UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 15, 2007.
OR
o
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: 000-31127
SPARTAN STORES, INC.(Exact Name of Registrant as Specified in Its Charter)
Michigan(State or Other Jurisdictionof Incorporation or Organization)
38-0593940(I.R.S. EmployerIdentification No.)
850 76th Street, S.W.P.O. Box 8700Grand Rapids, Michigan(Address of Principal Executive Offices)
49518(Zip Code)
(616) 878-2000(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes X
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act).
Large accelerated filer ___
Accelerated filer X
Non-accelerated filer ___
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).
Yes ___
No X
As of October 12, 2007 the registrant had 21,877,043 outstanding shares of common stock, no par value.
FORWARD-LOOKING STATEMENTS The matters discussed in this Quarterly Report on Form 10-Q include "forward-looking statements" about the plans, strategies, objectives, goals or expectations of Spartan Stores, Inc. (together with its subsidiaries, "Spartan Stores"). These forward-looking statements are identifiable by words or phrases indicating that Spartan Stores or management "expects," "anticipates," "plans," "believes," "estimates," that a particular occurrence "may," "could," or "will likely" result or that a particular event "will," "may," "could," "should" or "will likely" occur or "continue" in the future, that the "outlook," "strategy," or "trend" is toward a particular result or occurrence, or similarly stated expectations. Accounting estimates, such as those described under the heading "Critical Accounting Policies" in Item 2 of this Form 10-Q, are inherently forward-looking. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Qu arterly Report. In addition to other risks and uncertainties described in connection with the forward-looking statements contained in this Quarterly Report on Form 10-Q, Spartan Stores' Annual Report on Form 10-K for the year ended March 31, 2007 (in particular, you should refer to the discussion of "Risk Factors" in Item 1A of our Annual Report on Form 10-K) and other periodic reports filed with the Securities and Exchange Commission, there are many important factors that could cause actual results to differ materially. Our ability to maintain and strengthen our retail-store performance; assimilate acquired stores; maintain or grow sales; respond successfully to competitors; maintain or increase gross margin; anticipate and successfully respond to openings of competitors; maintain and improve customer and supplier relationships; realize expected benefits of new relationships; realize growth opportunities; expand our customer base; reduce operating costs; sell on favorable terms assets classified as held for sale; generate cash; continue to meet the terms of our debt covenants; continue to pay dividends; and, implement the other programs, plans, priorities, strategies, objectives, goals or expectations described in this Quarterly Report, our press releases and our public comments will be affected by changes in economic conditions generally or in the markets and geographic areas that we serve, adverse effects of the changing food and distribution industries and other factors including, but not limited to, those discussed below. Anticipated future sales are subject to competitive pressures from many sources. Our Distribution and Retail businesses compete with many supercenters, warehouse discount stores, supermarkets, pharmacies and product manufacturers. Future sales will be dependent on the number of retail stores that we own and operate, our ability to retain and add to the retail stores to whom we distribute, competitive pressures in the retail industry generally and our geographic markets specifically and our ability to implement effective new marketing and merchandising programs. Competitive pressures in these and other business segments may result in unexpected reductions in sales volumes, product prices or service fees. Our operating and administrative expenses, and as a result, our net earnings and cash flows, may be adversely affected by unexpected costs associated with, among other factors: difficulties in the operation of our business segments; future business acquisitions; adverse effects on business relationships with independent retail grocery store customers; difficulties in the retention or hiring of employees; labor shortages, stoppages or disputes; business and asset divestitures; increased transportation or fuel costs; current or future lawsuits and administrative proceedings; and losses of, or financial difficulties of, customers or suppliers. Our future costs for pension and postretirement benefit costs may be adversely affected by changes in actuarial assumptions and methods, investment return and the composition of the group of employees and retirees covered, changes in our business that result in a withdrawal liability under multi-employer plans, and the actions and con tributions of other employers who participate in multi-employer plans to which we contribute. Our future income tax expense, and as a result, our net earnings and cash flows, could be adversely affected by changes in tax laws. Our accounting estimates could change due to changes in facts, assumptions, or acceptable methods, and actual results may vary materially from our estimates. Our operating and administrative expenses, net earnings and cash flow could also be adversely affected by changes in our sales mix. Our ongoing cost reduction initiatives and changes in our marketing and merchandising programs may not be as successful as anticipated. Acts of terrorism, war, natural disaster, fire, accident, or other circumstances beyond our control could have adverse effects on the availability of and our ability to operate our warehouse and other facilities, consumer buying behavior, fuel costs, shipping and transportation, product imports and other factors affecting our company and the grocery industry generally . Our asset impairment and exit cost provisions are estimates and actual costs may be more or less than these estimates.
FORWARD-LOOKING STATEMENTS
The matters discussed in this Quarterly Report on Form 10-Q include "forward-looking statements" about the plans, strategies, objectives, goals or expectations of Spartan Stores, Inc. (together with its subsidiaries, "Spartan Stores"). These forward-looking statements are identifiable by words or phrases indicating that Spartan Stores or management "expects," "anticipates," "plans," "believes," "estimates," that a particular occurrence "may," "could," or "will likely" result or that a particular event "will," "may," "could," "should" or "will likely" occur or "continue" in the future, that the "outlook," "strategy," or "trend" is toward a particular result or occurrence, or similarly stated expectations. Accounting estimates, such as those described under the heading "Critical Accounting Policies" in Item 2 of this Form 10-Q, are inherently forward-looking. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this Qu arterly Report.
In addition to other risks and uncertainties described in connection with the forward-looking statements contained in this Quarterly Report on Form 10-Q, Spartan Stores' Annual Report on Form 10-K for the year ended March 31, 2007 (in particular, you should refer to the discussion of "Risk Factors" in Item 1A of our Annual Report on Form 10-K) and other periodic reports filed with the Securities and Exchange Commission, there are many important factors that could cause actual results to differ materially. Our ability to maintain and strengthen our retail-store performance; assimilate acquired stores; maintain or grow sales; respond successfully to competitors; maintain or increase gross margin; anticipate and successfully respond to openings of competitors; maintain and improve customer and supplier relationships; realize expected benefits of new relationships; realize growth opportunities; expand our customer base; reduce operating costs; sell on favorable terms assets classified as held for sale; generate cash; continue to meet the terms of our debt covenants; continue to pay dividends; and, implement the other programs, plans, priorities, strategies, objectives, goals or expectations described in this Quarterly Report, our press releases and our public comments will be affected by changes in economic conditions generally or in the markets and geographic areas that we serve, adverse effects of the changing food and distribution industries and other factors including, but not limited to, those discussed below.
Anticipated future sales are subject to competitive pressures from many sources. Our Distribution and Retail businesses compete with many supercenters, warehouse discount stores, supermarkets, pharmacies and product manufacturers. Future sales will be dependent on the number of retail stores that we own and operate, our ability to retain and add to the retail stores to whom we distribute, competitive pressures in the retail industry generally and our geographic markets specifically and our ability to implement effective new marketing and merchandising programs. Competitive pressures in these and other business segments may result in unexpected reductions in sales volumes, product prices or service fees.
Our operating and administrative expenses, and as a result, our net earnings and cash flows, may be adversely affected by unexpected costs associated with, among other factors: difficulties in the operation of our business segments; future business acquisitions; adverse effects on business relationships with independent retail grocery store customers; difficulties in the retention or hiring of employees; labor shortages, stoppages or disputes; business and asset divestitures; increased transportation or fuel costs; current or future lawsuits and administrative proceedings; and losses of, or financial difficulties of, customers or suppliers. Our future costs for pension and postretirement benefit costs may be adversely affected by changes in actuarial assumptions and methods, investment return and the composition of the group of employees and retirees covered, changes in our business that result in a withdrawal liability under multi-employer plans, and the actions and con tributions of other employers who participate in multi-employer plans to which we contribute. Our future income tax expense, and as a result, our net earnings and cash flows, could be adversely affected by changes in tax laws. Our accounting estimates could change due to changes in facts, assumptions, or acceptable methods, and actual results may vary materially from our estimates. Our operating and administrative expenses, net earnings and cash flow could also be adversely affected by changes in our sales mix. Our ongoing cost reduction initiatives and changes in our marketing and merchandising programs may not be as successful as anticipated. Acts of terrorism, war, natural disaster, fire, accident, or other circumstances beyond our control could have adverse effects on the availability of and our ability to operate our warehouse and other facilities, consumer buying behavior, fuel costs, shipping and transportation, product imports and other factors affecting our company and the grocery industry generally . Our asset impairment and exit cost provisions are estimates and actual costs may be more or less than these estimates.
