty's nor any of its subsidiaries owns less than 100% of the outstanding voting securities or other capital stock of any corporation or other entity (other than investments in marketable securities). 5.3 Capitalization. The authorized capital stock of Smitty's consists of (i) 1,500,000 shares of Smitty's Common Stock, 1,000,000 shares of which have been designated as "Class A Common Stock" and 500,000 shares of which have been designated "Class B Common Stock," and (ii) 10,000 shares of preferred stock, par value $.01 per share. As of the date hereof, 705,692.803 shares of Smitty's' Class A Common Stock, 303,300 shares of Smitty's' Class B Stock and no shares of Smitty's' preferred stock are issued and outstanding; none of such shares are held in Smitty's' treasury as of the date hereof. All of the issued and outstanding shares of Smitty's Common Stock are validly issued, fully paid and non-assessable. There are no existing options, warrants, calls, subscriptions, convertible securities or other securities, agreements other than this Agreement, commitments, or obligations which would require Smitty's to issue or sell shares of Smitty's Common Stock or any other equity securities, or securities convertible into or exchangeable or exercisable for shares of Smitty's Common Stock or any other equity securities of Smitty's. Neither Smitty's nor any of its subsidiaries has any commitments or obligations to purchase or redeem any shares of capital stock of any class of, or other equity interests in, Smitty's or any of its subsidiaries. 5.4 Authorization. Smitty's has the requisite corporate power and authority to execute, deliver and perform this Agreement and the transactions contemplated hereby. The execution and delivery of this Agreement by Smitty's and the performance by Smitty's of its obligations hereunder and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of Smitty's, other than the adoption and approval of this Agreement by the stockholders of Smitty's, and no other corporate proceedings on the part of Smitty's are necessary to authorize this Agreement and the transactions contemplated hereby. This Agreement has been duly and validly executed and delivered by Smitty's and constitutes a legally valid and binding obligation of Smitty's, enforceable against it in accordance with its terms, except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally or by general principles of equity. The Certificate of Merger will have been, as of the Effective Time, duly and validly authorized, executed and delivered by Smitty's, and will constitute as of such time a legally valid and binding obligation of Smitty's, enforceable against it in accordance with its terms, except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally or by general principles of equity. 5.5 Absence of Certain Changes or Events. Except as set forth in Section 5.5 of the Disclosure Schedule and the transactions contemplated hereby, since July 30, 1995, Smitty's and its subsidiaries have conducted their respective businesses only in the ordinary and usual course consistent with past practices and there has not been any change in Smitty's' business, operations, condition (financial or otherwise), results of operations, prospects, assets, liabilities, working capital or reserves, except for changes contemplated hereby or changes which have not, individually or in the aggregate, been materially adverse to Smitty's and its subsidiaries taken as a whole. Except as set forth in Section 5.5 of the Disclosure Schedule or the Smitty's SEC Reports, from July 30, 1995 through the date of this Agreement, neither Smitty's nor any of its subsidiaries has taken any of the actions prohibited by Section 7.2 hereof. 5.6 Assets. (a) Except as set forth in Section 5.6(a) of the Disclosure Schedule, Smitty's and its subsidiaries have good and marketable fee simple title to, or a valid leasehold interest in, all material Assets reflected on Smitty's' balance sheet at October 22, 1995, free and clear of all Encumbrances (other than Permitted Encumbrances). (b) Section 5.6(b) of the Disclosure Schedule sets forth a complete and accurate list of (i) each Property and/or Facility owned in fee by Smitty's or any of its subsidiaries, (ii) each Property and/or Facility held for development by Smitty's or any of its subsidiaries and (iii) each Property and/or Facility being leased, subleased or otherwise occupied by Smitty's or any of its subsidiaries pursuant to any Lease, in each case describing the location (property address), the identity of the tenant (if other than Smitty's) and the current use of such Property or Facility. (c) Smitty's and its subsidiaries, in person or by subtenant, as the case may be, enjoy peaceful and undisturbed possession of all of their respective Properties and Facilities, except for those Properties designated as unimproved land on Section 5.6(b) of the Disclosure Schedule and, with respect to which, such Properties are subject to no Encumbrances (other than Permitted Encumbrances) that would materially interfere with the development of or the market value of the same as Facilities. (d) There are no pending or, to the best knowledge of Smitty's, threatened condemnation or similar proceedings relating to any of the Properties or Facilities of Smitty's and its subsidiaries. (e) To the best knowledge of Smitty's, (i) the real property improvements (including leasehold improvements), which constitute a portion of the Facilities are structurally sound with no known material defects, and (ii) the building systems which constitute a portion of the Facilities and the equipment and other tangible Assets owned, leased or used by Smitty's and its subsidiaries in the conduct of their respective businesses are in good operating condition and repair, subject to ordinary wear and tear, and are adequate for the present uses thereof; none of such Facilities (except for Facilities scheduled for renovation in the ordinary course of business as set forth in Section 5.6(e) of the Disclosure Schedule), are in need of maintenance or repairs except for ordinary, routine maintenance and repairs. (f) Section 5.6(f) of the Disclosure Schedule sets forth a complete and accurate list of all leases (including subleases and licenses) of personal property entered into by Smitty's or any of its subsidiaries and involving any annual expense to Smitty's or any such subsidiary in excess of $50,000 and not cancelable (without material liability) within 30 days. (g) Section 5.6(g) of the Disclosure Schedule sets forth a complete and accurate list of all agreements pursuant to which Smitty's or any of its subsidiaries lease, sublease, or otherwise permit any third party to occupy all or any portion of its Properties or the Facilities (collectively, the "Third Party Leases"). (h) Section 5.6(h) of the Disclosure Schedule indicates with respect to each Lease entered into by Smitty's or any of its subsidiaries, as a tenant or subtenant: (i) the term, (ii) current rent and (iii) a brief summary of any terms which would be outside of the ordinary course of business which would have, or could reasonably be expected to have, a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. (i) Smitty's or its subsidiaries, as the case may be, has in all material respects performed all obligations on its part to be performed with respect to (i) all Assets leased by it or to it (whether as lessor or lessee) except where the failure to perform would not, individually or in the aggregate, have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole, and (ii) all Leases of its Facilities, and there exists no material default or event which, with the giving of notice or lapse of time or both, would become a default on the part of Smitty's or any of its subsidiaries under any Lease. (j) To the best knowledge of Smitty's, (i) no default (nor any event which, with the giving of notice or passage of time or both would constitute a default) has occurred on the part of any other party to any Lease of which it is a party and (ii) each of the Leases is valid, binding and enforceable in accordance with its terms and is in full force and effect, and assuming all consents required by the terms thereof or applicable law have been obtained, the Leases will continue to be valid, binding and enforceable in accordance with their respective terms and in full force and effect immediately following the consummation of the transactions contemplated hereby. (k) Smitty's has delivered to the Company, or otherwise made available, originals or true copies of all Leases and Third Party Leases (as the same may have been amended or modified from time to time). 5.7 Contracts and Commitments. Section 5.7 of the Disclosure Schedule contains a complete and accurate list of all Contracts of the following categories to which Smitty's or any of its subsidiaries is a party or by which any of them is bound as of the date of this Agreement: (i) Contracts not made in the ordinary course of business involving annual expenditures or liabilities in excess of $100,000 or total expenditures in excess of $300,000; (ii) employment contracts, including, without limitation, contracts to employ executive officers and other contracts with officers, directors or stockholders of Smitty's, and any other Contracts with or for the benefit of any Smitty's Stockholder or its affiliates, and all severance or similar arrangements with any Personnel that will result in any obligation (absolute or contingent) of Smitty's or any of its subsidiaries to make any payment to any Personnel following termination of employment; (iii) labor contracts; (iv) material distribution, franchise, license, sales, agency or advertising contracts; (v) options, rights of first refusal, purchase rights or other contractual rights to lease, purchase, acquire, sell or dispose of all, or any portion of, any real property or material personal property, whether as grantor or grantee, other than as set forth in the Leases; (vi) Contracts for the purchase of inventory which are not cancelable (without material penalty, cost or other liability) within 90 days (other than Contracts for the purchase of holiday goods in accordance with customary industry practices) and other Contracts made in the ordinary course of business involving expenditures or liabilities in excess of $100,000 which are not cancelable (without material penalty, cost or other liability) within 30 days; (vii) promissory notes, loans, agreements, indentures, evidences of indebtedness or other instruments relating to the lending of money, whether as borrower, lender or guarantor, in excess of $50,000; (viii) Contracts containing covenants limiting the freedom of Smitty's or any of its subsidiaries to engage in any line of business or compete with any person or operate at any location; (ix) powers of attorney; (x) joint venture or partnership agreements or joint development or similar agreements pursuant to which any third party is entitled to develop any Property and/or Facility on behalf of Smitty's or its subsidiaries; and (xi) any other Contract, whether similar or dissimilar to the foregoing, which would be material to Smitty's and its subsidiaries taken as a whole. True copies of the written Contracts identified in Section 5.7 of the Disclosure Schedule have been delivered or made available to the Company. 5.8 Absence of Breaches or Defaults. Except as set forth in Section 5.8 of the Disclosure Schedule, to best knowledge of Smitty's, neither Smitty's nor any of its subsidiaries is in default under, or in breach or violation of, any material Contract. No event has occurred which either entitles, or would, on notice or lapse of time or both, entitle the holder of any indebtedness affecting Smitty's or any of its subsidiaries (except for the execution of this Agreement) to accelerate, or which does accelerate, the maturity of any indebtedness affecting Smitty's or any of its subsidiaries, except as set forth in Section 5.8 of the Disclosure Schedule. 5.9 No Conflict or Violation. Except as set forth in Section 5.9 of the Disclosure Schedule, neither the execution and delivery of this Agreement, nor the performance by Smitty's of its obligations hereunder nor the consummation of the transactions contemplated hereby, will (i) conflict with Smitty's' certificate of incorporation or bylaws; (ii) assuming satisfaction of the requirements set forth in Section 5.10 below, violate any statute, law, ordinance, rule or regulation, applicable to Smitty's or any of its subsidiaries or any of their properties or assets; or (iii) violate, breach, be in conflict with or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or permit the termination of any provision of, or result in the termination of, the acceleration of the maturity of, or the acceleration of the performance of any obligation of Smitty's or any of its subsidiaries, or result in the creation or imposition of any lien upon any properties, assets or business of Smitty's or any of its subsidiaries under, any note, bond, indenture, mortgage, deed of trust, lease, franchise, permit, authorization, license, contract, instrument or other agreement or commitment or any order, judgment or decree to which Smitty's or any of its subsidiaries is a party or by which Smitty's or any of its subsidiaries or any of their respective assets or properties is bound or encumbered, except for such violations, conflicts, defaults or other occurrences which, in the aggregate, would not have, and would not reasonably be expected to have, a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole, and would not prevent or delay the Merger or the Recapitalization or otherwise prevent the Smitty's from performing its obligations under this Agreement. 5.10 Consents and Approvals. Except (i) pursuant to applicable requirements of the HSR Act, (ii) for the filing of the Certificate of Merger in accordance with the Delaware Law, or (iii) with respect to matters set forth in Section 5.10 of the Disclosure Schedule, no consent, approval or authorization of, permit from, or declaration, filing or registration with, any governmental or regulatory authority, or any other person or entity (including, without limitation, any landlord under any lease), is required to be made or obtained by Smitty's or its subsidiaries in connection with the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby. 5.11 Litigation. Except as set forth in Section 5.11 of the Disclosure Schedule, there are no Actions instituted, pending or, to the best knowledge of Smitty's, threatened, which, if adversely decided, would, individually or in the aggregate, directly or indirectly, have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole, or would prevent or delay the Merger or the Recapitalization or otherwise prevent Smitty's from performing its obligations under this Agreement, nor is there any outstanding judgment, decree, or injunction or any statute, rule or order of any domestic or foreign court, governmental department, commission or agency which has or will have, individually or in the aggregate, any such Material Adverse Effect. 