ITEM 1. BUSINESS
GENERAL
Stater Bros. Holdings Inc. was incorporated in Delaware in 1989 and together with its wholly-owned subsidiaries, Stater Bros. Markets and Stater Bros. Development, Inc., (collectively "Stater Bros." or the "Company") were founded in 1936 when the first Stater Bros. Market opened in Yucaipa, California. The Company is a leading supermarket chain in Southern California, operating 112 supermarkets in the Inland Empire Region of Southern California.
The Company has grown, primarily by constructing supermarkets in its primary trading areas and through the enlargement of existing supermarkets. The Company offers its customers a high level of customer service, broad selections of grocery, meat, produce, liquor and general merchandise. All of the Company's supermarkets have full-service meat departments and many of the supermarkets have service delicatessens and service bakery departments. All of the Company's supermarkets have expanded selections of produce merchandise.
The Company utilizes a central warehouse and distribution facility which provides the Company's supermarkets with approximately 84% of the merchandise they offer for sale. The Company's warehouse and distribution facilities encompass approximately 1,017,000 square feet and include a 118,000 square foot modern produce facility that was constructed in 1989 as well as facilities for grocery, meat, frozen foods, health and beauty aids and bakery products.
OWNERSHIP OF THE COMPANY
In August 1997, La Cadena Investments ("La Cadena") became the sole shareholder of the Company and holds all of the shares of the Company's Class A Common Stock which are entitled to 1.1 votes per share. La Cadena Investments is a California General Partnership whose partners include Jack H. Brown, Chairman of the Board, President and Chief Executive Officer of the Company and other members of senior management of the Company. Jack H. Brown has a majority interest in La Cadena and is the managing general partner with the power to vote the shares of the Company held by La Cadena.
RECAPITALIZATION TRANSACTION
In March 1994, the Company completed a Recapitalization Transaction (the "Recapitalization") which transferred effective voting control of the Company to La Cadena, reclassified the Company's outstanding equity, provided for certain cash payments and distributions to Craig Corporation ("Craig"), previously a common shareholder of the Company, and provided the Company with an option to acquire Craig's remaining equity in Stater Bros. Holdings Inc. The Recapitalization Transaction was funded through an offering of $165.0 million of 11% Senior Notes due 2001 (the "11% Notes") under Rule 144A of the Securities Act of 1933, as amended. Proceeds from the 1994 Notes were used to (a) repay $75.5 million of 9.8% Senior Notes, together with prepayment premiums of $13.9 million, (b) repay outstanding bank loans and mortgages of approximately $12.0 million, (c) repay an outstanding capital expenditure revolving credit facility of $9.0 million, (d) fund a $5.0 million five-year consulting agreement and covenant not to compete with Craig, (e) fund a payment of $14.6 million to purchase an option to acquire Craig's remaining interest in the Company, (f) pay $20.0 million in dividends on the Company's Common Stock (held by Craig) and (g) pay fees and expenses associated with the Recapitalization. The 11% Notes are listed and trade on the American Stock Exchange.
ITEM 1. BUSINESS (CONTD.)
CONVERSION AND REDEMPTION OF SERIES B PREFERRED STOCK
Effective March 8, 1996, pursuant to options available to the Company, the Company exercised its right to convert all of its outstanding shares of Common Stock (previously held by Craig) into 693,650 shares of its Series B Preferred Stock. The Series B Preferred Stock had a redemption value of approximately $69.4 million and currently paid dividends at the rate of 10.5% per annum. In August 1997, the Company redeemed all of the outstanding shares of its Series B Preferred Stock for $69.4 million plus accrued and unpaid dividends.
In July 1997, the Company issued $100 million of 9% Senior Subordinated Notes due 2004 (the "9% Notes") under Rule 144A of the Securities Act of 1933. Proceeds from the issuance of the 9% Notes were used as follows (a) $69.4 million to redeem the Series B Preferred Stock, (b) $4.6 million to pay accrued dividends due from the Series B Preferred Stock, (c) $4.9 million to obtain consents from the holders of the Company's 11% Senior Notes due 2001 to permit the issue of the 9% Notes, (d) $2.0 million to La Cadena for financial advice relating to the transaction, (e) $3.4 million for fees and expenses of the transaction. The remaining proceeds from the issuance of the 9% Notes were used for general corporate purposes, including capital expenditures. The 9% Notes are listed and trade on the American Stock Exchange.
BUSINESS STRATEGY
STORE PROFILE AND LOCATIONS
The Company's existing supermarkets have well-established locations and low overhead expenses, including fixed rent payments in most supermarkets. In addition, the Company believes that its existing supermarkets are well-maintained and generally require capital expenditures only for customary maintenance. An average Stater Bros. supermarket is approximately 30,000 square feet, while newly constructed Stater Bros. supermarkets range from approximately 35,300 to 43,200 square feet. Stater Bros. supermarkets typically utilize approximately 72% of total square feet for retail selling space. The Company operates its supermarkets with minimal back-room storage space because of the close proximity of its distribution facility to its store locations. Generally, all Stater Bros. supermarkets are similarly designed and stocked thereby allowing Stater Bros. customers to find items easily in any of the Company's supermarkets.
