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 June 15, 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.
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)
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SAFEWAY INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS (Continued)(In millions, except per-share amounts)(Unaudited)
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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 and 24 weeks ended June 15, 2002 and June 16, 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 and 24 weeks ended June 15, 2002 are not necessarily indicative of the results expected for the full year.
Inventory
Net income reflects the application of the LIFO method of valuing certain domestic inventories, based upon estimated annual inflation (“LIFO Indices”). Safeway recorded estimated LIFO expense of $2.3 million during the first 24 weeks of 2002 and $4.6 million during the first 24 weeks of 2001. Actual LIFO Indices are calculated during the fourth quarter of the year based upon a statistical sampling of inventories.
Other Income/Expense
Other expense for the 12 and 24 weeks ended June 16, 2001 includes a $30.1 million impairment charge to reduce the carrying amount of Safeway’s investment in GroceryWorks to its estimated fair value.
Comprehensive Loss/Income
Comprehensive (loss) income consists primarily of net income and foreign currency translation adjustments. Total comprehensive loss was $33.4 million for the first 24 weeks of 2002 compared to total comprehensive income of $571.1 million for the first 24 weeks 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.
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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, guideline company and similar transaction methods. 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. Safeway will test goodwill for impairment again in 2002 at an annual impairment test date that has yet to be selected by the Company.
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 24 weeks 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 second quarter of 2001 was $32.9 million ($0.06 per diluted share). Goodwill amortization for the first 24 weeks of 2001 was $64.2 million ($0.13 per diluted share). The following table adjusts net income (loss) and net income (loss) 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 June 15, 2002 and December 29, 2001 (in millions):
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NOTE E — RESTRUCTURING CHARGES
Safeway recorded restructuring charges totaling $58.9 million pre-tax in the second quarter of 2002 for costs associated with 10 announced store closures, for severance costs for 460 retail positions related to the centralization of marketing functions and for severance costs for 487 retail positions related to the restructuring of a 29-store labor contract. The revenue and net operating income associated with the 10 stores to be closed is not significant. Safeway has not made any cash payments related to these charges as of June 15, 2002 but expects these activities to be completed by the end of 2002. The following table presents the pre-tax charges recorded by category of expenditure (in millions):
NOTE F — 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 noted in subsequent filings, and except as described below.
In the lawsuit entitled Baker, et al. v. Jewel Food Stores, Inc., et al., the Court certified the action as a class action on July 9, 2002. Trial is scheduled to begin in early 2003.
NOTE G — SUBSEQUENT EVENTS
On July 16, 2002, Safeway issued $480 million of 4.80% Senior Notes due in 2007. Proceeds from this issuance were used to repay borrowings under the Company’s commercial paper program.
On July 18, 2002, the Company filed a shelf registration with the Securities and Exchange Commission to sell, periodically, up to $2 billion in debt securities and common stock.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Safeway’s net income was $309.3 million ($0.63 per share) for the second quarter ended June 15, 2002, compared to $307.3 million ($0.59 per share) for the second quarter of 2001.
Second-quarter 2002 comparable-store sales decreased 0.4%, while identical store sales (which exclude replacement stores) fell 1.1%. Sales were impacted by continued softness in the economy, an increase in competitive activity, an overly aggressive shrink effort and disruptions associated with the centralization of buying and merchandising. Total sales increased 1.2% to $8.1 billion from $8.0 billion in the second quarter of 2001 primarily because of new store openings.
Gross profit increased to 31.59% of sales in the second quarter of 2002 from gross profit of 31.16% in the second quarter of 2001 due to continued improvements in shrink control, buying practices and private-label growth.
Operating and administrative expense increased to 23.60% of sales in the second quarter of 2002 from 23.07% in 2001. Higher real estate occupancy costs, pension expense and employee benefit costs contributed to a 94 basis point increase that was partially offset by a 41 basis point reduction due to the elimination of goodwill amortization under SFAS No. 142.
Safeway recorded an after-tax charge of $36.7 million ($0.08 per share) in the second quarter of 2002 consisting of charges associated with 10 announced store closures, severance costs related to the centralization of marketing functions and severance costs related to the restructuring of a 29-store labor contract. In addition, Safeway incurred transition costs related to the centralization effort of $4.4 million after-tax ($0.01 per share).
Interest expense declined to $95.4 million in the second quarter of 2002 compared to $105.6 million in the second quarter of 2001 due primarily to lower interest rates partially offset by higher average borrowings because of the repurchase of Safeway common stock. EBITDA (defined on page 13) as a percentage of sales was 9.76% for the quarter. The interest coverage ratio (EBITDA divided by interest expense) remains very strong at 8.27 times for the quarter. Safeway has reduced outstanding debt by $138 million since the beginning of 2002 while continuing to invest in capital expenditures and purchasing its common stock.
Other income was $4.3 million in the second quarter of 2002 compared to other expense of $21.6 million in 2001. Other expense in 2001 included an impairment charge of $30.1 million related to GroceryWorks.