Our future interest expense and income also may differ from current expectations, depending upon, among other factors: the amount of additional borrowings; changes in our borrowing agreements; changes in the interest rate environment; changes in accounting pronouncements; and changes in the amount of fees received or paid. The availability of our secured loan agreement depends on compliance with the terms of the loan agreement.
Our ability to realize increased sales and earnings as a result of our recent acquisition of certain of the assets of G&R Felpausch Company and its affiliates ("Felpausch") depends on our ability to integrate the acquired assets successfully and to implement our plans and business practices at the acquired locations. Combining the operations of Felpausch with our existing operations is expected to require significant effort and expense. If we are unable to integrate the Felpausch assets as planned, we may not realize the synergies, business opportunities, and growth prospects anticipated in connection with this transaction.
Our dividend policy does not commit the Board of Directors to declare future dividends. Each future dividend will be considered and declared by the Board of Directors in its discretion. The ability of the Board of Directors to continue to declare dividends will depend on a number of factors, including our future financial condition and profitability and compliance with the terms of our credit facilities.
This section is intended to provide meaningful cautionary statements. This should not be construed as a complete list of all economic, competitive, governmental, technological and other factors that could adversely affect our expected consolidated financial position, results of operations or liquidity. We undertake no obligation to update or revise our forward-looking statements to reflect developments that occur or information obtained after the date of this Quarterly Report.
PART IFINANCIAL INFORMATION
ITEM 1.
Financial Statements
SPARTAN STORES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(In thousands)(Unaudited)
Assets
September 15,2007
March 31,2007
Current assets
Cash and cash equivalents
$
12,308
12,063
Accounts receivable, net
57,164
45,347
Inventories, net
144,411
106,854
Prepaid expenses and other current assets
9,272
7,122
Deferred taxes on income
5,694
10,214
Property and equipment held for sale
646
3,595
Total current assets
229,495
185,195
Other assets
Goodwill
176,329
142,888
Other, net
27,649
16,203
Total other assets
203,978
159,091
Property and equipment, net
164,449
143,213
Total assets
597,922
487,499
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable
110,991
93,729
Accrued payroll and benefits
28,475
33,367
Other accrued expenses
20,738
19,503
Current portion of exit costs
8,641
8,889
Current maturities of long-term debt and capital lease obligations
8,619
2,494
Total current liabilities
177,464
157,982
Long-term liabilities
Postretirement benefits
9,160
9,208
Other long-term liabilities
23,439
17,413
Exit costs
25,675
23,814
Long-term debt and capital lease obligations
172,535
106,341
Total long-term liabilities
230,809
156,776
Commitments and contingencies (Note 8)
Shareholders' equity
Common stock, voting, no par value; 50,000 shares authorized; 21,878 and 21,658 shares outstanding
128,951
126,447
Preferred stock, no par value, 10,000 shares authorized; no shares outstanding
- -
Accumulated other comprehensive income
126
Retained earnings
60,572
46,168
Total shareholders' equity
189,649
172,741
Total liabilities and shareholders' equity
See accompanying notes to condensed consolidated financial statements.
SPARTAN STORES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF EARNINGS(In thousands, except per share data)(Unaudited)
12 Weeks Ended
24 Weeks Ended
September 9,2006
Net sales
627,060
552,574
1,177,173
1,073,540
Cost of sales
497,888
441,898
941,682
860,935
Gross margin
129,172
110,676
235,491
212,605
Operating expenses
Selling, general and administrative expenses
109,089
92,736
202,457
183,401
Provision for asset impairments and exit costs
-
4,464
Total operating expenses
187,865
Operating earnings
20,083
17,940
33,034
24,740
Other income and expenses
Interest expense
2,913
4,995
5,728
(100
)
238
(178
206
Total other income and expenses
2,394
3,151
4,817
5,934
Earnings before income taxes and discontinued operations
17,689
14,789
28,217
18,806
Income taxes:
Net impact of enactment of Michigan Business Tax (Note 11)
2,748
Federal, net of Michigan Business Tax impact
6,190
5,175
9,875
6,583
Total income taxes
8,938
12,623
Earnings from continuing operations
8,751
9,614
15,594
12,223
Earnings (loss) from discontinued operations, netof taxes
351
(280
24
(200
Net earnings
9,102
9,334
15,618
12,023
Basic earnings per share:
0.41
0.46
0.74
0.59
Earnings (loss) from discontinued operations
0.02
(0.01
0.00
0.43
0.45
0.58
Diluted earnings per share:
0.40
0.72
0.42
0.44
0.57
Weighted average shares outstanding:
Basic
21,260
20,796
21,221
20,756
Diluted
21,695
21,191
21,673
21,148
SPARTAN STORES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY(In thousands)(Unaudited)
SharesOutstanding
CommonStock
AccumulatedOtherComprehensiveIncome
RetainedEarnings
Total
Balance - April 1, 2007
21,658
Adjustment to initially apply FIN 48
967
Comprehensive earnings:
Dividends - $.10 per share
(2,181
Stock-based employee compensation
1,312
Issuances of common stock and related
tax benefits on stock option exercises
91
1,251
Issuances of restricted stock and
related income tax benefits
172
1,018
Cancellations of restricted stock
(43
(1,077
Balance - September 15, 2007
21,878
SPARTAN STORES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)(Unaudited)
Cash flows from operating activities
(Earnings) loss from discontinued operations
(24
200
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization
10,920
10,211
Postretirement benefits expense
1,171
1,131
Deferred taxes on income related to enactment of the Michigan Business Tax (Note 11)
9,765
6,216
Stock-based compensation expense
1,310
908
Other
292
Change in operating assets and liabilities:
Accounts receivable
(12,879
(2,756
Inventories
(26,829
(19,500
Prepaid expenses and other assets
(4,065
(141
20,119
17,634
(6,365
(3,202
Postretirement benefits payments
(1,219
(1,162
Other accrued expenses and other liabilities
(3,523
(2,424
Net cash provided by operating activities
6,747
23,894
Cash flows from investing activities
Purchases of property and equipment
(16,004
(12,061
Acquisitions, net of cash acquired
(46,777
(47,922
28
135
Net cash used in investing activities
(62,753
(59,848
Cash flows from financing activities
Net (payments on) proceeds from revolving credit facility
(46,512
38,555
Proceeds from long-term borrowings
110,000
Repayment of long-term borrowings
(1,335
(1,040
Financing fees paid
(3,496
Proceeds from sale of common stock
575
1,464
Dividends paid
(1,065
Net cash provided by financing activities
57,051
37,914
Cash flows from discontinued operations
Net cash used in operating activities
(3,641
(1,069
Net cash provided by investing activities
2,841
1,675
Net cash used in financing activities
Net cash (used in) provided by discontinued operations
(800
606
Net increase in cash and cash equivalents
245
2,566
Cash and cash equivalents at beginning of period
7,655
Cash and cash equivalents at end of period
10,221
SPARTAN STORES, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
Note 1Basis of Presentation and Significant Accounting Policies
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Spartan Stores, Inc. and its subsidiaries ("Spartan Stores"). All significant intercompany accounts and transactions have been eliminated.
In the opinion of management, the accompanying condensed consolidated financial statements, taken as a whole, contain all adjustments, which are of a normal recurring nature, necessary to present fairly the financial position of Spartan Stores as of September 15, 2007 and the results of its operations and cash flows for the interim periods presented. Interim results are not necessarily indicative of results for a full year.
Note 2New Accounting Standards
In June 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes", and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Further, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are to be applied prospectively. FIN 48 became effective at the beginning of Spartan Stores' fiscal year 2008, and the effect of adoption of FIN 48 increased retained earnings by approximately $1.0 million as of the beginning of fiscal year 2008. The adoption of FIN 48 and its effects are more fully described in Note 11.
