UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 23, 2002 OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____ Commission file number 1-41
SAFEWAY INC.
Not Applicable(Former name, former address and former fiscal year, if changed since last report.)
TABLE OF CONTENTS
SAFEWAY INC. AND SUBSIDIARIES INDEX
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PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
SAFEWAY INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(In millions)(Unaudited)
(Continued)
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SAFEWAY INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS (Continued)(In millions, except per-share amounts)(Unaudited)
See accompanying notes to condensed consolidated financial statements.
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SAFEWAY INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(In millions, except per-share amounts)(Unaudited)
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SAFEWAY INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(In millions)(Unaudited)
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SAFEWAY INC. AND SUBSIDIARIESNOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)
NOTE A — THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying condensed consolidated financial statements of Safeway Inc. and subsidiaries (“Safeway” or the “Company”) for the 12 weeks ended March 23, 2002 and March 24, 2001 are unaudited and, in the opinion of management, contain all adjustments that are of a normal and recurring nature necessary to present fairly the financial position and results of operations for such periods. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s 2001 Annual Report to Stockholders. The results of operations for the 12 weeks ended March 23, 2002 are not necessarily indicative of the results expected for the full year.
Inventory
Cost of goods sold reflects the application of the LIFO method of valuing certain domestic inventories, based upon estimated annual inflation (“LIFO Indices”). Safeway recorded LIFO expense of $2.3 million in the first quarter of 2002 and 2001. Actual LIFO Indices are calculated during the fourth quarter of the year based upon a statistical sampling of inventories.
Comprehensive Income
Comprehensive (loss) income consists primarily of net (loss) income, foreign currency translation adjustments and the effects of accounting for hedges under SFAS No. 133. Total comprehensive loss was $362.3 million for the first quarter of 2002 compared to total comprehensive income of $251.5 million for the first quarter of 2001.
NOTE B — NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets in a business combination. In the event goodwill results from a future acquisition by Safeway it will not be amortized.
SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will be tested at least annually for impairment. Under the provisions of SFAS No. 142, any impairment loss identified upon adoption of this standard is recognized as a cumulative effect of a change in accounting principle. Any impairment loss incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge to current period earnings. The Company adopted SFAS No. 142 on December 30, 2001. Under the transitional provisions of SFAS No. 142, the Company’s goodwill was tested for impairment as of December 30, 2001. Each of the Company’s reporting units were tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value was determined based on a valuation study performed by an independent third party which primarily considered the discounted cash flow method, guideline company and similar transaction method. As a result of the Company’s impairment test, the Company recorded an impairment loss to reduce the carrying value of goodwill at Dominick’s by $589 million and Randall’s by $111 million to its implied fair value. Impairment in both cases was due to a combination of factors including acquisition price, post-acquisition capital expenditures and operating performance. In accordance with SFAS No. 142, the impairment charge was reflected as a cumulative effect of accounting change in the Company’s first-quarter 2002 statement of operations. See Note C.
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In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144, which replaces SFAS No. 121 and APB No. 30, became effective for Safeway in the first quarter of 2002. Adoption of this standard did not have a material effect on the Company’s financial statements.
NOTE C — GOODWILL
A summary of changes in Safeway’s goodwill during the first quarter of 2002 by reportable operating segment is as follows (in millions):
Safeway’s adoption of SFAS No. 142 eliminates the amortization of goodwill beginning in the first quarter of 2002. Goodwill amortization expense in the first quarter of 2001 was $31.3 million ($0.06 per diluted share). The following table adjusts net (loss) income and net (loss) income per share for the adoption of SFAS No. 142 (in millions):
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NOTE D — FINANCING
Notes and debentures were composed of the following at March 23, 2002 and December 29, 2001 (in millions):
NOTE E — CONTINGENCIES
Legal Matters
Note L to the Company’s consolidated financial statements, under the caption “Legal Matters” on pages 38 and 39 of the 2001 Annual Report to Stockholders, provides information on certain litigation in which the Company is involved. There have been no material developments to these matters, except as described below.
In the lawsuit entitled Baker, et al. v. Jewel Food Stores, Inc., et al., the defendants moved for immediate interlocutory review of the trial court’s decision denying the defendants’ motion for summary judgment. On April 16, 2002, the court denied the defendants’ motion. Discovery is continuing, and the trial is anticipated to begin in early 2003.