Substantially all of the Company's 112 supermarkets are located in neighborhood shopping centers in well-populated residential areas. The Company endeavors to locate its supermarkets in growing areas that will be convenient to potential customers and will accommodate future supermarket expansion.
Management actively pursues the acquisition of sites for new supermarkets. In an effort to determine sales potential, new supermarket sites are carefully researched and analyzed by management for population shifts, zoning changes, traffic patterns, nearby new construction and competitive locations. Stater Bros. works with developers to attain the Company's criteria for potential supermarket sites, and to insure adequate parking and a complementary co-tenant mix.
STORE EXPANSION AND REMODELING
The Company has historically focused its expansion in the Inland Empire. Such expansion has been accomplished through improving and remodeling existing stores and constructing new supermarkets rather than by acquiring other supermarket operations. The number of supermarkets operated by the Company has grown from 82 in September 1979 to 112 as of September 27, 1998. The Company intends to continue to expand its existing supermarket operations by enlarging and remodeling existing supermarkets and constructing new supermarkets. The Company may also make selective acquisitions of existing supermarkets, if such opportunities arise.
ITEM 1. BUSINESS (CONTD.)
STORE EXPANSION AND REMODELING (CONTD.)
The Company monitors sales and profitability of its operations on a store-by-store basis and enlarges, remodels or replaces stores in light of their performance and management's assessment of their future potential. Approximately 54% of the Company's supermarkets have been either newly constructed or remodeled within the last five years. Minor remodels cost between $100,000 and $250,000 and typically include new fixtures, a change in decor, and the addition of one or more specialty service departments such as a delicatessen or bakery. Major remodels cost in excess of $250,000 and typically involve more extensive refurbishment of the store's interior and often increase the retail selling space per store. Expansions entail enlargement of the store building and typically includes breaking through an exterior wall. The primary objectives of remodelings and expansions are to improve the attractiveness of supermarkets, increase sales of higher margin product categories and, where feasible, to increase selling area. The Company conducts all of its new construction and remodeling through its wholly-owned subsidiary, Stater Bros. Development, Inc., which serves as the general contractor for all Company construction projects.
The following table sets forth certain statistical information with respect to the Company's supermarket expansion and remodeling for the periods indicated.
Beyond 1998, the Company plans to open approximately two to four new stores per year, based upon a number of factors, including customer demand, market conditions, profitability, costs of opening, and availability of financing for such new stores. The Company's plans with respect to major and minor remodels, expansion and new construction are reviewed continually and are revised, if appropriate, to take advantage of marketing opportunities. The Company finances its new store construction primarily from cash provided by operating activities and short-term borrowings under its credit facilities. Long-term financing of new stores generally will be obtained through either sale/leaseback transactions or secured long-term financings. However, no assurances can be made as to the availability of such financings. The Company opened a new replacement supermarket in Loma Linda, California in December 1998 which is not included in the table above.
WAREHOUSE AND DISTRIBUTION FACILITIES
The Company's warehouse and distribution facilities and administrative offices are located in Colton, California, and encompass approximately 1,017,000 square feet. The facilities include warehouses for grocery, produce and deli products, meats and frozen products, health and beauty aids and bakery merchandise. Management believes that its existing warehouse and distribution facilities are adequate to meet its currently identified expansion plans. Approximately 84% of the products offered for sale in the Company's supermarkets are processed through the Company's warehouse and distribution facilities.
ITEM 1. BUSINESS (CONTD.)
WAREHOUSE AND DISTRIBUTION FACILITIES (CONTD.)
The Company's warehouse and distribution facilities are centrally located and are an average distance of approximately 30 miles from its supermarkets. Most supermarkets can be reached without using the most congested portions of the Southern California freeway system.
The Company's transportation fleet consists of modern well-maintained vehicles. As of September 27, 1998, the Company operated approximately 107 tractors and 302 trailers, approximately 5% of which were leased by the Company. The Company also operates a repair terminal at the Colton distribution facility.
PURCHASING AND MARKETING
The Company uses an aggressive Everyday Low Price ("EDLP") format supported by radio, TV, newspaper and direct mail advertising programs as an integral part of its purchasing and marketing strategy to provide its customers with the best overall supermarket value in its primary market areas. The Company supplements its everyday low price structure with chain-wide temporary price reductions on selected food and non-food merchandise. The geographic location of the Company's supermarkets allows it to reach its target consumers through a variety of media and the Company aggressively advertises its everyday low prices through local and regional newspapers, direct mail and printed circulars as well as advertisements on radio and television.
