FORWARD-LOOKING INFORMATION
This report contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements relate to
expectations concerning matters that (a) are not historical facts, (b) predict
or forecast future events or results, or (c) embody assumptions that may prove
to have been inaccurate. These forward-looking statements involve risks,
uncertainties and assumptions. When we use words such as "believe," "expect,"
"anticipate" or similar expressions, we are making forward-looking statements.
Although we believe that the expectations reflected in such forward-looking
statements are reasonable, we cannot give readers any assurance that such
expectations will prove correct. The actual results may differ materially from
those anticipated in the forward-looking statements as a result of numerous
factors, many of which are beyond our control. Important factors that could
cause actual results to differ materially from our expectations include, but are
not limited to, the factors discussed in the sections entitled "Risk Factors"
and "Critical Accounting Policies and Estimates" within "Management's Discussion
and Analysis of Financial Condition and Results of Operations." All
forward-looking statements attributable to us are expressly qualified in their
entirety by the factors that may cause actual results to differ materially from
anticipated results. Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's opinion only as of the
date hereof. We undertake no duty or obligation to revise or publicly release
the results of any revision to these forward-looking statements. Readers should
carefully review the risk factors described in this document as well as in other
documents we file from time to time with the Securities and Exchange Commission
(the "SEC").
COMPANY OVERVIEW
General
Unified Grocers, Inc. (referred to in this Form 10-Q, together with its
consolidated subsidiaries, as "Unified," "the Company," "we," "us" or "our"), a
California corporation organized in 1922 and incorporated in 1925, is a
retailer-owned, grocery wholesale cooperative serving supermarket, specialty and
convenience store operators located primarily in the western United States and
the Pacific Rim. We operate our business in two reportable business segments:
(1) Wholesale Distribution; and (2) Insurance. All remaining business activities
are grouped into All Other (see Note 4 of "Notes to Consolidated Condensed
Financial Statements - Unaudited" in Part I, Item 1. "Financial Statements
(Unaudited)" of this Quarterly Report on Form 10-Q for additional discussion).
We sell a wide variety of products typically found in supermarkets, as well as a
variety of specialty products, through the Cooperative and Dairy Divisions of
Unified, our specialty food subsidiary (Market Centre) and our international
sales subsidiary (Unified International, Inc.). We report all product sales and
results from certain of our support services to customers, including promotional
planning, retail technology, equipment purchasing and real estate services, in
our Wholesale Distribution segment, which represents approximately 99% of our
total net sales. We also provide insurance and financing to our customers
through separate subsidiaries, the results of which are reported in our
Insurance segment and All Other business activities, respectively. Insurance
activities account for approximately 1% of total net sales. The availability of
specific products and services may vary by geographic region. We have three
separate geographical and marketing regions: Southern California, Northern
California and the Pacific Northwest.
Our customers include our owners ("Members") and non-owners ("Non-Members"). We
do business primarily with those customers that have been accepted as Members.
Our Members operate supermarket companies that range in size from single store
operators to regional supermarket chains. Members are required to meet specific
requirements, which include ownership of our capital shares and may include
required cash deposits. Customers who purchase less than $1 million annually
from us would not generally be considered for membership, while customers who
purchase over $3 million annually are typically required to become Members. See
Part I, Item 1. "Business - Member Requirements," Part I, Item 1. "Business -
Capital Shares" and Part I, Item 1. "Business - Customer Deposits" of our Annual
Report on Form 10-K for the year ended October 1, 2011 for additional
information. Additionally, see "DESCRIPTION OF DEPOSIT ACCOUNTS" in our
Amendment No. 2 to Registration Statement on Form S-1 filed on April 19, 2012,
with respect to our offering of Partially Subordinated Patrons' Deposit Accounts
for further information. The membership requirements, including purchase and
capitalization requirements, may be modified at any time at the discretion of
our Board of Directors (the "Board").
17
--------------------------------------------------------------------------------
Table of Contents
We distribute the earnings from patronage activities conducted by us, excluding
our subsidiaries, with our Members ("Patronage Business") in the form of
patronage dividends. The Board approves the payment of patronage dividends and
the form of such payment for our three patronage earnings divisions: the
Cooperative Division, the Southern California Dairy Division and the Pacific
Northwest Dairy Division. See Part I, Item 1. "Business - Company Structure and
Organization - Wholesale Business - Wholesale Distribution" of our Annual Report
on Form 10-K for the year ended October 1, 2011 for additional discussion. An
entity that does not meet Member purchase requirements may conduct business with
us as a Non-Member customer. We may also grant an entity that meets our Member
purchase requirements the ability to conduct business with us as a Non-Member
customer. We retain the earnings from our subsidiaries and from business
conducted with Non-Members (collectively, "Non-Patronage Business").
Facilities and Transportation
We operate various warehouse and office facilities that are located in Commerce,
Los Angeles, Santa Fe Springs, Stockton and Fresno, California, Milwaukie,
Oregon and Seattle, Washington. We also operate a bakery manufacturing facility
and a milk, water and juice processing plant in Los Angeles, which primarily
serve the Southern California region.
We believe our properties are generally in good condition, well maintained and
suitable and adequate to carry on our business as presently conducted.
Our customers may choose either of two delivery options for the distribution of
our products: have us deliver orders to their stores or warehouses or pick-up
their orders from our distribution centers. For delivered orders, we primarily
utilize our fleet of tractors and trailers.
INDUSTRY OVERVIEW AND THE COMPANY'S OPERATING ENVIRONMENT
Competition
We compete in the wholesale grocery industry with regional and national food
wholesalers such as C&S Wholesale and Supervalu Inc., as well as other local
wholesalers and distributors that provide a more limited range of products and
services to their customers. We also compete with many local and regional meat,
produce, grocery, specialty, general food, bakery and dairy wholesalers and
distributors. Our customers compete directly with vertically integrated regional
and national chains. The growth or loss in market share of our customers could
also impact our sales and earnings. For more information about the competitive
environment we and our customers face, please refer to "Risk Factors."
The marketplace in which we operate continues to evolve and present challenges
both to our customers and us. The continued expansion of alternative grocery and
food store formats into the marketplace may present challenges for some of the
retail grocery stores owned by our customers. In addition, non-traditional
formats such as club stores, supercenters, discount, drug, natural and organic
and convenience stores continue to expand their offering of products that are a
core part of the conventional grocery store offering, thereby creating
additional competition for our customers.
Our strategy to help our customers effectively compete in the marketplace
includes a focus on helping our customers understand consumer trends. The
ongoing challenging economic climate continues to cause consumers to place a
higher emphasis on lower prices. Job losses have also caused a significant shift
in consumers' eating and living habits. To effectively adjust to these
conditions, many of our customers have focused on, among other things, enhancing
their corporate brand offerings to give consumers a lower-priced alternative to
nationally branded products. This includes a corporate brand health and wellness
offering to satisfy consumers' desire for products that support a healthy
lifestyle but at a lower price. Differentiation strategies in specialty and
ethnic products and items on the perimeter of the store such as produce, service
deli, service bakery and meat categories also continue to be an important part
of our strategy.
One of our sales initiatives is to continue our development of programs and
services designed with consumers in mind. The retail store is becoming a more
important source of information for consumers about the products that are
available to them. To provide this information, we are offering more in-store
literature to educate consumers about the products we offer, particularly to
promote value and savings through event marketing and everyday low price
campaigns.
18
--------------------------------------------------------------------------------
Table of Contents
Economic Factors
Economic factors such as low consumer confidence and high unemployment continue
to persist in certain of our operating markets. Higher food price inflation and
fuel costs during calendar 2011 placed more pressure on consumer discretionary
income, and these trends have continued during 2012, though to a lesser extent
during our third fiscal quarter ending June 30, 2012. Extreme drought conditions
currently prevailing in approximately one-fifth of the U.S. are expected to
result in higher prices on certain food products; however, the timing and degree
of any such impact is uncertain at this time. Consumers continue to be highly
price sensitive and seek lower-cost alternatives in their grocery purchases,
continuing to put pressure on profit margins in an industry already
characterized by low profit margins. Job losses have also caused greater
demographic shifts that can change the composition of consumers and their
related product focus in a given marketplace.
We are impacted by changes in the overall economic environment. An inflationary
or deflationary economic period could impact our operating income in a variety
of areas, including, but not limited to, sales, cost of sales, employee wages
and benefits, workers' compensation insurance and energy and fuel costs. We
typically experience significant volatility in the cost of certain commodities,
the cost of ingredients for our manufactured breads and processed fluid milk and
the cost of packaged goods purchased from other manufacturers. Our operating
programs are designed to give us the flexibility to pass on these costs to our
customers; however, we may not always be able to pass on such changes to
customers on a timely basis. Any delay may result in our recovering less than
all of a price increase. It is also difficult to predict the effect that
possible future purchased or manufactured product cost decreases might have on
our profitability. The effect of deflation in purchased or manufactured product
costs would depend on the extent to which we had to lower selling prices of our
products to respond to sales price competition in the market. Consequently, it
is difficult for us to accurately predict the impact that inflation or deflation
might have on our operations.
External factors continue to drive volatility in our costs associated with fuel.
Our pricing includes a fuel surcharge on product shipments to recover fuel costs
over a specified index. When fuel costs differ from a specified index, pricing
adjustments are passed on to our customers. The surcharge is reviewed monthly
and adjusted when appropriate.
Additionally, wage increases occur as a result of negotiated labor contracts and
adjustments for non-represented employees. Wage increases primarily occur in
September for negotiated labor contracts. Wage increases for non-represented
employees typically occur in January. We continually focus attention on
initiatives aimed at improving operating efficiencies throughout the
organization to offset the impact of these wage increases.
Our insurance subsidiaries invest a significant portion of premiums received in
fixed maturity securities and equity securities to fund loss reserves. As a
result, our operating performance may be impacted by the performance of these
investments. The majority of our investments (approximately 84%) are held by two
of our insurance subsidiaries, and include obligations of U.S. government
corporations and agencies, high quality investment grade corporate bonds, U.S.
government treasury securities, U.S. state and municipal securities and common
equity securities. The investments held by our insurance subsidiaries, excluding
the common equity securities, are generally not actively traded and are valued
based upon inputs including quoted prices for identical or similar assets.
Collectively, the estimated fair value or market value of these investments
continued to exceed their cost during the thirty-nine weeks ended June 30, 2012.
Approximately 11% of our investments are held by our Wholesale Distribution
segment, which consists primarily of Western Family Holding Company ("Western
Family") common stock. Western Family is a private cooperative located in Oregon
from which we purchase food and general merchandise products. Approximately 5%
of our investments are held by our other support businesses and consist of an
investment by our wholly-owned finance subsidiary in National Consumer
Cooperative Bank ("NCB"). NCB operates as a cooperative and therefore its
borrowers are required to own its Class B common stock.
