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TOPS HOLDING CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion should be read in conjunction with our consolidated
financial statements and related notes and other financial information appearing
elsewhere in this 10-K.
COMPANY OVERVIEW
We are a leading supermarket retailer in our Upstate New York and Northern
Pennsylvania markets. Introduced in 1962, our Tops brand is widely recognized as
a strong retail supermarket brand name in our markets supported by strong
customer loyalty and attractive supermarket locations. We are headquartered in
Williamsville, New York and have approximately 12,500 associates.
On January 29, 2010, we completed the acquisition of substantially all assets
and certain liabilities of Penn Traffic and its subsidiaries, including Penn
Traffic's 79 retail supermarkets, in exchange for cash consideration of $85.0
million. Twenty-four of the acquired supermarkets were closed or sold during
2010. In August 2010, the FTC issued a Proposed Order that required us to sell
seven of the retained supermarkets. On June 30, 2011, the FTC approved a
modified Final Order requiring the sale of the seven supermarkets and the
retention of a divestiture trustee to market the supermarkets subject to the
Final Order. Also on June 30, 2011, the FTC approved our application to sell
three of these supermarkets to Hometown Markets. The sale of these supermarkets
closed during July and August 2011. On September 27, 2011, as the divestiture
trustee was unable to identify a potential buyer for three of the remaining
supermarkets subject to the Final Order, control of these supermarkets reverted
to us. We continue to operate two of these supermarkets, while the third
supermarket was closed on October 15, 2011. Also on September 27, 2011, the FTC
approved a 90-day extension for the divestiture trustee to market the remaining
supermarket subject to the Final Order. During November 2011, a petition was
filed by the divestiture trustee with the FTC for approval of a proposed
divestiture of this remaining supermarket. This petition was approved by the FTC
during January 2012. The sale of the supermarket closed on January 30, 2012.
BASIS OF PRESENTATION
We operate on a 52/53 week fiscal year ending on the Saturday closest to
December 31. Our fiscal years include 13 four-week reporting periods, with an
additional week in the thirteenth reporting period for 53-week fiscal years. Our
first quarter of each fiscal year includes four reporting periods, while the
remaining quarters include three reporting periods. The period from January 2,
2011 to December 31, 2011 ("Fiscal 2011") included 52 weeks. The period from
January 3, 2010 to January 1, 2011 ("Fiscal 2010") included 52 weeks. The period
from December 28, 2008 to January 2, 2010 ("Fiscal 2009") included 53 weeks.
RECENT EVENTS AFFECTING OUR RESULTS OF OPERATIONS AND THE COMPARABILITY OF
REPORTED RESULTS OF OPERATIONS
Acquisition of Penn Traffic
On January 29, 2010, we completed the Penn Traffic acquisition, including Penn
Traffic's 79 retail supermarkets. We have currently retained 50 of the
acquired supermarkets. Three supermarkets were sold during late July and early
August 2011, one supermarket was closed in October 2011, and one supermarket was
sold in January 2012. The remaining 24 supermarkets were closed or sold during
2010. Net sales and operating loss for these 24 supermarkets were $33.9 million
and $2.8 million, respectively, during Fiscal 2010. Also included in our results
during Fiscal 2010 were integration costs of $23.3 million and one-time legal
and professional fees related to the Penn Traffic acquisition of $5.3 million.
Additionally, we incurred $0.7 million and $2.1 million of legal expenses
associated with the FTC's review of the acquired supermarkets during Fiscal 2011
and Fiscal 2010, respectively. Additional depreciation and amortization of $0.7
million was incurred during Fiscal 2011, as compared to Fiscal 2010, associated
with acquired property, equipment and intangible assets as a result of operating
the acquired supermarkets for four additional weeks during Fiscal 2011.
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The excess of net assets acquired over the purchase price of $15.7 million has
been recognized as a bargain purchase in the consolidated statement of
operations for Fiscal 2010. This bargain purchase was attributable to the
distressed status of Penn Traffic due to poor historical operating results,
which led to its November 2009 bankruptcy filing.
RESULTS OF OPERATIONS
Fiscal 2011 compared with Fiscal 2010
Summary
The results of operations during Fiscal 2011 when compared with Fiscal 2010 were
primarily impacted by a 1.4% increase in same store sales, the additional four
weeks of operating results for the acquired and retained Penn Traffic
supermarkets during Fiscal 2011, as well as one-time acquisition and integration
costs of $28.6 million associated with the Penn Traffic acquisition incurred
during Fiscal 2010.
Net Sales
The following table includes a comparison of the components of our net sales for
Fiscal 2011 and Fiscal 2010.
(Dollars in thousands)
Fiscal 2011 Fiscal 2010 %
(52 weeks) (52 weeks) $ Change Change
Inside sales $ 2,151,299 $ 2,107,524 $ 43,775 2.1 %
Gasoline sales 204,193 150,012 54,181 36.1 %
Net sales $ 2,355,492 $ 2,257,536 $ 97,956 4.3 %
Inside sales increased during Fiscal 2011 compared with Fiscal 2010 due to a
1.4% increase in same store sales, the operation of the acquired and retained
Penn Traffic supermarkets for four additional weeks, as well as incremental
inside sales associated with new stores opened since 2010. These factors were
partially offset by the impact of the sale or closure of 28 of the acquired Penn
Traffic supermarkets.
Gasoline sales increased during Fiscal 2011 compared with Fiscal 2010 due to a
27.0% increase in the retail price per gallon. Additionally, the number of
gallons sold increased 7.2%, primarily due to the addition of seven new fuel
stations since April 2010.
Gross Profit
The following table includes a comparison of cost of goods sold, distribution
costs and gross profit for Fiscal 2011 and Fiscal 2010.