In June 2006, the FASB ratified the consensus reached on Emerging Issues Task Force (EITF) Issue No. 06-03, "How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross Versus Net Presentation)" (EITF 06-03). The EITF reached a consensus that the presentation of taxes on either a gross or net basis is an accounting policy decision that requires disclosure. EITF 06-03 was effective at the beginning of Spartan Stores' fiscal 2008 first quarter. An entity is not required to reevaluate its existing policies related to taxes assessed by a governmental authority as a result of this consensus. Amounts collected from members, which under common trade practices are referred to as sales taxes, are and have been recorded on a net basis. Spartan Stores has no intention of modifying this accounting policy; therefore, the adoption of EITF 06-03 did not have any effect on Spartan Stores' financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements, but applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 will become effective for Spartan Stores at the beginning of fiscal year 2009. The provisions of the Statement are to be applied prospectively, except for limited retrospective application permitted for certain items. Spartan Stores is currently evaluating the impact, if any, that SFAS No. 157 will have on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements Nos. 87, 88, 106 and 132(R)" (SFAS No. 158). SFAS No. 158 required Spartan Stores to recognize the funded status of defined benefit postretirement plans as an asset or liability in the consolidated balance sheet and to recognize changes in funded status through comprehensive income as of March 31, 2007. SFAS No. 158 also requires that employers measure plan assets and obligations as of the date of their year-end financial statements beginning with Spartan Stores' fiscal year ending March 28, 2009. Spartan Stores is currently evaluating the impact of changing the measurement date on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB No. 115" (SFAS No. 159). Under SFAS 159, entities may irrevocably elect to measure many financial instruments and certain other items at fair value on an instrument-by-instrument basis, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 will become effective for Spartan Stores at the beginning of fiscal year 2009. Spartan Stores is currently evaluating the impact, if any, that SFAS No. 159 will have on the consolidated financial statements.
Note 3Acquisition of Assets
On June 15, 2007, Spartan Stores acquired certain assets and assumed certain liabilities related to 20 retail grocery stores, two fuel centers and three convenience stores from G&R Felpausch Company and affiliated companies ("Felpausch"), a privately-held retail grocery operator and customer of its Distribution segment. The Felpausch supermarkets include the operations of nine in-store pharmacies. The cash purchase price paid to Felpausch was $38.0 million plus $12.7 million for inventories. Spartan Stores acquired the store locations and operations of Felpausch in an effort to increase its leading market share position in West Michigan and expand its market presence in central Michigan. The purchased assets included leasehold improvements, fixtures, tangible personal property, equipment, intangible property and inventories. Spartan Stores assumed Felpausch's lease obligations for the 20 stores, two fuel centers and three convenience stores.
The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The preliminary purchase price allocations are estimates as of September 15, 2007 based on a combination of third-party valuations and internal analyses and may be further adjusted during the allocation period, as defined by SFAS No. 141. The primary areas of the purchase price allocation that are not yet finalized relate to the valuation of property and equipment, other intangible assets, capital lease obligations and residual goodwill. We expect the purchase price allocation to be finalized by the end of fiscal 2008.
(In thousands)
June 15,2007
13,271
31,653
Favorable leases
2,503
Customer lists
2,953
Other intangible assets
723
11,150
Total assets acquired
62,253
1,638
Capital lease obligations, less current portion
4,285
Exit cost reserves, less current portion
3,796
1,827
Total liabilities assumed
11,546
Net assets acquired
50,707
Goodwill of $21.4 million and $10.3 million was assigned to the Retail and Distribution segments, respectively, based upon the expected benefits to be derived from the business combination. Additionally, $1.7 million in costs directly related to the acquisition have been included in goodwill, of which $1.2 million and $0.5 million were assigned to the Retail and Distribution segments, respectively. Goodwill of $33.4 million is expected to be deductible for tax purposes.
Amortizable intangible assets acquired consisted of favorable leases and customer lists and amounted to $2.5 million and $3.0 million, respectively. The weighted average amortization period is 11.7 years for favorable leases and seven years for customer lists. Other intangible assets acquired include $0.7 million of licenses for the sale of alcoholic beverages. The licenses have an indefinite life and therefore are not amortized.
Note 4Goodwill and Other Intangible Assets
Changes in the carrying amount of goodwill were as follows:
Retail
Distribution
Balance at April 1, 2007
89,181
53,707
Felpausch stores acquisition
22,581
10,860
33,441
Balance at September 15, 2007
111,762
64,567
The following table reflects the components of amortized intangible assets, included in "Other, net" on the Consolidated Balance Sheets:
September 15, 2007
March 31, 2007
GrossCarryingAmount
AccumulatedAmortization
Non-compete agreements
2,551
1,528
3,234
2,096
6,488
1,924
4,025
1,655
6,439
545
3,293
239
Franchise fees and other
1,201
397
347
16,679
4,394
11,753
4,337
The weighted average amortization period for amortizable intangible assets is as follows:
10.3 years
11.4 years
7.2 years
11.0 years
9.2 years
Amortization expense for intangible assets was $0.3 million and $0.2 million for the 12 weeks ended September 15, 2007 and September 9, 2006, respectively. Amortization expense was $0.7 million and $0.4 million for the year-to-date periods ended September 15, 2007 and September 9, 2006, respectively. Estimated amortization expense for each of the five succeeding fiscal years is as follows:
Fiscal Year
AmortizationExpense
2008
1,749
2009
1,761
2010
1,635
2011
1,596
2012
Note 5Discontinued Operations
During the second quarter of fiscal year 2008, Spartan Stores decided to close five The Pharm stores and one Felpausch Xpressmart. The decision to close the stores was based on a comprehensive evaluation of the stores' performance trends, long-term growth prospects, on-going capital requirements and lease expiration dates. As Spartan Stores will have no continuing interest in the operations of these stores, they have been classified as discontinued operations for all years presented. Prescription lists and pharmacy inventories of five of the stores were sold during the second quarter of fiscal 2008 for $3.9 million and of the other store in the third quarter of fiscal 2008 for $0.8 million. Asset impairment charges of $0.9 million were recognized in the second quarter of fiscal 2008. The stores were closed early in the third quarter of fiscal 2008. The net impact of the closing of the stores and sale of certain assets was a $0.8 million pre-tax net gain in the second quarter.
Results of the discontinued operations are excluded from the accompanying notes to the consolidated financial statements for all periods presented, unless otherwise noted.
The following table details the results of discontinued operations reported on the Consolidated Statements of Earnings:
Loss from discontinued operations (net of taxes of ($669) and ($151))
(1,242
Gain on disposal of discontinued operations (net of taxes of $857)
1,593
Total earnings (loss) from discontinued operations
Loss from discontinued operations (net of taxes of ($845) and ($107))
(1,569
Sales for the quarters and year-to-date periods ended September 15, 2007 and September 9, 2006 and significant assets and liabilities of discontinued operations at the end of those periods are included below:
6,763
6,810
13,321
13,860
Basic and diluted earnings (loss) per share
Current assets *
4,570
6,146
Property, net
4,117
4,544
Other long-term assets
45
4,554
6,491
1,745
2,637
* Includes property and equipment held for sale
Note 6Asset Impairments and Exit Costs
The following table provides the activity of exit costs for our Retail segment for the 24 weeks ended September 15, 2007. Exit costs recorded in the Consolidated Balance Sheets are included in "Current portion of exit costs" in Current liabilities and "Exit costs" in Long-term liabilities based on when the obligations are expected to be paid.
Lease andAncillary Costs
32,703
Exit costs related to Felpausch acquisition
4,235
Payments, net of interest accretion
(2,622
34,316
Exit costs of $4.2 million were recorded in the purchase price allocation for the Felpausch acquisition (Note 3) for acquired stores that management plans to or has closed. The exit costs include the present value of future minimum lease payments, calculated using a risk-free interest rate, and related ancillary costs from the date of closure to the end of the remaining lease term.
Note 7Long-Term Debt
On May 30, 2007, Spartan Stores issued $110 million in aggregate principal amount of unsecured 3.375% convertible senior notes due May 15, 2027. The notes are general unsecured obligations and rank equally in right of payment with all of our other existing and future unsecured and unsubordinated obligations. They are effectively subordinated to our existing and any future secured indebtedness to the extent of the assets securing such indebtedness. The net proceeds from the sale of the notes after deducting selling discounts of 2.5% and estimated offering expenses of $0.7 million were approximately $106.5 million, and were used to pay down amounts owed under our senior secured revolving credit facility and partially fund the Felpausch stores acquisition.
Interest at an annual rate of 3.375% is payable semi-annually beginning November 15, 2007. Contingent interest will be paid to holders of the notes during the period commencing May 20, 2012 and ending on November 14, 2012 and for any six-month period thereafter, if the average contingent interest trading price per $1,000 principal amount of the notes for the five-consecutive-trading-day-period ending on the third trading day immediately preceding the first day of such interest period equals 120% or more of the principal amount of the notes. Contingent interest payable with respect to any six-month period will equal 0.25% per annum of the average contingent interest trading price of $1,000 principal amount of notes during the five-consecutive-trading-day measurement period described above.