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Results of Operations
Safeway’s income before the cumulative effect of an accounting change was $332.1 million ($0.67 per share) for the first quarter ended March 23, 2002, compared to net income of $283.9 million ($0.55 per share) for the first quarter of 2001.
Safeway adopted SFAS No. 142 during the first quarter of 2002 and recorded an aggregate charge of $700 million for the cumulative effect of adopting this statement. The charge was an impairment loss to reduce the carrying value of goodwill at Dominick’s by $589 million and Randall’s by $111 million to its implied fair value. Impairment in both cases was due to a combination of factors including acquisition price, post-acquisition capital expenditures and operating performance. See Notes B and C to the condensed consolidated financial statements. Net loss after the cumulative effect of this accounting change was $367.9 million ($0.74 per share).
First-quarter sales increased 3.5% to $7.9 billion in 2002 from $7.7 billion in 2001, primarily because of new store openings and the Genuardi’s Family Markets, Inc. (“Genuardi’s”) acquisition. First-quarter comparable-store sales increased 0.6%, while identical-store sales (which exclude replacement stores) were flat.
Safeway’s continued improvement in shrink control, buying practices and private-label growth helped increase gross profit to 31.35% of sales in the first quarter of 2002 from 30.56% in the first quarter of 2001.
Operating and administrative expense increased to 23.65% of sales in the first quarter of 2002 from 23.00% in 2001. Pension expense, higher real estate occupancy costs and lower real estate gains contributed to a 106 point increase that was partially offset by a 41 basis point reduction due to the elimination of goodwill amortization.
Interest expense decreased from $109.2 million in the first quarter of 2001 to $94.6 million in the first quarter of 2002. This decrease is primarily due to lower interest rates in 2002 partially offset by higher average borrowings as a result of the repurchase of Safeway stock and the acquisition of Genuardi’s. The interest coverage ratio (EBITDA divided by interest expense) remains very strong at 8.61 times for the first quarter of 2002. EBITDA as a percentage of sales was 10.27% for the quarter.
Other income was $9.0 million in the first quarter of 2002 compared to $9.4 million in the first quarter of 2001. Other income consists primarily of net equity in earnings of Casa Ley, S.A. de C.V. and GroceryWorks Holdings, Inc. and interest income.
The income tax rate was 36.9% for the first quarter of 2002, down from 40.8% in the first quarter of 2001. The decrease was primarily due to the elimination of goodwill amortization. In addition, the tax rate improved from continued tax planning strategies and a change in foreign tax law.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets in a business combination. In the event goodwill results from a future acquisition by Safeway it will not be amortized.
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SAFEWAY INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS
SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will be tested at least annually for impairment. Under the provisions of SFAS No. 142, any impairment loss identified upon adoption of this standard is recognized as a cumulative effect of a change in accounting principle. Any impairment loss incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge to current period earnings. The Company adopted SFAS No. 142 on December 30, 2001. Under the transitional provisions of SFAS No. 142, the Company’s goodwill was tested for impairment as of December 30, 2001. Each of the Company’s reporting units were tested for impairment by comparing the fair value of each reporting unit with its carrying value. Fair value was determined based on a valuation study performed by an independent third party which primarily considered the discounted cash flow method, guideline company and similar transaction method. As a result of the Company’s impairment test, the Company recorded an impairment loss to reduce the carrying value of goodwill at Dominick’s by $589 million and Randall’s by $111 million to its implied fair value. Impairment in both cases was due to a combination of factors including acquisition price, post-acquisition capital expenditures and operating performance. In accordance with SFAS No. 142, the impairment charge was reflected as a cumulative effect of accounting change in the Company’s first-quarter 2002 statement of income. See Notes B and C.
Liquidity and Financial Resources
Cash flow from operating activities was $284.9 million in the first quarter of 2002 compared to cash flow from operating activities of $271.9 million in the first quarter of 2001. This change is primarily due to improved results of operations and changes in working capital. Working capital (excluding cash and debt) at March 23, 2002 was $307.1 million compared to $194.0 million at March 24, 2001.
Cash flow used by investing activities for the first quarter of the year was $167.9 million in 2002 compared to $784.4 million in 2001. The decrease in cash used is primarily due to the acquisition of Genuardi’s and higher capital expenditures in 2001.
Cash flow used by financing activities was $120.5 million in the first quarter of 2002 compared to cash provided of $497.6 million in 2001. The first quarter of 2001 includes the issuance of the debentures and commercial paper to help finance the acquisition of Genuardi’s in 2001.