(Dollars in thousands)
Fiscal 2011 % of Fiscal 2010 % of $ %
(52 weeks) Net Sales (52 weeks) Net Sales Change Change
Cost of goods sold $ (1,650,166 ) 70.1 % $ (1,579,016 ) 69.9 % $ 71,150 4.5 %
Distribution costs (44,189 ) 1.9 % (44,829 ) 2.0 % (640 ) (1.4 )%
Gross profit $ 661,137 28.1 % $ 633,691 28.1 % $ 27,446 4.3 %
As a percentage of net sales, cost of goods sold increased during Fiscal 2011
compared with Fiscal 2010 due to the higher proportion of gasoline sales versus
inside sales, as gasoline sales occur at higher cost of goods sold percentages.
This was partially offset by a higher cost of goods sold percentage on inside
sales during Fiscal 2010 due to promotional activities associated with the
rebannering and grand re-openings of the retained Penn Traffic supermarkets,
price optimization efforts during Fiscal 2011, as well as a higher percentage of
private label merchandise sales during Fiscal 2011.
Distribution costs remained consistent during Fiscal 2011 compared with Fiscal
2010. The decline in distribution costs as a percentage of net sales was
primarily driven by the increase in the retail price per gallon on gasoline
sales.
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Operating Expenses
The following table includes a comparison of operating expenses for Fiscal 2011
and Fiscal 2010.
(Dollars in thousands)
Fiscal 2011 % of Fiscal 2010 % of $ %
(52 weeks) Net Sales (52 weeks) Net Sales Change Change
Wages, salaries and benefits
$ 317,738 13.5 % $ 310,800 13.8 % $ 6,938 2.2 %
Selling and general expenses 103,153 4.4 % 104,841 4.6 % (1,688 ) (1.6 )%
Administrative expenses 79,780 3.4 % 102,754 4.6 % (22,974 ) (22.4 )%
Rent expense 18,856 0.8 % 19,135 0.8 % (279 ) (1.5 )%
Depreciation and amortization 51,205 2.2 % 62,353 2.8 % (11,148 ) (17.9 )%
Advertising 18,789 0.8 % 23,175 1.0 % (4,386 ) (18.9 )%
Impairment charges 2,791 0.1 % - N/A 2,791 N/A
Total $ 592,312 25.1 % $ 623,058 27.6 % $ (30,746 ) (4.9 )%
Wages, Salaries and Benefits
As a percentage of net sales, the decrease in wages, salaries and benefits
during Fiscal 2011 compared with Fiscal 2010 was largely attributable to the
more effective utilization of labor, particularly in the retained Penn Traffic
supermarkets as a result of significant increases in sales levels in these
stores. The decrease also reflects the higher proportion of gasoline sales
versus inside sales, as gasoline sales require relatively less labor support.
These factors were partially offset by lower vacation expense of $6.4 million
during Fiscal 2010 related to a policy change for union associates that modified
the period over which vacation time is earned and a $1.5 million increase in
bonus expense in Fiscal 2011 due to improved performance against bonus metrics.
Selling and General Expenses
As a percentage of net sales, the decrease in selling and general expenses
during Fiscal 2011 compared with Fiscal 2010 was largely due to a $2.7 million
decrease in utility costs, primarily attributable to lower commodity costs for
electricity. Additionally, $0.7 million of Penn Traffic integration costs were
classified in selling and general expenses during Fiscal 2010 that were not
incurred in 2011. We also benefitted from the renegotiation of certain cleaning
contracts during Fiscal 2011. These positive factors were largely offset by a
$1.1 million increase in repairs and maintenance expense, and a $1.4 million
increase in credit and debit card transaction fees due to increases in usage and
fee rates.
Administrative Expenses
The decrease in administrative expenses during Fiscal 2011 compared with Fiscal
2010 was primarily attributable to a combined $21.7 million of Penn Traffic
integration costs, legal and professional fees related to the Penn Traffic
acquisition and higher legal expenses associated with the FTC's review of the
acquired supermarkets recorded in Fiscal 2010. Additionally, we experienced a
$5.1 million decrease in information technology, or IT, costs in Fiscal 2011,
largely resulting from our renegotiated IT services contract. These items were
partially offset by a $0.9 million increase in depreciation related to recent IT
equipment capital expenditures, a $2.1 million increase in bonus expense due to
improved performance against bonus metrics, a $0.5 million increase in
share-based compensation expense due to stock option forfeitures that reduced
our recorded expense during Fiscal 2010, normal wage rate increases and
severance expense related to corporate headcount reductions during early 2011.
Rent Expense, Net
Rent expense reflects our rental expense for our supermarkets under operating
leases, net of income we receive from various entities that rent space in our
supermarkets under subleases. Rent expense remained relatively consistent during
Fiscal 2011 compared with Fiscal 2010.
Depreciation and Amortization
The decrease in depreciation and amortization during Fiscal 2011 compared with
Fiscal 2010 was largely attributable to a significant amount of assets that
became fully depreciated near the conclusion of Fiscal 2010, partially offset by
incremental depreciation and amortization of $0.7 million associated with assets
acquired as part of the Penn Traffic acquisition, and 2010 and 2011 capital
expenditure activity.
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Advertising
The decrease in advertising during Fiscal 2011 compared with Fiscal 2010 was due
to $5.2 million in costs associated with the communication of the Penn Traffic
acquisition to our customers and the promotion of the grand re-openings related
to the rebannered supermarkets during Fiscal 2010. This was partially offset by
investments in additional advertising initiatives during Fiscal 2011.
Impairment Charges
On June 30, 2011, the FTC approved our application to sell three supermarkets
acquired as part of the Penn Traffic acquisition to Hometown Markets. The sale
of these supermarkets closed in late July and early August 2011. As a result of
the sale, we recorded a $1.9 million impairment within the consolidated
statement of operations during Fiscal 2011, representing the excess of the
carrying value of assets over the fair value of assets.