5.12 Compliance with Law. Except as set forth in Section 5.12 of the Disclosure Schedule, Smitty's and each of its subsidiaries is in compliance with all foreign, federal, state and local laws and regulations applicable to its operations or with respect to which compliance is a condition of engaging in the business thereof (including, without limitation, all Environmental Laws), except to the extent that failure to comply would not have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. Except as set forth in Section 5.12 of the Disclosure Schedule, to the best knowledge of Smitty's, neither Smitty's nor any of its subsidiaries has received any notice asserting a failure, or possible failure, to comply with any such law or regulation, the subject of which notice has not been resolved as required thereby or otherwise to the satisfaction of the party sending the notice, except for such failure as would have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole or the transactions contemplated hereby. Smitty's and its subsidiaries have all material permits, licenses and franchises from governmental agencies required to conduct their respective businesses as they are now being conducted and all such permits, licenses and franchises will remain in effect after the Effective Time. 5.13 Labor Matters. (a) Section 5.13(a) of the Disclosure Schedule contains a complete list of all organizations representing the employees of Smitty's or any of its subsidiaries. There is no strike, work stoppage or labor disturbance pending or, to the best knowledge of Smitty's, threatened, which involves any employees of Smitty's or any of its subsidiaries. (b) Section 5.13(b) of the Disclosure Schedule contains a list of all unfair employment or labor practice charges which are presently pending, as well as a description and the status of each, which to the best knowledge of Smitty's have been filed with any governmental authority by or on behalf of any employee of Smitty's or any of its subsidiaries and a list of all employment-related litigation or administrative proceedings which are presently pending (together with a description and the status of each such litigation or proceeding), filed by or on behalf of any employee of Smitty's or any of is subsidiaries. (c) Except as described in Sections 5.11, 5.13(a) and (b) of the Disclosure Schedule, there are not presently pending or, to the best knowledge of Smitty's, threatened, against Smitty's or any of its subsidiaries any material claims by any governmental authority, labor organization, or employee alleging that Smitty's or any such employer has violated any applicable laws respecting employment practices. Smitty's and each of its subsidiaries is in compliance in all material respects with its obligations under all statutes, executive orders and other governmental regulations or judicial decrees governing its employment practices, including without limitation, provisions relating to wages, hours, equal opportunity and payment of social security and other taxes. (d) Except as described in Section 5.13(d) of the Disclosure Schedule, (i) Smitty's has paid, or caused to be paid, in full to all employees of Smitty's and its subsidiaries all wages, salaries, commissions, bonuses, benefits and other compensation due to such employees or otherwise arising under any policy, practice, agreement, plan, program, statute or other law, (ii) neither Smitty's nor any of its subsidiaries is liable for any severance pay or other payments to any employee or former employee arising from the termination of employment, nor will Smitty's or its subsidiaries have any liability under any benefit or severance policy, practice, agreement, plan, or program which exists or arises, or may be deemed to exist or arise, as a result of or in connection with the transactions contemplated hereunder or as a result of the termination by Smitty's or such subsidiaries of any persons employed on or prior to the Merger Closing Date, (iii) Smitty's and its subsidiaries have not closed any plant or facility, effectuated any layoffs of employees or implemented any early retirement, separation or window program within the past year, nor has Smitty's or its subsidiaries planned or announced any such future action or program for the future, and (iv) Smitty's is in compliance with its obligations, if any, pursuant to the Worker Adjustment and Retraining Notification Act of 1988, and all other notification and bargaining obligations arising under any collective bargaining agreement, statute or otherwise. 5.14 Smitty's SEC Reports. Smitty's has delivered or made available to the Company true and complete copies of each registration statement, report and proxy or information statement filed with the SEC, including, without limitation, all exchange offer registration statements on Form S-4 (the "Smitty's Exchange Registration Statements"), in the form (including exhibits and any amendments thereto) required to be filed with the SEC since July 31, 1994 (collectively, the "Smitty's SEC Reports"). As of the respective dates such Smitty's SEC Reports were filed or, if any such Smitty's SEC Reports were amended, as of the date such amendment was filed, each of the Smitty's SEC Reports (i) complied in all material respects with all applicable requirements of the Securities Act and the Exchange Act and the rules and regulations promulgated thereunder, and (ii) did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Each of the audited consolidated financial statements and unaudited consolidated interim financial statements of Smitty's (including any related notes and schedules) included or incorporated by reference in its Annual Reports on Form 10-K for the three fiscal years ended July 30, 1995 and Quarterly Reports on Form 10-Q for all interim periods subsequent thereto fairly present, in conformity with GAAP applied on a consistent basis (except as may be indicated in the notes thereto), the consolidated financial position of Smitty's and its subsidiaries as of its date and the consolidated results of operations and changes in financial position for the period then ended (subject to normal year-end adjustments in the case of any unaudited interim financial statements). 5.15 No Brokers. Except as specified in Schedule 5.15 hereto, no broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the Merger or the Recapitalization or in connection with any proposed sale of Smitty's or any of its assets, or a restructuring of or merger or similar transaction involving Smitty's based upon arrangements made by or on behalf of Smitty's and its subsidiaries. 5.16 No Other Agreements to Sell Smitty's or its Assets. Except as set forth in Section 5.16 of the Disclosure Schedule, Smitty's has no legal obligation, absolute or contingent, to any other Person to sell any material portion of the Assets of Smitty's, to sell the capital stock of Smitty's or any of its subsidiaries, or to effect any merger, consolidation or other reorganization of Smitty's or any of its subsidiaries or to enter into any agreement with respect thereto. 5.17 Proprietary Rights. Section 5.17 of the Disclosure Schedule contains a list of all Proprietary Rights which are owned by Smitty's or any of its subsidiaries, or in which Smitty's or any of its subsidiaries has any interest, or which, to the best knowledge of Smitty's, have been used in connection with, or which relate to the business of Smitty's or any of its subsidiaries (whether or not presently used in connection therewith). Except as set forth in Section 5.17 of the Disclosure Schedule, Smitty's or a subsidiary of Smitty's owns and has the sole and exclusive right to use all such Proprietary Rights and such items are not subject to any licenses, Encumbrances or charges of any kind. Neither Smitty's nor any of its subsidiaries has been charged, or to the best knowledge of Smitty's is any of them threatened to be charged, with infringement of, nor to the best knowledge of Smitty's has any of them infringed, any unexpired patent, trademark, trademark registration, trade name, service mark, copyright, copyright registration or other proprietary right of any party. Smitty's and each of its subsidiaries owns, or is licensed or otherwise has the right to use, all patents, trademarks, trade names, service marks, copyrights, technology, know-how, processes, methods and designs used in or necessary for the conduct of its business as presently being conducted. The consummation of the Merger and the other transactions contemplated hereby will not alter or impair any of such rights. 5.18 Employee Benefit Plans. (a) Section 5.18 of the Disclosure Schedule contains a complete list of the Employee Plans of Smitty's. Copies or descriptions of the Employee Plans of Smitty's have been or will be furnished or made available to the Company and their counsel within 10 Business Days of the date of this Agreement. (b) Except as described in Section 5.18 of the Disclosure Schedule, each of Smitty's Employee Plans (other than any Multiemployer Plan) has been administered and is in compliance with the terms of such Plan and all applicable laws, rules and regulations where the failure thereof would have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. (c) No "reportable event" (as such term is used in section 4043 of ERISA), "prohibited transaction" (as such term is used in section 406 of ERISA or section 4975 of the Code) or "accumulated funding deficiency" (as such term is used in section 412 or 4971 of the Code) has heretofore occurred with respect to any Smitty's Employee Plan (other than any Multiemployer Plan) which would have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. (d) No litigation or administrative or other proceeding involving any Smitty's Employee Plans (other than any Multiemployer Plan) has occurred or are threatened where an adverse determination would have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. (e) Except as set forth in Section 5.18 of the Disclosure Schedule, neither Smitty's nor any ERISA Affiliate of Smitty's has incurred any withdrawal liability with respect to any Multiemployer Plan under Title IV of ERISA which remains unsatisfied in an amount which would have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. (f) Any termination of, or withdrawal from, any Smitty's Employee Plans or Multiemployer Plans, on or prior to the Closing Date, would not subject Smitty's to any material liability under Title IV of ERISA. 5.19 Insurance. Section 5.19 of the Disclosure Schedule contains a complete and accurate list of all policies or binders of fire, liability, property, title, workers' compensation, business interruption, errors or omissions and other forms of insurance (showing as to each policy or binder the carrier, policy number, coverage limits, including without limitation, retentions and deductibles, expiration dates, annual premiums and a general description of the type of coverage provided) maintained by Smitty's or any of its subsidiaries on its business, property or Personnel within the last five years. All of such policies are sufficient for compliance with all requirements of law and of all contracts to which Smitty's or any of its subsidiaries is a party. 5.20 Affiliate Transactions. Except as set forth in Section 5.20 of the Disclosure Schedule or in the Smitty's SEC Reports, from July 30, 1995 through the date of this Agreement there have been no transactions, agreements, arrangements or understandings between Smitty's or any of its subsidiaries, on the one hand, and Smitty's' affiliates (other than wholly owned subsidiaries of Smitty's) or other Persons, on the other hand, that would be required to be disclosed under Item 404 of Regulation S- K under the Securities Act. 5.21 Environmental Matters. Except as set forth in Section 5.21 of the Disclosure Schedule, each of the Properties of Smitty's or any of its subsidiaries is maintained in compliance with all Environmental Laws, except where the failure to so comply, or any aggregation of such failures, would not have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. Except as set forth in Section 5.21 of the Disclosure Schedule, no conditions exist with respect to the soil, surface waters, groundwaters, land, stream sediments, surface or subsurface strata, ambient air, and any other environmental medium on or off the Properties, which, individually or in the aggregate, could result in any damage, claim, or liability to or against Smitty's or any of its subsidiaries by any third party (including without limitation, any government entity), including, without limitation, any condition resulting from the operation of Smitty's' business and/or operator in the vicinity of any of the Properties and/or any activity or operation formerly conducted by any Person on the Properties, except in any such case which would not be reasonably expected to have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. With the exception of retail consumer products sold in the ordinary course and supplies used in the ordinary course of business and except as set forth in Section 5.21 of the Disclosure Schedule, Smitty's and any other Person for whose conduct Smitty's is or may be held responsible, has not generated, manufactured, refined, transported, treated, stored, handled, disposed, transferred, produced, or processed any Hazardous Materials. Except as set forth in Section 5.21 of the Disclosure Schedule, (i) there are no existing uncured notices of violation, administrative actions, or lawsuits against Smitty's or any of its subsidiaries arising under Environmental Laws or relating to the use, handling, storage, treatment, recycling, generation, or release of Hazardous Materials at any of the Properties, nor has Smitty's received any uncured notification of any allegation of any responsibility for any disposal, release, or threatened release at any location of any Hazardous Materials; (ii) there have been no spills or releases of Hazardous Materials at any of the Properties in excess of quantities reportable under Environmental Laws, except in any such case which would not be reasonably expected to have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole; and (iii) there are no consent decrees, consent orders, judgments, judicial or administrative orders, or liens by any governmental authority relating to any Environmental Law which regulate, obligate, or bind Smitty's or any of its subsidiaries. 5.22 Taxes. As of the date of this Agreement, except as set forth in Section 5.22 of the Disclosure Schedule: (i) Smitty's and its subsidiaries have (A) duly filed (or there have been filed on their behalf) with the appropriate governmental authorities all Tax Returns required to be filed by them and such Tax Returns are true, correct and complete in all material respects, and (B) duly paid in full or made provision in accordance with GAAP (or there has been paid or provision has been made on their behalf) for the payment of all Taxes for all periods (or portions thereof) ending on or prior to the Merger Closing Date; (ii) Smitty's and its subsidiaries have complied in all material respects with all applicable laws, rules and regulations relating to the payment and withholding of Taxes and have, within the time and the manner prescribed by law, withheld and paid over to the proper governmental authorities all amounts required to be so withheld and paid over under applicable laws; (iii) no federal, state, local or foreign audits or other administrative proceedings or court proceedings are presently pending with regard to any Taxes or Tax Returns of Smitty's or its subsidiaries and neither Smitty's nor its subsidiaries has received a written notice of any pending audits or proceedings; (iv) neither the Service nor any other taxing authority (whether domestic or foreign) has asserted, or to the best knowledge of Smitty's, is threatening to assert, against Smitty's or any of its subsidiaries any deficiency or claim for Taxes; (v) there are no material liens for Taxes upon any property or assets of Smitty's or any subsidiary thereof, except for liens for Taxes not yet due and payable and liens for Taxes that are being contested in good faith by appropriate proceedings; (vi) neither Smitty's nor any of its subsidiaries has agreed to or is required to make any adjustment under Section 481(a) of the Code; (vii) the applicable statutes of limitation for the assessment of federal income Taxes upon Smitty's and its subsidiaries for all periods have expired, except as set forth on Section 5.22 of the Disclosure Schedule; (viii) neither Smitty's nor any of its subsidiaries is a party to any material agreement providing for the allocation or sharing of Taxes; and (ix) neither Smitty's nor any of its subsidiaries has, with regard to any assets or property held or acquired by any of them, filed a consent to the application of Section 341(f) of the Code, or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as such term is defined in Section 341(f)(4) of the Code) owned by Smitty's or any of its subsidiaries. 5.23 Bank Accounts. Section 5.23 of the Disclosure Schedule contains a true and complete listing of all bank accounts or other depositary accounts maintained by Smitty's or any of its subsidiaries and the authorized signatories thereto. 5.24 Information in Proxy Statement and Financing Registration Statements. Information supplied by Smitty's, Yucaipa or any of their respective affiliates for inclusion in (i) the Proxy Statement (or any amendment thereof or supplement thereto), at the date mailed to the Company's stockholders and at the time of the Company Stockholders' Meeting, and (ii) the Financing Registration Statements (or any amendments thereof or supplements thereto), on the date declared effective by the SEC, will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they are made, not misleading. ARTICLE 6. REPRESENTATIONS OF YUCAIPA Yucaipa, on behalf of itself and on behalf of the Smitty's Principal Stockholders that are affiliates of the Yucaipa, hereby represents and warrants to the Company and Acquisition as follows: 6.1 Organization; Authorization; etc. Yucaipa and each Smitty's Principal Stockholder is duly organized, validly existing and in good standing under the laws of its jurisdiction of organization. The execution and delivery of this Agreement and the consummation of the Merger and the other transactions contemplated hereby have been duly authorized by all necessary partnership action on the part of Yucaipa. This Agreement has been duly executed and delivered by Yucaipa, and, assuming the due execution hereof by each other party hereto, this Agreement constitutes the legally valid and binding obligation of Yucaipa, enforceable against Yucaipa in accordance with its terms, except to the extent that such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws affecting the enforcement of creditors' rights generally and to general equitable principles. 