Safeway repurchased 4.7 million shares of Safeway common stock at a total purchase price of $196 million in the first quarter of 2002. From initiation of the program in 1999 through the end of the first quarter of 2002, the Company has repurchased 41.5 million shares of common stock at a cost of $1.6 billion, leaving $900 available for repurchases under the current level authorized by the Company’s board of directors. The timing and volume of future purchases will depend on market conditions.
Net cash flow from operating activities as presented in the condensed consolidated statements of cash flows is an important measure of cash generated by the Company’s operating activities. EBITDA, as defined below, is similar to net cash flow from operations because it excludes certain noncash items. However, EBITDA also excludes interest expense and income taxes. EBITDA should not be considered as an alternative to net income or cash flows from operating activities (which are determined in accordance with GAAP) as an indicator of operating performance or a measure of liquidity. Management believes that EBITDA is relevant because it assists investors in evaluating Safeway’s ability to service its debt by providing a commonly used measure of cash available to pay interest, and it facilitates comparisons of Safeway’s results of operations with those of companies having different capital structures. Other companies may define EBITDA differently and, as a result, such measures may not be comparable to Safeway’s EBITDA. Safeway’s computation of EBITDA is as follows:
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Based upon the current level of operations, Safeway believes that cash flow from operating activities and other sources of liquidity, including borrowings under Safeway’s commercial paper program and bank credit agreement, will be adequate to meet anticipated requirements for working capital, capital expenditures, interest payments and scheduled principal payments for the foreseeable future. There can be no assurance, however, that the Company’s business will continue to generate cash flow at or above current levels or that the Company will maintain its ability to borrow under the commercial paper program and bank credit agreement.
If the Company’s credit rating were to decline below its current level of Baa2/BBB, the ability to borrow under the commercial paper program would be adversely affected. Safeway’s ability to borrow under the bank credit agreement is unaffected by Safeway’s credit rating. However, if Safeway’s rolling four-quarter EBITDA to interest ratio of 8.34 to 1 as of March 29, 2002 were to decline to 2.0 to 1, or if Safeway’s 2002 first-quarter-end debt to rolling four-quarter EBITDA ratio of 2.07 to 1 were to grow to 3.5 to 1, Safeway’s ability to borrow under the bank credit agreement would be impaired.
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Capital Expenditure Program
During the first quarter of 2002, Safeway invested $247 million in capital expenditures (as defined on page 10 of the Company’s 2001 Annual Report to Stockholders). The Company opened 19 new stores and closed 10 stores. The Company expects to spend more than $2.1 billion in 2002 while opening 80 to 85 new stores and completing approximately 250 remodels.
Forward -Looking Statements
This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements relate to, among other things, capital expenditures, acquisitions, share repurchases, improvements in operations, gross margin and costs, and are indicated by words or phrases such as “continuing,” “on-going,” “expects,” and similar words or phrases. The following are among the principal factors that could cause actual results to differ materially from the forward-looking statements: general business and economic conditions in our operating regions, including the rate of inflation, population, employment and job growth in our markets; pricing pressures and competitive factors, which could include pricing strategies, store openings and remodels; results of our programs to control or reduce costs; results of our programs to increase sales; results of our programs to improve capital management; the ability to integrate any companies we acquire and achieve operating improvements at those companies; increases in labor costs and relations with union bargaining units representing our employees or employees of third-party operators of our distribution centers; opportunities or acquisitions that we pursue; the availability and terms of financing; and unfavorable legislative, regulatory or judicial developments. Consequently, actual events and results may vary significantly from those included in or contemplated or implied by such statements. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do so.
There have been no material changes regarding the Company’s market risk position from the information provided under the caption “Market Risk from Financial Instruments” on page 11 of the Company’s 2001 Annual Report to Stockholders.
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SAFEWAY INC. AND SUBSIDIARIES
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
Item 6(a). Exhibits
Exhibit 11.1 Computation of Earnings Per Share.
Exhibit 12.1 Computation of Ratio of Earnings to Fixed Charges.
Item 6(b). Reports on Form 8-K
The Company filed no Current Reports on Form 8-K during the first quarter of 2002.
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SAFEWAY INC. AND SUBSIDIARIES Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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SAFEWAY INC. AND SUBSIDIARIES Exhibit Index
LIST OF EXHIBITS FILED WITH FORM 10-Q FOR THE PERIODENDED March 23, 2002
Exhibit 11.1 Computation of Earnings Per Share
Exhibit 12.1 Computation of Ratio of Earnings to Fixed Charges
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