During November 2011, we executed an agreement to sell the remaining acquired
Penn Traffic supermarket subject to the Final Order from the FTC. As a result of
the pending sale that closed during January 2012, we recorded a $0.9 million
impairment within the consolidated statement of operations during Fiscal 2011,
representing the excess of the carrying value of assets over the fair value of
assets.
Bargain Purchase
The excess of $15.7 million of the estimated fair value of Penn Traffic net
assets acquired over the purchase price has been recognized as a gain in the
consolidated statement of operations for Fiscal 2010. This bargain purchase was
attributable to the distressed status of Penn Traffic due to poor historical
operating results, which led to its November 2009 bankruptcy filing.
Loss on Debt Extinguishment
On January 29, 2010, we entered into a $25.0 million bridge loan and an
$11.0 million term loan, and capitalized related financing costs. As both the
bridge loan and term loan were repaid in full on February 12, 2010 with the
proceeds from the issuance of the additional $75.0 million of Senior Notes,
unamortized costs of $0.7 and $0.3 million, respectively, were recorded as a
loss on debt extinguishment in our consolidated statement of operations for
Fiscal 2010.
Interest Expense, Net
The $0.5 million increase in interest expense during Fiscal 2011 compared with
Fiscal 2010 was primarily attributable to incremental interest expense related
to the $75.0 million Senior Notes issued on February 12, 2010 that were
outstanding for all of Fiscal 2011.
Income Tax (Expense) Benefit
The income tax expense during Fiscal 2011 primarily reflects our income before
income taxes, the benefit of federal tax credits, and the reversal of valuation
allowance against net deferred tax assets. The overall effective tax rate was
18.2%. The effective tax rate would have been 38.0% without the impact of
federal tax credits and adjustments to the valuation allowance.
The income tax benefit during Fiscal 2010 was primarily attributable to the
reversal of $10.3 million of the valuation allowance established during Fiscal
2009. The reversal of the valuation allowance was the result of recording a
deferred tax liability that resulted from the bargain purchase associated with
the Penn Traffic acquisition. The timing of taxable income resulting from the
amortization of the gain for tax purposes provides sufficient future taxable
income to support the future deductibility of the Company's deferred tax assets.
The overall effective rate for Fiscal 2010 was 25.0%. The effective tax rate
would have been 39.9% without the impact of adjustments to the valuation
allowance, the bargain purchase, and discrete charges.
Net Income (Loss)
Our net income (loss) improved to net income of $5.8 million during Fiscal 2011
compared with net loss of $27.0 million during Fiscal 2010.
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Fiscal 2010 compared with Fiscal 2009
Summary
The results of operations during Fiscal 2010 when compared with Fiscal 2009 were
impacted primarily by the Penn Traffic acquisition. Fifty-five supermarkets
acquired in the Penn Traffic acquisition had been retained and operated through
the end of Fiscal 2010.
Net Sales
The following table includes a comparison of the components of our net sales for
Fiscal 2010 and Fiscal 2009.
(Dollars in thousands)
Fiscal 2010 Fiscal 2009
(52 weeks) (53 weeks) $ Change % Change
Inside sales $ 2,107,524 $ 1,579,448 $ 528,076 33.4 %
Gasoline sales 150,012 116,160 33,852 29.1 %
Net sales $ 2,257,536 $ 1,695,608 $ 561,928 33.1 %
Inside sales increased 33.4% in Fiscal 2010 compared with Fiscal 2009, primarily
due to net sales of $560.8 million related to new supermarkets, including the
acquired Penn Traffic supermarkets. Excluding the 53rd week in Fiscal 2009, same
store sales increased 0.1%. Net sales for the 24 acquired supermarkets that were
closed, sold or liquidated during Fiscal 2010 were $33.9 million during Fiscal
2010.
Gasoline sales increased 29.1% in Fiscal 2010 compared with Fiscal 2009 due to
an 18.9% increase in the retail price per gallon. The number of gallons sold
increased 8.6%, primarily due to the addition of four new fuel stations during
Fiscal 2010, and a full-year of operation for three fuel stations added during
Fiscal 2009.
Gross Profit
The following table includes a comparison of cost of goods sold, distribution
costs and gross profit for Fiscal 2010 and Fiscal 2009.
(Dollars in thousands)
Fiscal 2010 % of Fiscal 2009 % of $ %
(52 weeks) Net Sales (53weeks) Net Sales Change Change
Cost of goods sold
$ (1,579,016 ) 69.9 % $ (1,185,344 ) 69.9 % $ 393,672 33.2 %
Distribution costs (44,829 ) 2.0 % (33,852 ) 2.0 % 10,977 32.4 %
Gross profit $ 633,691 28.1 % $ 476,412 28.1 % $ 157,279 33.0 %
As a percentage of net sales, cost of goods sold, distribution costs and gross
profit remained consistent for Fiscal 2010 compared with Fiscal 2009.
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Operating Expenses
The following table includes a comparison of operating expenses for Fiscal 2010
and Fiscal 2009.