6.2 Ownership of Shares. At the time of the Merger Closing, each of the Smitty's Principal Stockholders will own, beneficially and of record, all of the shares of Smitty's Common Stock issued in its name and set forth opposite its name on Section 6.2 of the Disclosure Schedule, free of any Encumbrance and subject to no restriction with respect to the voting thereof (except as contemplated by this Agreement or the Smitty's Stockholders' Agreements), other than restrictions generally applicable under federal or state securities laws. 6.3 Consents and Approvals; No Violations. Except for the filing of the Certificate of Merger with the Secretary of State of Delaware as set forth in Section 1.2, filings pursuant to the HSR Act and the matters set forth in Section 6.3 of the Disclosure Schedule, and assuming compliance with any applicable antitrust laws, there is no requirement applicable to Yucaipa or any Smitty's Principal Stockholder to make any filing or registration with, or to obtain any permit, authorization, consent or approval of, any government or regulatory authority or any non-governmental person or entity in connection with the execution and delivery by Yucaipa of this Agreement, the consummation of the Merger, and the performance of the other transactions contemplated hereby, except where the failure to make such filings or registrations or to obtain such permits, authorizations, consents or approvals would not, individually or in the aggregate, have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole or the consummation of the transactions contemplated hereby. Except as set forth in Section 6.3 of the Disclosure Schedule, neither the execution or delivery of this Agreement by Yucaipa nor the performance by Yucaipa of its obligations under this Agreement will (i) violate any provision of the partnership agreement or bylaws (or other comparable governing instrument) of Yucaipa or any Smitty's Principal Stockholder, (ii) violate any provision of, or constitute (with or without notice, the passage of time or both) a default under, or result in the acceleration of or entitle any party to accelerate (whether after the giving of notice or lapse of time or both) or terminate any obligation under, any mortgage, lien, lease, agreement or other instrument or obligation to which Yucaipa or any Smitty's Principal Stockholder is a party or by which it or the shares of Smitty's Common Stock owned by it are bound, except where such event would not, individually or in the aggregate, have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole or the consummation of the transactions contemplated hereby, or (iii) assuming compliance with any applicable antitrust laws, violate any order, writ, injunction, decree, statute, rule or regulation to which Yucaipa or any Smitty's Principal Stockholder is subject. 6.4 Agreement to Sell Smitty's and Other Matters. Neither Yucaipa nor any Smitty's Principal Stockholder has any legal obligation, absolute or contingent, to any other Person to sell or dispose of its interest in the capital stock of Smitty's, by way of a sale of capital stock, merger, consolidation or other reorganization, or otherwise, or to enter into any agreement with respect thereto. Except as set forth on Section 6.4 of the Disclosure Schedule, neither Yucaipa nor any Smitty's Principal Stockholder has directly or through any Affiliate or agent created, or caused to be created, (i) any legal obligation, absolute or contingent, of any other Person to sell any material portion of the Assets of Smitty's or its subsidiaries, to sell the capital stock of Smitty's or its subsidiaries, to effect any merger, consolidation or other reorganization of Smitty's or its subsidiaries, or to enter into any agreement with respect thereto, or (ii) any liability (contingent or otherwise) for payment of a brokerage, finder's, investment banking or other fee or commission in connection with any sale or restructuring of Smitty's and its subsidiaries, or (iii) any obligation with respect to the issuance or sale of capital stock by Smitty's or any of its subsidiaries. ARTICLE 7. CONDUCT OF BUSINESS PENDING THE MERGER CLOSING 7.1 The Company. From the date hereof through the Merger Closing Date, except as otherwise provided for in this Agreement, the Company shall conduct the business of the Company and its subsidiaries only in the ordinary and usual course as such business has been conducted, and shall use all reasonable efforts to keep intact the business organization in all material respects. The Company shall use all reasonable efforts to avoid, and to cause its subsidiaries to avoid, the occurrence of a breach of any representation or warranty hereunder as of the Merger Closing, or a violation of any covenant to be performed by it pursuant hereto, or the failure to satisfy any condition to the obligations of any party hereto. In addition, from the date hereof through the Merger Closing Date, neither the Company nor any of its subsidiaries shall, except as otherwise provided in this Agreement: (a) (i) amend its certificate of incorporation or bylaws (other than amendments to defer the redemption of the Series I Preferred Stock for up to five years); (ii) split, combine or reclassify any of its outstanding equity securities or declare, set aside or pay any dividend payable in cash, stock or property or make any other distribution with respect to any of its equity securities, except regularly scheduled dividends on its Common Stock, consistent with past practice; or (iii) redeem, purchase or otherwise acquire, directly or indirectly, any shares of its equity securities (other than redemptions of Series I Preferred Stock in accordance with the Company's certificate of incorporation); (b) except as set forth in Section 4.4 of the Disclosure Schedule, issue or sell or agree to issue or sell any additional shares of, or options, warrants or rights of any kind to acquire any shares of, its capital stock of any class or series; (ii) enter into any agreement, contract or commitment out of the ordinary course of its business to dispose of or acquire, or relating to the disposition or acquisition of, a segment of its business; (iii) except in the ordinary course of business, sell, pledge, dispose of or encumber any material Assets (including, without limitation, any indebtedness owed to it or any material claims held by it); (iv) acquire (by merger, consolidation or acquisition of stock or assets) any corporation, partnership or other business organization or division thereof or make any material investment, either by purchase of stock or securities, contribution to capital, property transfer or purchase, in any case, of any material amount of property or assets, in any other individual or entity; or (v) enter into any contract, agreement, commitment or arrangement with respect to any of the foregoing; (c) adopt or amend any bonus, profit sharing, compensation, stock option, pension, retirement, deferred compensation, employment or other employee benefit plan, agreement, trust, fund or other arrangement for the benefit or welfare of any employee or increase in any manner the compensation or fringe benefits of any employee or pay any benefit not required by any existing plan, arrangement or agreement; (d) incur any material amount of indebtedness for borrowed money, or make any loans or advances or capital contributions to any other person other than a wholly owned subsidiary of the Company, or issue or sell any debt securities, other than borrowings under existing lines of credit in the ordinary course of business or acquire any debt instruments of others; (e) make or commit to make any capital expenditures in excess of $1,000,000 in the aggregate, other than expenditures for (i) routine maintenance and repair or (ii) pursuant to existing contracts or commitments; (f) enter into or amend any Contract for the purchase of inventory which is not cancelable within 90 days (other than Contracts for the purchase of holiday goods in accordance with customary industry practices) without penalty, cost or liability or any other Contract in excess of $100,000 which is not cancelable within 30 days without penalty, cost or liability; (g) grant any severance or termination pay (other than pursuant to policies or agreements in effect on the date hereof) or increase the benefits payable under its severance or termination pay policies or agreements in effect on the date hereof; and (h) take or permit any action which would prevent the Merger from qualifying as a reorganization under Section 368 of the Code. Notwithstanding the foregoing provisions, in no event shall the Company be required to comply with the provisions contained in Sections 7.1(b) through (h) following the date, if any, that the Company shall have terminated the Recapitalization. 7.2 Smitty's. From the date hereof through the Merger Closing Date, except as otherwise provided for in this Agreement, Smitty's shall conduct its business and the business of its subsidiaries only in the ordinary and usual course as such business has been conducted, and shall use reasonable efforts to keep intact the business organization in all material respects. Without limiting the foregoing, Smitty's shall, and shall cause its subsidiaries to; (i) maintain reasonably comparable advertising and promotional expenditures; (ii) maintain reasonably comparable overall levels of inventory subject to seasonal variation and changes in sales volume; (iii) maintain comparable insurance coverage at commercially reasonable rates; (iv) pay amounts due to vendors consistent with past practices; and (v) perform customary maintenance on its Properties, Facilities and Fixtures and Equipment and provide for the security of such Properties, Facilities and Fixtures and Equipment in accordance with past practices. Smitty's shall use all reasonable efforts to avoid, and to cause each of its subsidiaries to avoid, the occurrence of a breach of any representation or warranty hereunder as of the Merger Closing, or a violation of any covenant to be performed by it pursuant hereto, or the failure to satisfy any condition to the obligations of any party hereto. In addition, from the date hereof through the Merger Closing, except as set forth in Section 7.2 of the Disclosure Schedule or as otherwise specifically provided for in this Agreement or as the Company may specifically consent in writing, which consent shall not be unreasonably withheld, neither Smitty's or any of its subsidiaries shall: (a) close any Facility, except as required by applicable law or in the event of casualty or as a result of the expiration of any Lease which, after reasonable efforts, is not renewed; (b) enter into, with respect to any Facility or Property or any other real property or any material assets, any new lease, lease termination agreement or material amendment (excluding any extension or renewal of any lease in accordance with past practices) of any agreement to lease such real property; (c) sell, assign or sublease any Facility or Property; (d) (i) sell, assign or sublease any Fixtures and Equipment or other material Assets (other than as specified in clause (ii)), the aggregate sales prices and the annual rental payments of which are $100,000 or more in the aggregate, other than in the ordinary course of business, or (ii) enter into any sale-leaseback transaction resulting in annual rental payments in excess of $100,000, except for sale- leaseback transactions for Fixtures and Equipment in the ordinary course of business consistent with past practice; (e) make or commit to make any capital expenditures in excess of $250,000 in the aggregate, other than expenditures for (i) routine maintenance and repair or (ii) pursuant to existing contracts or commitments; (f) incur any material amount of indebtedness for borrowed money, or make any loans or advances or capital contributions to any other person other than a wholly owned subsidiary of the Company, or issue or sell any debt securities, other than borrowings under existing lines of credit in the ordinary course of business or acquire any debt instruments of others; (g) make any transfer of Assets from Smitty's or any of its subsidiaries to any Affiliate (other than a wholly owned subsidiary); (h) materially reduce any store operating hours except as consistent with past practices, as a result of security concerns, material changes in sales volume, or as required by law; (i) (i) amend its certificate of incorporation or bylaws or the charter or bylaws of any of its subsidiaries; (ii) split, combine or reclassify the outstanding shares of its capital stock or declare, set aside or pay any dividend payable in cash, stock or property or make any other distribution with respect to such shares of capital stock; (iii) redeem, purchase or otherwise acquire, directly or indirectly, any shares of its capital stock; or (iv) sell or pledge any stock of any of its subsidiaries; (j) (i) issue or sell or agree to issue or sell any additional shares of, or options, warrants or rights of any kind to acquire any shares of, its capital stock of any class; (ii) enter into any agreement, contract or commitment out of the ordinary course of its business, to dispose of or acquire, or relating to the disposition or acquisition of, a segment of its business; (iii) except in the ordinary course of business, sell, pledge, dispose of or encumber any material Assets (including without limitation, any indebtedness owed to them or any material claims held by them); (iv) acquire (by merger, consolidation or acquisition of stock or assets) any corporation, partnership or other business organization or division thereof or make any material investment, either by purchase of stock or securities, contribution to capital, property transfer or purchase, in any case, of any material amount of property or assets, in any other Person; or (v) enter into any contract, agreement, commitment or arrangement with respect to any of the foregoing; (k) fail to preserve intact its business organization, or fail to keep available the services of its present officers and key employees, and fail to preserve the good will of customers of, and other persons having business relationships with it; (l) grant any severance or termination pay (other than pursuant to policies or agreements in effect on the date hereof) or increase the benefits payable under its severance or termination pay policies or agreements in effect on the date hereof; (m) adopt or amend any bonus, profit sharing, compensation, stock option, pension, retirement, deferred compensation, employment or other employee benefit plan, agreement, trust, fund or other arrangement for the benefit or welfare of any employee or increase in any manner the compensation or fringe benefits of any employee or pay any benefit not required by any existing plan, arrangement or agreement; (n) enter into or amend any Contract for the purchase of inventory which is not cancelable within 90 days (other than Contracts for the purchase of holiday goods in accordance with customary industry practices) without penalty, cost or liability or any other Contract in excess of $100,000 which is not cancelable within 30 days without penalty, cost or liability; (o) negotiate, enter into, or modify any agreement or agree to be bound by any agreement with any collective bargaining agent relating to its business, except for agreements with respect to routine employee grievance matters in the ordinary course of business; (p) take or permit any action which would prevent the Merger from qualifying as a reorganization under Section 368 of the Code; and (q) make any material change in its tax or accounting policies or any material reclassification of assets or liabilities. ARTICLE 8. ADDITIONAL COVENANTS 8.1 Further Assurances and Cooperation. Subject to the terms and conditions herein provided, each of the parties hereto agrees to use all reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable to consummate and make effective as promptly as practicable the transactions contemplated by this Agreement and to cooperate with each other in connection therewith, (a) to obtain all necessary waivers, consents and approvals from other parties to material loan agreements, leases and other contracts (provided that Smitty's shall not agree to any substantial modification to any such agreement, lease or contract or to any payment of funds in order to obtain such waiver, consent