Spartan Stores may redeem the notes for cash in whole or in part, at any time or from time to time, on or after May 15, 2014 at 100% of the principal amount of the notes to be redeemed, and prior to that date on or after May 20, 2012 at a price equal to a specified percentage of the principal amount, plus, in each case, any accrued and unpaid interest. Holders may require Spartan Stores to repurchase their notes, in whole or in part, on May 15, 2014, May 15, 2017 and May 15, 2022 for a cash price equal to 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest. In addition, upon certain fundamental change transactions, each holder would have the option, subject to certain conditions, to require Spartan Stores to repurchase for cash, in whole or in part, such holder's notes. For the purposes of the notes, a "fundamental change" would include, among other events set forth in the Indenture governing the notes, the acquisition of 50% or more of our common stock by a person o r group, a consolidation, merger, or sale of all or substantially all of our assets, certain changes in our board of directors, or a termination of trading of our common stock.
The notes will be convertible at the option of the holder only under certain circumstances summarized as follows:
1.
If the closing sale price per share of Spartan Stores common stock is greater than 130% of the applicable conversion price for a specified period of time,
2.
If the trading price of the notes was less than 98% of the product of the closing sale price per share of Spartan Stores common stock and the conversion rate in effect for the notes for a specified period of time,
3.
If the notes are called for redemption,
4.
At any time on or after February 15, 2027 until the close of business on the business day immediately preceding the maturity date,
5.
Upon the occurrence of specified corporate transactions.
Upon conversion by the holder, the notes convert at an initial conversion rate of 28.0310 shares of Spartan Stores common stock per $1,000 principal amount of notes (equal to an initial conversion price of approximately $35.67 per share), subject to adjustments upon certain events, under the following circumstances: 1) during specified periods if the price of Spartan Stores stock reaches specified thresholds; 2) if the trading price of the notes is below a specified threshold; 3) at any time on or after February 15, 2027; 4) upon the occurrence of certain corporate transactions; or 5) in the case of notes called for redemption, at any time prior to the close of business on the business day prior to the redemption date. Upon a surrender of notes for conversion, Spartan Stores will deliver cash equal to the lesser of the aggregate principal amount of notes to be converted and our total conversion obligation, and shares of Spartan Stores common stock in respect of the remainder, if any, of our conversion obl igation - unless we have elected to satisfy our obligation under such conversion by delivering only shares of our common stock. For the twelve weeks and twenty-four weeks ended September 15, 2007, the notes had no impact on diluted earnings per share because the average stock price during the period was below $35.67 per share, and the notes, if converted, would require only cash at settlement.
In connection with the closing of the sale of the notes, Spartan Stores entered into a registration rights agreement with the initial purchasers of the notes, pursuant to which Spartan Stores filed with the Securities and Exchange Commission (SEC) a shelf registration statement covering resale by security holders of the notes and the shares of Spartan Stores common stock issuable upon conversion of the notes. The registration statement was declared effective by the SEC on September 27, 2007.
On August 17, 2007, Spartan Stores entered into an agreement to increase the maximum credit available under its existing senior secured credit facility from $225.0 million to $255.0 million.
Spartan Stores' long-term debt consists of the following:
Senior secured revolving credit facility, due December 2012
30,313
78,182
Convertible subordinated notes, 3.375% due May 2027
Capital lease obligations (Note 9)
31,873
26,354
Other, 5.00% - 9.25% due fiscal 2009 - 2021
8,968
4,299
181,154
108,835
Less current portion
Total long-term debt
At September 15, 2007, long-term debt was due as follows:
4,859
7,522
2,612
2,728
2,898
Thereafter
160,535
The estimated fair value of our long-term debt, including current maturities, was lower than book value by approximately $26.9 million and $12.8 million at September 15, 2007 based upon a twenty-year maturity and seven-year prepayment provision of the convertible subordinated notes, respectively. The estimated fair value was based on market quotes for similar instruments.
Note 8Commitments and Contingencies
Various lawsuits and claims, arising in the ordinary course of business, are pending or have been asserted against Spartan Stores. While the ultimate effect of such actions cannot be predicted with certainty, management believes that their outcome will not result in a material adverse effect on the consolidated financial position, operating results or liquidity of Spartan Stores.
Note 9Leases
In conjunction with the Felpausch acquisition (see Note 3), Spartan Stores assumed the leases of the 20 retail stores, two fuel centers and two convenience stores that it continues to operate. Total future lease commitments of Spartan Stores under capital and operating leases in effect at September 15, 2007 are as follows:
Capital
Operating
Used inOperations
Subleasedto Others
2,642
207
2,849
13,976
476
14,452
5,007
26,359
1,094
27,453
5,002
23,599
1,004
24,603
4,878
20,597
837
21,434
4,795
15,370
754
16,124
27,724
45,912
47,224
50,048
50,255
145,813
5,477
151,290
Interest
(18,362
(20
(18,382
Present value of minimum lease obligations
31,686
187
Current portion
2,303
2,490
Long-term obligations at September 15, 2007
29,383
Assets held under capital leases consisted of the following:
Buildings and improvements
25,241
20,299
Equipment
2,553
889
27,794
21,188
Less accumulated depreciation
6,250
4,098
Net property
21,544
17,090
Note 10Associate Retirement Plans
The following table provides the components of net periodic pension and postretirement benefit costs for the second quarter and year-to-date periods ended September 15, 2007 and September 9, 2006:
Pension Benefits
SERP Benefits
Postretirement Benefits
Sept. 15,2007
Sept. 9,2006
Service cost
883
771
13
11
53
56
Interest cost
683
610
9
100
102
Expected return on plan assets
(933
(802
Amortization of prior service cost
(173
(16
Recognized actuarial net loss
73
78
7
10
17
Net periodic benefit cost
533
484
29
27
147
159
1,766
1,542
26
22
106
112
1,366
1,219
18
205
(1,866
(1,604
Net amortization and deferral
(346
(32
146
156
14
20
33
1,066
58
294
318
Spartan Stores expects to contribute $2.5 million to its defined benefit plans in fiscal 2008 to meet the minimum funding requirements. Contributions of $3.7 million were made in the fiscal year ended March 31, 2007. As of September 15, 2007 and September 9, 2006, $1.4 million and $1.2 million, respectively, had been contributed.
Note 11Taxes on Income
During the second quarter, the Michigan legislature enacted a new business income tax effective January 1, 2008. The new income tax will replace the current Michigan Single Business Tax that is in effect through December 31, 2007 and is currently included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings. The new income tax law was subsequently revised on September 30, 2007, two weeks after the end of Spartan Stores' second quarter, to correct a deficiency in the tax code that would have significantly penalized Michigan-based companies. Because the legislative revision was not enacted until Spartan Stores' fiscal 2008 third quarter, generally accepted accounting principles required recognition of the negative impact of the originally enacted law in Spartan Stores' second quarter results, and a credit of this same charge in the third quarter of fiscal 2008 when the revision was enacted. As a result, Spartan Stores recorded a one-time, non-cash charge of $2.7 million in Income taxes in the second quarter and a corresponding change in deferred taxes on income. This charge has already been credited in the third quarter as a reduction to Income taxes of $2.7 million. As a result of this charge in the second quarter, the effective income tax rate was 51% and 45% for the second quarter and year-to-date period, respectively, versus the Federal statutory income tax rate of 35%.
Spartan Stores adopted the provisions of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48) on April 1, 2007, the first day of fiscal year 2008. Spartan Stores recorded the cumulative effect of adopting FIN 48 by increasing shareholders' equity by $1.0 million. As of April 1, 2007, unrecognized tax benefits
were not material. Spartan Stores recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. Accrued interest and penalties is not material.
Spartan Stores files income tax returns with federal, state and local tax authorities within the United States. With few exceptions, we are no longer subject to U.S. federal or state examinations by tax authorities for fiscal years before 2004, and are no longer subject to local examination by tax authorities for fiscal years before 2003. In February 2005, the Internal Revenue Service (IRS) completed its examination of Spartan Stores' federal income tax returns for fiscal years 2001 through 2003. In October 2007, the IRS will begin its examination of the fiscal 2006 tax return.
As of September 15, 2007, there have been no material changes to the amount of unrecognized tax benefits. Spartan Stores does not anticipate that total unrecognized tax benefits will significantly change prior to September 13, 2008.