(Dollars in thousands)
Fiscal 2010 % of Fiscal 2009 % of $ %
(52 weeks) Net Sales (53 weeks) Net Sales Change Change
Wages, salaries and benefits $ 310,800
13.8 % $ 224,958 13.3 % $ 85,842 38.2 %
Selling and general expenses 104,841 4.6 % 73,474 4.3 % 31,367 42.7 %
Administrative expenses 102,754 4.6 % 65,013 3.8 % 37,741 58.1 %
Rent expense 19,135 0.8 % 13,219 0.8 % 5,916 44.8 %
Depreciation and amortization 62,353 2.8 % 52,727 3.1 % 9,626 18.3 %
Advertising 23,175 1.0 % 12,531 0.7 % 10,644 84.9 %
Total $ 623,058 27.6 % $ 441,922 26.0 % $ 181,136 41.0 %
Wages, Salaries and Benefits
As a percentage of net sales, the increase in wages, salaries and benefits for
Fiscal 2010 compared with Fiscal 2009 is largely attributable to investments in
labor during the rebannering and re-openings of the retained Penn Traffic
supermarkets, as well as the lower average sales base of these supermarkets. The
comparative percentage is also impacted by the fact that none of the acquired
Penn Traffic supermarkets had fuel stations, for which gasoline sales require
less labor expense than inside sales. Furthermore, we experienced a 10%
year-over-year increase in pension and health and welfare costs, as required by
our collective bargaining agreements.
Selling and General Expenses
As a percentage of net sales, selling and general expenses increased for Fiscal
2010 compared with Fiscal 2009 due to $0.7 million of Penn Traffic integration
costs included in selling and general expenses during Fiscal 2010, as well as an
increase of $10.8 million in electricity costs due to the warmer temperatures in
2010 and higher commodity prices.
Administrative Expenses
The increase in administrative expenses for Fiscal 2010 compared with Fiscal
2009 was primarily attributable to a combined $22.4 million of Penn Traffic
integration costs, one-time legal and professional fees related to the Penn
Traffic acquisition and non-recurring legal expenses associated with the FTC's
review of the acquired supermarkets. Furthermore, we incurred additional labor
expense of $12.8 million related to 2010 head count additions to accommodate
increased corporate activities following the Penn Traffic acquisition, combined
with normal wage rate increases.
Rent Expense
As a percentage of net sales, rent expense remained relatively consistent for
Fiscal 2010 compared with Fiscal 2009.
Depreciation and Amortization
The increase in depreciation and amortization from Fiscal 2010 compared with
Fiscal 2009 was largely attributable to $7.4 million associated with assets
acquired from Penn Traffic, as well as incremental depreciation related to
Fiscal 2010 and Fiscal 2009 capital expenditures.
Advertising
The increase in advertising expenses for Fiscal 2010 compared with Fiscal 2009
was primarily attributable to $5.2 million in costs associated with the
communication of the Penn Traffic acquisition to our customers and the promotion
of the re-bannered supermarkets. Additionally, we incurred increased circular
costs of $6.4 million due to enhancements made to our circulars, our increased
store base and expanded geographic area, as well as duplicative costs of
producing circulars under the P&C, Quality Markets and Bi-Lobanners subsequent
to the Penn Traffic acquisition. In early Fiscal 2010, we incurred costs of $1.7
million associated with our Monopoly® promotion. The increase was partially
offset by a decrease in media production.
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Bargain Purchase
The excess of $15.7 million of the estimated fair value of Penn Traffic net
assets acquired over the purchase price has been recognized as a gain in the
consolidated statement of operations for Fiscal 2010. This bargain purchase was
attributable to the distressed status of Penn Traffic due to poor historical
operating results, which led to its November 2009 bankruptcy filing.
Loss on Debt Extinguishment
On January 29, 2010, we entered into a $25.0 million bridge loan and an
$11.0 million term loan and capitalized related financing costs. As both the
bridge loan and term loan were repaid in full on February 12, 2010 with the
proceeds from the issuance of the additional $75.0 million of Senior Notes,
unamortized costs of $0.7 and $0.3 million, respectively, were recorded as a
loss on debt extinguishment in our consolidated statement of operations for
Fiscal 2010.
In connection with prepayments of $20.0 million related to our previous first
lien credit agreement during Fiscal 2009, $0.8 million of additional debt was
forgiven. This amount, net of the write-off of $0.3 million of unamortized
deferred financing costs, was recorded as a gain on debt extinguishment in our
consolidated statement of operations for Fiscal 2009. Effective October 9, 2009,
we issued $275.0 million of Senior Notes and simultaneously entered into the
$70.0 million revolving ABL Facility. The proceeds from the Senior Notes and the
ABL Facility were used, in part, to retire the outstanding balances related to
our previous first lien credit agreement and warehouse mortgage. In connection
with these retirements, we wrote off unamortized deferred financing costs of
$7.0 million and incurred additional costs of $0.3 million, which were recorded
as a loss on debt extinguishment in our consolidated statement of operations for
Fiscal 2009.
Interest Expense, Net
The $13.2 million increase in interest expense during Fiscal 2010 compared with
Fiscal 2009 reflects an $18.7 million increase in interest on our outstanding
indebtedness as a result of our October 2009 and February 2010 financing
activities, as well as an increase of $1.3 million attributable to deferred
financing fees and bond discount amortization (net of premium amortization).
These factors were partially offset by a $6.6 million decrease in interest
expense related to our interest rate swap that was settled in October 2009.
Income Tax Benefit (Expense)
The change from the income tax expense of $5.4 million in Fiscal 2009 to the
income tax benefit of $9.0 million in Fiscal 2010 is primarily attributable to
the higher pre-tax loss in Fiscal 2010, combined with the non-taxability of the
bargain purchase related to the Penn Traffic acquisition. Additionally, we
established a $13.9 million valuation allowance during Fiscal 2009 related to
our deferred tax assets, compared to an additional valuation allowance of $11.9
million during Fiscal 2010. The resulting effective tax rate for Fiscal 2010 was
25.0% compared to an effective tax rate for Fiscal 2009 of (26.5)%.
Deferred income tax assets or liabilities reflect temporary differences between
amounts of assets and liabilities, including net operating loss carryforwards,
for financial and tax reporting. Such amounts are adjusted as appropriate to
reflect changes in the tax rates expected to be in effect when the temporary
differences reverse. A valuation allowance is established for any deferred
income tax asset for which realization is uncertain.