or approval without the prior written consent of the Company), (b) to defend any lawsuits or other legal proceedings challenging this Agreement or the consummation of the transactions contemplated hereby, (c) to lift or rescind any injunction or restraining order or other order adversely affecting the ability of the parties to consummate the transactions contemplated hereby, (d) to effect all necessary registrations and filings (including any registrations and filings which may be required to be made by the Company pursuant to any federal or state securities laws), (e) to negotiate and enter into, on terms reasonably satisfactory to the Company, the Financing Agreements and to satisfy all conditions thereto, and (f) to fulfill all conditions to this Agreement. Without limitation of the foregoing, Smitty's shall use all reasonable efforts to (i) cause each of the Smitty's Stockholders to execute a Smitty's Stockholders' Agreement, Continuity-of-Interest Letter and Investment Letter as referred to in Section 1.7 hereof, and (ii) take such actions as the Company may reasonably request to facilitate the repayment by the Company of the Specified Smitty's Indebtedness on the Merger Closing Date. 8.2 Certain Filings and Consents. Each party hereto shall (a) as promptly as practicable make any required filings and submissions under the HSR Act with respect to the Merger, (b) cooperate with each other in determining whether any other filings are required to be made or consents, approvals, permits or authorizations are required to be obtained under any other federal, state, local or foreign law or regulation or whether any consents, approvals or waivers are required to be obtained from other parties to loan agreements, leases or other contracts in connection with the consummation of the Financings, the Merger, the Offer and the other transactions contemplated by this Agreement, and (c) actively assist each other in obtaining any consents, permits, authorizations, approvals or waivers which are required. Each party hereto shall promptly inform the other of any material communication between such party and the Federal Trade Commission, the Department of Justice or any other government or governmental authority regarding the Merger or the other transactions contemplated by this Agreement. If any party receives a request for additional information or documentary material from any such government or governmental authority, then such party shall endeavor in good faith to make, or cause to be made, as soon as reasonably practicable and after consultation with the other party, an appropriate response to such request. Notwithstanding the foregoing, in connection with proceedings under or relating to the HSR Act or any other federal or state antitrust law, all analyses, appearances, presentations, memoranda, briefs, arguments, and opinions made or submitted by or on behalf of any party hereto shall be subject to the joint approval or disapproval and the joint control of the Company and Smitty's, acting with the advice of their respective counsel, provided that nothing herein shall prevent any party hereto or their authorized representatives from making or submitting any such analysis, appearance, presentation, memorandum, brief, argument, or opinion in response to a subpoena or as otherwise required by law. The parties hereto shall cooperate in connection with reaching any understandings, undertakings or agreements (oral or written) involving the Federal Trade Commission, the Department of Justice or any other governmental authority in connection with the transactions contemplated hereby. The Company shall use all reasonable efforts to resolve such objections, if any, as may be asserted with respect to the transactions contemplated hereby under any applicable federal or state antitrust laws; provided, however, that in no event shall the Company or any of its subsidiaries or the Surviving Corporation or any of its subsidiaries be required in that connection to (i) effect any divestitures of any material assets of the Company, Smitty's or their respective subsidiaries, (ii) hold separate any such material assets or (iii) agree to any material restrictions on the operations of the Company, Smitty's or their respective subsidiaries of any material portion of the business or assets of the Company, Smitty's or their respective subsidiaries. 8.3 Access to Information; Confidentiality. (a) Upon reasonable notice, each party shall, and shall cause each of its subsidiaries to, afford the other parties and their representatives, full access during normal business hours to all of its officers, agents, properties, books, contracts, commitments and records (including but not limited to tax returns) and, during such period, shall furnish promptly to such other party and such other persons all information concerning its business, properties and personnel as such other party or such other persons may reasonably request. No investigation pursuant to this Section 8.3 or otherwise shall affect the representations and warranties or indemnities of the parties hereto or the conditions to the parties' respective obligations to consummate the Financings, the Merger, the Offer or the other transactions contemplated by the Recapitalization. (b) Each party hereto shall (and shall use all reasonable efforts to cause its representatives to) hold all such non-public documents, work papers and other materials in confidence in accordance with the provisions of the Confidentiality Agreements. In the event of termination of this Agreement, each party hereto shall return promptly every confidential document furnished to it by the other parties hereto in connection with the transactions contemplated hereby, and shall use all reasonable efforts to cause its representatives to return the same, in each case subject to the continued application of the Confidentiality Agreements. 8.4 Notification of Certain Matters. The Company shall give prompt notice to Smitty's, and Smitty's shall give prompt notice to the Company, of (a) the occurrence, or failure to occur, of any event which occurrence or failure would be likely to cause any representation or warranty contained in this Agreement to be untrue or inaccurate in any material respect at any time from the date hereof to the Merger Closing Date, (b) any material failure of the Company or Smitty's or any of their respective affiliates, as the case may be, or of any of their respective officers, directors, employees or agents, to comply with or satisfy any covenant, condition or agreement to be complied with or satisfied by it under this Agreement, and (c) the status or fulfillment of any of the conditions set forth in Article 9 hereof, upon reasonable request of the other party; provided, however, that no such notification shall affect the representations or warranties of the parties or the conditions to the obligations of the parties hereunder. 8.5 Alternative Proposals. (a) Smitty's (and its subsidiaries, and affiliates over which it exercises control) will not, and Smitty's (and each of its subsidiaries and affiliates over which it exercises control) will use its best efforts to ensure that its respective officers, directors, employees, investment bankers, attorneys, accountants and other agents do not, directly or indirectly: (i) initiate, solicit or encourage, or take any action to facilitate the making of, any offer or proposal which constitutes or is reasonably likely to lead to any Alternative Transaction (as defined below) or an inquiry with respect thereto, or, (ii) in the event of an unsolicited Alternative Transaction for Smitty's or any subsidiary or affiliate of Smitty's, engage in negotiations or discussions with, or provide any information or data to, any corporation, partnership, person or other entity or group (other than the Company or any of its affiliates or representatives) relating to any Alternative Transaction, except in the case of clause (ii) above to the extent that (x) the Alternative Transaction is a bona fide written proposal submitted to Smitty's Board of Directors and (y) Smitty's Board of Directors determines, after having received the oral or written opinion of outside legal counsel to Smitty's, that the failure to engage in such negotiations or discussions or provide such information would result in a breach of the Board of Directors' fiduciary duties under applicable law. Smitty's shall, and shall cause its subsidiaries and affiliates over which it exercises control, and will use its best efforts to ensure their respective officers, directors, employees, investment bankers, attorneys, accountants and other agents to, immediately cease and cause to be terminated all discussions and negotiations that have taken place prior to the date hereof, if any, with any parties conducted heretofore with respect to any Alternative Transaction relating to Smitty's. Smitty's represents that it is not now engaged in discussions or negotiations with any party with respect to an Alternative Transaction. (b) The Company (and its subsidiaries, and affiliates over which it exercises control) will not, and the Company (and its subsidiaries, and affiliates over which it exercises control) will use their best efforts to ensure that their respective officers, directors, employees, investment bankers, attorneys, accountants and other agents do not, directly or indirectly: (i) initiate, solicit or encourage, or take any action to facilitate the making of, any offer or proposal which constitutes or is reasonably likely to lead to any Alternative Transaction (as defined below) or an inquiry with respect thereto, or, (ii) in the event of an unsolicited Alternative Transaction for the Company or any subsidiary or affiliate of the Company, engage in negotiations or discussions with, or provide any information or data to, any corporation, partnership, person or other entity or group (other than Yucaipa or any of its affiliates or representatives) relating to any Alternative Transaction, except in the case of clause (ii) above to the extent that (x) the Alternative Transaction is a bona fide written proposal submitted to the Company's Board of Directors and (y) the Company's Board of Directors determines, after having received the oral or written opinion of outside legal counsel to the Company, that the failure to engage in such negotiations or discussions or provide such information would result in a breach of the Board of Directors' fiduciary duties under applicable law. The Company shall, and shall cause its subsidiaries and affiliates over which it exercises control, and will use its best efforts to ensure their respective officers, directors, employees, investment bankers, attorneys, accountants and other agents to, immediately cease and cause to be terminated all discussions and negotiations that have taken place prior to the date hereof, if any, with any parties conducted heretofore with respect to any Alternative Transaction relating to the Company. The Company represents that it is not now engaged in discussions or negotiations with any party with respect to an Alternative Transaction. Nothing contained in this Section 8.5 shall prohibit the Company or its Board of Directors from taking and disclosing to its stockholders a position with respect to a tender offer by a third party pursuant to Rules 14d-9 and 14e-2(a) promulgated under the Exchange Act or making such disclosure as may be required by applicable law. (c) As used in this Agreement, "Alternative Transaction" when used in connection with any Person shall mean any tender or exchange offer involving the capital stock of such Person, any proposal for a merger, consolidation or other business combination involving such Person or any subsidiary of such Person, any proposal or offer to acquire in any manner a substantial equity interest in, or a substantial portion of the business or assets of, such Person or any subsidiary of such Person, any proposal or offer with respect to any recapitalization or restructuring with respect to such Person or any subsidiary of such Person or any proposal or offer with respect to any other transaction similar to any of the foregoing with respect to such Person or any subsidiary of such Person other than pursuant to the transactions to be effected pursuant to this Agreement. (d) In case of any capital reorganization, sale, merger or consolidation of the Company in connection with an Alternative Transaction (other than a merger or consolidation in which the Company is the continuing corporation and which does not result in any reclassification of the outstanding shares of Common Stock into shares of other stock or other securities or assets) (collectively such actions being hereinafter referred to as "Reorganizations") is consummated, the Smitty's Stockholders shall, to the extent they do not receive the Merger Consideration prior to the consummation of such Alternative Transaction, be entitled upon consummation of the Merger to receive the same number of shares of stock or other securities or assets to which a holder of the number of shares of the Company's Common Stock included in the Merger Consideration would have been entitled to receive upon the consummation of such Reorganization. 8.6 Public Statements and Press Releases. The Company, Smitty's and each of their respective affiliates shall not from and after the date hereof make, issue or release any public announcement, press release, statement or acknowledgment of the existence of, or reveal publicly the terms, conditions and status of, the transactions provided for herein, without the prior consent of the other parties as to the content and time of release of and the media in which such statement or announcement is to be made, except as may be required by applicable law, court process or by obligations pursuant to any requirements of the New York Stock Exchange, Inc.; provided, in the case of any such exception, the Company shall use all reasonable efforts to provide Smitty's and Yucaipa with prior notice of such disclosure or release. Each party hereto agrees that it will not unreasonably withhold any such consent. 8.7 Directors' and Officers' Insurance and Indemnification. (a) The Company agrees that after the Merger Closing Date it shall, and shall cause its subsidiaries to, indemnify each person who is now, or has been at any time prior to the date hereof, a director or officer of Smitty's or any of Smitty's subsidiaries, successors and assigns (individually a "Smitty's Indemnified Party" and collectively the "Smitty's Indemnified Parties"), to the fullest extent permitted by law, with respect to any claim, liability, loss, damage, judgment, fine, penalty, amount paid in settlement or compromise, cost or expense, including reasonable fees and expenses of legal counsel (whenever asserted or claimed) ("Smitty's Indemnified Liability"), based in whole or in part on, or arising in whole or in part out of, any matter existing or occurring at or prior to the Merger Closing Date whether commenced, asserted or claimed before or after the Merger Closing Date, including liability arising under the Securities Act, the Exchange Act or state law. The Company shall, and shall cause the Surviving Corporation to, maintain in effect for not less than four years after the Merger Closing Date the current policies of directors' and officers' liability insurance maintained by Smitty's and its subsidiaries on the date hereof (provided that the Company may substitute therefor policies having at least the same coverage and containing terms and conditions which are no less advantageous to the persons currently covered by such policies as insured) with respect to matters existing or occurring at or prior to the Merger Closing Date, and the Company shall use its best efforts to prepay premiums with respect to the foregoing insurance for the four-year period following the Merger Closing Date; provided, however, that if the aggregate annual premiums for such insurance during such period shall exceed 200% of the per annum rate of the aggregate premium currently paid by Smitty's and its subsidiaries for such insurance on the date of this Agreement, then the Company shall cause the Surviving Corporation to, and the Surviving Corporation shall, provide the maximum coverage that shall then be available at an annual premium equal to 200% of such rate. The Company agrees to pay all reasonable expenses (including reasonable fees and expenses of counsel) that may be incurred by any Smitty's Indemnified Party in successfully enforcing the indemnity or other obligations under this Section 8.7(a). (b) The Company agrees that after the Offer Closing Date it shall, and shall cause its subsidiaries to, indemnify each person who is now, or has been at any time prior to the date hereof, a director or officer of the