We invest in life insurance policies (reported at cash surrender value) and
various publicly-traded mutual funds (reported at estimated fair value based on
quoted market prices) to fund obligations pursuant to our Executive Salary
Protection Plan and deferred compensation plan (see Note 7 of "Notes to
Consolidated Condensed Financial Statements - Unaudited" in Part I, Item 1.
"Financial Statements (Unaudited)" of this Quarterly Report on Form 10-Q for
additional discussion). Life insurance and mutual fund assets with values tied
to the equity markets are impacted by overall market conditions. During the
thirty-nine weeks ended June 30, 2012, net earnings and net comprehensive
earnings experienced an increase corresponding to the increase in life insurance
and mutual fund assets, respectively.
19
--------------------------------------------------------------------------------
Table of Contents
Technology
Technological improvements have been an important part of our strategy to
improve service to our customers and lower costs. As supermarket chains increase
in size and alternative format grocery stores gain market share, independent
grocers are further challenged to compete. Our customers benefit from our
substantial investment in supply-chain technology, including improvements in our
vendor management activities through new item introductions, promotions and
payment support activities.
Technological improvements in our distribution systems have been an area of
concentration. Over the past several years, we have continued to upgrade our
warehouse and enterprise reporting systems to improve efficiency, order
fulfillment accuracy and internal management reporting capabilities. This
process has been instrumental in helping drive labor efficiency. We are
realizing the expected improvements from each facility's upgrade.
We are in the process of implementing a proof of delivery application throughout
our private transportation fleet. The new mobile application is expected to
improve the accuracy of the delivery process. At the heart of the application is
a mobile hand-held computer that tracks customer shipments. This fully
electronic solution replaces the need for existing paper documents and
provides real time information on service level and delivery performance.
We provide our customers with network connectivity, data exchange and a
portfolio of retail automation applications. We continue to enhance these
products and services to allow the retailer to easily and efficiently strengthen
their business application functionality and comply with new regulations. Most
of these offerings are provided under a subscription model allowing our
retailers to utilize these systems without high up-front costs. We fully support
these products, eliminating the need for our customers to manage these systems.
In the difficult business environment and economic conditions our retailers have
been facing, this approach has been helpful in promoting their success. We
continue to invest in technology solutions that offer value to the supply chain
and bring our customers closer to the consumer.
RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations
should be read in conjunction with the consolidated condensed financial
statements and notes to the consolidated condensed financial statements,
specifically Note 4 of "Notes to Consolidated Condensed Financial Statements -
Unaudited," "Segment Information," included in Part I, Item 1. "Financial
Statements (Unaudited)" of this report. Certain statements in the following
discussion are not historical in nature and should be considered to be
forward-looking statements that are inherently uncertain.
The following table sets forth our selected consolidated financial data
expressed as a percentage of net sales for the periods indicated and the
percentage increase or decrease in such items over the prior year period.
Thirteen Weeks Thirty-Nine Weeks
Ended % Change Ended % Change
June 30, July 2, Thirteen June 30, July 2, Thirty-Nine
Fiscal Period Ended 2012 2011 Weeks 2012 2011 Weeks
Net sales 100.0 % 100.0 % (2.6 )% 100.0 % 100.0 % (0.8 )%
Cost of sales 91.5 91.1 (2.2 ) 91.6 91.1 (0.3 )
Distribution, selling and
administrative expenses 7.5 7.6 (4.2 ) 7.7 7.9 (3.7 )
Operating income 1.0 1.3 (24.4 ) 0.7 1.0 (28.4 )
Interest expense (0.3 ) (0.3 ) 6.9 (0.3 ) (0.3 ) 0.5
Estimated patronage dividends (0.5 ) (0.8 ) (43.6 ) (0.3 ) (0.4 ) (26.5 )
Income taxes (0.1 ) (0.1 ) 17.3 - (0.1 ) (66.8 )
Net earnings 0.1 % 0.1 % 6.7 % 0.1 % 0.2 % (53.1 )%
20
--------------------------------------------------------------------------------
Table of Contents
THIRTEEN WEEK PERIOD ENDED JUNE 30, 2012 ("2012 PERIOD") COMPARED TO THE
THIRTEEN WEEK PERIOD ENDED JULY 2, 2011 ("2011 PERIOD")
Overview of the 2012 Period. We experienced an overall net sales decrease of
$25.4 million, or 2.6%, to $943.9 million for the 2012 Period as compared to
$969.3 million for the 2011 Period. Our net sales for the Wholesale Distribution
segment decreased $29.1 million, or 3.0%, for the comparable 2012 and 2011
Periods. We achieved higher sales to our continuing customers; however, those
sales improvements were exceeded by the loss of sales due to lost customers,
including the loss of one of our top ten customers in the third quarter of
fiscal 2011, and store closures. Net sales in our Insurance segment and our All
Other business activities increased $3.6 million and $0.1 million, respectively,
for the comparable thirteen week periods.
Our consolidated operating income decreased $3.1 million to $9.5 million in the
2012 Period compared to $12.6 million in the 2011 Period.
The overall decrease in operating income is summarized in our operating segments
and other business activities as follows:
· Wholesale Distribution Segment: The Wholesale Distribution segment's
operating income decreased $4.4 million to $7.8 million in the 2012 Period
compared to $12.2 million in the 2011 Period. This decrease in earnings was
primarily due to a change in sales mix towards lower margin products,
decreased inventory holding gains and lower net sales, partially offset by
a decline in distribution, selling and administrative expenses.
· Insurance Segment: Operating income increased $1.2 million in our Insurance segment to earnings of $1.6 million in the 2012 Period compared
to earnings of $0.4 million in the 2011 Period. This increase was primarily
due to an increase in investment income.
· All Other: Operating income increased $0.1 million in our All Other
business activities to $0.1 million in the 2012 Period compared to an insignificant loss in the 2011 Period. All Other business activities
primarily consist of activities conducted through our finance subsidiary.
The following tables summarize the performance of each business segment for the
2012 and 2011 Periods.
Wholesale Distribution Segment
(dollars in thousands)
Thirteen Weeks Ended Thirteen Weeks Ended
June 30, 2012 July 2, 2011
Amounts in Percent to Amounts in Percent to
000's Net Sales 000's Net Sales Difference
Gross sales $ 937,430 - $ 966,486 - $ (29,056 )
Inter-segment eliminations - - - - -
Net sales 937,430 100.0 % 966,486 100.0 % (29,056 )
Cost of sales 861,150 91.9 882,560 91.3 (21,410 )
Distribution, selling and
administrative expenses 68,478 7.3 71,723 7.4 (3,245 )
Operating income $ 7,802 0.8 % $ 12,203 1.3 % $ (4,401 )
21
--------------------------------------------------------------------------------
Table of Contents
Insurance Segment
(dollars in thousands)
Thirteen Weeks Ended Thirteen Weeks Ended
June 30, 2012 July 2, 2011
Amounts in Percent to Amounts in Percent to
000's Net Sales 000's Net Sales Difference
Gross sales - premiums earned
and investment income $ 9,197 - $ 5,879 - $ 3,318
Inter-segment eliminations (2,928 ) - (3,213 ) - 285
Net sales - premiums earned
and investment income 6,269 100.0 % 2,666 100.0 % 3,603
Cost of sales - underwriting
expenses 2,701 43.1 468 17.6 2,233
Selling and administrative
expenses 1,940 30.9 1,814 68.0 126
Operating income $ 1,628 26.0 % $ 384 14.4 % $ 1,244
All Other
(dollars in thousands)
Thirteen Weeks Ended Thirteen Weeks Ended
June 30, 2012 July 2, 2011
Amounts in Percent to Amounts in Percent to
000's Net Sales 000's Net Sales Difference
Gross sales $ 310 - $ 250 - $60
Inter-segment eliminations (30 ) - (61 ) - 31
Net sales 280 100.0 % 189 100.0 % 91
Selling and administrative expenses 207 73.9 208 110.1 (1)
Operating income (loss) $ 73 26.1 % $ (19 ) (10.1 )% $92
Net sales. Consolidated net sales decreased $25.4 million, or 2.6%, to $943.9
million in the 2012 Period compared to $969.3 million for the 2011 Period.
Factors impacting net sales are as follows:
· Wholesale Distribution Segment: Wholesale Distribution net sales decreased
$29.1 million to $937.4 million in the 2012 Period compared to $966.5
million for the 2011 Period. Significant components of this decrease are
summarized below.
(dollars in millions)
Key Net Sales Changes Increase (Decrease)
Increase in net sales to continuing customers $ 2.1
Loss of significant Member in May 2011 (17.0 )
Other lost customers, net (6.3 )
Store closures (7.9 )
Change in net sales $ (29.1 )
· Insurance Segment: Net sales, consisting principally of premium revenues
and investment income, increased $3.6 million to $6.3 million in the 2012
Period compared to $2.7 million for the 2011 Period. The increase is
primarily due to an increase in workers' compensation premium revenue
resulting from the addition of new policyholders, increased renewal
premiums and an increase in investment income.
· All Other: Net sales increased $0.1 million to $0.2 million in the 2012
Period compared to $0.1 million in the 2011 Period.
Cost of sales (including underwriting expenses). Consolidated cost of sales was
$863.9 million for the 2012 Period and $883.0 million for the 2011 Period and
comprised 91.5% and 91.1% of consolidated net sales for the 2012 and 2011
Periods, respectively. Factors impacting cost of sales are as follows:
· Wholesale Distribution Segment: Cost of sales decreased by $21.4 million
to $861.2 million in the 2012 Period compared to $882.6 million in the 2011
Period. As a percentage of Wholesale Distribution net sales, cost of sales
was 91.9% and 91.3% for the 2012 and 2011 Periods, respectively.
22
--------------------------------------------------------------------------------
Table of Contents
· The change in product and customer sales mix resulted in a 0.2% increase
in cost of sales as a percent of Wholesale Distribution net
sales in the
2012 Period compared to the 2011 Period.
· Vendor related activity resulted in a 0.4% increase in cost of sales as
a percent of Wholesale Distribution net sales in the 2012 Period
compared to the 2011 Period. This was comprised of declines in inventory
holding gains (realized upon sale) and changes in vendor marketing
activity.