Based on an assessment of the available positive and negative evidence,
including our historical results for the preceding three years, we determined
that there are uncertainties relating to our ability to utilize the net deferred
tax assets. In recognition of these uncertainties, we have provided a valuation
allowance of $13.9 million on the net deferred income tax assets as of
January 2, 2010, representing a charge to income tax expense during Fiscal 2009.
During Fiscal 2010, we established an additional valuation allowance of $11.9
million, with an offsetting charge to income tax expense. If we were to
determine that we could realize our deferred tax assets in the future in excess
of their net recorded amount, we would make an adjustment to the valuation
allowance.
Net Loss
The increase in net loss from $25.7 million in Fiscal 2009 to $27.0 million in
Fiscal 2010 is attributable to the factors discussed above.
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LIQUIDITY AND CAPITAL RESOURCES
On October 9, 2009, we issued $275.0 million of Senior Notes, bearing annual
interest of 10.125%. We received proceeds from the issuance of the Senior Notes,
net of a $4.5 million original issue discount, of $270.5 million. The Senior
Notes mature October 15, 2015 and require semi-annual interest payments on
April 15 and October 15. The Senior Notes are collateralized by
(i) first-priority interests, subject to certain exceptions, in our warehouse
distribution facility in Lancaster, New York, certain owned real property
acquired by us following the issue date of the Senior Notes, intellectual
property, equipment, stock of subsidiaries and substantially all of our other
assets (other than leasehold interests in real property), other than assets
securing the ABL Facility (as defined below) on a first priority basis
(collectively, the "Notes Priority Collateral"), and (ii) second-priority
interests, subject to certain exceptions and permitted liens, in our assets that
secure the ABL Facility on a first-priority basis, including present and future
receivables, inventory, prescription lists, deposit accounts and certain related
rights and proceeds relating thereto (collectively, the "ABL Priority
Collateral").
Also effective October 9, 2009, we entered into the ABL Facility, which expires
on October 9, 2013. The ABL Facility allowed a maximum borrowing capacity of
$70.0 million, including a sub-limit for the issuance of letters of credit,
subject to a borrowing base calculation. The ABL Facility was amended on
January 29, 2010 to increase the maximum borrowing capacity to $100.0 million.
As of December 31, 2011, the unused availability under the ABL Facility was
$70.4 million, after giving effect to $13.1 million of letters of credit
outstanding thereunder. As of January 1, 2011, $12.5 million of letters of
credit were outstanding. Revolving loans under the ABL Facility, at our option,
bear interest at either i) LIBOR plus a margin of 350 to 400 basis points,
determined based on levels of borrowing availability, or ii) the prime rate plus
a margin of 250 to 300 basis points, determined based on levels of borrowing
availability. As of December 31, 2011, the effective interest rate on borrowings
under the ABL Facility was 5.75%. The ABL Facility is collateralized primarily
by (i) first-priority interests, subject to certain exceptions, in the ABL
Priority Collateral and (ii) second-priority interests, subject to certain
exceptions, in the Notes Priority Collateral.
On January 29, 2010, we completed the Penn Traffic acquisition. In addition to
cash consideration of $85.0 million paid to Penn Traffic, we recorded $23.3
million of integration costs and $2.1 million of legal expenses associated with
the FTC's review of the acquired supermarkets during Fiscal 2010, and $5.3
million and $1.1 million of transaction costs during Fiscal 2010 and Fiscal
2009, respectively. We received proceeds from the sale of Penn Traffic stores
acquired assets of $1.3 million and $20.8 million during Fiscal 2011 and Fiscal
2010, respectively.
On February 12, 2010, we issued an additional $75.0 million of Senior Notes on
the same terms as the October 2009 issuance. We received proceeds of
$76.1 million from this issuance, including a $1.1 million original issue
premium. The proceeds were used, in part, to repay in full short-term borrowings
that were entered into in order to finance the Penn Traffic acquisition. We
incurred $4.7 million of financing costs related to the additional Senior Notes
issuance, which were capitalized in other assets in our consolidated balance
sheet during Fiscal 2010.
The Senior Notes and ABL Facility contain customary affirmative and negative
covenants, including restrictions on indebtedness, liens, type of business,
acquisitions, investments, sale or transfer of assets, payment of dividends,
transactions involving affiliates, change in control and other matters
customarily restricted in such agreements. Failure to meet any of these
covenants would be an event of default.
On January 29, 2010, we received $30.0 million of proceeds from the issuance of
44,776 shares of common stock to certain shareholders of Holding.
On July 26, 2010, we paid a dividend to our shareholders totaling $30.0 million,
or $207.22 per share of common stock outstanding.
Our primary sources of cash are cash flows generated from our operations and
borrowings under our ABL Facility. We believe that these sources will be
sufficient to meet working capital requirements, anticipated capital
expenditures and scheduled debt payments for at least the next twelve months.
Our ability to satisfy debt service obligations, to fund planned capital
expenditures and to make acquisitions will depend upon our future operating
performance, which will be affected by prevailing economic conditions in the
grocery industry and financial, business, and other factors, some of which are
beyond our control.
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Cash Flows Information
The following is a summary of cash provided by or used in each of the indicated
types of activities:
(Dollars in thousands)
Fiscal 2011 Fiscal 2010 Fiscal 2009
(52 weeks) (52 weeks) (53 weeks) Cash provided by (used in):
Operating activities $ 68,651 $ 49,458 $ 66,813
Investing activities (45,209 ) (113,933 ) (36,693 )
Financing activities (21,680 ) 62,172 (40,717 )
Cash provided by operating activities during Fiscal 2011 increased $19.2 million
compared with Fiscal 2010 due to a $49.3 million increase in earnings, adjusted
for non-cash income and expenses. Operating cash flows for Fiscal 2010 included
$31.4 million of integration costs and one-time legal and professional fee cash
expenditures related to the Penn Traffic acquisition. Changes in operating
assets and liabilities represented a use of cash from operating activities of
$13.3 million during Fiscal 2011, compared to a source of cash of $16.8 million
during Fiscal 2010. This period-over-period change was primarily attributable to
the timing of vendor payments and the resulting changes in accounts payable
during the respective periods.