For the first 24 weeks of 2002, net income before the cumulative effect of an accounting change was $641.4 million ($1.30 per share) on sales of $16.0 billion compared to net income of $591.2 million ($1.14 per share) on sales of $15.7 billion for the first 24 weeks of 2001. The gross profit margin increased to 31.47% in the first 24 weeks of 2002 from 30.87% in 2001. Operating and administrative expense increased to 23.62% of sales in the first 24 weeks of 2002 from 23.03% in the first 24 weeks of 2001. Results for the 24 weeks ended June 15, 2002 were the result of trends similar to those experienced for the 12 weeks ended June 15, 2002, which are discussed above. Net loss after the cumulative effect of an accounting change related to SFAS No. 142 was $58.6 million ($0.12 per share) for the first 24 weeks of 2002. See Notes B and C to the condensed consolidated financial statements.
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SAFEWAY INC. AND SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS
New Accounting Pronouncements
Liquidity and Financial Resources
Cash flow from operating activities was $1,096.7 million in the first 24 weeks of 2002 compared to cash flow from operations of $830.3 million in the first 24 weeks of 2001. This change is due primarily to improved results of operations and changes in working capital. Working capital (excluding cash and debt) at June 15, 2002 was $73.3 million compared to $180.9 million at June 16, 2001.
Cash flow used by investing activities for the first 24 weeks of the year decreased to $518.6 million in 2002 compared to $1,127.5 million in 2001, due primarily to the Genuardi’s acquisition and higher cash capital expenditures in 2001.
Cash flow used by financing activities was $596.1 million in the first 24 weeks of 2002 primarily due to the purchase of Safeway common stock and the utilization of cash from operations to pay down debt. Cash flow provided by financing activities was $308.0 million in the first 24 weeks of 2001 primarily due to the issuance of the debentures and commercial paper to help finance the acquisition of Genuardi’s.
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Safeway repurchased 5.2 million shares of Safeway common stock at a total purchase price of $225 million in the second quarter of 2002. Safeway’s board of directors has increased the authorized level of the Company’s stock repurchase program to $3.5 billion from $2.5 billion. From initiation of the program in 1999 through the end of the second quarter of 2002, the Company has repurchased 46.7 million shares of common stock at a cost of $1.9 billion, leaving $1.6 billion available for repurchases under the new authorized level. The timing and volume of future purchases will depend on market conditions.
On July 16, 2002, Safeway issued $480 million of 4.80% Senior Notes due in 2007. Proceeds from this issuance were used to repay borrowings under the Company’s commercial paper program. On July 18, 2002, the Company filed a shelf registration with the Securities and Exchange Commission to sell, periodically, up to $2 billion in debt securities and common stock.
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 8.35 to 1 as of June 15, 2002 were to decline to 2.0 to 1, or if Safeway’s 2002 second-quarter-end debt to rolling four-quarter EBITDA ratio of 2.06 to 1 were to grow to 3.5 to 1, Safeway’s ability to borrow under the bank credit agreement would be adversely affected.
Capital Expenditure Program
During the first 24 weeks of 2002, Safeway invested $669.5 million in capital expenditures and opened 35 new stores and closed 16 stores. The Company expects to spend more than $1.9 billion in 2002 while opening approximately 80 new stores and completing approximately 200 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, same-store sales, capital expenditures, acquisitions, share repurchases, improvements in operations, gross margin and costs, shrink reduction efforts, centralization of operations, restructuring and transition charges, the valuation of goodwill and our investments in other companies and debt reductions and are indicated by words or phrases such as “continuing,” “on-going,” “expects,” “comfortable,” “guidance,” “management believes,” “the Company believes,” “the Company intends,” “we believe,” “we intend,” and similar words or phrases. These statements are based on our current plans and expectations and involve risks and uncertainties. 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, consumer spending levels, population, employment and job growth in our markets; pricing pressures and competitive factors, which could include pricing strategies, store openings and remodels by our competitors; results of our programs to control or reduce costs including our ability to implement our programs to centralize buying and merchandising and realize savings from that program and the potential operating effects of implementing that program; results of our programs to reduce and control shrink; results of our programs to increase sales, including private-label sales and our promotional programs; results of our programs to improve capital management; the ability to integrate any companies we acquire and achieve operating improvements at those companies; changes in financial performance of other companies in which we have investments, including GroceryWorks; increases in labor costs and relations with union bargaining units representing our employees or employees of third-party operators of our distribution centers; changes in state or federal legislation, regulation or judicial developments; the cost and stability of power sources; opportunities or acquisitions that we pursue; the availability and timely delivery of perishables and other products; market valuation assumptions and internal projections of future operating results which affect the valuation of goodwill; the rate of return on our pension assets; and the availability and terms of financing. 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.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
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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PART II — OTHER INFORMATION
Item 1. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on May 16, 2002 at which the stockholders voted on proposals as follows:
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Item 6(a). Exhibits
Item 6(b). Reports on Form 8-K
On June 12, 2002, the Company filed a current report on Form 8-K under “Item 5. Other Events.”
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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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Exhibit Index
LIST OF EXHIBITS FILED WITH FORM 10-Q FOR THE PERIODENDED June 15, 2002