Company or any of the Company's subsidiaries, successors and assigns (individually a "Company Indemnified Party" and collectively the "Company Indemnified Parties"), to the fullest extent permitted by law, with respect to any claim, liability, loss, damage, judgment, fine, penalty, amount paid in settlement or compromise, cost or expense, including reasonable fees and expenses of legal counsel (whenever asserted or claimed) ("Company Indemnified Liability"), based in whole or in part on, or arising in whole or in part out of, any matter existing or occurring at or prior to the Offer Closing Date whether commenced, asserted or claimed before or after the Offer Closing Date, including liability arising under the Securities Act, the Exchange Act or state law. The Company shall maintain in effect for not less than four years after the Offer Closing Date the current policies of directors' and officers' liability insurance maintained by the Company and its subsidiaries on the date hereof (provided that the Company may substitute therefor policies having at least the same coverage and containing terms and conditions which are no less advantageous to the persons currently covered by such policies as insured) with respect to matters existing or occurring at or prior to the Offer Closing Date and the Company shall use its best efforts to prepay premiums with respect to the foregoing insurance for the four-year period following the Merger Closing Date; provided, however, that if the aggregate annual premiums for such insurance during such period shall exceed 200% of the per annum rate of the aggregate premium currently paid by the Company and its subsidiaries for such insurance on the date of this Agreement, then the Company shall provide the maximum coverage that shall then be available at an annual premium equal to 200% of such rate. The Company agrees to pay all reasonable expenses (including reasonable fees and expenses of counsel) that may be incurred by any Company Indemnified Parties in successfully enforcing the indemnity or other obligations under this Section 8.7(b). (c) Indemnity Procedures. The rights under this Section 8.7 are in addition to rights that a Smitty's Indemnified Party or a Company Indemnified Party may have under the certificate of incorporation, bylaws, other similar organizational documents of the Company, Smitty's or any of their subsidiaries or applicable law. The rights under this Section 8.7 shall survive consummation of the Merger and the Recapitalization and are expressly intended to benefit each Indemnified Party. The Company shall keep, and shall cause the Surviving Corporation and any of its other subsidiaries (or their successors) to keep, in effect the provisions of its certificate of incorporation or bylaws or similar organizational documents providing for indemnification to the fullest extent provided by law. 8.8 Financial Information. Smitty's shall deliver to the Company as soon as available all interim and other financial statements and other management reports generated in the ordinary course of business prepared by or for Smitty's, prior to the Merger Closing. In addition, subject to compliance with any applicable antitrust laws, Smitty's shall deliver to the Company, on a weekly and monthly basis, such internal sales reports on a store by store basis promptly as they are prepared by Smitty's for each such week or month. 8.9 Smitty's Stockholders' Approval. Smitty's agrees to promptly hold a meeting of its stockholders, or receive the written consent of its stockholders in lieu of a meeting (either of such actions, the "Smitty's Stockholders' Meeting"), in order for such stockholders to approve the Merger as required by applicable law. 8.10 Proxy Statement; Company Stockholders' Meeting. (a) The Company agrees to promptly hold a meeting of its stockholders (the "Company Stockholders' Meeting") in order for such stockholders to approve all of the transactions contemplated by the Recapitalization, including, without limitation, (i) the issuance of Common Stock by the Company in the Merger and in connection with the Financings, (ii) the election of directors of the Company, and (iii) the adoption of an amended and restated certificate of incorporation for the Company. The Company shall use all reasonable efforts to obtain stockholder approval thereof. The Company Stockholders' Meeting shall be held as soon as practicable following the date upon which the Proxy Statement shall have been approved for release to the Company's stockholders by the SEC. (b) The Company shall, as promptly as practicable, prepare and file with the SEC the Proxy Statement, with forms of proxy in connection with the vote of its stockholders at the Company Stockholders' Meeting. The Company will use all reasonable efforts to have or cause the Proxy Statement declared effective as promptly as practicable, and will take any other action required or necessary to be taken under federal or state securities laws or otherwise in connection with the SEC approval process. The Company shall use all reasonable efforts to cause the Proxy Statement to be mailed to its stockholders at the earliest practicable date and shall use all reasonable efforts to hold the Company Stockholders' Meeting as soon as practicable after the date thereof. (c) Smitty's and its counsel shall be given the opportunity to participate in the preparation of the Proxy Statement prior to its being filed with the SEC. The Company agrees to provide Smitty's and its counsel with any written comments the Company or its counsel may receive from the SEC with respect to the Proxy Statement promptly after the receipt of such comments. The form and substance of the Proxy Statement and any amendments, modifications or supplements to the Proxy Statement shall be determined by the Company in its reasonable discretion; provided, however, that the Company will provide Smitty's a reasonable opportunity to review and comment on any such amendment, modification or supplement prior to filing or distribution. 8.11 Stockholders' Representative. Yucaipa is hereby appointed as the "Stockholders' Representative" on behalf of the Smitty's Stockholders and irrevocably constituted and appointed as each Smitty's Stockholder's attorney-in-fact, to act in each Smitty's Stockholder's name, place and stead in any way in which he/she/it could do any or all of the following: (i) to supervise the Closings and determine whether the conditions to the Closings have been satisfied and waive any conditions which, in its sole discretion, it deems appropriate to facilitate the Closings; (ii) to take any and all actions that may be necessary or desirable in connection with this Agreement; (iii) to execute and deliver in its capacity as Stockholders' Representative any and all notices, documents or certificates to be executed by the Stockholders' Representative in accordance with this Agreement and the other Transaction Documents; (iv) deliver at the Merger Closing stock powers and any other required instruments of transfer to be executed by the Smitty's Stockholders, including a letter of transmittal, and to accept certificate or certificates in the name of each Smitty's Stockholder Merger Consideration as set forth in Section 3.1(c); (v) take all other actions and do other things provided in or contemplated by this Agreement as to be taken or performed by the Stockholders' Representative. This power of attorney shall be coupled with an interest and irrevocable and shall survive, and shall not be affected by, the subsequent death, disability or incompetence, or liquidation or dissolution, as applicable of any Smitty's Stockholder. 8.12 Termination of Consulting Agreement. As of the Merger Closing Date, Smitty's and Yucaipa shall mutually terminate the Consulting Agreement dated as of April 30, 1994 among Smitty's, Smitty's Super Valu, Inc. and Yucaipa and Smitty's shall pay, or cause to be paid, to Yucaipa all fees and expense reimbursements accrued through the Merger Closing Date and owing to Yucaipa thereunder, without regard to any change of control or other payments caused by the transactions contemplated by this Agreement. ARTICLE 9. CONDITIONS PRECEDENT TO THE MERGER 9.1 Conditions Precedent to the Company's and Acquisition's Obligations. The obligation of the Company and Acquisition to effect the Merger shall be subject to the fulfillment, at or prior to the Effective Time, of the following conditions: (a) Representations and Warranties. The representations and warranties of Smitty's and Yucaipa contained in this Agreement which by their terms require an event or condition having a Material Adverse Effect in order to be inaccurate shall be true and correct on and as of the Merger Closing Date with the same effect as though such representations and warranties had been made on and as of such date, except for representations and warranties that speak as of a specific date or time other than the Merger Closing Date (which need only be true and correct as of such date or time). The representations and warranties of Smitty's and Yucaipa contained in this Agreement which by their terms do not require an event or condition having a Material Adverse Effect in order to be inaccurate shall be true and correct on and as of the Merger Closing Date with the same effect as though such representations and warranties had been made on and as of such date (except for representations and warranties that speak as of a specific date or time other than the Merger Closing Date, which need only be true and correct as of such date or time), except for such breaches or inaccuracies that, individually or in the aggregate, would not have a Material Adverse Effect on Smitty's and its subsidiaries taken as a whole. (b) Compliance with Covenants. The covenants and agreements of Smitty's and Yucaipa to be performed on or complied with prior to the Effective Time shall have been duly performed and complied with, except for such breaches that, individually or in the aggregate, would not have a Material Adverse Effect on the Company and its subsidiaries taken as a whole, on Smitty's and its subsidiaries taken as a whole or the consummation of the transactions contemplated hereby. (c) Absence of Certain Injunctions and Government Actions. The waiting period, and any extension thereof, under the HSR Act and any other applicable federal or state antitrust or fair trade law shall have expired. There (i) shall not be in effect a temporary restraining order or a preliminary or permanent injunction or other order, decree or ruling by a court of competent jurisdiction or by a governmental, regulatory or administrative agency or commission which (A) restrains or prohibits the Merger or the consummation of all or any of the other transactions contemplated hereby, (B) (i) prohibits or restricts the ownership or operation by the Company or any of its subsidiaries of any portion of their or Smitty's' business or assets or (ii) compels the Company or any of its subsidiaries to dispose of or hold separate any portion of their or Smitty's' business or assets which, in either case, would be reasonably likely to have a Material Adverse Effect on the Company and its subsidiaries taken as a whole or on Smitty's and its subsidiaries taken as a whole, (C) imposes any limitations on the ability of the Company or any of its subsidiaries effectively to control in any material respect the business and operations of Smitty's, or (D) is otherwise reasonably likely to have a Material Adverse Effect on the Company and its subsidiaries taken as a whole, the value of Smitty's and its subsidiaries taken as a whole, the consummation of the transactions contemplated hereby or on the Combined Companies taken as a whole; or (ii) shall not be pending before any court of competent jurisdiction or before any administrative law judge or court or before any governmental, regulatory or administrative agency or commission, any action or proceeding, whether in law or in equity or otherwise, brought by any governmental, regulatory or administrative agency, commission or authority, which seeks as relief a result described in clause (i) above; or (iii) shall not have been promulgated or enacted by a governmental authority a statute, rule, regulation or executive order which has an effect described in clause (i)(A), (B), (C) or (D) above. (d) Approvals and Consents of Third Parties. All approvals, consents, authorizations and waivers from governmental and other regulatory agencies and other third parties disclosed in Section 5.10 of the Disclosure Schedule (including the expiration of any applicable waiting period under any regulation or statute other than the HSR Act and any other federal or state antitrust or fair trade law) which, either individually or in the aggregate, if not obtained on or prior to the Effective Time would have a Material Adverse Effect on the Company and its subsidiaries taken as a whole or on Smitty's and its subsidiaries taken as a whole, or would adversely affect the validity or enforceability of this Agreement or the transactions contemplated hereby, shall have been obtained. (e) Company Stockholders' Approval. The stockholders of the Company shall have approved this Agreement and the other transactions contemplated by the Recapitalization at the Company Stockholders' Meeting, provided that, if the Company terminates the Recapitalization in accordance with Section 10.2, then the condition set forth in this Section 9.1(e) shall automatically be deemed to have been satisfied without any further action required by the Company. (f) Standstill Agreement. The Standstill Agreement, in the form attached hereto as Annex K, shall remain in full force and effect. (g) Consummation of Offer. The Offer shall have been consummated concurrently in accordance with the terms thereof (including the satisfaction or waiver of the conditions set forth in Annex N hereto) and shall have resulted in the purchase by the Company pursuant to the Offer of 50% of the Company's outstanding Common Stock, provided that, if the Company terminates the Recapitalization in accordance with Section 10.2, then the condition set forth in this Section 9.1(g) shall automatically be deemed to have been satisfied without any further action required by the Company. 9.2 Conditions Precedent to Smitty's' Obligations. The obligation of Smitty's to effect the Merger shall be subject to the fulfillment, at or prior to the Effective Time, of the following conditions: (a) Representations and Warranties. The representations and warranties of the Company and Acquisition contained in this Agreement which by their terms require an event or condition having a Material Adverse Effect in order to be inaccurate shall be true and correct on and as of the Merger Closing Date with the same effect as though such representations and warranties had been made on and as of such date, except for representations and warranties that speak as of a specific date or time other than the Merger Closing Date (which need only be true and correct as of such date or time). The representations and warranties of the Company and Acquisition contained in this Agreement which by their terms do not require an event or condition having a Material Adverse Effect in order to be inaccurate shall be true and correct on and as of the Merger Closing Date with the same effect as though such representations and warranties had been made on and as of such date (except for representations and warranties that speak as of a specific date or time other than the Merger Closing Date which need only be true and correct as of such date or time), except for such breaches or inaccuracies that, individually or in the aggregate, would not have a Material Adverse Effect on the Smitty's Stockholders, the value of the Merger Consideration, the consummation of the transactions contemplated hereby or on the Combined Companies taken as a whole. (b) Compliance with Covenants. The covenants and agreements of the Company and Acquisition to be performed on or complied with prior to the Effective Time shall have been duly performed and complied with, except for such breaches that, individually or in the aggregate, would not have a Material Adverse Effect on the Smitty's Stockholders, the value of the Merger Consideration, the consummation of the transactions contemplated hereby or on the Combined Companies taken as a whole. (c) Absence of Certain Injunctions and Government Actions. The waiting period, and any extension thereof, under the HSR Act and any other applicable federal or state antitrust or fair trade law shall have expired. There (i) shall not be in effect a temporary restraining order or a preliminary or permanent injunction or other order, decree or ruling by a court of competent jurisdiction or by a governmental, regulatory or administrative agency or commission