· Insurance Segment: Cost of sales primarily consists of claims loss and
loss adjustment expenses, underwriting expenses, commissions, premium taxes
and regulatory fees. Cost of sales increased $2.3 million to $2.7 million
in the 2012 Period compared to $0.4 million in the 2011 Period. The
increase is primarily due to additional claims exposure related to new
workers' compensation policies written during the 2012 Period. The cost of
insurance and the adequacy of loss reserves are impacted by actuarial
estimates based on a detailed analysis of health care cost trends, claims
history, demographics and industry trends. As a result, the amount of loss
reserves and future expenses is significantly affected by these variables
and may significantly change, depending on the cost of providing benefits
and the results of further legislative action. See additional discussion
related to insurance reserves under "Risk Factors - Our insurance reserves
may be inadequate if unexpected losses occur."
Distribution, selling and administrative expenses. Consolidated distribution,
selling and administrative expenses were $70.6 million in the 2012 Period
compared to $73.7 million in the 2011 Period, reflecting a decrease of $3.1
million, and comprised 7.5% and 7.6% of net sales for the 2012 and 2011 Periods,
respectively. Factors impacting distribution, selling and administrative
expenses are as follows:
· Wholesale Distribution Segment: Distribution, selling and administrative
expenses decreased $3.2 million to $68.5 million in the 2012 Period
compared to $71.7 million in the 2011 Period, and comprised 7.3% and 7.4%
of Wholesale Distribution net sales for the 2012 and 2011 Periods,
respectively.
· Member Settlement: During the 2012 Period, distribution, selling and
administrative expenses increased $3.4 million, or 0.3% as a percent of
Wholesale Distribution net sales, resulting from settlement proceeds
recorded during the 2011 Period due to the loss of a significant Member.
See "Company Overview - Sales Highlights and Other Information - Fiscal
2011" discussed in Part II, Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations" ofour Annual
Report on Form 10-K for the year ended October 1, 2011 for
additional
information.
· Officers' Life Insurance: During the 2012 Period, we experienced net
insurance expense increases of $0.8 million, or 0.1% as a
percent of
Wholesale Distribution net sales. This increase in expense is primarily
due to the decrease in the cash surrender value of our life
insurance
policy assets, which are held in a rabbi trust to support
post-termination retirement benefits and are not available for general
corporate purposes. The changes in our policy assets are a
result of
changes in the fair value of the underlying securities, which are highly
concentrated in U.S. equity markets and priced based on readily
determinable market values.
· Fuel Expense: During the 2012 Period, we experienced diesel fuel
expense decreases of $0.6 million, or 0.1% as a percent ofWholesale
Distribution net sales. This decrease is primarily due to the decrease
in the cost of oil.
· General Expenses: General expenses decreased $6.8 million, or 0.4% as a
percent of Wholesale Distribution net sales, due primarily to our
continued focus on cost containment, including employee-related
expenses.
· Insurance Segment: Selling and administrative expenses for the Insurance segment increased $0.1 million to $1.9 million for the 2012 Period compared
to $1.8 million for the 2011 Period.
· All Other: Selling and administrative expenses for our All Other business activities were $0.2 million in both the 2012 and 2011 Periods.
23
--------------------------------------------------------------------------------
Table of Contents
Interest. Interest expense increased $0.2 million to $3.3 million compared to
$3.1 million for the 2011 Period and comprised 0.3% of consolidated net sales
for both the 2012 and 2011 Periods. Factors impacting interest expense are as
follows:
· Interest expense on our primary debt instruments (as described below)
increased $0.3 million to $3.1 million in the 2012 Period compared to $2.8
million in the 2011 Period.
· Weighted Average Borrowings: Interest expense decreased marginally from
the 2011 Period as a result of lower outstanding debt. Weighted average
borrowings decreased by $4.7 million primarily due to decreased
inventory levels during the 2012 Period.
· Interest Rates: Interest expense increased $0.3 million from the 2011
Period. Our effective borrowing rate for the combined primarydebt, made
up of the revolving lines of credit for Unified and Grocers Capital
Company, and senior secured notes, was 4.7% and 4.3% for the 2012 and
2011 Periods, respectively. The rate increase was due to a higher
effective rate on Unified's revolving line of credit.
Borrowings on Unified's revolving credit agreement are subject to market rate
fluctuations. A 25 basis point change in the market rate of interest over the
period would have resulted in a $0.1 million increase or decrease in
corresponding interest expense.
· Interest expense on our other debt instruments decreased $0.1 million to
$0.2 million for the 2012 Period compared to $0.3 million for the 2011
Period.
Estimated patronage dividends. Estimated patronage dividends for the 2012
Period were $4.4 million, compared to estimated patronage dividends of $7.8
million in the 2011 Period. Patronage dividends for the 2012 and 2011 Periods
consisted of the patronage activities from our three patronage earnings
divisions: the Southern California Dairy Division, the Pacific Northwest Dairy
Division and the Cooperative Division. For the 2012 and 2011 Periods,
respectively, we had patronage earnings of $2.3 million and $2.5 million in the
Southern California Dairy Division, $0.2 million and $0.3 million in the Pacific
Northwest Dairy Division and patronage earnings of $1.9 million and $5.0 million
in the Cooperative Division. The decrease in the Cooperative Division patronage
earnings for the 2012 Period was primarily due to a change in sales mix towards
lower margin products, decreased inventory holding gains and lower net sales,
partially offset by a decline in distribution, selling and administrative
expenses. Patronage dividends produced by the Cooperative Division are
distributed annually, historically in cash, Class B and Class E Shares (see Part
I, Item 1. "Business - Patronage Dividends" of our Annual Report on Form 10-K
for the year ended October 1, 2011 for additional information), while patronage
dividends produced by the dairy divisions are paid quarterly, historically in
cash.
Income taxes. Our effective income tax rate was 30.4% for the 2012 Period
compared to 28.4% for the 2011 Period. The lower than statutory rate for the
2012 and 2011 Periods was due to favorable returns on our corporate-owned life
insurance policies for the 2012 and 2011 Periods. Gains and losses in the value
of corporate-owned life insurance are included in net earnings, but are not
subject to income taxes.
THIRTY-NINE WEEK PERIOD ENDED JUNE 30, 2012 ("2012 PERIOD") COMPARED TO THE
THIRTY-NINE WEEK PERIOD ENDED JULY 2, 2011 ("2011 PERIOD")
Overview of the 2012 Period. We experienced an overall net sales decrease of
$24.2 million, or 0.8%, to $2.858 billion for the 2012 Period as compared to
$2.883 billion for the 2011 Period. Our net sales for the Wholesale Distribution
segment decreased $29.1 million, or 1.0%, for the comparable 2012 and 2011
Periods. We achieved higher sales to our continuing customers; however, those
sales improvements were offset by the loss of sales due to lost customers,
including the loss of one of our top ten customers in the third quarter of
fiscal 2011, and store closures. Net sales in our Insurance segment and our All
Other business activities increased $4.5 million and $0.4 million, respectively,
for the comparable thirty-nine week periods.
Our consolidated operating income decreased $8.6 million to $21.8 million in the
2012 Period compared to $30.4 million in the 2011 Period.
24
--------------------------------------------------------------------------------
Table of Contents
The overall decrease in operating income is summarized in our operating segments
and other business activities as follows:
· Wholesale Distribution Segment: The Wholesale Distribution segment's
operating income decreased $7.9 million to $19.5 million in the 2012 Period
compared to $27.4 million in the 2011 Period. This decrease in earnings was
primarily due to a change in sales mix towards lower margin products and
decreased inventory holding gains, partially offset by a decline in
distribution, selling and administrative expenses.
· Insurance Segment: Operating income decreased $1.0 million in our
Insurance segment to $2.0 million in the 2012 Period compared to $3.0 million in the 2011 Period. This decrease was primarily due to additional
claims exposure related to new workers' compensation policies written
during the 2012 Period.
· All Other: Operating income increased $0.3 million in our All Other business activities to $0.3 million in the 2012 Period compared to an
insignificant loss in the 2011 Period. All Other business activities
primarily consist of activities conducted through our finance subsidiary.
The following tables summarize the performance of each business segment for the
2012 and 2011 Periods.
Wholesale Distribution Segment
(dollars in thousands)
Thirty-Nine Weeks Ended Thirty-Nine Weeks Ended
June 30, 2012 July 2, 2011
Amounts in Percent to Amounts in Percent to
000's Net Sales 000's Net Sales Difference
Gross sales $ 2,843,085 - $ 2,872,181 - $ (29,096 )
Inter-segment eliminations - - - - -
Net sales 2,843,085 100.0 % 2,872,181 100.0 % (29,096 )
Cost of sales 2,611,252 91.8 2,623,879 91.4 (12,627 )
Distribution, selling and
administrative expenses 212,399 7.5 220,923 7.7 (8,524 )
Operating income $ 19,434 0.7 % $ 27,379 0.9 % $ (7,945 )
Insurance Segment
(dollars in thousands)
Thirty-Nine Weeks Ended Thirty-Nine Weeks Ended
June 30, 2012 July 2, 2011
Amounts in Percent to Amounts in Percent to
000's Net Sales 000's Net Sales Difference
Gross sales - premiums earned and
investment income $ 22,980 - $ 19,458 - $ 3,522
Inter-segment eliminations (8,595 ) - (9,588 ) - 993
Net sales - premiums earned and
investment income 14,385 100.0 % 9,870 100.0 % 4,515
Cost of sales - underwriting
expenses 6,665 46.3 1,331 13.5 5,334
Selling and administrative
expenses 5,682 39.5 5,478 55.5 204
Operating income $ 2,038 14.2 % $ 3,061 31.0 % $ (1,023 )
25
--------------------------------------------------------------------------------
Table of Contents
All Other
(dollars in thousands)
Thirty-Nine Weeks Ended Thirty-Nine Weeks Ended
June 30, 2012 July 2, 2011
Amounts in Percent to Amounts in Percent to
000's Net Sales 000's Net Sales Difference
Gross sales $ 984 - $ 729 - $ 255
Inter-segment eliminations (95 ) - (185 ) - 90
Net sales 889 100.0 % 544 100.0 % 345
Selling and administrative expenses 593 66.7 583 107.2 10
Operating income (loss) $ 296 33.3 % $ (39 ) (7.2 )% $ 335
Net sales. Consolidated net sales decreased $24.2 million, or 0.8%, to $2.858
billion in the 2012 Period compared to $2.883 billion for the 2011 Period.
Factors impacting net sales are as follows:
· Wholesale Distribution Segment: Wholesale Distribution net sales decreased
$29.1 million, or 1.0%, to $2.843 billion in the 2012 Period compared to
$2.872 billion for the 2011 Period. Significant movements are summarized
below.