Note 12Stock-Based Compensation
Spartan Stores has two shareholder-approved stock incentive plans that provide for the granting of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, and other stock-based awards to directors, officers and other key associates.
Spartan Stores accounts for stock-based compensation awards in accordance with the provisions of SFAS No. 123(R), "Share-Based Payment", which requires that share-based payment transactions be accounted for using a fair value method and the related compensation cost recognized in the consolidated financial statements over the period that an employee is required to provide services in exchange for the award. Spartan Stores recognized stock-based compensation expense (net of tax) of $0.5 million ($0.02 per diluted share) and $0.3 million ($0.01 per diluted share) in the second quarter of fiscal 2008 and 2007, respectively, as a component of Selling, general and administrative expenses in the Consolidated Statements of Earnings. Stock-based compensation expense (net of tax) was $0.9 million ($0.04 per diluted share) and $0.6 million ($0.03 per diluted share) for the year-to-date period ended September 15, 2007 and September 9, 2006, respectively.
The following table summarizes activity in the share-based compensation plans for the year-to-date period ended September 15, 2007:
SharesUnderOptions
WeightedAverageExercise Price
RestrictedStockAwards
WeightedAverageGrant-DateFair Value
Outstanding at April 1, 2007
609,397
9.44
546,704
10.86
Granted
94,135
28.18
163,939
28.19
Exercised/Vested
(91,395
6.29
(129,248
9.83
Cancelled/Forfeited
(1,658
6.73
(3,836
14.91
Outstanding at September 15, 2007
610,479
12.81
577,559
15.99
Vested and expected to vest in the future at September 15, 2007
584,292
12.50
Exercisableat September 15, 2007
313,632
8.60
The weighted average grant-date fair value of stock options granted during the second quarter ended September 15, 2007 was $9.51. The weighted average grant-date fair value of stock options granted during the year-to-date period ended September 15, 2007 and September 9, 2006 was $10.99 and $4.73, respectively. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The following weighted average assumptions were used to estimate the fair value of stock options at the date of grant using the Black-Scholes option-pricing model:
Sept. 15, 2007
Sept. 9, 2006
Dividend yield
0.70%-0.79%
1.46%
Expected volatility
32.84%-32.92%
30.43%
Risk-free interest rate
4.43%-4.76%
5.05%
Expected life of option
6.25 years
As of September 15, 2007, total unrecognized compensation cost related to nonvested share-based awards granted under our stock incentive plans was $1.6 million for stock options and $8.5 million for restricted stock. The remaining compensation costs not yet recognized are expected to be recognized over a weighted average period of 2.5 years for stock options and 3.9 years for restricted stock.
Note 13Supplemental Cash Flow Information
Non-cash financing activities include the issuance of restricted stock to employees and directors of $4.6 million and $3.5 million for the year-to-date periods ended September 15, 2007 and September 9, 2006, respectively.
Note 14Operating Segment Information
The following tables set forth information about Spartan Stores by operating segment:
12 Weeks Ended September 15, 2007
293,820
333,240
1,717
3,892
5,609
8,142
11,941
Capital expenditures
1,874
5,990
7,864
12 Weeks Ended September 9, 2006
281,469
271,105
1,838
3,048
4,886
7,768
10,172
1,243
4,008
5,251
24 Weeks Ended September 15, 2007
576,235
600,938
3,466
7,270
10,736
13,862
19,172
3,756
12,248
16,004
24 Weeks Ended September 9, 2006
557,324
516,216
3,854
6,078
9,932
13,369
11,371
2,879
9,182
12,061
237,150
193,475
352,040
283,334
Discontinued operations
8,732
10,690
ITEM 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview
Spartan Stores is a leading regional grocery distributor and grocery retailer, operating principally in Michigan, Ohio and Indiana.
We currently operate two reportable business segments: Distribution and Retail. Our Distribution segment provides a full line of grocery, general merchandise, health and beauty care, frozen and perishable items to nearly 400 independently owned grocery stores and our 102 corporate owned stores. Our Retail segment operates 88 retail supermarkets in Michigan under the banners Family Fare Supermarkets, Glen's Markets, D&W Fresh Markets and Felpausch Food Centers, 14 deep-discount food and drug stores in Ohio and Michigan under the banner The Pharm, 15 fuel centers and convenience stores under the banners Family Fare Quick Stop, Glen's Quick Stop, D&W Fresh Markets Quick Stop and Felpausch Quick Stop which are typically located adjacent to one of our supermarkets.
Our sales and operating performance vary with seasonality. Our first and fourth quarters are typically our lowest sales quarters and therefore operating results are generally lower during these two quarters. Additionally, these two quarters can be affected by the timing of the Easter holiday, which results in a strong sales week. All quarters are 12 weeks, except for our third quarter, which is 16 weeks and includes the Thanksgiving and Christmas holidays. Many northern Michigan stores are dependent on tourism, and therefore, are most affected by seasons and weather patterns, including, but not limited to, the amount and timing of snowfall during the winter months and the range of temperature during the summer months.
On April 24, 2007, we reached an agreement to significantly expand our distribution supply relationship with Martin's Super Markets, an independent supermarket retailer with locations in southwest Michigan and north central Indiana. Our existing supply relationship expanded to include dry groceries, dairy and frozen products and our portfolio of corporate private label brands in addition to the existing health and beauty care products, general merchandise and pharmacy products. The expanded relationship includes all 20 locations of Martin's Super Markets. We expect annual distribution sales to increase by approximately $100 million after we have fully transitioned the customer, which occurred during September 2007. This new relationship, our first major move to distribute to independent retailers outside the state of Michigan, significantly increases our distribution presence in Indiana and demonstrates a successful beginning to fulfill our stated business strategy of gr owing our distribution customer base to contiguous midwestern states.
On June 15, 2007, we acquired certain assets and assumed certain liabilities related to 20 retail grocery stores, two fuel centers and three convenience stores from G&R Felpausch Company and affiliated companies ("Felpausch"), a privately-held retail grocery operator serving south and central Michigan. The retail stores include the operations of nine in-store pharmacies. The transaction represents another step in the component of our business strategy focused on growing our business through opportunistic acquisitions of other grocery operators that are adjacent to or in markets where we operate today. The Felpausch stores serve many communities where we previously had no retail presence. They also provide a geographic fit with our current retail store footprint, while providing expansion into central Michigan.
The Felpausch transaction is expected to increase annual retail segment sales by approximately $200 million, but annual consolidated sales are expected to increase by approximately $100 million as Felpausch is an existing distribution customer. The Company expects to realize many operational synergies from the transaction, however, the gains are initially expected to be more than offset by transition expenditures of approximately $5.0 million to $6.0 million. These transitional expenses are for marketing and promotional activities associated with merchandising, product and branding initiatives, as well as initial employee training and other costs associated with integrating the acquired operations and are expected to be primarily incurred over the first 15 to 21 months of operation.
Results of Operations
The following table sets forth items from our Consolidated Statements of Earnings as a percentage of net sales and the year-to-year percentage change in dollar amounts:
Percentage of Net Sales
Percentage Change
12 WeeksEnded
24 WeeksEnded
100.0
13.5
9.7
20.6
20.0
19.8
16.7
10.8
Selling, general and administrative
17.4
16.8
17.2
17.1
17.6
10.4
0.0
0.4
(100.0
3.2
2.8
2.3
11.9
33.5
0.5
0.6
(24.0
(18.8
2.7
2.4
1.7
19.6
50.0
Net impact of enactment of Michigan Business Tax
0.2
*
1.0
0.9
1.4
1.1
72.7
91.8
Earnings from continuing - operations
1.8
1.3
(9.0
27.6
Earnings (loss) from discontinued operations, net of taxes
0.1
(0.1
(0.0
1.5
(2.5
29.9
* Percentage change is not meaningful
Net Sales - Net sales for the quarter ended September 15, 2007 ("second quarter") increased $74.5 million, or 13.5 percent, from $552.6 million in the quarter ended September 9, 2006 ("prior year second quarter") to $627.1 million. Net sales for the year-to-date period ended September 15, 2007 ("current year-to-date") increased $103.6 million, or 9.7 percent, from $1,073.5 million in the prior year-to-date period ended September 9, 2006 ("prior year-to-date") to $1,177.2 million.
