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 EXCHANGEACT OF 1934
For the quarterly period ended September 7, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934
For the transition period from __________ to __________
Commission file number 1-41
SAFEWAY INC.(Exact name of registrant as specified in its charter)
Not Applicable
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 [ ]. As of October 11, 2002 there were issued and outstanding 441.1 million shares of the registrant’s common stock.
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 INCOME(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 SUBSIDIARIESMANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 36 weeks ended September 7, 2002 and September 8, 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 36 weeks ended September 7, 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 36 weeks of 2002 and $6.9 million during the first 36 weeks of 2001. Actual LIFO Indices are calculated during the fourth quarter of the year based upon a statistical sampling of inventories.
Investment in GroceryWorks
During the third quarter Safeway invested $5.9 million in GroceryWorks bringing Safeway’s ownership interest in GroceryWorks to 52.5%. Therefore, Safeway changed its method of accounting for its investment in GroceryWorks from the equity method to consolidation beginning in the third quarter of 2002. This change in accounting has no effect on reported earnings.
Other Income/Expense
Other expense for the 36 weeks ended September 8, 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 Income
Comprehensive income consists primarily of net income and foreign currency translation adjustments. Total comprehensive income was $239.2 million for the first 36 weeks of 2002 compared to total comprehensive income of $861.7 million for the first 36 weeks of 2001.
NOTE B — NEW ACCOUNTING STANDARDS
SFAS No. 142, “Goodwill and Other Intangible Assets,” 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 the fourth quarter of 2002. Since December 30, 2001, when Safeway initially tested its goodwill for impairment, the market capitalization of many retail grocery companies, including Safeway, has declined significantly. The effects of these external market factors may result in additional goodwill impairment.
In October 2001, the Financial Accounting Standards Board (“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.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses accounting for restructuring and similar costs, including store closures. SFAS No. 146 replaces previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Under Issue 94-3, a liability for an exit cost was recognized at the date of the company’s commitment to an exit plan. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future store closures and restructuring costs, if any, as well as the amounts recognized. The Company adopted the provisions of SFAS No. 146 during the third 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 36 weeks of 2002 by reportable operating segment is as follows (in millions):
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Safeway’s adoption of SFAS No. 142 eliminated the amortization of goodwill beginning in the first quarter of 2002. The following table adjusts net income and net 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 September 7, 2002 and December 29, 2001 (in millions):
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 administrative 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 was not significant. Safeway 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):
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NOTE F — FURR’S AND HOMELAND CHARGE
In 2001, Safeway recorded a pre-tax charge to earnings of $42.7 million to recognize estimated lease liabilities associated with the bankruptcies of Furr’s Inc. (“Furr’s”) and Homeland Stores, Inc. (“Homeland”). During the first 36 weeks of 2002 Safeway reduced the accrual by $8.4 million for cash expenditures. In addition, Homeland emerged from bankruptcy during the third quarter of 2002 and, based on the resolution of various leases, Safeway reversed $5.2 million of the accrual, leaving a balance of $29.1 million as of September 7, 2002.
NOTE G — 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.
NOTE H — SUBSEQUENT EVENTS
Casa Ley has informed Safeway that it has discovered discrepancies in physical inventory counts of certain of its stores. Casa Ley has advised Safeway that it has taken steps to improve its inventory control procedures and is conducting a company-wide physical inventory which it expects to complete in the fourth quarter of 2002. The amount of any inventory adjustment cannot be estimated until the physical inventory counts are completed. Safeway has a 49% equity interest in Casa Ley and will reflect in its income statement 49% of any adjustment to Casa Ley’s inventory. However, Safeway does not expect any adjustment to Casa Ley’s inventory to be material to Safeway’s financial statements.
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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 $281.3 million ($0.60 per share) for the third quarter ended September 7, 2002, compared to $309.2 million ($0.60 per share) for the third quarter of 2001.
Third-quarter 2002 comparable-store sales decreased 0.7%, while identical store sales (which exclude replacement stores) fell 1.4%. Sales were impacted by continued softness in the economy and competitive factors. Total sales increased to $8.1 billion from $8.0 billion in the third quarter of 2001 primarily due to new store openings.
Gross profit decreased 26 basis points to 30.69% of sales in the third quarter of 2002 from gross profit of 30.95% in the third quarter of 2001 as cost savings were reinvested in pricing and promotion.
Operating and administrative expense increased 90 basis points to 23.92% of sales in the third quarter of 2002 compared to operating and administrative expense of 23.02% in the third quarter of 2001 primarily due to higher employee benefit costs, higher real estate occupancy costs and pension expense.
Interest expense remained relatively flat at $101.5 million in the third quarter of 2002 compared to $101.2 million in the third quarter of 2001 as lower interest rates were offset by higher average borrowings resulting from the repurchase of Safeway stock. EBITDA (defined on page 13) as a percentage of sales was 9.35% for the quarter and 9.92% over the last 52 weeks. The interest coverage ratio (EBITDA divided by interest expense) remains very strong at 7.4 times for the quarter and 8.2 times for the last 52 weeks.