(dollars in millions)
Key Net Sales Changes Increase (Decrease)
Increase in net sales to continuing customers $ 103.2
Loss of significant Member in May 2011 (87.2 )
Other lost customers, net (14.9 )
Store closures (30.2 )
Change in net sales $ (29.1 )
· Insurance Segment: Net sales, consisting principally of premium revenues
and investment income, increased $4.5 million to $14.4 million in the 2012
Period compared to $9.9 million for the 2011 Period. The increase is
primarily due to an increase in workers' compensation premium revenue
resulting from the addition of new policyholders and increased renewal
premiums.
· All Other: Net sales increased $0.4 million to $0.9 million in the 2012 Period compared to $0.5 million in the 2011 Period.
Cost of sales (including underwriting expenses). Consolidated cost of sales was
$2.618 billion for the 2012 Period and $2.625 billion for the 2011 Period and
comprised 91.6% and 91.1% of consolidated net sales for the 2012 and 2011
Periods, respectively. Factors impacting cost of sales are as follows:
· Wholesale Distribution Segment: Cost of sales decreased by $12.6 million
to $2.611 billion in the 2012 Period compared to $2.624 billion in the 2011
Period. As a percentage of Wholesale Distribution net sales, cost of sales
was 91.8% and 91.4% for the 2012 and 2011 Periods, respectively.
· The change in product and customer sales mix resulted in a 0.3% increase
in cost of sales as a percent of Wholesale Distribution netsales in the
2012 Period compared to the 2011 Period.
· Vendor related activity contributed to a 0.1% increase in cost of sales
as a percent of Wholesale Distribution net sales in the 2012 Period
compared to the 2011 Period. This change was driven by adecrease in
inventory holding gains (realized upon sale) due to a lack of vendor
price increases and changes in vendor marketing activity.
· Insurance Segment: Cost of sales primarily consists of claims loss and
loss adjustment expenses, underwriting expenses, commissions, premium taxes
and regulatory fees. Cost of sales increased $5.3 million to $6.6 million
in the 2012 Period compared to $1.3 million in the 2011 Period. The
increase is primarily due to additional claims exposure related to new
workers' compensation policies written during the 2012 Period. The cost of
insurance and the adequacy of loss reserves are impacted by actuarial
estimates based on a detailed analysis of health care cost trends, claims
history, demographics and
26
--------------------------------------------------------------------------------
Table of Contents
industry trends. As a result, the amount of loss reserves and future
expenses is significantly affected by these variables and may significantly
change, depending on the cost of providing benefits and the results of
further legislative action. See additional discussion related to insurance
reserves under "Risk Factors - Our insurance reserves may be inadequate if
unexpected losses occur."
Distribution, selling and administrative expenses. Consolidated distribution,
selling and administrative expenses were $218.7 million in the 2012 Period
compared to $227.0 million in the 2011 Period, reflecting a decrease of $8.3
million, and comprised 7.7% and 7.9% of net sales for the 2012 and 2011 Periods,
respectively. Factors impacting distribution, selling and administrative
expenses are as follows:
· Wholesale Distribution Segment: Distribution, selling and administrative
expenses decreased $8.5 million to $212.4 million in the 2012 Period
compared to $220.9 million in the 2011 Period, and comprised 7.5% and 7.7%
of Wholesale Distribution net sales for the 2012 and 2011 Periods,
respectively.
· Member Settlement: During the 2012 Period, distribution, selling and
administrative expenses increased $3.4 million, or 0.1% as a percent of
Wholesale Distribution net sales, resulting from settlement proceeds
recorded during the 2011 Period due to the loss of a significant Member.
See "Company Overview - Sales Highlights and Other Information - Fiscal
2011" discussed in Part II, Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations" ofour Annual
Report on Form 10-K for the year ended October 1, 2011 for
additional
information.
· General Expenses: General expenses decreased $11.9 million, or 0.3% as
a percent of Wholesale Distribution net sales, due primarily to our
continued focus on cost containment, including employee-related
expenses.
· Insurance Segment: Selling and administrative expenses for the Insurance segment increased $0.2 million to $5.7 million for the 2012 Period compared
to $5.5 million for the 2011 Period.
· All Other: Selling and administrative expenses for our All Other business activities were $0.6 million in both the 2012 and 2011 Periods.
Interest. Interest expense was $9.4 million and comprised 0.3% of consolidated
net sales for both the 2012 and 2011 Periods. Factors impacting interest expense
are as follows:
· Interest expense on our primary debt instruments (as described below)
increased $0.1 million to $8.7 million in the 2012 Period compared to $8.6
million in the 2011 Period.
· Weighted Average Borrowings: Interest expense increased $0.2 million
from the 2011 Period as a result of higher outstanding debt. Weighted
average borrowings increased by $7.3 million primarily due to increased
inventory levels during the 2012 Period as compared to the 2011 Period.
· Interest Rates: Interest expense decreased $0.1 million from the 2011
Period due to a decrease in our effective borrowing rate. Our effective
borrowing rate for the combined primary debt, made up of the revolving
lines of credit for Unified and Grocers Capital Company, and senior
secured notes, was 4.4% and 4.5% for the 2012 and 2011 Periods,
respectively. The rate decrease was due to a lower proportion of the
senior secured notes in the primary debt.
Borrowings on Unified's revolving credit agreement are subject to market rate
fluctuations. A 25 basis point change in the market rate of interest over the
period would have resulted in a $0.3 million increase or decrease in
corresponding interest expense.
· Interest expense on our other debt instruments decreased $0.1 million to
$0.7 million for the 2012 Period compared to $0.8 million for the 2011
Period.
Estimated patronage dividends. Estimated patronage dividends for the 2012
Period were $8.0 million, compared to $10.9 million in the 2011 Period.
Patronage dividends for the 2012 and 2011 Periods consisted of the patronage
activities from our three patronage earnings divisions: the Southern California
Dairy Division, the Pacific Northwest Dairy Division and the Cooperative
Division. For the 2012 and 2011 Periods, respectively, we had patronage earnings
of $7.3 million and $8.2 million in the Southern California Dairy Division, $0.8
million and $1.1 million in the Pacific Northwest Dairy Division and patronage
losses of $0.1 million and patronage earnings of $1.6
27
--------------------------------------------------------------------------------
Table of Contents
million in the Cooperative Division. The decrease in the Cooperative Division
patronage earnings for the 2012 Period was primarily due to a change in sales
mix towards lower margin products, decreased inventory holding gains and lower
net sales, partially offset by a decline in distribution, selling and
administrative expenses. Patronage dividends produced by the Cooperative
Division are distributed annually, historically in cash, Class B and Class E
Shares (see Part I, Item 1. "Business - Patronage Dividends" of our Annual
Report on Form 10-K for the year ended October 1, 2011 for additional
information), while patronage dividends produced by the dairy divisions are paid
quarterly, historically in cash.
Income taxes. Our effective income tax rate was 23.4% for the 2012 Period
compared to 30.1% for the 2011 Period. The lower rate for the 2012 Period is due
to lower book income and similar favorable returns on our corporate-owned life
insurance policies for the 2012 Period as compared to the 2011 Period. Gains and
losses in the value of corporate-owned life insurance are included in net
earnings, but are not subject to income taxes.
LIQUIDITY AND CAPITAL RESOURCES
We finance our capital needs through a combination of internal and external
sources. These sources include cash flows from operations, Member capital and
other Member investments, bank borrowings, various types of long-term debt and
lease financing.
The acquisition, holding and redemption of our capital shares and making of
deposits by our Members, and our policies with respect to such matters, can
significantly affect our liquidity and capital resources. Our Bylaws, which may
be changed by the Board at its discretion, currently require that each Member
own 350 Class A Shares. In addition, we currently require each Member to own
such amount of Class B Shares as may be established by the Board. This
requirement to own Class B Shares is referred to as the "Class B Share
Requirement." Members who do not satisfy the Class B Share Requirement solely
from their holdings of Class B Shares are generally required to make a
subordinated deposit (a "Required Deposit") with us. Member and Non-Member
customers may be required to provide us a Credit Deposit in order to purchase
products on credit terms established by us. "Credit Deposit" means any
non-subordinated deposit that is required to be maintained by a Member or
Non-Member customer in accordance with levels established by our credit office
from time to time in excess of the amount of the Required Deposit set by the
Board. We do not pay interest on Required Deposits or Credit Deposits; however,
interest is paid at the prime rate for deposits in excess of a Member's Required
Deposit or Credit Deposit (an "Excess Deposit"). See Part I, Item 1. "Business -
Capital Shares," Part I, Item 1. "Business - Customer Deposits" and Part I,
Item 1. "Business - Pledge of Shares and Guarantees" of our Annual Report on
Form 10-K for the year ended October 1, 2011 for additional information.
Additionally, see "DESCRIPTION OF DEPOSIT ACCOUNTS" in our Amendment No. 2 to
Registration Statement on Form S-1 filed on April 19, 2012, with respect to our
offering of Partially Subordinated Patrons' Deposit Accounts and see "OFFERING
OF CLASS A, CLASS B AND CLASS E SHARES" in our Amendment No. 2 to Registration
Statement on Form S-1 filed on April 19, 2012, with respect to our offering of
Class A, Class B and Class E Shares for further information.
At June 30, 2012, we had $0.2 million of tendered Class A Shares and $17.9
million of tendered Class B Shares pending redemption, whose redemption is
subject to final approval by the Board, and in the case of Class B Shares,
subject to the 5% limitation on redemptions contained in our redemption policy
(see "DESCRIPTION OF CAPTIAL STOCK - Redemption Policy" in our Amendment No. 2
to Registration Statement on Form S-1 filed on April 19, 2012, with respect to
our offering of Class A, Class B and Class E Shares for further information).
Our obligations to repay a Member's Required Deposit on termination of Member
status (once the Member's obligations to us have been satisfied) is reported as
a long-term liability within "Members and Non-Members' deposits" on our
consolidated condensed balance sheets. Excess Deposits are not subordinated to
our other obligations and are reported as short-term liabilities within
"Members' deposits and estimated patronage dividends" on our consolidated
condensed balance sheets. At June 30, 2012 and October 1, 2011, we had $9.3
million and $6.0 million, respectively, in "Members and Non-Members' deposits"
and $12.2 million and $13.4 million, respectively, in "Members' deposits and
estimated patronage dividends" (of which $11.0 million and $10.8 million,
respectively, represented Excess Deposits).
We believe that the combination of cash flows from operations, current cash
balances and available lines of credit will be sufficient to service our debt,
redeem Members' capital shares, make income tax payments and meet our
anticipated needs for working capital and capital expenditures through at least
the next three fiscal years.
28
--------------------------------------------------------------------------------
Table of Contents
CASH FLOW
We generated positive cash flow from operating activities during the thirty-nine
week 2012 Period. Cash from operations was used for investing and financing
activities, including investing in our infrastructure. We also reinvested
proceeds from maturing investments. Cash was also used for certain financing
activities, including redemption of Members' capital shares.