Cash provided by operating activities during Fiscal 2010 decreased $17.4 million
compared with Fiscal 2009 due to cash expenditures of $31.4 million related to
integration efforts, legal expenses associated with the FTC's review of the
acquired supermarkets and other one-time legal and professional fees related to
the Penn Traffic acquisition. These cash expenditures were partially offset by a
$14.8 million improvement in cash from changes in operating assets and
liabilities due to the more effective management of working capital, despite
incremental working capital investment requirements related to the acquired Penn
Traffic supermarkets. Additionally, Fiscal 2010 reflects incremental cash flows
generated by the acquired Penn Traffic supermarkets.
Cash used in investing activities during Fiscal 2011 decreased $68.7 million
compared with Fiscal 2010, primarily due to cash consideration paid in
connection with the Penn Traffic acquisition during Fiscal 2010, net of proceeds
from the subsequent divestiture of Penn Traffic stores. Cash paid for property
and equipment totaled $45.6 million and $49.7 million during Fiscal 2011 and
Fiscal 2010, respectively. We expect to invest $35 million to $40 million in
capital expenditures during the next 12 months.
Cash used in investing activities during Fiscal 2010 increased $77.2 million
compared with Fiscal 2009, primarily due to cash consideration paid as part of
the Penn Traffic acquisition, net of proceeds from the subsequent divestiture of
certain acquired stores. Cash paid for property and equipment totaled $49.7
million and $28.1 million during Fiscal 2010 and Fiscal 2009, respectively.
Cash (used in) provided by financing activities decreased $83.9 million during
Fiscal 2011 compared with Fiscal 2010 as a result of the issuance of an
additional $75.0 million of Senior Notes and the proceeds of $30.0 million from
the issuance of additional common shares during Fiscal 2010. This was partially
offset by a $30.0 million dividend paid to our shareholders during Fiscal 2010,
the change in net borrowings and repayments related to our ABL Facility, as well
as $5.8 million of deferred financing costs incurred during Fiscal 2010.
Cash provided by (used in) financing activities during Fiscal 2010 changed
$102.9 million compared with Fiscal 2009 as a result of the issuance of an
additional $75.0 million of senior secured notes and proceeds of $30.0 million
from the issuance of additional shares of common stock during Fiscal 2010, as
well as prepayments made on our previous senior secured credit facility during
Fiscal 2009. These factors were partially offset by the dividend to our
shareholders and financing costs incurred in connection with our Fiscal 2010
financing activities.
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Contractual Obligations
The following table sets forth a summary of our significant contractual
obligations as of December 31, 2011:
(Dollars in thousands)
Payments due by Period
2012 2013 2014 2015 2016 Thereafter Total
Long-term debt:
Notes(1) $ - $ - $ - $ 350,000 $ - $ - $ 350,000
Other long- term debt 434 7,290 280 165 - - 8,169
Interest(2) 53,670 51,560 49,438 39,249 9,947 26,480 230,344
Operating leases(3) 25,822 25,471 25,610 25,445 26,038 111,329 239,715
Capital leases(3) 12,701 15,812 17,100 12,219 16,454 98,229 172,515
Purchase obligations(4) 161,173 110,286 15,328 15,118 15,038 14,911 331,854
Other liabilities(5) 56,121 60,143 60,886 734 692 2,784 181,360
Total $ 309,921 $ 270,562 $ 168,642 $ 442,930 $ 68,169 $ 253,733 $ 1,513,957
(1) No principal amounts are due on the Senior Notes until October 15, 2015.
Assumes aggregate principal amount of $350.0 million of Senior Notes are
outstanding until maturity.
(2) Amount primarily includes contractual interest payments related to the Senior
Notes, capital leases and other long-term debt.
(3) Some of our lease agreements provide us with an option to renew. We have not
included renewal options in our future minimum lease amounts for renewals
that are not reasonably assured. Our future operating lease obligations will
change if we exercise these renewal options and if we enter into additional
operating or capital lease agreements.
(4) In addition to the purchase obligations reflected in the table above, we
enter into supply contracts to purchase products for resale in the ordinary
course of business. This category of contracts covers a broad spectrum of
products and sometimes includes specific merchandising obligations relative
to those products. These supply contracts typically include either a volume
commitment or a fixed expiration date, pricing terms based on the vendor's
published list price, termination provisions, and other standard contractual
considerations. Our obligation related to these contracts is typically
limited to return of unearned allowances and therefore no amounts have been
included above. Purchase obligations above relate to the outsourcing of a
major portion of our information system functions and pharmacy inventory
procurement through long-term agreements, as noted below:
• In July 2010, we extended our existing IT outsourcing agreement with
HP through December 31, 2017 to cover a wide range ofinformation
systems services. Under the agreement, HP provides data center
operations, mainframe processing, business applications and systems
development to enhance our customer service and efficiency. The
charges under this agreement are based upon the servicesrequested at
predetermined rates.
• Effective December 1, 2010, we extended the term of our existing
supply contract with McKesson through January 1, 2014 for the supply
of substantially all of our prescription drugs and other health and
beauty care products requirements. We are required to purchase a
minimum of $400 million of product during the period from December 1,
2010 to January 1, 2014.
(5) Other liabilities consist of health and welfare benefits and multiemployer
pension plan contributions under collective bargaining agreements, as well as
other pension and post-retirement benefits.