which (A) restrains or prohibits the Merger or the consummation of all or any of the other transactions contemplated thereby, (B) (i) prohibits or restricts the ownership or operation by the Company or any of its subsidiaries of any portion of their or Smitty's' business or assets or (ii) compels the Company or any of its subsidiaries to dispose of or hold separate any portion of their or Smitty's' business or assets which, in either case, would be reasonably likely to have a Material Adverse Effect on the Company and its subsidiaries taken as a whole or on Smitty's and its subsidiaries taken as a whole, (C) imposes any limitations on the ability of the Company or any of its subsidiaries effectively to control in any material respect the business and operations of Smitty's, or (D) is otherwise reasonably likely to have a Material Adverse Effect on the Smitty's Stockholders, the value of the Merger Consideration, the consummation of the transactions contemplated hereby or on the Combined Companies taken as a whole; or (ii) shall not be pending before any court of competent jurisdiction or before any administrative law judge or court or before any governmental, regulatory or administrative agency or commission, any action or proceeding, whether in law or in equity or otherwise, brought by any governmental, regulatory or administrative agency, commission or authority, which seeks as relief a result described in clause (i) above; or (iii) shall not have been promulgated or enacted by a governmental authority a statute, rule, regulation or executive order which has an effect described in clause (i)(A) or (B) above. (d) Approvals and Consents of Third Parties. All approvals, consents, authorizations and waivers from governmental and other regulatory agencies and other third parties disclosed in Section 5.10 of the Disclosure Schedule (including the expiration of any applicable waiting period under any regulation or statute other than the HSR Act and any other federal or state antitrust or fair trade law) which, either individually or in the aggregate, if not obtained on or prior to the Effective Time would have a Material Adverse Effect on the Combined Companies taken as a whole. (e) Other Agreements. The Registration Rights Agreement, in the form attached as Annex F hereto, and, unless the Recapitalization has been terminated in accordance with Section 10.2, the Management Agreement and the Warrant Agreement, in the forms attached hereto as Annexes L and M, respectively, shall have been duly executed by the Company and shall be in full force and effect. ARTICLE 10. TERMINATION, AMENDMENT AND WAIVER 10.1 Termination of the Agreement. This Agreement may be terminated at any time prior to the Closing Date by: (a) the mutual consent of the Company and Smitty's, set forth in a written instrument executed by both parties; (b) either the Company or Smitty's, if neither the Merger nor the Offer shall have been consummated on or before the Termination Date; (c) the Company, if Smitty's or Yucaipa is in material breach of its obligations under this Agreement, or by Smitty's, if the Company or Acquisition is in material breach of its obligations under this Agreement; provided that no party shall be entitled to terminate this Agreement by reason of this clause if it or any of its affiliates is in material breach of its obligations under this Agreement; or (d) by Smitty's or Yucaipa, if within 13 Business Days after the date of this Agreement, Yucaipa and Smitty's reasonably determine that the contents of the portions, if any, of the Disclosure Schedule which are delivered by the Company after the date of execution of this Agreement, or updates to any portions of the Disclosure Schedule, are materially adverse relative to the information disclosed in writing on or prior to the date hereof to Yucaipa and Smitty's or would otherwise have a Material Adverse Effect on the consummation of the transactions contemplated hereby. 10.2 Termination of Recapitalization. At any time prior to the Closing Date, if, in the exercise of its fiduciary duties to the Company's stockholders under applicable law, the Company's Board of Directors (i) determines that the termination of the Recapitalization is required by reason of its acceptance of any Alternative Transaction (which acceptance and termination shall be deemed to have occurred upon (A) the execution and delivery by the Company and the other parties thereto of the definitive merger or other agreement with respect to any such Alternative Transaction or (B) the Board of Directors' determination to (1) recommend that the holders of Company Common Stock tender their shares into any tender offer or exchange offer seeking to acquire more than 10% of the Company Common Stock or (2) remain neutral with respect to any such offer) or (ii) withdraws or materially modifies or changes its recommendation of the Recapitalization, the Company may terminate the terms and conditions contained herein which relate to the Company's consummation of the Recapitalization, including the provisions contained in Article 2 and Sections 3.2, 7.1 and 8.10(b); provided, however, that any such termination of the Recapitalization shall not otherwise affect the Company's obligation to consummate the Merger in accordance with the terms and conditions set forth herein. 10.3 Procedure and Effect of Termination. In the event of termination of this Agreement as provided in Section 10.1, this Agreement shall forthwith become void and no party hereto shall have any liability or further obligation to any other party hereto under or by reason of this Agreement or the transactions contemplated hereby, except that: (i) each party shall redeliver all documents, work papers and other material of any other party relating to the transactions contemplated hereby, whether so obtained before or after the execution hereof, to the party furnishing the same; and (ii) the provisions of this Section 10.3 and Sections 8.3(b) and 10.4 shall continue in full force and effect. The foregoing provisions shall not limit or restrict the availability of specific performance or other injunctive relief to the extent that specific performance or such other relief would otherwise be available to a party hereunder. Nothing contained in this Section shall relieve any party of liability for any breach of the representations, warranties, covenants or agreements set forth in this Agreement. 10.4 Fees and Expenses. In the event that (i) the Merger and the Recapitalization are consummated, or (ii) the Merger is consummated, but the Recapitalization is terminated in accordance with Section 10.2 hereof, the fees and expenses of the Company, Yucaipa and Smitty's in connection with the transactions contemplated hereby (including all Financing Expenses) shall be paid by the Company. In the event that neither the Merger nor the Recapitalization are consummated, each of the parties hereto shall pay its own fees and expenses; provided, however, that in such an eventuality, the Company shall bear 65% of the Financing Expenses and Smitty's shall bear 35% of the Financing Expenses. Each of the Company and Smitty's shall indemnify and hold harmless the other party to the extent it pays any portion of the Financing Expenses in excess of the percentages specified in the preceding sentence. 10.5 Amendments. This Agreement may not be amended except by action of each of the parties hereto set forth in an instrument in writing signed by or on behalf of each of the parties hereto. 10.6 Waivers. At any time prior to the Closing Date, any party hereto may (i) extend the time for the performance of any of the obligations or other acts of any other party hereto, (ii) waive any inaccuracies in the representations and warranties of any other party contained herein or in any document delivered pursuant hereto, or (iii) waive compliance with any of the agreements of any other party or with any conditions to its own obligations. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed on behalf of such party by a duly authorized officer or partner. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar), nor shall such waiver constitute a continuing waiver unless otherwise expressly provided. ARTICLE 11. DEFINITIONS 11.1 Defined Terms. As used herein, the terms below shall have the following meanings: "Action" shall mean any action, order, writ, injunction, judgment or decree outstanding or claim, suit, litigation, proceeding, arbitration or investigation by or before any court, governmental or other regulatory or administrative agency or commission or any other person. "Affiliate" shall mean, with respect to any Person, any other Person that directly, or through one or more intermediaries, controls or is controlled by or is under common control with such Person. "Assets" shall mean, with respect to any Person, all land, buildings, improvements, leasehold improvements, Fixtures and Equipment and other assets (tangible or intangible) owned or leased by such Person or any of its subsidiaries. "Benefit Arrangement" shall mean, with respect to any Person, any employment, consulting, severance or other similar contract, arrangement or policy and each plan, arrangement (written or oral), program, agreement or commitment providing for insurance coverage (including without limitation any self-insured arrangements), workers' compensation, disability benefits, supplemental unemployment benefits, vacation benefits, retirement benefits, life, health, disability or accident benefits (including without limitation any "voluntary employees' beneficiary association" as defined in Section 501(c)(9) of the Code providing for the same or other benefits) or for deferred compensation, profit-sharing bonuses, stock options, stock appreciation rights, stock purchases or other forms of incentive compensation or post-retirement insurance, compensation or benefits which (A) is not a Welfare Plan, Pension Plan or Multiemployer Plan, (B) is entered into, maintained, contributed to or required to be contributed to, as the case may be, by such Person or an ERISA Affiliate or under which such Person or any ERISA Affiliate may incur any liability, and (C) covers any employee or former employee of such Person or any ERISA Affiliate (with respect to their relationship with such entities). "Business Day" shall mean any day that is not a Saturday, Sunday or a day on which banking institutions in New York, New York or Los Angeles, California are not required to be open. "Code" shall mean the Internal Revenue Code of 1986, as it may be amended from time to time. "Combined Companies" shall mean the Company and its subsidiaries after the Effective Time. "Confidentiality Agreements" shall mean those certain confidentiality agreements between the Company and Yucaipa dated December 13, 1995 and between the Company and Smitty's dated October 9, 1995. "Contract" shall mean any contract (written or oral), plan, undertaking or other commitment or agreement. "Disclosure Schedule" means the schedules attached to this Agreement which set forth exceptions to the representations and warranties contained in Articles 4, 5 and 6 hereof and certain other information called for by other provisions of this Agreement. "Employee Plans" shall mean all Benefit Arrangements, Multiemployer Plans, Pension Plans and Welfare Plans. "Encumbrances" shall mean any claim, lien, pledge, option, charge, easement, security interest, deed of trust, mortgage, right-of-way, covenant, condition, restriction, encumbrance or other rights of third parties. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" shall mean, with respect to any Person, any entity which is (or at any relevant time was) a member of a "controlled group of corporations" with, under "common control" with, or a member of an "affiliated service group" with, such Person as defined in Section 414(b), (c), (m) or (o) of the Code. "Environmental Laws" shall mean any federal, state or local law, statute, ordinance, order, decree, rule or regulation relating to releases, discharges, emissions or disposals to air, water, land or groundwater, to the withdrawal or use of groundwater, to the use, handling or disposal of polychlorinated biphenyls, asbestos or urea formaldehyde, to the treatment, storage, disposal or management of Hazardous Materials, to exposure to toxic, hazardous or other controlled, prohibited or regulated substances, and to the transportation, release or any other use of Hazardous Materials, including the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. 9601, et seq. ("CERCLA"), the Resource Conservation and Recovery Act, 42 U.S.C. 6901, et seq. ("RCRA"), the Toxic Substances Control Act, 15 U.S.C. 2601, et seq. ("TSCA"), the Occupational, Safety and Health Act, 29 U.S.C. 651, et seq., the Clean Air Act, 42 U.S.C. 7401, et seq., the Federal Water Pollution Control Act, 33 U.S.C. 1251, et seq., the Safe Drinking Water Act, 42 U.S.C. 300f, et seq., the Hazardous Materials Transportation Act, 49 U.S.C. 1802 et seq. ("HMTA") and the Emergency Planning and Community Right to Know Act, 42 U.S.C. 11001 et seq. ("EPCRA"), and other comparable state laws and all rules, regulations and guidance documents promulgated pursuant thereto or published thereunder. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and the regulations promulgated thereunder. "Facility" shall mean each store, office, plant or warehouse. "Financing Expenses" shall mean all fees, costs and expenses incurred by the Company in connection with the Financings, including, without limitation, all fees, costs and expenses: (i) identified in the Commitment Letters (including, without limitation, the fees and expenses of counsel to the bank lenders), (ii) of counsel to Smitty's and the Company for the allocable portion of such counsel's time spent working on matters related to the Financings and the Recapitalization, (iii) of the Company's independent certified public accountants, and (iv) in connection with printing, engraving, messenger and delivery services customarily incurred in financing transactions similar to the Financings. "Fixtures and Equipment" shall mean, with respect to any Person, all of the furniture, fixtures, furnishings, machinery and equipment owned by such Person and located in, at or upon the Facilities of such Person. "GAAP" shall mean time generally accepted accounting principles in the United States of America, as in effect from time to time, consistently applied. "Hazardous Materials" shall mean each and every element, compound, chemical mixture, contaminant, pollutant, material, waste or other substance which is defined, determined or identified as hazardous or toxic under Environmental Laws or the release of which is regulated under Environmental Laws. Without limiting the generality of the foregoing, the term includes: "hazardous substances" as defined in CERCLA; "extremely hazardous substances" as defined in EPCRA; "hazardous waste" as defined in RCRA; "hazardous materials" as defined in HMTA; "chemical substance or mixture" as defined in TSCA; crude oil, petroleum products or any fraction thereof; radioactive materials including source, byproduct or special nuclear materials; asbestos or asbestos-containing materials; and radon. "HSR Act" shall mean the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. "Leases" shall mean, with respect to any Person, all leases (including subleases and any other occupancy agreement) of real property, in each case to which such Person or any of its subsidiaries is a party, whether as lessor, lessee, guarantor or otherwise, or by which any of them or their respective properties or assets are bound, or which otherwise relate to the operation of their respective businesses. "Material Adverse Effect" shall mean, with respect to any person or entity, a material adverse effect on the business, operations, prospects, assets, liabilities, results of operations or financial condition of such person or entity. "Multiemployer Plan" shall mean, with respect to any Person, any "multiemployer plan," as defined in Section 4001(a)(3) of ERISA, (A) which such Person or any ERISA Affiliate maintains, administers, contributes to or is required to contribute to, or, after September 25, 1980, maintained, administered, contributed to or was required to contribute to, or under which such Person or any ERISA Affiliate may incur any liability and (B) which covers any employee or former employee of such Person or any ERISA Affiliate (with respect to their relationship with such entities). "Multiemployer Welfare Plan" shall mean a Welfare Plan that is a "multiemployer plan," as defined in Section 3(37) of ERISA. "Offer Statement" shall mean an issuer tender offer statement on Schedule 13E-4 (which statement shall contain the Offer to Purchase and forms of the related letter of transmittal and summary