As a result of these activities, net cash, consisting of cash and cash
equivalents, increased by $4.3 million to $9.4 million as of June 30, 2012
compared to $5.1 million as of October 1, 2011.
The following table summarizes the impact of operating, investing and financing
activities on our cash flows for the thirty-nine week 2012 and 2011 Periods:
(dollars in thousands)
Summary of Net Increase in Total Cash 2012 2011
Difference
Cash provided by operating activities $ 41,616 $ 21,349 $ 20,267
Cash utilized by investing activities (21,682 ) (11,120 ) (10,562 )
Cash utilized by financing activities (15,589 ) (6,089 ) (9,500 )
Total increase in cash $ 4,345 $ 4,140 $ 205
Net cash flows from operating, investing and financing activities increased by
$0.2 million, resulting in a $4.3 million increase in cash for the 2012 Period
compared to an increase of $4.1 million in cash for the 2011 Period. The
increase in net cash flow for the 2012 Period consisted of cash provided by
operating activities of $41.6 million, offset by cash used in investing
activities of $21.7 million and financing activities of $15.6 million. The
primary factors contributing to the changes in cash flow are discussed below. At
June 30, 2012 and October 1, 2011, working capital was $183.0 million and $193.0
million, respectively, and the current ratio was 1.7 for each respective
period-end date.
Operating Activities: Net cash provided by operating activities increased by
$20.3 million to $41.6 million provided in the 2012 Period compared to $21.3
million provided in the 2011 Period. The increase in cash provided by operating
activities compared to the 2011 Period was attributable to (1) an increase
between the periods in net cash flows related to decreased inventories of $26.1
million, (2) a decrease between the periods in cash used to pay accounts payable
and accrued liabilities of $8.9 million, and (3) an increase in long-term
liabilities, other between the periods of $0.3 million primarily attributable to
an increase in pension and postretirement liabilities. The foregoing increases
of $35.3 million in cash provided were partially offset by (1) an increase in
accounts receivable during the 2012 Period compared to a decrease in the 2011
Period, resulting in a decrease in cash provided between the periods of $11.0
million, (2) an increase between the periods in cash used to fund pension plan
contributions of $1.7 million, (3) an increase between the periods related to
prepaid expenses of $1.5 million, and (4) an increase between the periods in net
cash used by other operating activities of $0.8 million.
Investing Activities: Net cash utilized by investing activities increased by
$10.6 million to $21.7 million for the 2012 Period compared to $11.1 million in
the 2011 Period. The increase in cash utilized by investing activities during
the 2012 Period as compared to the 2011 Period was due mainly to (1) an increase
in capital expenditures between the periods of $4.2 million as a result of the
purchase of a warehouse adjacent to our Stockton facility, (2) an increase of
$1.0 million in net investment activities by our insurance subsidiaries,
consisting of the purchase and sale of securities to replace maturing
investments in their portfolios, (3) an increase in cash used for net notes
receivable activities of $1.7 million, reflecting normal fluctuation in loan
activity to Members for their inventory and equipment financing, and (4) an
increase in other assets between the periods of $3.7 million, primarily related
to the changes in value between the periods of our mutual fund and life
insurance policy assets. Spending on investing activities is expected to be
funded by existing cash balances, cash generated from operations or additional
borrowings.
Financing Activities: Net cash utilized by financing activities was $15.6
million for the 2012 Period compared to $6.1 million in the 2011 Period. The net
increase of $9.5 million in cash utilized by financing activities for the 2012
Period as compared to the 2011 Period was due to an increase in cash utilized of
$14.1 million related to changes in our long-term and short-term notes payable
and deferred financing fees. See "Outstanding Debt and
29
--------------------------------------------------------------------------------
Table of Contents
Other Financing Arrangements" for further discussion regarding our credit
facilities and financing arrangements. The increase in cash utilized by debt
financing activities was partially offset by decreased cash utilized by Member
investment and share activity of $4.6 million. Future cash used by financing
activities to meet capital spending requirements is expected to be funded by our
continuing operating cash flow or additional borrowings.
OFF-BALANCE SHEET ARRANGEMENTS
As of the date of this report, we do not participate in transactions that
generate relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually, narrow or limited
purposes.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
There have been no material changes in our contractual obligations and
commercial commitments outside the ordinary course of our business during the
thirty-nine week period ended June 30, 2012. See "Contractual Obligations and
Commercial Commitments" discussed in Part II, Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations" of our Annual
Report on Form 10-K for the year ended October 1, 2011 for additional
information.
OUTSTANDING DEBT AND OTHER FINANCING ARRANGEMENTS
As discussed below, we entered into amendments with both of our senior lenders
in June 2012 to provide temporary adjustments on certain loan covenants. The
changes were pursued to provide flexibility due to the volatility and
uncertainty associated with the prevailing economic environment. Other than
discussed below, there have been no material changes in our outstanding debt and
other financing arrangements outside the ordinary course of our business during
the thirty-nine week period ended June 30, 2012. Amounts outstanding related to
our secured revolving credit agreement, senior secured notes and Member
financing arrangement are disclosed below. See "Outstanding Debt and Other
Financing Arrangements" discussed in Part II, Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and Note 5 "Notes
Payable" of "Notes to Consolidated Financial Statements" in Part II, Item 8.
"Financial Statements and Supplementary Data" of our Annual Report on Form 10-K
for the year ended October 1, 2011 for additional information.
Secured Revolving Credit Agreement
In fiscal 2011, we entered into a Credit Agreement (the "Agreement") with the
lenders party thereto and Wells Fargo Bank, National Association, as
Administrative Agent. The Agreement replaced our previous revolving credit
agreement, with substantially the same parties, terms and conditions. The
Agreement expires on October 8, 2015, and refinanced existing indebtedness and
finances capital expenditures, working capital needs, potential acquisitions and
general corporate purposes.
Outstanding borrowings under the Agreement decreased to $97.3 million at
June 30, 2012 (Eurodollar and Base Rate Loans at a blended average rate of
2.27% per annum) from $108.3 million at October 1, 2011 (Eurodollar and Base
Rate Loans at a blended average rate of 1.89% per annum), with access to
approximately $177.7 million of additional capital available under the Agreement
to fund our continuing operations and capital spending requirements for the
foreseeable future.
On June 19, 2012, we entered into the second amendment (the "Second Amendment")
of the Agreement. The Second Amendment raises the Consolidated Total Funded Debt
to EBITDAP ratio (as defined) of the Company allowed by the financial covenants
to be no higher than 4.0 to 1 for the fiscal quarters ended June 30 and
September 29, 2012, after which it returns to 3.5 to 1, and sets forth a 0.5%
increase in the interest rates to be charged if the ratio is greater than 3.5 to
1.
Senior Secured Notes
At June 30, 2012 and October 1, 2011, respectively, we had a total of $105.8
million and $108.5 million outstanding in senior secured notes to certain
insurance companies and pension funds (referred to collectively as "John Hancock
Life Insurance Company" or "Hancock") under a note purchase agreement dated
September 29, 1999 (as amended, the "Senior Note Agreement") as amended and
restated effective January 6, 2006 and further amended on November 3, 2009.
30
--------------------------------------------------------------------------------
Table of Contents
On June 29, 2012, we entered into the fourth amendment (the "Fourth Amendment")
to the Senior Note Agreement. The Fourth Amendment (1) amends the covenant on
Indebtedness to Consolidated EBITDAP ratio (as defined) to allow for a ratio of
4.0 to 1 for the fiscal quarters ended June 30 and September 29, 2012, after
which it is reduced to 3.75 to 1 for the fiscal quarters ended December 29, 2012
and March 30, 2013, 3.5 to 1 for the fiscal quarter ended June 29, 2013 and 3.25
to 1 for all fiscal quarters thereafter, (2) sets forth the increase in the
interest rates to be charged based on the Indebtedness to Consolidated EBITDAP
ratio (0.5% if the ratio is greater than 3.5 to 1 but less than 3.75 to 1, and
1.5% if the ratio is equal to or greater than 3.75 to 1), (3) amends the
debt-to-capital covenant to permit a ratio of Consolidated Adjusted Indebtedness
to Consolidated Adjusted Indebtedness plus Consolidated Tangible Net Worth (as
defined) of no higher than 65% from the beginning of the third fiscal quarter of
the Company's fiscal 2012 through the end of the first fiscal quarter of the
Company's fiscal 2014, after which the ratio returns to 60%, and (4) adds an
additional covenant providing that the Company's Consolidated Lease Expense (as
defined) for the fiscal quarter ended September 29, 2012 and subsequent fiscal
quarters may not exceed $7.5 million for the quarter.
Copies of the Second Amendment and the Fourth Amendment are attached hereto as
Exhibit 10.1 and Exhibit 10.2, respectively, and are incorporated herein by this
reference. The foregoing description of the Second Amendment and the Fourth
Amendment does not purport to be complete and is qualified in its entirety by
reference to the exhibits.
Member Financing Arrangement
In fiscal 2010, our wholly-owned finance subsidiary, Grocers Capital Company
("GCC"), entered into a Loan and Security Agreement (the "GCC Loan Agreement"),
by and among GCC, the lenders signatory thereto and California Bank & Trust, as
Arranger and Administrative Agent. The GCC Loan Agreement matures on
September 24, 2013, and the proceeds therefrom will be used to fund loans to our
customers and for GCC's general corporate purposes, including customary
financing and operating activities. The GCC Loan Agreement provides for
revolving loans and term loans. GCC had revolving loan borrowings of $15.0
million and $13.0 million, both bearing an interest rate of 4.00% (3.25% prime
plus 0.75% interest rate margin), outstanding at June 30, 2012 and October 1,
2011, respectively. There were no term loan borrowings outstanding at June 30,
2012 and October 1, 2011.
REDEMPTION OF CAPITAL STOCK
Our Articles of Incorporation and Bylaws provide that the Board has the absolute
discretion to repurchase, or not repurchase, any Class A, Class B or Class E
Shares of any outgoing Member regardless of when the membership terminated, and
any Class B Shares in excess of the Class B Share Requirement held by a current
Member, whether or not the shares have been tendered for repurchase and
regardless of when the shares were tendered. The Board considers the redemption
of eligible Class A Shares at each board meeting. All other shares eligible for
redemption are considered by the Board on an annual basis, usually in December.