For the first 36 weeks of 2002, net income before the cumulative effect of an accounting change was $922.7 million ($1.90 per share) compared to net income of $900.3 million ($1.75 per share) for the first 36 weeks of 2001. Sales in the first 36 weeks of 2002 increased 1.9% to $24.1 billion from sales of $23.6 billion in the first 36 weeks of 2001. Sales were adversely impacted by continued softness in the economy, competitive factors, an overly aggressive shrink effort and disruptions associated with centralization of buying and merchandising. The gross profit margin increased to 31.21% in the first 36 weeks of 2002 from 30.89% in 2001 due to continued improvements in shrink control, buying practices and private-label growth. Operating and administrative expense increased to 23.72% of sales in the first 36 weeks of 2002 from 22.76% in the first 36 weeks of 2001 due to higher real estate occupancy costs, pension expense and higher employee benefit costs. Safeway recorded an after-tax restructuring 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. Other expense for the first 36 weeks of 2001 included an impairment charge of $30.1 million related to GroceryWorks. Net income after the cumulative effect of an accounting change related to SFAS No. 142 was $222.7 million ($0.46 per share) for the first 36 weeks of 2002. See New Accounting Pronouncements below and Notes B and C to the condensed consolidated financial statements.
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Fourth Quarter 2002
New Accounting Pronouncements
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 the fourth quarter of 2002. Since December 30, 2001, when Safeway initially tested its goodwill for impairment, the market capitalization of many retail grocery companies, including Safeway, has declined significantly. The effects of these external market factors may result in additional goodwill impairment.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses accounting for restructuring and similar costs, including store closures. SFAS No. 146 replaces previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Under Issue 94-3, a liability for an exit cost was recognized at the date of the company’s commitment to an exit plan. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future store closures and restructuring costs, if any, as well as the amounts recognized. The Company early adopted the provisions of SFAS No. 146 during the third quarter of 2002. Adoption of this standard did not have a material effect on the Company’s financial statements.
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Liquidity and Financial Resources
Cash flow from operating activities was $1,573.5 million in the first 36 weeks of 2002 compared to cash flow from operations of $1,697.3 million in the first 36 weeks of 2001. This change is due primarily to changes in working capital. Working capital (excluding cash and debt) at September 7, 2002 was $34.1 million compared to a deficit of $145.5 million at September 8, 2001.
Cash flow used by investing activities for the first 36 weeks of the year decreased to $890.5 million in 2002 compared to $1,492.7 million in 2001. Cash flow used by investing activities was greater in 2001 because of the Genuardi’s acquisition and higher cash capital expenditures.
Cash flow used by financing activities was $681.5 million in the first 36 weeks of 2002 primarily due to the purchase of Safeway common stock, partially offset by additional borrowings to fund part of the purchases. Cash flow used by financing activities was $227.3 million in the first 36 weeks of 2001 primarily due to the issuance of debentures and commercial paper to help finance the acquisition of Genuardi’s, partially offset by the utilization of cash from operations to pay down debt.
The Company repurchased 32.9 million shares of Safeway’s common stock at a total purchase price of $918 million during the third quarter of 2002. From initiation of the program in 1999 through the end of the third quarter of 2002, Safeway has repurchased 79.7 million shares of common stock at a total purchase price of $2.8 billion leaving $0.7 billion available for repurchases under the current level authorized by the company’s board of directors. The timing and volume of future repurchases 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. On August 12, 2002, Safeway issued $225 million of 3.80% Senior Notes due in 2005 and $800 million of 5.80% Senior Notes due in 2012. Proceeds from these issuances were used to repay borrowings under the Company’s commercial paper program.
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 8.17 to 1 as of September 7, 2002 were to decline to 2.0 to 1, or if Safeway’s 2002 third-quarter-end debt to rolling four-quarter EBITDA ratio of 2.36 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 36 weeks of 2002, Safeway invested approximately $1.2 billion in capital expenditures ($0.9 billion in cash) and opened 55 new stores and closed 35 stores. The Company expects to spend approximately $1.9 billion ($1.6 billion in cash) in 2002 while opening 75 to 80 new stores and completing approximately 200 remodels.
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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, investments in other companies, debt reductions and inventory adjustments at Casa Ley 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 and the amount of any inventory adjustments at Casa Ley; 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.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures which, by their nature, can provide only reasonable assurance regarding management’s control objectives. The Company also has investments in certain unconsolidated entities, including Casa Ley. As the Company does not control or manage these entities, its disclosure controls and procedures with respect to such entities are necessarily more limited than those it maintains with respect to its consolidated subsidiaries.
Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the foregoing, the Company’s President and Chief Executive Officer along with the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act reports. There have been no significant changes in the Company’s internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation.
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PART II — OTHER INFORMATION
Item 1. Legal Proceedings
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Item 6(a). Exhibits
Item 6(b). Reports on Form 8-K
On August 21, 2002, the Company filed a current report on Form 8-K under “Item 9. Regulation FD Disclosure.”
On August 14, 2002, the Company filed a current report on Form 8-K under “Item 9. Regulation FD Disclosure.”
On August 13, 2002, the Company filed a current report on Form 8-K under “Item 5. Other Events.”
On July 16, 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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Certifications
I, Steven A. Burd, Chairman, President and Chief Executive Officer of Safeway Inc., certify that:
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I, Vasant M. Prabhu, Chief Financial Officer of Safeway Inc., certify that:
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Exhibit Index
LIST OF EXHIBITS FILED WITH FORM 10-Q FOR THE PERIODENDED September 7, 2002
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