Net sales for the second quarter in our Distribution segment increased $12.4 million, or 4.4 percent, from $281.5 million in the prior year second quarter to $293.8 million. Net sales for the current year-to-date period increased $18.9 million, or 3.4 percent, from $557.3 million in the prior year-to-date period to $576.2 million. The second quarter increase was due to the addition of new distribution customers of $35.0 million and an increase in sales to existing customers of $4.0 million primarily as a result of a retail competitor exiting the eastern Michigan market. These increases were partially offset by the elimination of sales to Felpausch stores of $23.2 million (due to the acquisition), and lost sales of $3.4 million as a result of ending relationships with two unprofitable customers in the prior year's second quarter. The increase for the current year-to-date period was due to the addition of new distribution customers of $52.8 million, partially offset by the elimination of sales to Felpausch stores of $26.2 million and lost sales of $7.7 million as a result of the terminated relationships. In April of 2007, we reached an agreement to significantly expand our supply relationship with Martin's Super Markets. As a result, we expect annual distribution sales to increase by approximately $100 million after we have fully transitioned the customer, which occurred during September 2007. As a result of the acquisition of Felpausch, we expect annual Distribution sales to decline approximately $100 million due to the elimination of intercompany sales.
Net sales for the second quarter in our Retail segment increased $62.1 million, or 22.9 percent, from $271.1 million in the prior year second quarter to $333.2 million. Net sales for the year-to-date period increased $84.7 million, or 16.4 percent, from $516.2 million in the prior year-to-date period to $600.9 million. The increases were primarily due to increases in supermarket comparable sales growth of $3.7 million and $12.9 million for the second quarter and current year-to-date period, respectively, and fuel center sales of $7.8 million and $15.4 million for the second quarter and current year-to-date period, respectively, incremental sales from the recently acquired Felpausch retail stores of $46.9 million and $52.2 million for the second quarter and current year-to-date period, respectively, and the PrairieStone pharmacies of $4.8 million and $9.7 million for the second quarter and current year-to-date period, respectively, partially offset by lost sales relating to the previously disclosed closing of two retail stores near the end of the prior year first quarter of $3.1 million for the current year-to-date period.
Total Retail comparable store sales increased 5.1 percent during the second quarter due to our continued capital investments, including store remodels, the opening of additional fuel centers and the PrairieStone Pharmacy acquisition. Fuel center sales contributed a positive 2.3 percentage points toward the total comparable store sales increase. Total Retail comparable store sales increased 5.9 percent in the current year-to-date period, while fuel center sales contributed a positive 2.6 percent to the total. We define a retail store as comparable when it is in operation for 14 accounting periods (a period equals four weeks), and we include remodeled, expanded and relocated stores in comparable stores.
Cost of Sales and Gross Margin - Gross margin represents net sales less cost of sales, which include purchase costs and promotional allowances. Vendor allowances that relate to our buying and merchandising activities consist primarily of promotional allowances, which are generally allowances on purchased quantities and, to a lesser extent, slotting allowances, which are billed to vendors for our merchandising costs, such as setting up warehouse infrastructure. Vendor allowances associated with product cost are recognized as a reduction in cost of sales when the product is sold. Lump sum payments received for multi-year contracts are amortized over the life of the contracts based on contractual terms.
Gross margin for the second quarter increased $18.5 million, or 16.7 percent, from $110.7 million in the prior year second quarter to $129.2 million. As a percent of net sales, gross margin for the second quarter increased to 20.6 percent from 20.0 percent. Gross margin for the year-to-date period increased $22.9 million, or 10.8 percent, from $212.6 million in the prior year-to-date period to $235.5 million. As a percent of net sales, gross margin for the year-to-date period increased to 20.0 percent from 19.8 percent. On a year-to-date basis, the gross margin rate improvement was primarily due to a larger concentration of higher margin retail sales as a percentage of consolidated sales.
Selling, General and Administrative Expenses - Selling, general and administrative ("SG&A") expenses consist primarily of salaries and wages, employee benefits, warehousing costs, store occupancy costs, utilities, equipment rental, depreciation and other administrative costs.
SG&A expenses for the second quarter increased $16.4 million, or 17.6 percent, from $92.7 million in the prior year second quarter to $109.1 million. As a percent of net sales, SG&A expenses were 17.4 percent for the current quarter compared to 16.8 percent in the prior year second quarter. SG&A expenses for the year-to-date period increased $19.1 million, or 10.4 percent, from $183.4 million in the prior year-to-date period to $202.5 million. As a percent of net sales, SG&A expenses were 17.2 percent for the current year-to-date period compared to 17.1 percent in the prior year-to-date period.
•
Incremental operating costs associated with the acquired retail stores of $11.6 million, including approximately $0.3 million of training and other start-up related costs
Increased store labor of $1.2 million primarily due to increases in volume
Increases in other compensation and benefits of $2.3 million due to increased sales volume and a $1.3 million insurance reserve adjustment in the prior year quarter due to positive loss trends in health care and workers' compensation
The cost of operating additional fuel centers of $0.6 million
The net increase in year-to-date SG&A expenses was primarily due to the following:
Incremental operating costs associated with the acquired retail stores of $13.3 million, including approximately $0.8 million of training and other start-up related costs
Increased store labor of $2.2 million primarily due to increases in volume
Increases in other compensation and benefits of $3.2 million due to increased sales volume and a $1.3 million insurance reserve adjustment in the prior year quarter due to positive loss trends in health care and workers' compensation
The cost of operating additional fuel centers of $1.0 million
Reduced operating costs due to the closure of two supermarkets near the end of the prior year first quarter of $1.1 million
Provision for Asset Impairments and Exit Costs - In the prior year first quarter, the Retail segment recognized charges of $4.5 million for asset impairment and lease and related ancillary costs related to the closure of two Family Fare Supermarkets stores and moving the central bakery operation into individual retail stores. The store base rationalization and associated charge was incurred due to the proximity of acquired stores to our existing store base. This limited reduction of our store network was based on an evaluation of stores that were best positioned to provide customers with the highest quality overall shopping experience. The central bakery decision was based on the desire to move the production of bakery products closer to the consumer, and the economics of the central bakery operation.
Interest Expense - Interest expense for the second quarter decreased $0.4 million, or 14.4 percent, from $2.9 million in the prior year second quarter to $2.5 million. Interest expense for the year-to-date period decreased $0.7 million, or 12.8 percent, from $5.7 million in the prior year-to-date period to $5.0 million. The decrease in interest expense is primarily due to the amendment of our existing revolving credit facility and the issuance of the convertible senior notes, the proceeds of which were used to pay down amounts owed under our revolving credit facility which has a higher interest rate. See the Liquidity section for additional information on the issuance of convertible senior notes.
Income Taxes - During the second quarter, the Michigan legislature enacted a new business income tax effective January 1, 2008. The new income tax will replace the current Michigan Single Business Tax that is in effect through December 31, 2007 and is currently included in Selling, general and administrative expenses in the accompanying consolidated statements of earnings. The new income tax law was subsequently revised on September 30, 2007, two weeks after the end of our second quarter, to correct a deficiency in the tax code that would have significantly penalized Michigan-based companies. Because the legislative revision was not enacted until our fiscal 2008 third quarter, generally accepted accounting principles required recognition of the negative impact of the originally enacted law in our second quarter results, and a credit of this same charge in the third quarter of fiscal 2008 when the revision was enacted. As a result, we recorded a one-time, no n-cash charge of $2.7 million in Income taxes in the second quarter and a corresponding change in deferred taxes on income. This charge has already been credited in the third quarter as a reduction to Income taxes of $2.7 million. As a result of this charge in the second quarter, the effective income tax rate was 51% and 45% for the second quarter and year-to-date period, respectively, versus the Federal statutory income tax rate of 35%.
Discontinued Operations
Our former convenience distribution operations, insurance operations and certain of our retail, grocery distribution and real estate operations have been recorded as discontinued operations. Results of the discontinued operations are excluded from the accompanying notes to the condensed consolidated financial statements for all periods presented, unless otherwise noted.
During the second quarter of fiscal year 2008, we decided to close five The Pharm stores and one Felpausch Xpressmart. The decision to close the stores was based on a comprehensive evaluation of the stores' performance trends, long-term growth prospects, on-going capital requirements and lease expiration dates.
Prescription lists and pharmacy inventories of five of the stores were sold during the second quarter of fiscal 2008 for $3.9 million and of the other store in the third quarter of fiscal 2008 for $0.8 million. The gain on disposal was $1.6 million, net of tax, in the second quarter. Asset impairment charges of $0.9 million, pre-tax, were recognized in the second quarter of fiscal 2008. The stores were closed early in the third quarter of fiscal 2008. The net impact of the closing of the stores and sale of certain assets was a $0.8 million pre-tax net gain in the second quarter.