Class E Shares will only be redeemed upon approval of the Board or upon sale or
liquidation of the Company. The Class E Shares, when redeemed, will be redeemed
at their stated value of $100 per share. The following table presents our
redemption of Class A and Class B Shares during the thirty-nine weeks ended
June 30, 2012:
Number of Shares Approximate Value of Shares
Share Class Date of Redemption Redeemed Redeemed
Class A October 10, 2011 2,800 $ 0.9 million
Class A December 29, 2011 700 $ 0.2 million
Class B December 27, 2011 10,658 $ 3.2 million
Class B January 17, 2012 16 $ 5 thousand
Class B January 30, 2012 207 $ 0.1 million
Class A February 24, 2012 2,100 $ 0.6 million
Class B March 08, 2012 677 $ 0.2 million
Class A May 31, 2012 700 $ 0.2 million
Class A June 27, 2012 2,450 $ 0.8 million
See Part I, Item 1. "Business - Capital Shares - Classes of Shares" and Part I,
Item 1. "Business - Capital Shares - Redemption of Class A, Class B and Class E
Shares" of our Annual Report on Form 10-K for the year ended October 1, 2011 for
additional information.
31
--------------------------------------------------------------------------------
Table of Contents
PENSION AND POSTRETIREMENT BENEFIT PLANS
We sponsor a cash balance plan ("Unified Cash Balance Plan"). The Unified Cash
Balance Plan is a noncontributory defined benefit pension plan covering
substantially all of our employees who are not subject to a collective
bargaining agreement. Under the Unified Cash Balance Plan, participants are
credited with an annual accrual based on their years of service with us. Our
funding policy is to make contributions to the Unified Cash Balance Plan in
amounts that are at least sufficient to meet the minimum funding requirements of
applicable laws and regulations, but no more than amounts deductible for federal
income tax purposes. All of our qualifying employees not subject to a collective
bargaining agreement accrue benefits pursuant to the Unified Cash Balance Plan.
We also sponsor an Executive Salary Protection Plan ("ESPP") for our executive
officers that provides supplemental post-termination retirement income based on
each participant's salary and years of service as an officer with us. Funds are
held in a rabbi trust for the ESPP consisting primarily of life insurance
policies tied to underlying investments in the equity market (reported at cash
surrender value) and mutual fund assets consisting of various publicly-traded
mutual funds (reported at estimated fair value based on quoted market prices).
We sponsor other postretirement benefit plans that provide certain medical
coverage to retired non-union employees and provide unused sick leave benefits
for certain eligible non-union and union employees. Those plans are not funded.
Our net periodic benefit cost for our combined pension and other postretirement
benefits was approximately $11.8 million and $12.1 million for the thirty-nine
weeks ended June 30, 2012 and July 2, 2011, respectively.
We expect to make estimated contributions to the Unified Cash Balance Plan
totaling $12.9 million during fiscal 2012, which is comprised of $5.8 million
for the 2012 plan year and $7.1 million for the 2011 plan year. At our
discretion, we may contribute in excess of these amounts. Additional
contributions, if any, will be based, in part, on future actuarial funding
calculations and the performance of plan investments. We contributed $2.9
million and $5.1 million to the Unified Cash Balance Plan during the thirty-nine
weeks ended June 30, 2012 for the 2012 and 2011 plan years, respectively.
During July 2012, legislation to provide pension funding relief was enacted as
part of the 2012 student loan and transportation legislation titled "Moving
Ahead for Progress in the 21st Century" ("MAP-21"). Funding relief is to be
achieved through changes in the methodology employed to determine interest rates
used to calculate required funding contributions. The funding relief applies to
Employee Retirement Income Security Act ("ERISA") single-employer plans that
base pension liability calculations on interest rates determined pursuant to the
Patient Protection and Affordable Care Act and is predicted to reduce 2012
contribution requirements for typical plans. We are currently assessing the
impact of the legislation on the minimum contribution amounts required to fund
the Unified Cash Balance Plan.
Additionally, we expect to contribute $0.7 million to the ESPP to fund projected
benefit payments to participants for the 2012 plan year. We contributed $0.6
million to the ESPP during the thirty-nine weeks ended June 30, 2012 to fund
benefit payments to participants for the 2012 plan year.
During fiscal year 2010, comprehensive health care reform legislation under the
Patient Protection and Affordable Care Act (HR 3590) and the Health Care
Education and Affordability Reconciliation Act(HR 4872) (collectively, the
"Acts") was passed and signed into law. The Acts contain provisions that could
impact our accounting for retiree medical benefits in future periods. However,
the extent of that impact, if any, cannot be determined until regulations are
promulgated under the Acts and additional interpretations of the Acts become
available. We will continue to assess the accounting implications of the Acts as
related regulations and interpretations of the Acts become available. In
addition, we may consider plan amendments in future periods that may have
accounting implications. See Note 7 of "Notes to Consolidated Condensed
Financial Statements - Unaudited" in Part I, Item 1. "Financial Statements
(Unaudited)" of this Quarterly Report on Form 10-Q for additional discussion.
32
--------------------------------------------------------------------------------
Table of Contents
RISK FACTORS
The risks and uncertainties described below are those that we believe are the
material risks related to our business. If any of the following risks occur, our
business, prospects, financial condition, operating results and cash flows could
be adversely affected in amounts that could be material.
The markets in which we operate are highly competitive; characterized by high
volume and low profit margins, customer incentives (including pricing, variety
and delivery) and industry consolidation. The shifting of market share among
competitors is typical of the wholesale food business as competitors attempt to
increase sales in various markets. A significant portion of our sales are made
at low margins. As a result, our profit levels may be negatively impacted if we
are forced to respond to competitive pressure by reducing prices.
Increased competition has caused the industry to undergo changes as participants
seek to lower costs, further increasing pressure on the industry's already low
profit margins. In addition to price competition, food wholesalers also compete
with regard to quality, variety and availability of products offered, strength
of corporate label brands offered, schedules and reliability of deliveries and
the range and quality of services provided.
Continued consolidation in the industry, new entrants and trends toward vertical
integration could create additional competitive pressures that reduce margins
and adversely affect our business, financial condition and results of
operations.
We may experience reduced sales if Members lose market share to fully integrated
chain stores, warehouse stores and supercenters that have continued to gain
increased market share. These supercenters have benefited from concentrated
buying power and low-cost distribution technology, and have increasingly gained
market share at the expense of traditional supermarket operators, including some
independent operators, many of whom are our customers. The market share of such
alternative format stores may grow in the future, potentially resulting in a
loss of sales volume for us. A loss of sales volume could potentially cause
patronage dividends to be reduced and/or the Exchange Value Per Share (see Part
I, Item 1. "Business - Capital Shares - Ownership and Exchange of Shares" of our
Annual Report on Form 10-K for the year ended October 1, 2011) of our Class A
and Class B Shares to decrease.
We will continue to be subject to the risk of loss of Member and Non-Member
customer volume, including the potential concentration of credit risk. Our
operating results are highly dependent upon maintaining or growing our
distribution volume to our customers. Our largest customer, Smart & Final, Inc.,
a Non-Member customer, and our ten largest Member and Non-Member customers
(including Smart & Final, Inc.) constituted approximately 13% and 46%,
respectively, of our total net sales for the thirty-nine week period ended
June 30, 2012. A significant loss in membership or volume could adversely affect
our operating results. We will continue to be subject to the risks associated
with consolidation within the grocery industry. When independent retailers are
acquired by large chains with self-distribution capacity, are driven from
business by larger grocery chains, or become large enough to develop their own
self-distribution system, we will lose distribution volume. Members may also
select other wholesale providers. Reduced volume is normally injurious to
profitable operations since fixed costs must be spread over a lower sales volume
if the volume cannot be replaced.
In addition, we are exposed to concentrations of credit risk related primarily
to trade receivables, notes receivable and lease guarantees for certain Members.
Our ten customers with the largest accounts receivable balances accounted for
approximately 39% and 37% of total accounts receivable at June 30, 2012 and
October 1, 2011, respectively. These concentrations of credit risk may be
affected by changes in economic or other conditions affecting the western United
States, particularly Arizona, California, Nevada, Oregon and Washington.
Management believes that receivables are well diversified, and the allowances
for doubtful accounts are sufficient to absorb estimated losses. Further,
obligations of Members to the Company, including lease guarantees, are generally
supported by our right of offset, upon default, against the Members' cash
deposits and shareholdings, as well as personal guarantees and reimbursement and
indemnification agreements. Nevertheless, we could still suffer losses as a
result of our concentrated credit risk in the event of a significant adverse
change in economic or other conditions.
33
--------------------------------------------------------------------------------
Table of Contents
We may experience reduced sales if Members purchase directly from
manufacturers. Increased industry competitive pressure is causing some of our
Members that can qualify to purchase directly from manufacturers to increase
their level of direct purchases from manufacturers and expand their
self-distribution activities. Our operating results could be adversely affected
if a significant reduction in distribution volume occurred in the future as a
result of such a shift to direct purchases by our customers.
We are vulnerable to changes in general economic conditions. We are affected by
certain economic factors that are beyond our control, including changes in the
overall economic environment. In recent periods, we have experienced significant
volatility in the cost of certain commodities, the cost of ingredients for our
manufactured breads and processed fluid milk and the cost of packaged goods
purchased from other manufacturers. An inflationary economic period could impact
our operating expenses in a variety of areas, including, but not limited to,
employee wages and benefits, workers' compensation insurance and energy and fuel
costs. A portion of the risk related to employee wages and benefits is mitigated
by bargaining agreements that contractually determine the amount of inflationary
increases. General economic conditions also impact our pension plan liabilities,
as the assets funding or supporting these liabilities are invested in securities
that are subject to interest rate and stock market fluctuations. A portion of
our debt is at floating interest rates and an inflationary economic cycle
typically results in higher interest costs. We operate in a highly competitive
marketplace and passing on such cost increases to customers could be difficult.
It is also difficult to predict the effect that possible future purchased or
manufactured product cost decreases might have on our profitability. The effect
of deflation in purchased or manufactured product costs would depend on the
extent to which we had to lower selling prices of our products to respond to
sales price competition in the market. Consequently, it is difficult for us to
accurately predict the impact that inflation or deflation might have on our
operations. To the extent we are unable to mitigate increasing costs, or retain
the benefits from decreases in costs, patronage dividends may be reduced and/or
the Exchange Value Per Share of our Class A and Class B Shares may decrease.
Changes in the economic environment could adversely affect our customers'
ability to meet certain obligations to us or leave us exposed for obligations we
have guaranteed. Loans to Members, trade receivables and lease guarantees could
be at risk in a sustained economic downturn. We establish reserves for notes
receivable, trade receivables and lease commitments for which the customer may
be at risk for default. Under certain circumstances, we would be required to
foreclose on assets provided as collateral or assume payments for leased
locations for which we have guaranteed payment. Although we believe our reserves
to be adequate, our operating results could be adversely affected in the event
that actual losses exceed available reserves.