Multiemployer Pension Plans
We contribute to the Local One plan, a defined benefit multiemployer pension
plan, under our collective bargaining agreements with Local One. The Local One
plan generally provides retirement benefits to participants based on their
service to contributing employers. The actuary for the Local One plan has
estimated that, as of December 31, 2010, our withdrawl liability would be
approximately $241.6 million in the event of our complete withdrawal from the
Local One plan during the 2011 plan year. During Fiscal 2011 and Fiscal 2010, we
made contributions of $8.9 million and $7.9 million, respectively, to this plan.
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We will be required to increase our annual contributions to the Local One plan
pursuant to our collective bargaining agreements and the Local One plan's
rehabilitation plan. We are also contingently liable for withdrawal liability in
the event that we withdraw from the Local One plan. In accordance with
applicable accounting rules, our contingent withdrawal liability is not included
in our consolidated financial statements. We have no intention to withdraw from
the Local One plan.
In addition, at the time our supply arrangement was entered into with C&S,
certain of our warehouse personnel became employees of C&S, with C&S assuming
our obligations under several multiemployer pension plans. Although we are not a
sponsoring employer of, and make no contribution payments to any of these other
multiemployer pension plans, we have certain contractual indemnification
obligations for withdrawal liability that may arise in the event of C&S's
withdrawal from such plans, or upon termination of the supply agreement.
According to estimates of the actuary for the multiemployer plan for which we
indemnify C&S, the withdrawal liability for a withdrawal from such plan in 2011
would have been $130.6 million.
Off-Balance Sheet Arrangements
Other than our operating leases and contingent multiemployer pension liabilities
previously discussed, and letters of credit, we are not a party to any
off-balance sheet arrangements that have, or are reasonably likely to have, a
current or future material effect on our financial condition, net sales,
expenses, results of operations, liquidity, capital expenditures or capital
resources.
Inflation
Product cost inflation could vary from our estimates due to general economic
conditions, weather, availability of raw materials and ingredients in the
products that we sell and their packaging, and other factors beyond our control.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America, or GAAP, which
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of revenues and
expenses during the reported periods. We have provided a description of all of
our significant accounting policies in Note 1 to our consolidated financial
statements in Item 8 of Part II of this 10-K. We believe that of these
significant accounting policies, the following may involve a higher degree of
judgment or complexity.
Vendor Allowances
We receive allowances from many of the vendors whose products we stock in our
supermarkets. Allowances are received for a variety of merchandising activities,
which consist of the inclusion of vendor products in our advertising, placement
of vendor products in prominent locations in our supermarkets, introduction of
new products, slotting fees, exclusivity rights in certain categories of
products and temporary price reductions offered to customers on products held
for sale. We also receive vendor allowances associated with buying activities
such as volume purchase rebates and rebates for purchases made during specific
periods.
We record a receivable for vendor allowances for which we have fulfilled our
contractual commitments but have not received payment from the vendor. When
payment for vendor allowances is received prior to fulfillment of contractual
terms or before the programs necessary to earn such allowances are initiated, we
record such amounts as deferred income or vendor allowances received in advance,
respectively, which are classified within accrued expenses and other current
liabilities and other long-term liabilities in the consolidated balance sheets.
Once all contractual commitments have been met, we record vendor allowances as a
reduction of the cost of inventory. Due to system constraints and the nature of
certain allowances, it is sometimes not practicable to apply allowances to the
item cost of inventory. In those instances, the allowances are applied as a
reduction of merchandise costs using a rational and systematic methodology,
which results in the recognition of these incentives when the inventory related
to the vendor consideration received is sold based on an inventory turns
calculation. Accordingly, when the inventory is sold, the vendor allowances are
recognized as a reduction of the cost of goods sold. The amount and timing of
recognition of vendor allowances, as well as the amount of vendor allowances
remaining as deferred income or vendor allowances received in advance, requires
management judgment and estimates. Management determines these amounts based on
estimates of current year purchase volume using forecasted and historical data
and review of average inventory turnover. These judgments and estimates impact
our reported operating earnings and accrued deferred income.
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Inventory Valuation
We value inventories at the lower of cost or market using the last-in,
first-out, or LIFO, method. Our inventory balances consist primarily of finished
goods. Inventory costs include the purchase price of the product and freight
charges to deliver the product and are net of certain cash or non-cash
consideration received from vendors.
Cost is determined using the retail method. Under the retail method, the
valuation of inventories, and the resulting gross margins, is determined by
applying a cost-to-retail ratio for various groupings of similar items to the
retail value of inventories. Inherent in the retail inventory method
calculations are certain management judgments and estimates which could impact
the ending inventory valuation at cost, as well as the resulting gross margins.
Our cost to retail ratios contain uncertainties as the calculation requires
management to make assumptions and apply judgment regarding inventory mix,
inventory spoilage and shrink. Because of the significance of the judgments and
estimation processes, it is likely that materially different amounts could be
recorded if we used different assumptions or if the underlying circumstances
were to change.
Physical inventory counts are taken on a cycle basis. We record an estimated
inventory shrinkage reserve for the period between each store's last physical
inventory and the consolidated balance sheet date.
Valuation of Tradename
In accordance with the provisions of Accounting Standards Codification ("ASC")
350, "Intangibles-Goodwill and Other," or ASC 350, we do not amortize the Tops
tradename, which is deemed to have an indefinite useful life.
The Tops tradename is tested for impairment whenever events or circumstances
make it more likely than not that an impairment may have occurred, or at least
annually, in accordance with ASC 350. We have identified December 1 as the
impairment test date for the Tops tradename. Our impairment review is based on a
relief from royalty method that requires significant judgment with respect to
future volume, revenue growth assumptions, and the selection of the appropriate
discount and royalty rates.