A key factor in the Company's business strategy is to provide its customers with a variety of quality brand-name merchandise as well as alternative selections of high-quality private label and generic brands of merchandise. To meet the needs of customers, most supermarkets are stocked with approximately 35,000 items. The Company places particular emphasis on the freshness and quality of its meat and produce merchandise and maintains high standards for these perishables by processing and distributing the merchandise through its perishable warehouses and distribution facilities.
RETAIL OPERATIONS
The Company's supermarkets are well maintained, have sufficient off-street parking and generally are open from 7:00 a.m. until 10:00 p.m. or 11:00 p.m., seven days a week, including all holidays with the exception of Christmas Day. Because Stater Bros. operates all its supermarkets under a single format, management believes it is able to achieve certain operating economies.
Store Management. Each supermarket is managed by a store manager and an assistant manager, each of whom receives a base salary and may receive a bonus based on the individual supermarket's overall performance and management of labor costs within the supermarket. The store manager and assistant manager are supported by their store management staff who have the training and skills necessary to provide proper customer service, operate the store and manage personnel in each department. Additionally, the store manager is supported by individual department managers for grocery, meat, produce, and where applicable, bakeries and delicatessens. Store managers report to one of six district managers, each of whom is responsible for an average of 18 supermarkets. District managers report to one of three Regional Vice Presidents.
Customer Service. The Company considers customer service and customer confidence to be critical to the success of its business strategy. This strategy, to provide courteous and efficient customer service through specific programs and training, is a focus of the executive officers and is implemented at all levels of employees. The Company maintains an intensive checker training school to train prospective checkers and to provide a refresher program for existing checkers. All of the Company's supermarkets provide customers with purchase carry-out service and have express check-out lanes for purchases of 10 items or less.
ITEM 1. BUSINESS (CONTD.)
SANTEE DAIRIES, LLC
The Company and Hughes Family Markets ("Hughes") currently each own a 50% interest in Santee Dairies Limited Liability Company ("Santee LLC"), and have jointly owned Santee Dairies, Inc. ("Santee") since 1986. Santee is a wholly-owned subsidiary of Santee LLC. Santee operates one of the largest dairy plants in California and provides fluid milk products to the Company, Hughes, and other customers in Southern California. Santee processes, packages and distributes whole milk, low-fat and non-fat milk, as well as orange juice, fruit drinks and certain cultured milk products under the Knudsen, Foremost and certain store brand names. Santee is the exclusive licensee of the Knudsen trademark from Kraft Foods, Inc. for fluid milk, juices and certain cultured milk products in the Southern California market. In addition, Santee is the exclusive licensee for Foremost Farms USA, Cooperative of the Foremost trademark for fluid milk in Southern California. Santee also processes, packages and distributes Hershey chocolate milk under license. In calendar 1997, Santee processed approximately 69 million gallons of fluid products, including 60 million gallons of fluid milk. Total revenues in Santee's fiscal year ended December 27, 1997 were $169.7 million, of which approximately 29% were sales to the Company and approximately 12% were from sales to Hughes. Santee also sells to unaffiliated supermarkets, independent food distributors, military bases and food service providers in Southern California.
Santee's prior dairy plant was built in 1914 and due to its age, Santee was required to make significant expenditures for repairs and maintenance over the past several years. In order to provide a consistent source of milk, fluid milk products and other dairy products to accommodate expected expansion, Santee constructed a new dairy plant in City of Industry, California (the "New Facility"). The New Facility is expected to increase Santee's capacity to process milk to approximately 250,000 to 350,000 gallons per day, with the ability to expand capacity to approximately 500,000 gallons per day. The Company expects that the New Facility, when fully operational, will also lower Santee's costs of producing fluid milk and other products. However, as with any major construction and capital expenditure project, the realization of these anticipated benefits is subject to a number of risks and uncertainties and there can be no assurance that these benefits will be realized.
Construction costs of the New Facility (excluding capitalized interest, transition and training costs), are estimated to be approximately $91.5 million. However, there can be no assurance that the cost of the new dairy will not exceed this amount. To provide the funds necessary to finance the construction, Santee issued $80 million of senior secured notes (the "Santee Notes") in a private placement. The Company does not guarantee payment of the Santee Notes.