We may on occasion hold investments in the common and/or preferred stock of
Members and suppliers. These investments are generally held at cost or the
equity method and are periodically evaluated for impairment. As a result,
changes in the economic environment that adversely affect the business of these
Members and suppliers could result in the write-down of these investments. This
risk is unique to a cooperative form of business in that investments are made to
support Members' businesses, and those economic conditions that adversely affect
the Members can also reduce the value of our investment, and hence the Exchange
Value Per Share of our Class A and Class B Shares. We do not currently hold any
equity investments in our Members.
The United States economy and financial markets have declined and experienced
volatility due to uncertainties related to energy prices, availability of
credit, difficulties in the banking and financial services sectors, the decline
in the housing market, diminished market liquidity, falling consumer confidence
and high unemployment rates. As a result, consumers may be more cautious. This
may lead to additional reductions in consumer spending, to consumers trading
down to a less expensive mix of products or to consumers trading down to
discounters for grocery and non-food items, all of which may affect our
financial condition and results of operations. We are unable to predict when the
economy will improve. If the economy does not improve, our business, results of
operations and financial condition may be adversely affected.
Litigation could lead to unexpected losses. During the normal course of
carrying out our business, we may become involved in litigation. In the event
that management determines that the likelihood of an adverse judgment in a
pending litigation is probable and that the exposure can be reasonably
estimated, appropriate reserves are recorded at that time pursuant to FASB's
Accounting Standards Codification Topic 450, "Contingencies." The final outcome
of any litigation could adversely affect operating results if the actual
settlement amount exceeds established reserves and insurance coverage.
34
--------------------------------------------------------------------------------
Table of Contents
We are subject to environmental laws and regulations. We own and operate
various facilities for the manufacture, warehousing and distribution of products
to our customers. Accordingly, we are subject to increasingly stringent federal,
state and local laws, regulations and ordinances that (i) govern activities or
operations that may have adverse environmental effects, such as discharges to
air and water, as well as handling and disposal practices for solid and
hazardous wastes and (ii) impose liability for the costs of cleaning up, and
certain damages resulting from, past or present spills, disposals or other
releases of hazardous materials. In particular, under applicable environmental
laws, we may be responsible for remediation of environmental conditions and may
be subject to associated liabilities (including liabilities resulting from
lawsuits brought by private litigants) relating to our facilities and the land
on which our facilities are situated, regardless of whether we lease or own the
facilities or land in question and regardless of whether such environmental
conditions were created by us or by a prior owner or tenant. In addition, we may
be subject to pending federal and state legislation that if ultimately passed,
may require us to incur costs to improve facilities and equipment to reduce
emissions in order to comply with regulatory limits or to mitigate the financial
consequences of a "cap and trade" regime. We are unable to predict the ultimate
outcome of such legislation; however, should such legislation require us to
incur significant expenditures, our business, results of operations and
financial condition may be adversely affected.
We are exposed to potential product liability claims and potential negative
publicity surrounding any assertion that our products caused illness or
injury. The packaging, marketing and distribution of food products purchased
from others involve an inherent risk of product liability, product recall and
adverse publicity. Such products may contain contaminants that may be
inadvertently redistributed by us. These contaminants may result in illness,
injury or death if such contaminants are not eliminated. Accordingly, we
maintain stringent quality standards on the products we purchase from suppliers,
as well as products manufactured by us. We generally seek contractual
indemnification and insurance coverage from parties supplying products to us and
rigorously test our corporate brands and manufactured products to ensure our
quality standards are met. Product liability claims in excess of insurance
coverage, as well as the negative publicity surrounding any assertion that our
products caused illness, injury or death could have a material adverse effect on
our reputation, business, financial condition and results of operations.
Our insurance reserves may be inadequate if unexpected losses occur. Our
insurance subsidiaries are regulated by the State of California and are subject
to the rules and regulations promulgated by the appropriate regulatory agencies.
Insurance reserves are recorded based on estimates made by management and
validated by third party actuaries to ensure such estimates are within
acceptable ranges. Actuarial estimates are based on detailed analyses of health
care cost trends, claims history, demographics, industry trends and federal and
state law. As a result, the amount of reserve and related expense is
significantly affected by the outcome of these studies. Significant and adverse
changes in the experience of claims settlement and other underlying assumptions
could negatively impact our operating results.
We may not have adequate resources to fund our operations. We rely primarily
upon cash flow from our operations and Member investments to fund our operating
activities. In the event that these sources of cash are not sufficient to meet
our requirements, additional sources of cash are expected to be obtained from
our credit facilities to fund our daily operating activities. Our revolving
credit agreement, which expires on October 8, 2015, requires compliance with
certain financial covenants, including minimum tangible net worth, fixed charge
coverage ratio and total funded debt to earnings before interest, taxes,
depreciation, amortization and patronage dividends ("EBITDAP"). See Note 5 of
"Notes to Consolidated Financial Statements" in Part II, Item 8. "Financial
Statements and Supplementary Data" of our Annual Report on Form 10-K for the
year ended October 1, 2011 and "Outstanding Debt and Other Financing
Arrangements" in this Quarterly Report on Form 10-Q for additional information.
While we are currently in compliance with all required covenants and expect to
remain in compliance, this does not guarantee we will remain in compliance in
future periods.
As of June 30, 2012, we believe we have sufficient cash flow from operations and
availability under the revolving credit agreement to meet our operating needs,
capital spending requirements and required debt repayments through October 8,
2015. However, if access to operating cash or to the revolving credit agreement
becomes restricted, we may be compelled to seek alternate sources of cash. We
cannot assure that alternate sources will provide cash on terms favorable to us.
Consequently, the inability to access alternate sources of cash on terms similar
to our existing agreement could adversely affect our operations.
35
--------------------------------------------------------------------------------
Table of Contents
The value of our benefit plan assets and liabilities is based on estimates and
assumptions, which may prove inaccurate. Our non-union employees participate in
a Company sponsored defined benefit pension plan and Company sponsored
postretirement benefit plans. Certain eligible union and non-union employees
participate in separate plans providing payouts for unused sick leave. Our
officers also participate in a Company sponsored Executive Salary Protection
Plan ("ESPP"), which provides additional post-termination retirement income
based on each participant's salary and years of service as an officer of the
Company. The postretirement plans provide medical benefits for retired non-union
employees, life insurance benefits for retired non-union employees for which
active non-union employees are no longer eligible and lump-sum payouts for
unused sick days covering certain eligible union and non-union employees.
Liabilities for the ESPP and postretirement plans are not funded. We account for
these benefit plans in accordance with ASC Topic 715, "Compensation - Retirement
Benefits" and ASC Topic 712, "Compensation - Nonretirement Postemployment
Benefits," which require us to make actuarial assumptions that are used to
calculate the carrying value of the related assets, where applicable, and
liabilities and the amount of expenses to be recorded in our consolidated
financial statements. Assumptions include the expected return on plan assets,
discount rates, health care cost trend rate, projected life expectancies of plan
participants and anticipated salary increases. While we believe the underlying
assumptions are appropriate, the carrying value of the related assets and
liabilities and the amount of expenses recorded in the consolidated financial
statements could differ if other assumptions are used. See Note 11 of "Notes to
Consolidated Financial Statements" in Part II, Item 8. "Financial Statements and
Supplementary Data"of our Annual Report on Form 10-K for the year ended
October 1, 2011 for additional information.
The credit and liquidity crisis in the United States and throughout the global
financial system triggered substantial volatility in the world financial markets
and banking system. As a result, the investment portfolio of the Unified Cash
Balance Plan incurred a significant decline in fair value during fiscal 2008.
While the values of the investment portfolios of our defined benefit pension
plans increased during fiscal 2009 and 2010, they declined in fiscal 2011 and
reflected improvement for the thirty-nine weeks ended June 30, 2012, as the
values of the plans' individual investments have and will fluctuate in response
to changing market conditions, and the amount of gains or losses that will be
recognized in subsequent periods, if any, cannot be determined.
Authoritative accounting guidance may necessitate companies who issue and redeem
shares based on book value to redefine the method used to value their
shares. Authoritative accounting guidance that requires adjustments to
shareholders' equity has the potential to impact companies whose equity
securities are issued and redeemed at book value ("book value companies")
disproportionately more than companies whose share values are market-based
("publicly traded"). While valuations of publicly traded companies are primarily
driven by their income statement and cash flows, the traded value of the shares
of book value companies, however, may be immediately impacted by adjustments
affecting shareholders' equity upon implementation. Therefore, such guidance may
necessitate companies who issue and redeem shares based on book value to
redefine the method used to value their shares. As such, we modified our
Exchange Value Per Share calculation to exclude accumulated other comprehensive
earnings (loss) from Book Value (see Part II, Item 6. "Selected Financial Data"
of our Annual Report on Form 10-K for the year ended October 1, 2011 for
additional information on the calculation of the Exchange Value Per Share),
thereby excluding the potentially volatile impact that (1) ASC Topic 715-20,
"Compensation - Retirement Benefits - Defined Benefit Plans - General" and
(2) changes in unrealized gains and losses, net of taxes, on available for sale
investments would have on shareholders' equity and Exchange Value Per Share.
A system failure or breach of system or network security could delay or
interrupt services to our customers or subject us to significant liability.
We
have implemented security measures such as firewalls, virus protection,
intrusion detection and access controls to address the risk of computer viruses
and unauthorized access. A business continuity plan has been developed focusing
on the offsite restoration of computer hardware and software applications. We
have also developed business resumption plans which include procedures to ensure
the continuation of business operations in response to the risk of damage from
energy blackouts, natural disasters, terrorism, war and telecommunication
failures, and we have implemented change management procedures and quality
assurance controls designed to ensure that new or upgraded business management
systems operate as intended. However, there can be no assurances that any of
these efforts will be adequate to prevent a system failure, accident or security
breach, any of which could result in a material disruption to our business. In
addition, substantial costs may be incurred to remedy the damages caused by any
such disruptions.
36
--------------------------------------------------------------------------------
Table of Contents
Our success depends on our retention of our executive officers and senior
management, and our ability to hire and retain additional key personnel. Our
success depends on the skills, experience and performance of our executive
officers, senior management and other key personnel. The loss of service of one
or more of our executive officers, senior management or other key employees
could have a material adverse effect on our business, prospects, financial
condition, operating results and cash flows. Our future success also depends on
our continuing ability to attract and retain highly qualified technical, sales
and managerial personnel. Competition for these personnel is intense, and there
can be no assurance that we can retain our key employees or that we can attract,
assimilate or retain other highly qualified technical, sales and managerial
personnel in the future.