advertisement and the other information and exhibits required by law to be included therein) to be prepared with respect to the Offer, together with any amendments thereof or supplements thereto. "Pension Plan" shall mean, with respect to any Person, any "employee pension benefit plan" as defined in Section 3(2) of ERISA (other than a Multiemployer Plan) (A) which such Person or any ERISA Affiliate maintains, administers, contributes to or is required to contribute to, or, within the six years prior to the Closing Date, maintained, administered, contributed to or was required to contribute to, or under which such Person or any ERISA Affiliate may incur any liability and (B) which covers any employee or former employee of such Person or any ERISA Affiliate (with respect to their relationship with such entities). "Permitted Encumbrances" shall mean any Encumbrances resulting from (i) all statutory or other liens for Taxes or assessments which are not yet due or delinquent or the validity of which are being contested in good faith by appropriate proceedings for which adequate reserves are being maintained in accordance with GAAP; (ii) all cashiers', workers' and repairers' liens, and other similar liens imposed by law, incurred in the ordinary course of business; (iii) all laws and governmental rules, regulations, ordinances and restrictions; (iv) all leases, subleases, licenses, concessions or service contracts to which Smitty's or any of its subsidiaries is a party; (v) Encumbrances identified on title policies delivered to the Company prior to the date hereof; and (vi) all other liens and mortgages (but solely to the extent such liens or mortgages secure indebtedness described in Section 5.7 of the Disclosure Schedule), covenants, imperfections in title, charges, easements, restrictions and other Encumbrances which, in the case of any such Encumbrances pursuant to clauses (i) through (vi), do not materially detract from or materially interfere with the value or present use of the asset subject thereto or affected thereby. "Person" shall mean any individual, corporation, partnership, limited liability company, joint venture, governmental agency or instrumentality, or any other entity. "Personnel" shall mean, with respect to any Person, all officers, employees and agents of such Person. "Property" shall mean, with respect to any Person, all improved or unimproved real property owned or leased by such Person or any of its subsidiaries. "Proprietary Rights" shall mean all patents, trademarks, trade names, service marks and copyrights, and applications therefor. "Proxy Statement" shall mean a proxy statement and forms of proxy in connection with the votes of the stockholders of the Company with respect to the Merger, the Offer and the other transactions contemplated by the Recapitalization, together with any amendments thereof or supplements thereto, in the form or forms mailed to the Company's stockholders. "SEC" shall mean the Securities and Exchange Commission. "Securities Act" shall mean the Securities Act of 1933, as amended, and the regulations promulgated thereunder. "Service" shall mean the Internal Revenue Service or any successor thereto. "Smitty's Principal Stockholders" shall mean, collectively, the investment partnerships which own shares in Smitty's for which Yucaipa acts as the general partner. "Smitty's Stockholders" shall mean the holders of the Common Stock (Class A and Class B) of Smitty's. "Specified Smitty's Indebtedness" shall mean the Smitty's Notes, the Smitty's Debentures and all indebtedness under the Credit Agreement dated as of June 29, 1994 among Smitty's Super Valu, Inc., a wholly owned subsidiary of Smitty's, and The Chase Manhattan Bank, N.A. "Specified Company Indebtedness" shall mean the indebtedness of the Company identified on Schedule I hereto. "subsidiary" shall mean, with respect to any Person, (i) any corporation in an unbroken chain of corporations beginning with such Person if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain; (ii) any partnership in which such Person is a general partner; or (iii) any partnership in which such Person possesses a 50% or greater interest in the total capital or total income of such partnership. "Tax" or "Taxes" shall mean all federal, state, local, foreign and other taxes, levies, imposts, assessments, impositions or other similar government charges, including, without limitation, income, estimated income, business, occupation, franchise, real property, payroll, personal property, sales, transfer, stamp, use, employment, commercial rent or withholding, occupancy, premium, gross receipts, profits, windfall profits, deemed profits, license, lease, severance, capital, production, corporation, ad valorem, excise, duty or other taxes, including interest, penalties and additions (to the extent applicable) thereto. "Tax Return" shall mean any report, return, document, declaration or other information or filing required to be supplied to any taxing authority or jurisdiction (foreign or domestic) with respect to Taxes, including, without limitation, information returns, any documents with respect to or accompanying payments of estimated Taxes, or with respect to or accompanying requests for the extension of time in which to file any such report, return, document, declaration or other information. "Termination Date" shall mean July 30, 1996. "Transaction Documents" shall mean the collective reference to this Agreement, the Certificate of Merger, the Registration Rights Agreement, the Standstill Agreement, the Management Agreement and the Warrant Agreement; provided, however, that if the Recapitalization is terminated pursuant to Section 10.2 hereof, "Transaction Documents" shall be deemed to refer only to this Agreement, the Certificate of Merger, the Standstill Agreement and the Registration Rights Agreement. "Welfare Plan" shall mean, with respect to any Person, any "employee welfare benefit plan" as defined in Section 3(1) of ERISA, (A) which such Person or any ERISA Affiliate maintains, administers, contributes to or is required to contribute to, or under which such Person or any ERISA Affiliate may incur any liability and (B) which covers any employee or former employee of such Person or any ERISA Affiliate (with respect to their relationship with such entities). 11.2 Other Defined Terms. The following terms shall have the meanings defined for such terms in the Sections set forth below: Term Section - ---- ------- Acquisition Preamble Agreement Preamble Alternative Transaction 8.5(c) Certificate of Merger 1.2 Class A Common Stock Recitals Class B Common Stock Recitals Closing 3.2 Closing Date 3.2 Commitment Letters 2.2 Common Stock Preamble Company Preamble Company Indemnified Liability 8.7(b) Company Indemnified Party 8.7(b) Company SEC Reports 4.9 Company Stockholders' Agreement 1.7 Company Stockholders' Meeting 8.10(c) Constituent Corporations Preamble Debt Offer 1.9 Debt Offer Prices 1.9 Debt Offer to Purchase 1.9 Delaware Law Recitals Dissenting Shares 1.11 Effective Time 1.2 Fairness Opinion 4.14 Financing Agreements 2.2 Financing Registration Statements 2.3 Financings 2.2 Management Agreement Recitals Merger Recitals Merger Closing 3.1(a) Merger Closing Date 3.1(a) Merger Consideration 1.10(c) Minimum Debt Condition 1.9 New Debt Securities 2.2 Notification Date 1.10(e) Offer Recitals Offer Closing 3.2(a) Offer Closing Date 3.2(a) Offer Price Recitals PIK Preferred Stock 2.2 Recapitalization 2.7 Series I Preferred Stock Recitals Smitty's Preamble Smitty's Common Stock 1.10 Smitty's Debentures 1.9 Smitty's Indemnified Liability 8.7(a) Smitty's Indemnified Party 8.7(a) Smitty's Notes 1.9 Smitty's SEC Reports 5.14 Smitty's Securities 1.9 Smitty's Stockholders' Agreement 1.7 Smitty's Stockholders' Meeting 8.9 Standstill Agreement 2.4(a) Stockholders' Representative 8.11 Surviving Corporation 1.1 Third Party Leases 5.6(g) Warrant Agreement 2.4(c) Yucaipa Preamble ARTICLE 12. MISCELLANEOUS 12.1 Non-survival of Representations and Warranties. None of the representations and warranties in this Agreement or in any schedule, instrument or other document delivered pursuant to this Agreement shall survive the Merger Closing Date or the Offer Closing Date. 12.2 Assignment. Neither this Agreement, nor any of the rights, duties or obligations hereunder or contemplated hereby, may be assigned by the parties hereto without the prior written consent of the other parties hereto. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns. 12.3 Notices. Unless otherwise provided herein, any notice, request, instruction or other document to be given hereunder by any party to the others shall be in writing and delivered in person or by courier, telegraphed, telexed or by facsimile transmission or mailed by certified mail, postage prepaid, return receipt requested (such mailed notice to be effective on the date of such receipt is acknowledged), as follows: (a) if to the Company, to Smith's Food & Drug Centers, Inc. 1550 South Redwood Road Salt Lake City, Utah 84104 Attn: General Counsel Fax Number: (801) 974-1676 With a copy to: Simpson Thacher & Bartlett 425 Lexington Avenue New York, New York 10017 Attn: Robert L. Friedman, Esq. Fax Number: (212) 455-2502 (b) if to Smitty's or Yucaipa, to The Yucaipa Companies 10000 Santa Monica Boulevard, Fifth Floor Los Angeles, California 90067 Attn: Mark A. Resnik Fax Number: (310) 789-7201 With a copy to: Latham & Watkins 633 West Fifth Street, Suite 4000 Los Angeles, California 90071 Attn: Thomas C. Sadler, Esq. Fax Number: (213) 891-8763 or to such other place and with such other copies as any party hereto may designate as to itself by written notice to the others. 12.4 Payment to Yucaipa. If the Offer is consummated, the Company shall pay to Yucaipa, on the Offer Closing Date, a success fee of $15 million by wire transfer of immediately available funds to an account designated at least one Business Day prior to the Offer Closing Date by Yucaipa. 12.5 Choice of Law. This Agreement shall be construed, interpreted and the rights of the parties determined in accordance with the laws of the State of Delaware, without reference to the choice of laws provisions thereof. 12.6 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 12.7 No Third Party Beneficiaries. None of the provisions of this Agreement shall be for the benefit of or enforceable by any third party, except for the provisions set forth in Section 8.7 hereof. 12.8 Invalidity. In the event that any one or more of the provisions contained in this Agreement or in any other instrument referred to herein, shall, for any reason, be held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provision of this Agreement or any other such instrument. 12.9 Headings. The headings of the Articles and Sections herein are inserted for convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. All references to Sections or Articles contained herein mean Sections or Articles of this Agreement unless otherwise stated. 12.10 Gender. Words used in this Agreement, regardless of the number and gender specially used, shall be deemed and construed to include any other number, singular or plural, and any other gender, masculine, feminine or neuter, as the context requires. 12.11 Delivery of Company Disclosure Schedule. The portions of the Disclosure Schedule which are to be prepared by the Company may be so prepared and delivered to, or updated and delivered to, Smitty's and Yucaipa not later than 10 Business Days after the date of this Agreement and, if not reasonably acceptable to Smitty's and Yucaipa, Smitty's and Yucaipa shall be entitled to terminate this Agreement as set forth in Section 10.1(d) hereof. IN WITNESS WHEREOF, the parties hereto have executed this Agreement, or have caused this Agreement to be duly executed on their respective behalf by their respective officers thereunto duly authorized, as of the day and year first above written. SMITH'S FOOD & DRUG CENTERS, INC. By: /s/ Jeffrey P. Smith -------------------- Name: Jeffrey P. Smith Title: Chairman, President and Chief Executive Officer CACTUS ACQUISITION, INC. By: /s/ Jeffrey P. Smith -------------------- Name: Jeffrey P. Smith Title: President and Chief Executive Officer SMITTY'S SUPERMARKETS, INC. By: /s/ Mark A. Resnik ------------------ Name: Mark A. Resnik Title: Vice President THE YUCAIPA COMPANIES By: /s/ Mark A. Resnik ------------------ Name: Mark A. Resnik Title: General Partner EX-10.11 3 [LOGO] CREDIT SUISSE FOUNDED 1856 SCHWEIZERISCHE KREDITANSTALT CREDITO SVIZZERO November 28, 1995 LOS ANGELES Telephone (213) 955-8200 Cable Address Credswiss Telex 67227 Letters 633 West Fifth Street, 64th Floor Los Angeles, CA 90071 SMITH'S FOOD & DRUG CENTERS, INC. 1550 So. Redwood Road Salt Lake City, UT 84104 Attn: Mr. Casey Jones Director of Capital Development and Banking Gentlemen: We are pleased to confirm to you by this letter agreement (the "Agreement") that a new unsecured revolving credit facility has placed at the disposal of Smith's Food & Drug Centers, Inc. (the "Company") for general corporate purposes under the following terms and conditions. This facility replaces the existing $15,000,000 revolving credit facility with Credit Suisse dated October 15, 1993, as amended. 1. THE REVOLVING CREDIT 1.1 AMOUNT AND GENERAL TERMS: Subject to the terms hereof, we will make loans to the Company as you may request from time to time from the date hereof (the "Effective Date") to June 30, 1999 (the "Commitment Termination Date"), up to but not exceeding $15,000,000 in aggregate principal amount at any time outstanding (the "Commitment"). The Company may borrow, repay, and reborrow hereunder, from the date of its acceptance of this Agreement until the Commitment Termination Date, either the full amount of the Commitment or any lesser sum which is $1,000,000 or a multiple thereof, by means of the borrowing options outlined below, provided that all loans will be repaid to us on or before the Commitment Termination Date. 1.2 BORROWING OPTIONS AND INTEREST RATES: Interest on the principal balance of the loan, from time to time outstanding, will be payable at the Company's option at the following rates per annum: (a) For periods of one, two, three or six months, London Interbank Offered Rate (LIBOR) plus a margin of 50.0 basis points. LIBOR means the average (rounded upwards, if necessary, to next higher 1/16 of 1%) of the respective rate per annum at which deposits in dollars are offered to Credit Suisse in the London interbank market at approximately 11:00 AM (London time) two Euro-dollar business days before the first day of such interest period in an amount approximately equal to the principal amount of the euro-dollar loan of Credit Suisse to which such interest period is to apply and for a period of time comparable to such interest period. (b) For periods of one to twenty-nine days, Credit Suisse Base Rate. "Base Rate" means the higher of (1) the base commercial lending rate announced by us from time to time or (2) the rate of interest quoted to us from time to time for the purchase by us from other banks or dealers of United States Federal Funds on an overnight basis in an amount comparable to the principal amount of the relevant loan plus 50 basis points. Any change in such Base Rate shall be effective on the date specified in the public announcement of such change. (c) For periods of one to twenty-nine days, bid option at negotiated rates. Interest is payable on the last business day of the interest period of the relevant borrowing and if such interest period is longer than three months, at intervals of three months after the first day thereof, and at maturity of the relevant borrowing. Interest shall be computed on the actual number of days elapsed on a 360-day year basis. Overdue payments of principal and interest shall bear interest, payable on demand, at a rate equal to the Base Rate plus 1% per annum until paid in full. All borrowing under this Commitment will be evidenced by one Revolving Promissory Note (attached) duly executed by the Company. 1.3 BORROWING NOTICES, PAYMENTS AND PREPAYMENTS: (a) Request for Base Rate borrowing and bid option should be made before 11:00 AM Los Angeles time on the date of such request. (b) Request for LIBOR borrowing should be made before 8:00 AM Los Angeles time three business days prior to the intended drawing as it is customary that the rate applicable to the specific borrowing period be fixed two London business days preceding the date of borrowing. All loans will be paid free and clear of all taxes now imposed, or those that will affect any change in the basis of taxation of any amounts payable to the Bank (other than Federal, State and Local income taxes imposed on the Bank). Loans based on Base Rate may be prepaid without penalty. Prepayment of loans granted on a LIBOR basis will be subject to a prepayment penalty equal to the amount of any loss incurred by us in liquidating and/or re-employing the amounts borrowed by us to fund the loans, plus related reasonable expenses. 