Liquidity and Capital Resources
The following table summarizes our consolidated statements of cash flows for the year-to-date and prior year-to-date periods:
Net cash provided by operating activities decreased from the prior year-to-date period primarily due to changes in working capital requirements related to sales growth and delayed payment terms for customers opening stores previously closed by a competitor.
Our Federal income tax net operating loss carryforward was fully utilized during the second quarter.
Net cash used in investing activities increased during the current fiscal year primarily due to increased capital expenditure activity. We used cash of $46.4 million for the acquisition of Felpausch stores in the current year and we used cash of $47.9 million in the prior year for the acquisition of D&W Food Centers stores. Capital expenditures, which do not include the acquisitions, increased $3.9 million to $16.0 million, of which our Retail and Distribution segments utilized 76.5% and 23.5%, respectively. Expenditures were used for store replacements, remodels and refurbishments, new fuel centers and new equipment and software. Under the terms of our senior secured revolving credit facility, should our available borrowings fall below certain levels, our capital expenditures would be restricted each fiscal year. We expect capital expenditures to range from $40.0 million to $45.0 million for fiscal 2008, which would be allowed even if the restriction applied.
Net cash provided by financing activities includes cash paid and received related to our long-term borrowings, dividends paid and proceeds from the issuance of common stock. Proceeds of $110 million from the issuance of convertible senior notes were used to reduce borrowings on the senior secured revolving credit facility, to pay related financing fees and to partially fund the Felpausch acquisition. Cash dividends of $2.2 million and $1.1 million were paid in each year-to-date period and cash dividends of $1.1 million were paid in the current year quarter. Although we expect to continue to pay a quarterly cash dividend, adoption of a dividend policy does not commit the board of directors to declare future dividends. Each future dividend will be considered and declared by the board of directors in its discretion. Whether the board of directors continues to declare dividends depends on a number of factors, including our future financial condition and profitability and com pliance with the terms of our credit facilities. Our current maturities of long-term debt and capital lease obligations at September 15, 2007 are $8.6 million. Our ability to borrow additional funds is governed by the terms of our credit facilities.
Net cash (used in) provided by discontinued operations contains the net cash flows of our discontinued operations and consists primarily of the payment of store exit cost reserves, insurance run-off claims and other liabilities and proceeds from the sale of assets. Included in current year cash flows from discontinued operations are proceeds on the disposal of assets of $2.9 million. We expect the cash usage of our discontinued operations will be approximately $3.0 million to $4.0 million in fiscal 2008.
Our principal sources of liquidity are cash flows generated from operations, proceeds from the issuance of convertible senior notes and our senior secured revolving credit facility. Net proceeds from the issuance of the convertible senior notes, after deducting the initial purchasers' discounts of 2.5% and estimated offering expenses of $0.7 million, of $106.5 million were used to pay down the senior secured revolving credit facility. Interest on our convertible senior notes is payable on May 15 and November 15 of each year, beginning on November 15, 2007. The credit facility matures December 2012, and is secured by substantially all of our assets. As of September 15, 2007, our senior secured revolving credit facility had outstanding borrowings of $30.3 million, available borrowings of $173.3 million and maximum availability of $183.3 million, which exceeds the minimum excess availability levels, as defined in the credit agreement. We believe that cash generated from ope rating activities and available borrowings under the credit facility will be sufficient to meet anticipated requirements for working capital, capital expenditures, dividend payments, and debt service obligations for the foreseeable future. However, there can be no assurance that Spartan Stores' business will continue to generate cash flow at or above current levels or that we will maintain our ability to borrow under our credit facility.
Our current ratio increased to 1.29:1.00 at September 15, 2007 from 1.17:1.00 at March 31, 2007 and our investment in working capital was $52.0 million at September 15, 2007 versus $27.2 million at March 31, 2007. Our debt to total capital ratio at September 15, 2007 was .49:1.00 versus .39:1.00 at March 31, 2007. The change in these ratios was primarily due to obligations assumed related to the Felpausch acquisition, sales growth, seasonal inventory build-up and delayed payment terms to customers opening stores previously closed by a competitor.
For information on contractual obligations, see our Annual Report on Form 10-K for the fiscal year ended March 31, 2007. At September 15, 2007, there have been no material changes to our significant contractual obligations outside the ordinary course of business, except for the assumption of lease obligations in the Felpausch acquisition. As of September 15, 2007, our obligations under the leases assumed in the Felpausch acquisition are as follows:
Payment Due by Period
Less than 1year
1-3 years
3-5 years
More than 5years
Operating leases
17,383
3,875
6,118
4,748
Capital leases
4,713
514
852
1,015
2,332
Interest on capital leases
2,043
352
632
478
581
Lease and ancillary costs of closed stores, including imputed interest
4,912
718
1,721
839
1,634
29,051
5,459
9,323
7,080
7,189
Indebtedness and Liabilities of Subsidiaries
On May 30, 2007, the Company sold $110 million aggregate principal amount of 3.375% Convertible Senior Notes due 2027 (the "Notes") in an offering exempt from registration under the Securities Act of 1933. The Notes are general unsecured obligations and rank equally in right of payment with all of the Company's other existing and future obligations that are unsecured and unsubordinated.
Because the Notes are unsecured, they are structurally subordinated to our subsidiaries' existing and future indebtedness and other liabilities and any preferred equity issued by our subsidiaries. We rely in part on distributions and advances from our subsidiaries in order to meet our payment obligations under the notes and our other obligations. The Notes are not guaranteed by our subsidiaries. Many of our subsidiaries serve as guarantors with
respect to our existing credit facility. Creditors of each of our subsidiaries, including trade creditors, and preferred equity holders, generally have priority with respect to the assets and earnings of the subsidiary over the claims of our creditors, including holders of the Notes. The Notes, therefore, are effectively subordinated to the claims of creditors, including trade creditors, judgment creditors and preferred equity holders of our subsidiaries. In addition, our rights and the rights of our creditors, including the holders of the notes, to participate in the assets of a subsidiary during its liquidation or reorganization are effectively subordinated to all existing and future liabilities and preferred equity of that subsidiary. The Notes are effectively subordinated to our existing and future secured indebtedness to the extent of the assets securing such indebtedness and to existing and future indebtedness and other liabilities of our subsidiaries (including subsidiary guarantees of our senior cred it facility).
The following table shows the indebtedness and other liabilities of our subsidiaries as of September 15, 2007:
Spartan Stores Subsidiaries Only(In thousands)
Current Liabilities
110,864
27,459
17,735
173,318
Long-term Liabilities
8,542
12,485
32,222
78,924
Total Subsidiary Liabilities
252,242
Operating Leases
146,434
Total Subsidiary Liabilities and Operating Leases
398,676
Ratio of Earnings to Fixed Charges
Our ratio of earnings to fixed charges was 4.51:1.0 and 3.87:1.0 for the second quarter and prior year second quarter, respectively, and 3.88:1.0 and 2.85:1.0 for the year-to-date and prior year-to-date periods, respectively. For purposes of calculating the ratio of earnings to fixed charges, earnings consist of pretax earnings from continuing operations plus fixed charges (excluding capitalized interest). Fixed charges consist of interest costs, whether expensed or capitalized, the interest component of rental expense and amortization of debt issue costs, whether expensed or capitalized.
Off-Balance Sheet Arrangements
We had letters of credit of $5.3 million outstanding and unused at September 15, 2007. The letters of credit are maintained primarily to support payment or deposit obligations. We pay a commission of approximately 2% on the face amount of the letters of credit.
New Accounting Standards
In June 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes", and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Further, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The provisions of FIN 48 are to be applied prospectively. FIN 48 became effective at the beginning of our fiscal year 2008, and the adoption of FIN 48 increased retained earnings by approximately $1.0 million as of the beginning of fiscal year 2008. The adoption of FIN 48 and its effects are more fully described in Note 11 to the consolidated financial statements for the quarter ended September 15, 2007.