We use estimates based on expected trends in making these assumptions. An
impairment loss, if necessary, is recorded as the excess of the carrying value
over the net present value of estimated cash flows, which represents the
estimated fair value of the asset. We did not recognize any losses during Fiscal
2011, Fiscal 2010 or Fiscal 2009. In connection with our December 1, 2011 Tops
tradename impairment review, the fair value of the tradename was approximately
70% greater than the carrying value.
Valuation of Long-lived Assets
It is our policy to review our long-lived assets for possible impairment
whenever events or circumstances indicate that the carrying amount of an asset
may not be recoverable. Factors we consider important, and which could trigger
an impairment review, include the following:
• significant under-performance of a store in relation to expectations;
• significant negative industry or economic trends; and
• significant changes or planned changes in our use of the assets.
We determine whether the carrying value of our long-lived assets, including
property and equipment, and finite-lived intangible assets may not be
recoverable based upon the existence of one or more of the foregoing or other
indicators of impairment. We determine if impairment exists relating to
long-lived assets by comparing future undiscounted cash flows to the asset's
carrying value. If the carrying value is greater than the undiscounted cash
flows, we measure the impairment as the amount by which the carrying value of
the assets exceeds the fair value of the assets. The projected cash flows for
each asset group considers multiple factors including store sales over its
remaining lease term, including sales trends, labor rates, commodity costs and
other operating cost assumptions. Because of the significance of long-lived
assets and finite-lived intangible assets and the judgments and estimates that
go into the fair value analysis, we believe that our policies regarding
impairment are critical. As discussed in Note 10 to the consolidated financial
statements in Item 8 of Part II of this 10-K, the Company recorded impairment
charges of $2.8 million during Fiscal 2011. There were no impairment charges
recorded during Fiscal 2010 or Fiscal 2009.
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Leases
We lease buildings and equipment under operating and capital lease arrangements.
In accordance with ASC 840, "Leases," we classify our leases as capital leases
when the lease agreement transfers substantially all risks and rewards of
ownership to us. For leases determined to be capital leases, the asset and
liability are recognized at an amount equal either to the fair value of the
leased asset or the present value of the minimum lease payments during the lease
term, whichever is lower. Leases that do not qualify as capital leases are
classified as operating leases, and the related lease payments are expensed on a
straight-line basis (taking into account rent escalation clauses) over the lease
term, including, as applicable, any rent-free period during which we have the
right to use the asset. Determining whether a lease is a capital or an operating
lease requires judgment on various aspects that include the fair value of the
leased asset, the economic life of the leased asset, whether or not to include
renewal options in the lease term and determining an appropriate discount rate
to calculate the present value of the minimum lease payments.
Self-Insurance Programs
We are primarily self-insured for costs related to workers' compensation and
general liability claims. As of December 31, 2011, our workers' compensation and
general liability reserves were $13.4 million and $2.4 million, respectively.
The liabilities represent our best estimates, using generally accepted actuarial
reserving methods, of the ultimate obligations for reported claims plus those
incurred but not reported for all claims incurred through the balance sheet
date. We establish case reserves for reported claims using case-basis evaluation
of the underlying claim data which is updated as new information becomes known.
For both workers' compensation and general liability claims, we have purchased
stop-loss coverage to limit our exposure to any significant exposure on a per
claim basis. We are insured for covered costs in excess of established per claim
limits. We account for the liabilities for workers' compensation and general
liability claims on a present value basis utilizing a risk-adjusted discount
rate.
The assumptions underlying the ultimate costs of existing claim losses are
subject to a high degree of unpredictability, which can affect the liability
recorded for such claims. For example, variability in inflation rates of health
care costs inherent in these claims can affect the amounts realized. Similarly,
changes in legal trends and interpretations, as well as a change in the nature
and method of how claims are settled, can affect ultimate costs. Our estimates
of liabilities incurred do not anticipate significant changes in historical
trends for these variables, and any changes could have a considerable effect on
future claim costs and currently recorded liabilities.
Income Taxes
We account for income taxes using the liability method in accordance with ASC
740, "Income Taxes." Under this method, deferred tax assets and liabilities are
determined based upon differences between the financial reporting and the tax
basis of assets and liabilities, NOL carry forwards and federal tax credits, and
are measured using the enacted tax rates expected to apply to taxable income in
the periods in which the deferred tax assets or liabilities are expected to be
realized or settled. The Company uses the provisions of ASC 740 to assess and
record income tax uncertainties. In relation to recording the provision for
income taxes, management must estimate the future tax rates applicable to the
reversal of temporary differences, make certain assumptions regarding whether
book/tax differences are permanent or temporary, and if temporary, the related
timing of expected reversal. Also, estimates are made as to whether taxable
operating income in future periods will be sufficient to fully recognize any
gross deferred tax assets. If recovery is not more likely than not, we must
increase our provision for taxes by recording a valuation allowance against the
deferred tax assets. Alternatively, we may make estimates about the potential
usage of deferred tax assets that decrease our valuation allowances. The
calculation of our tax liabilities involves dealing with uncertainties in the
application of complex tax regulations. Significant judgment is required in
evaluating our tax positions and determining our provision for income taxes.
During the ordinary course of business, there are many transactions and
calculations for which the ultimate tax determination is uncertain. We establish
reserves for uncertain tax positions when we believe that such tax positions do
not meet the more likely than not threshold. We adjust these reserves in light
of changing facts and circumstances, such as the outcome of a tax audit or the
lapse of the statute of limitations. The provision for income taxes includes the
impact of reserve provisions and changes to the reserves that are considered
appropriate.
Recent Accounting Pronouncements-Not Yet Adopted
Recent Accounting Pronouncements are included in Note 1 to the consolidated
financial statements in Item 8 of Part II of this 10-K.
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