We depend on third parties for the supply of products and raw materials and for
marketing and promotional programs. We depend upon third parties for the supply
of products, including corporate brand products, and raw materials. Any
disruption in the services provided by any of these suppliers, or any failure by
them to handle current or higher volumes of activity, could have a material
adverse effect on our business, prospects, financial condition, operating
results and cash flows.
We participate in various marketing and promotional programs to increase sales
volume and reduce merchandise costs. Failure to continue these relationships on
terms that are acceptable to us, or to obtain adequate marketing relationships,
could have a material adverse effect on our business, prospects, financial
condition, operating results and cash flows.
Increased electricity, diesel fuel and gasoline costs could reduce our
profitability. Our operations require and are dependent upon the continued
availability of substantial amounts of electricity, diesel fuel and gasoline to
manufacture, store and transport products. Our trucking operations are extensive
and diesel fuel storage capacity represents approximately two weeks average
usage. The prices of electricity, diesel fuel and gasoline fluctuate
significantly over time. Given the competitive nature of the grocery industry,
we may not be able to pass on increased costs of production, storage and
transportation to our customers. As a result, either a shortage or significant
increase in the cost of electricity, diesel fuel or gasoline could disrupt
distribution activities and negatively impact our business and results of
operations.
A strike or work stoppage by employees could disrupt our business and/or we
could face increased operating costs from higher wages or benefits we must pay
our employees. Approximately 60% of our employees are covered by collective
bargaining agreements, which have various expiration dates ranging from 2012
through 2015. If we are unable to negotiate acceptable contracts with labor
unions representing our unionized employees, we may be subject to a strike or
work stoppage that disrupts our business and/or increased operating costs
resulting from higher wages or benefits paid to union members or replacement
workers. Any such outcome could have a material adverse effect on our operations
and financial results.
If we fail to maintain an effective system of internal controls, we may not be
able to detect fraud or report our financial results accurately, which could
harm our business and subject us to regulatory scrutiny. Pursuant to
Section 404 of the Sarbanes-Oxley Act of 2002, we perform an annual evaluation
of our internal controls over financial reporting. In July 2010, the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the "Reform Act") became law.
The Reform Act includes a provision that indefinitely exempts companies that
qualify as either a non-accelerated filer or smaller reporting company from the
auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act of
2002. For fiscal 2012 and subsequent foreseeable fiscal years, we expect to be
exempt from such requirement. Although we believe our internal controls are
operating effectively, we cannot guarantee that we will not have any material
weaknesses in the future. In addition, any failure to implement required new or
improved controls, or difficulties encountered in their implementation, could
harm our operating results or cause us to fail to meet our reporting
obligations.
A loss of our cooperative tax status could increase tax liability. Subchapter T
of the Internal Revenue Code sets forth rules for the tax treatment of
cooperatives. As a cooperative, we are allowed to offset patronage earnings with
patronage dividends that are paid in cash or through qualified written notices
of allocation. However, we are taxed as a typical corporation on the remainder
of our earnings from our Member business and on earnings from our Non-Member
business. If we are not entitled to be taxed as a cooperative under Subchapter
T, our revenues would be taxed when earned by us and the Members would be taxed
when dividends are distributed. The Internal Revenue Service can challenge the
tax status of cooperatives. The Internal Revenue Service has not challenged our
37
--------------------------------------------------------------------------------
Table of Contents
tax status, and we would vigorously defend any such challenge. However, if we
were not entitled to be taxed as a cooperative, taxation at both the Company and
the Member level could have a material, adverse impact on us and our Members.
Each method used to meet the Class B Share Requirement has its own tax
consequences. Class B Shares required to be held by a new Member may be
purchased directly at the time of admission as a Member or may be acquired over
the five consecutive fiscal years commencing with the first year after admission
as a Member at the rate of 20% per year. In addition, certain Members, including
former shareholders of United Grocers, Inc. or Associated Grocers, Incorporated,
may elect to satisfy their Class B Share Requirement only with respect to stores
owned at the time of admission as a Member solely from their patronage dividend
distributions. Each of these purchase alternatives may have tax consequences
which are different from those applicable to other purchase alternatives.
Members and prospective Members are urged to consult their tax advisers with
respect to the application of U.S. federal income, state or local tax rules to
the purchase method selected.
Members' Class A, Class B and Class E Shares are subject to risk of
loss. Class A and Class B Shares are purchased and sold at purchase prices
equal to the Exchange Value Per Share at the close of the last fiscal year end
prior to the date the shares are purchased or tendered for redemption. Class E
Shares are purchased and sold at a value of $100 per share. If a Member were to
sell shares at a price that is less than the price at which the shares were
purchased, the Member would lose all or a portion of its investment in the
Class A, Class B or Class E Shares. See "OFFERING OF CLASS A, CLASS B AND CLASS
E SHARES" in our Amendment No. 2 to Registration Statement on Form S-1 filed on
April 19, 2012, with respect to our offering of Class A, Class B and Class E
Shares for further information.
If the Board decides in any year to retain a portion of our earnings from our
Non-Patronage Business, and not to allocate those earnings to the Exchange Value
Per Share, the redemption price of Class A and Class B Shares that are
repurchased in the year of such retention and in future years will be reduced.
The requirement that Members invest in our shares and/or make Required Deposits,
and the lack of liquidity with respect to such investments and Required
Deposits, may make attracting new Members difficult and may cause existing
Members to withdraw from membership. Members are required to meet specific
requirements, which include ownership of our capital shares and may include
required cash deposits. These investments by Members are a principal source of
our capital, and for the thirty-nine weeks ended June 30, 2012, approximately
81% of our net sales were to Members. We compete with other wholesale suppliers
who are not structured as cooperatives and therefore have no investment
requirements for customers. Our requirements to purchase shares or maintain cash
deposits may become an obstacle to retaining existing business and attracting
new business. For a discussion of required Member equity investments and
deposits, see Part I, Item 1. "Business - Capital Shares" and Part I, Item 1.
"Business - Customer Deposits" of our Annual Report on Form 10-K for the year
ended October 1, 2011.
Our Bylaws give the Board complete discretion with respect to the redemption of
the shares held by terminated Members and excess shares held by Members. Our
redemption policy currently provides that the number of Class B Shares that we
may redeem in any fiscal year is limited to no more than 5% of the outstanding
Class B Shares (after patronage dividends payable in Class B Shares). In fiscal
2012, we redeemed 11,558 Class B Shares, leaving 59,566 Class B Shares that have
been tendered for redemption but not yet redeemed. See Part II, Item 8.
"Financial Statements and Supplementary Data - Notes 10 and 18" of our Annual
Report on Form 10-K for the year ended October 1, 2011 for recent redemption
activity and the number of outstanding shares tendered for redemption but which
have not yet been redeemed. Furthermore, required cash deposits are
contractually subordinated and subject to the prior payment in full of our
senior indebtedness. For a discussion of the limitations on the redemption of
capital shares and the subordination of cash deposits, see Part I, Item 1.
"Business - Capital Shares - Redemption of Class A, Class B and Class E Shares,"
Part I, Item 1. "Business - Customer Deposits" and Part I, Item 1. "Business -
Pledge of Shares and Guarantees" of our Annual Report on Form 10-K for the year
ended October 1, 2011. These limitations on our obligation to redeem capital
shares or repay the cash deposits of Members may cause Members to withdraw from
membership or potential Members to not become Members.
38
--------------------------------------------------------------------------------
Table of Contents
Severe weather, natural disasters and adverse climate changes may adversely
affect our financial condition and results of operations. Severe weather
conditions, such as hurricanes or tornadoes, or natural disasters, such as
earthquakes or fires, in areas in which we have distribution facilities in which
customers' stores are located or from which we obtain products may adversely
affect our results of operations. Such conditions may cause physical damage to
our properties, closure of one or more of our distribution facilities, closure
of customers' stores, lack of an adequate work force in a market, temporary
disruption in the supply of products, disruption in the transport of goods,
delays in the delivery of goods to our distribution centers or customer stores
or a reduction in the availability of products we offer. In addition, adverse
climate conditions and adverse weather patterns, such as droughts and floods,
which impact growing conditions and the quantity and quality of crops yielded by
food producers, may adversely affect the availability or cost of certain
products within the grocery supply chain. Our business resumption plans may not
be effective in a timely manner and a significant disruption to our business
could occur in the event of a natural disaster, terrorism or war. In addition,
while we carry insurance to cover business interruption and damage to buildings
and equipment, some of the insurance carries high deductibles. Any of these
factors may disrupt our business and adversely affect our financial condition
and results of operations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our consolidated condensed financial statements in conformity
with accounting principles generally accepted in the United States of America
requires us to make estimates, assumptions and judgments that affect the amount
of assets and liabilities reported in the consolidated condensed financial
statements, the disclosure of contingent assets and liabilities as of the date
of the consolidated condensed financial statements and reported amounts of
revenues and expenses during the year. We believe our estimates and assumptions
to be reasonable; however, future results could differ from those estimates
under different assumptions or conditions.
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated condensed financial statements. On an ongoing
basis, we evaluate our estimates, including those related to allowances for
doubtful accounts, lease loss reserves, investments, goodwill and intangible
assets, long-lived assets, income taxes, insurance reserves, pension and
postretirement benefits 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.
The accompanying consolidated condensed financial statements are prepared using
the same critical accounting policies and estimates discussed in Part II,
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations" of our Annual Report on Form 10-K for the fiscal year ended
October 1, 2011.
RECENTLY ADOPTED AND RECENTLY ISSUED AUTHORITATIVE ACCOUNTING GUIDANCE
Refer to Note 9 of "Notes to Consolidated Condensed Financial Statements -
Unaudited" in Part I, Item 1. "Financial Statements (Unaudited)" of this
Quarterly Report on Form 10-Q for management's discussion of recently adopted
and recently issued authoritative accounting guidance and their expected impact,
if any, on our consolidated condensed financial statements.
AVAILABILITY OF SEC FILINGS
We make available, free of charge, through our website
(http://www.unifiedgrocers.com) our Forms 10-K, 10-Q and 8-K, as well as our
registration statements, proxy statements and all amendments to those reports,
as soon as reasonably practicable after those reports are electronically filed
with the SEC. A copy of any of the reports filed with the SEC can be obtained
from the SEC'sPublic Reference Room at 100 F Street, N.E., Washington, D.C.
20549. A copy may also be obtained by calling the SEC at 1-800-SEC-0330. All
reports filed electronically with the SEC are available on the SEC's web site at
http://www.sec.gov.
39
--------------------------------------------------------------------------------
Table of Contents