1.4 COMMITMENT FEES: From and after the date hereof, until the Commitment Termination Date, the Company will pay us a commitment fee equal to 20.0 basis points per annum on the average daily undisbursed amount of the Commitment, from the date hereof to the Commitment Termination Date, payable quarterly in arrears, commencing on December 31, 1995. The commitment fee shall be calculated on the basis of actual days elapsed and a year of 360 days. All disbursements and payments hereunder are to be made in U.S. dollars in immediately available funds. All payments by or on behalf of the Company to us under this Agreement shall be made prior to 12:00 PM Los Angeles time on the date due to us at the offices at 12 East 49th Street, New York, NY 10017 (Attn: Loan Department). 2. YIELD PROTECTION AND ILLEGALITY 2.1 ADDITIONAL COSTS: In the event that by reason of the provisions of Federal Reserve Board Regulation D as presently in effect or by reason of any amendment or change in said regulation or in any other applicable banking law or regulations or the interpretation thereof or by reason of any requirements or directives of any governmental authority whatsoever, we incur reserve costs on, or on account of, any advance or commitment, we shall inform the Company accordingly and shall from time to time charge the Company for such reserve costs. 2.2 CAPITAL ADEQUACY: In addition, the Company agrees to pay us on demand such amounts as we reasonably determine are necessary to compensate us for any increased costs or reduction in rates of return attributable to this Agreement and resulting from the applications of any law, regulation, directive or request becoming effective after the date of this Agreement (regardless if earlier promulgated or announced) and applicable to the Bank regarding any reserve, assessment, capital adequacy or capital maintenance or similar requirement relating to this Agreement. 2.3 ILLEGALITY: Notwithstanding any other provision in this Agreement, in the event that it becomes unlawful for us to honor our obligation to make or maintain LIBOR loans hereunder, then we shall promptly notify the Company thereof and our obligation to make, maintain or to convert into LIBOR loans hereunder shall be suspended until such time as we may again make and maintain LIBOR loans. In such event, we shall make every effort to provide an alternative hereunder to such LIBOR loans which is reasonably comparable thereto. 3. REPRESENTATIONS AND WARRANTIES The Company hereby represents to us that: 3.1 CORPORATE ORGANIZATION AND AUTHORITY: (i) The Company has the power, authority and capacity to execute, deliver and perform this Agreement and all other documents executed in connection herewith and (ii) this Agreement and the documents executed in connection herewith constitute valid and binding obligations of the Company and are enforceable in accordance with their respective terms. 3.2 FINANCIAL CONDITION: The Company represents and warrants that the financial statements of the Company furnished to the Bank fairly present the Company's financial position as of the date of such statements and the results of its operations and the changes in such financial position for the period then ended in accordance with generally accepted accounting principles consistently applied. As of the date of this Agreement and the date of any borrowing hereunder, the Company represents that no material adverse change has occurred since September 30, 1995 with respect to the ability of the Company to perform under this facility. The Company will furnish the Bank audited financial statements within 120 days after the closing of the Company's fiscal year, and unaudited financial statements within 60 days after the closing of each of the first three fiscal quarters and will submit an Officer's Certificate of Compliance along with calculations of the financial covenants under 4.1. The Company will also provide any additional information as the Bank may reasonably request and will allow the Bank reasonable access to its books and records. Accompanying the annual financial statements, the Company will provide an opinion of an independent certified public accountant of recognized national standing, which opinion shall state that said consolidated financial statements fairly present the consolidated financial condition and results of operations of the Company as at the end of, and for, such fiscal year, and a certificate of such accountants stating that, in making the examination necessary for their opinion, they obtained no knowledge, except as specifically stated, of any Default. Promptly after the Company knows or has reason to know that any Default has occurred or any event which with notice or lapse of time or both would become an Event of Default, a notice of such Default describing the same in reasonable detail and, together with such notice or as soon thereafter as possible, a description of the action that the Company has taken and proposes to take with respect thereto; and The Company will furnish, at the time it furnishes each set of financial statements, a certificate of a senior financial officer of the Company (i) to the effect that no Default has occurred and is continuing (or, if any Default has occurred and is continuing, describing the same in reasonable detail and describing the action that the Company has taken and proposes to take with respect thereto) and (ii) setting forth in reasonable detail the computations necessary to determine whether the Company is in compliance with the covenants per 4.1. 3.3 RESTRICTION ON FUNDAMENTAL CHANGES: The Company will not, and will not permit any of its subsidiaries to, enter into any transaction of merger or consolidation or liquidate, wind up or dissolve itself or convey, sell, lease, transfer or otherwise dispose of substantially all of its assets to any other Person, except in the ordinary course of its business, provided that the Company may merge with another Person if (i) the Company is the corporation surviving such merger and (ii) immediately after giving effect to such merger, no Default shall have occurred and be continuing. 4. COVENANTS 4.1 FINANCIAL COVENANTS: The Company covenants and agrees that so long as this facility shall remain available, and until the full and final payment of all indebtedness incurred hereunder, it will, unless we waive compliance in writing: (a) Maintain a Fixed Charge Coverage ratio of not less than 1.5 to 1, measured at the end of each fiscal quarter. "Fixed Charge Coverage" means the sum of net income plus income taxes plus fixed charges (interest plus net rents) divided by fixed charges. (b) Maintain a Tangible Net Worth of not less than the sum of $350 million, plus 30% of net income after taxes on a quarterly basis, plus 100% of any increase in shareholders' equity other than the quarterly income increases, measured at the end of each fiscal quarter, commencing with the quarter ended September 30, 1994. (c) Maintain a Leverage Ratio not to exceed 2.5 to 1, measured at the end of each fiscal quarter, commencing with the quarter ended September 30, 1994. As used herein, "Leverage Ratio" means the ratio of total debt to tangible net worth. Total debt includes all borrowed money and lease obligations (including capital leases and operating leases, the latter to be calculated as six times the annual amount owed). 4.2 NEGATIVE PLEDGE: The Company will cause the payment obligations under this Agreement at all times to rank at least equally and ratably in all respects with all its other unsecured and unsubordinated indebtedness, and the Company will not, nor will it permit any of its subsidiaries to, create, incur, assume or suffer to exist any Lien upon any of its inventory, whether now owned or hereafter acquired, unless the benefit of the relevant security, or of alternative security satisfactory to us, is at the same time and in a manner satisfactory to us extended equally and ratably to the loans made and/or to be made and all other sums payable by the Company under this Agreement. 5. EVENTS OF DEFAULT In the event of any of the following defaults, the Bank may without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived by the Company, declare the principal of all drawings plus accrued interest to be immediately due and payable and terminate this line of credit: 5.1 Failure to pay principal, interest or fees under this Agreement within 10 days after such becomes due. 5.2 Failure to comply with any other covenants or obligation in this Agreement for 30 days. 5.3 If any material representation made by the Company to us concerning the Company's business or financial condition shall prove to have been incorrect when made. 5.4 If the Company shall default in the performance or observance of any provision or covenant contained within any existing loan agreement other than this Agreement which the Company may have in effect with any other lender, other than to us, during the tenor of this Agreement, and such default shall continue unremedied for a period of 20 calendar days. 5.5 If the Company shall admit its inability to pay its debts as they mature, or shall make an assignment for the benefit of any of its creditors, or proceedings are instituted by or against the Company under any bankruptcy, reorganization or insolvency law or other law for the relief of debtors. 5.6 If the Company shall suffer final judgment for the payment of money aggregating in excess of US$5,000,000 and shall not discharge the same within a period of 30 days unless, pending further proceedings, execution has not been commenced or if commenced has been effectively stayed. 5.7 The Company shall fail to meet any of its obligations under the Employment Retirement Income Security Act of 1974 ("ERISA") or notice of a proceeding to terminate any "plan" under ERISA to appoint a trustee of a "plan" is not dismissed within 60 days of such notice. Upon the occurrence of any of the above listed events of default, we may, without prior notice, set off and apply any and all deposits maintained with us and any other indebtedness owing by us to the Company against any and all obligations of the Company hereunder. 6. EXPENSES The Company agrees to reimburse us for all out-of-pocket expenses that we may incur relating to any default, dispute or enforcement of these terms and conditions or of the Revolving Promissory Note, including reasonable attorneys' fees, and all costs of collection. The party prevailing with respect to any action brought by the other party with respect to the enforceability of this Agreement in any court of competent jurisdiction shall be reimbursed by the non-prevailing party for all reasonable costs and expenses, including reasonable attorneys' fees, with respect to this Agreement. 7. DOCUMENTATION By your signature on this Agreement, you certify the continuing validity of the following documents: (a) Certified copy of the Resolution of the Board of Directors of the Company dated September 16, 1992 authorizing the execution, delivery and performance of all documents relative to the commitment contemplated herein, and the making of the credit. (b) Certified copies of the Articles of Incorporation and By-laws of the Company, certified as of September 16, 1992. (c) Specimen Signature Records of the Company. Our obligation to extend credit under this line of credit is conditioned upon the receipt of updated copies of any of the above documents as necessary, in form and substance satisfactory to us, and a signed copy of the enclosed Revolving Promissory Note. 8. MISCELLANEOUS 8.1 This Agreement is governed by California law, and may not be amended except by instrument in writing signed by the Company and us. 8.2 We may assign, negotiate, pledge, or otherwise hypothecate all or any portion of this Agreement, or grant participation herein or in any of our rights and security hereunder. 8.3 Nothing herein shall prohibit us from pledging or assigning the Revolving Promissory Note to any Federal Reserve Bank in accordance with applicable law. If the foregoing meets with your approval, please sign and return to us the enclosed copy of this Agreement to signify your agreement with the terms and conditions stipulated therein. It is our pleasure to make this line available to you, and we look forward to a long and mutually satisfactory relationship. Very truly yours, CREDIT SUISSE /s/ Stephen M. Flynn /s/ Deborah Shea Stephen M. Flynn Deborah Shea Member Senior Management Associate Read, agreed and accepted: Smith's Food & Drug Centers, Inc. By: /s/ Paul Tezak Title: V.P. Finance & Treasurer REVOLVING PROMISSORY NOTE US$15,000.000 November 28, 1995 FOR VALUE RECEIVED, SMITH'S FOOD & DRUG CENTERS, INC., a Delaware Corporation (the "Company"), hereby promises to pay to Credit Suisse, (the "Bank"), or order, at the office of the Bank at 12 East 49th Street, New York, NY 10017 the principal sum of US$15,000,000 (US DOLLAR FIFTEEN MILLION) or such lesser amount as shall equal the aggregate unpaid principal amount of the loans made by the Bank to the Company under the letter agreement dated as of November 28, 1995 between the Company and the Bank (the "Agreement"), in lawful money of the United States of America and in immediately available funds, on the dates and in the amounts specified in the Agreement and to pay interest on the principal amount of each such loan, at such office, in like money and funds, for the period commencing on the date of such loan until such loan shall be paid in full, at the rates per annum and on the dates provided in the Agreement. The books and accounts of the Bank shall be conclusive evidence, absent manifest error, of the amounts of all loans, interest, fees and other charges advanced, due, outstanding, or paid pursuant to the Agreement and this Note. This Note is the Revolving Promissory Note referred to in the Agreement under Section 1.2 and evidences loans by the Bank thereunder. This Note is entitled to the benefits of the Agreement, which Agreement, among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events. This Note shall remain valid and in force despite the fact that there may be times when no indebtedness is owning hereunder. If payment is not made when due, then the unpaid principal and any accrued interest which are past due shall bear interest at the Bank's Base Rate (as defined in the Agreement) plus 1% per annum until paid in full. Presentment, demand protest and diligence and notices of protest, dishonor and nonpayment of this Note and all notices of every kind are hereby waived by the Company and each endorser, guarantor and surety of this Note. This Note shall be governed by and construed in accordance with the laws of the State of California. SMITH'S FOOD & DRUG CENTERS, INC. By: /s/Paul Tezak V.P. Finance & Treasurer Address: 1550 S. Redwood Rd. S.L.C. UT 84104 EX-12.1 4 Computation of Ratio of Earnings to Fixed Charges The formula for the computation is as follows: Ratio of Earning to Fixed Charges = (net income + income taxes + restructuring charges + fixed charges) / (fixed charges) Fixed Charges = (interest expense + amortization of deferred debt issuance costs + one-third of rental expense (the portion deemed representative of the interest factor)) Supporting Data of the Calculation (dollar amounts in thousands) 1991 1992 1993 1994 1995 Net income (loss) $ 45,097 $ 53,650 $ 45,820 $ 48,781 $(40,512) Add: Income taxes 28,300 34,400 34,300 31,300 (29,300) Restructuring charges 140,000 Fixed Charges: Interest expense 30,319 36,130 44,627 53,715 60,478 Debt issue amort expense 509 344 344 509 254 1/3 Rental expense 5,564 6,372 6,607 13,382 15,565 -------- -------- -------- -------- -------- Total fixed charges 36,392 42,846 51,578 67,606 76,297 -------- -------- -------- -------- -------- Earnings plus fixed charges $109,789 $130,896 $131,698 $147,687 $146,485 ======== ======== ======== ======== ======== Ratio of earnings to fixed charges 3.02 3.06 2.55 2.18 1.92 ======== ======== ======== ======== ======== EX-23.1 5 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Forms S-8 No. 33-48627 and No. 33-56966 and Form S-3 No. 33-51097) pertaining to the Smith's Food & Drug Centers, Inc. Amended and Restated 1989 Stock Option Plan, the Smith's Food & Drug Centers, Inc. 1993 Employee Stock Purchase Plan, and the Smith's Food & Drug Centers, Inc. Pass Through Certificates of our report dated January 29, 1996, with respect to the consolidated financial statements of Smith's Food & Drug Centers, Inc. included in the Annual Report (Form 10-K) for the fiscal year ended December 30, 1995. ERNST & YOUNG LLP Salt Lake City, Utah March 26, 1996 -----END PRIVACY-ENHANCED MESSAGE-----