In June 2006, the FASB ratified the consensus reached on Emerging Issues Task Force (EITF) Issue No. 06-03, "How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross Versus Net Presentation)" (EITF 06-03). The EITF reached a consensus that the presentation of taxes on either a gross or net basis is an accounting policy decision that requires disclosure. EITF 06-03 was effective at the beginning of our fiscal 2008 first quarter. An entity is not required to reevaluate its existing policies related to taxes assessed by a governmental authority as a result of this consensus. Amounts collected from members, which under common trade practices are referred to as sales taxes, are and have been recorded on a net basis. We have no intention of modifying this accounting policy; therefore, the adoption of EITF 06-03 did not have any effect on our financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements, but applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 will become effective at the beginning of our fiscal year 2009. The provisions of the Statement are to be applied prospectively, except for limited retrospective application permitted for certain items. We are currently evaluating the impact, if any, that SFAS No. 157 will have on the consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements Nos. 87, 88, 106 and 132(R)" (SFAS No. 158). SFAS No. 158 required that we recognize the funded status of defined benefit postretirement plans as an asset or liability in the consolidated balance sheet and to recognize changes in funded status through comprehensive income as of March 31, 2007. SFAS No. 158 also requires that employers measure plan assets and obligations as of the date of their year-end financial statements beginning with our fiscal year ending March 28, 2009. We are currently evaluating the impact of changing the measurement date on the consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB No. 115" (SFAS No. 159). Under SFAS 159, entities may irrevocably elect to measure many financial instruments and certain other items at fair value on an instrument-by-instrument basis, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 will become effective for at the beginning of our fiscal year 2009. We are currently evaluating the impact, if any, that SFAS No. 159 will have on the consolidated financial statements.
Critical Accounting Policies
This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts. On an ongoing basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, assets held for sale, long-lived assets, income taxes, self-insurance reserves, exit costs, retirement benefits, stock-based compensation and contingencies and litigation. We base our estimates on historical experience and on various other assumptions and factors that we believe to be reasonable under the circumstances. Based on our ongoing review, we make adjustments we consider appropriate under the
facts and circumstances. We have discussed the development, selection and disclosure of these estimates with the Audit Committee. The accompanying condensed consolidated financial statements are prepared using the same critical accounting policies discussed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2007.
ITEM 3.
Quantitative and Qualitative Disclosure About Market Risk
There have been no material changes in market risk of Spartan Stores from the information provided under Part II, Item 7A, "Quantitative and Qualitative Disclosure About Market Risk", of the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2007.
ITEM 4.
Controls and Procedures
An evaluation of the effectiveness of the design and operation of Spartan Stores' disclosure controls and procedures (as currently defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) was performed as of September 15, 2007 (the "Evaluation Date"). This evaluation was performed under the supervision and with the participation of Spartan Stores' management, including its Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"). As of the Evaluation Date, Spartan Stores' management, including the CEO and CFO, concluded that Spartan Stores' disclosure controls and procedures were effective as of the Evaluation Date to ensure that material information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls a nd procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities and Exchange Act of 1934 is accumulated and communicated to management, including our principal executive and principal financial officers as appropriate to allow for timely decisions regarding required disclosure. During the last fiscal quarter there was no change in Spartan Stores' internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, Spartan Stores' internal control over financial reporting.
PART IIOTHER INFORMATION
ITEM 1A.
Risk Factors
In addition to the risk factors contained in Part I, Item 1A, "Risk Factors," of our Annual Report on Form 10-K for the fiscal year ended March 31, 2007, we have identified the following modification to our risk factors disclosure:
The accounting treatment of our convertible subordinated notes could change in a manner that has a negative impact on our reported earnings and earnings per share.
The Financial Accounting Standards Board is considering a proposed staff position which would change the accounting principles which govern our accounting treatment of the convertible subordinated notes. The proposal would, if issued, require us to record interest expense for the notes from time to time in amounts that exceed the amounts we actually pay. Such an increase in our recorded interest expense would result in a decrease in our reported net earnings and earnings per share which could have an adverse impact on the market value of our common stock.
Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information regarding the Company's purchases of its own common stock during the second quarter. The Company has no public stock repurchase plans or programs. All transactions reported are with associates under stock compensation plans. These include: (1) shares of Spartan Stores, Inc. stock delivered in satisfaction of the exercise price and/or tax withholding obligations by holders of employee stock options who exercised options, and (2) shares withheld to satisfy tax withholding obligations that occur upon the vesting of the restricted shares. The value of the shares delivered or withheld is determined by the applicable stock compensation plan.
Spartan Stores, Inc. Purchases of Equity Securities
Period
TotalNumber ofSharesPurchased
AveragePrice Paidper Share
June 24 - July 21, 2007
Employee Transactions
55
32.00
July 22 - August 18, 2007
25.45
August 19 - September 15, 2007
314
24.41
Total for Second Quarter ended September 15, 2007
425
25.53
Submission of Matters to a Vote of Security Holders
Spartan Stores held its 2007 annual meeting on August 15, 2007. At the meeting, the following matters were submitted to a vote of the shareholders:
Election of two directors; and
Ratification of the selection of Deloitte & Touche LLP as Spartan Stores' independent auditors for fiscal 2008.
The following two persons were duly elected at the meeting:
Term Expiring
Votes For
Votes Withheld
Craig C. Sturken
17,658,959
827,529
Frederick J. Morganthall
17,756,759
729,729
The following six persons continue to serve as directors of Spartan Stores: Elizabeth A. Nickels, Kenneth T. Stevens and James F. Wright are currently serving terms that will expire at Spartan Stores' 2008 annual meeting of shareholders, and M. Shan Atkins, Dr. Frank M. Gambino and Timothy J. O'Donovan are currently serving terms that will expire at Spartan Stores' 2009 annual meeting of shareholders.
The shareholders voted on a proposal to ratify the selection of Deloitte & Touche LLP as Spartan Stores' independent auditors for fiscal year 2008. With respect to this proposal, shares were voted as follows:
Proposal
For
Against
Abstain
Broker Non-Votes
Proposal to ratify the selection of Deloitte & Touche LLP as Spartan Stores' independent auditors for fiscal year 2008
17,598,234
864,961
23,293
ITEM 6.
Exhibits
The following documents are filed as exhibits to this Quarterly Report on Form 10-Q:
Exhibit Number
Document
2.1
Asset Purchase Agreement dated December 17, 2005, by and among Family Fare, LLC, Prevo's Family Markets, Inc., D&W Food Centers, Inc., and D&W Associate Resources, LLC. Previously filed as an exhibit to Spartan Stores' Current Report on Form 8-K, filed December 22, 2005. Here incorporated by reference.
2.2
First Amendment to Asset Purchase Agreement dated March 24, 2006, by and among Family Fare, LLC, Prevo's Family Markets, Inc., D&W Food Centers, Inc., and D&W Associate Resources, LLC. Previously filed as an exhibit to Spartan Stores' Current Report on Form 8-K, filed March 30, 2006. Here incorporated by reference.
Asset Purchase Agreement, dated March 19, 2007, by and among G&R Felpausch Company, Felpausch Food Centers, LLC, Hastings Catalog Sales, Inc., and Felpausch Kalamazoo, LLC as Seller, and Family Fare, LLC, Prevo's Family Markets, Inc., MSFC, LLC, and Spartan Stores Fuel, LLC as Purchaser, previously filed as an exhibit to Spartan Stores' Current Report on Form 8-K, filed March 23, 2007. Here incorporated by reference.
Third Amendment to the Asset Purchase Agreement, dated June 15, 2007, by and among G&R Felpausch Company, Felpausch Food Centers, LLC, Hastings Catalog Sales, Inc., Felpausch Kalamazoo, LLC, and Felpausch-Kelly, L.L.C. as Seller, and Family Fare, LLC, Prevo's Family Markets, Inc., MSFC, LLC, and Spartan Stores Fuel, LLC as Purchaser, previously filed as an exhibit to Spartan Stores' Current Report on Form 8-K, filed June 21, 2007. Here incorporated by reference.
3.1
Amended and Restated Articles of Incorporation of Spartan Stores, Inc. Previously filed as an exhibit to Spartan Stores' Quarterly Report on Form 10-Q for the quarter ended September 10, 2005. Here incorporated by reference.
Bylaws of Spartan Stores, Inc., as amended. Previously filed as an exhibit to Spartan Stores' Current Report on Form 8-K on August 20, 2007. Here incorporated by reference.
10.1
Letter Agreement between the Company and Wachovia Capital Finance Corporation (Central) as Agent for the Lenders, dated August 17, 2007. Previously filed as an exhibit to Spartan Stores' Current Report on Form 8-K filed August 23, 2007. Here incorporated by reference.
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SPARTAN STORES, INC.(Registrant)
Date: October 18, 2007
By
/s/ David M. Staples
David M. Staples Executive Vice President and Chief Financial Officer (Principal Financial Officer and duly authorized signatory for Registrant)
EXHIBIT INDEX