Stater Bros. Markets entered into a Fluid Milk and Other Products Requirements Agreement (the "Product Purchase Agreement") with Santee. The term of the Product Purchase Agreement is for ten years and requires that Stater Bros. Markets purchase essentially the same type of products from Santee's New Facility and to purchase from Santee a minimum volume of products each year equal to approximately 80% of such products purchased by Stater Bros. Markets in its 1996 fiscal year. The price for products charged by Santee to Stater Bros. Markets, may increase or decrease, subject to the financial performance of Santee and the price charged for products shall not, under any circumstances, be adjusted to include any amount of principal on indebtedness of Santee which is owing solely by reason of acceleration of principal payments under any loan agreement. Additionally, if as a result of one of several events (an Alternative Rate Event), Santee causes the interest rate charged on its debt to be increased (an Alternative Rate), then the price charged for products shall be reset to Market Price which is substantially the same price Santee charges to customers other than its owners for the same product. Stater Bros. Markets believes it is currently charged in excess of Market Price for the products it is currently purchasing from Santee. The Company continues to explore alternatives available to it regarding its investment in Santee.
ITEM 1. BUSINESS (CONTD.)
SANTEE DAIRIES, LLC (CONTD.)
The Company accounts for its investment in Santee using the equity method of accounting.
MANAGEMENT INFORMATION SYSTEMS
The Company's management information systems and point-of-sale scanning technology reduce the labor costs attributable to product pricing and customer check-out, and provide management with information that facilitates purchasing, receiving and management of inventory and accounts payable. The Company has point-of-sale scanning checkout technology in all of its stores. All stores use electronic systems for employee time and attendance records, inventory orderings, and labor scheduling, which assist store management in developing a more efficient and customer-sensitive work schedule.
During fiscal 1998, the Company installed in fifteen stores, NCR's new generation of electronic scan systems, the 7452 ACS Scan System, and will install an additional 28 systems during fiscal 1999. These new systems are more customer oriented, operate more efficiently and reduce the time required to check out customers.
During 1995, the Company completed the installation of the Stater Express(R) system in all of the Company's supermarkets. Stater Express(R) is a combined supermarket technology platform that includes enhanced systems for check verification and acceptance and provides alternative pay choices such as most nationally recognized financial institution debit and credit cards. Stater Express(R) also provides each supermarket with the technology required to print in-store advertising signs and connects each supermarket to the Company's host computer which provides certain efficiencies in data transfers between the supermarkets and the Company's main office. The Company has obtained a federal service mark for the name "Stater Express".
EMPLOYEES
The Company has approximately 8,700 employees, approximately 600 of whom are management and administrative employees and approximately 8,100 of whom are hourly employees. Approximately 69% of the Company's employees work part-time. Substantially all of the Company's hourly employees are members of either the United Food & Commercial Workers or International Brotherhood of Teamsters labor unions and are represented by several different collective bargaining agreements. The Company's collective bargaining agreements, with the United Food & Commercial Workers, which covers the largest number of employees, were renewed in October 1995 and expire in October 1999. The International Brotherhood of Teamsters agreement was renewed in September 1998 and expires in September 2002.
The Company values its employees and believes its relationship with them is good and that employee loyalty and enthusiasm are key elements of its operating performance.
COMPETITION
The Company operates in a highly competitive industry characterized by narrow profit margins. Competitive factors include price, quality and variety of products, customer service, and store location and condition. The Company believes that its competitive strengths include its specialty services, everyday low prices, breadth of product selection, high product quality, one-stop shopping convenience, attention to customer service, convenient store locations and a long history of community involvement.
ITEM 1. BUSINESS (CONTD.)
COMPETITION (CONTD.)
Given the wide assortment of products it offers, the Company competes with various types of retailers, including local, regional and national supermarket retailers, convenience stores, retail drug stores, national general merchandisers and discount retailers, membership clubs and warehouse stores. The Company's primary competitors include Lucky, Vons, Albertson's, Ralphs, and a number of independent supermarket operators.
GOVERNMENT REGULATION
The Company is subject to regulation by a variety of governmental authorities, including federal, state and local agencies that regulate trade practices, building standards, labor, health, safety and environmental matters and regulate the distribution and sale of alcoholic beverages, tobacco products, milk and other agricultural products and other food items.
ENVIRONMENTAL
During fiscal 1998, the Company removed all of its underground gasoline fuel storage tanks and remediated the surrounding soils, where necessary. The costs incurred in 1998 to remove the underground gasoline storage tanks and to remediate the surrounding soils amounted to approximately $84,000. During fiscal 1997, the Company removed all of its underground diesel fuel storage tanks and related diesel refueling equipment from its Colton, California distribution facility. The costs incurred during fiscal 1997 to remove the underground diesel fuel storage tanks and to remediate the surrounding soils, amounted to approximately $330,000. The Company refuels its transportation equipment at several off-site locations which are owned and operated by an unrelated third party.
Environmental remediation costs incurred over the past five years have been approximately $684,000, in the aggregate, including remediation costs of approximately, $8,000 in 1995, $80,000 in 1996, $330,000 in 1997 and $174,000 in 1998. Management believes that any such future remediation costs will not have an adverse material effect on the financial condition or results of operations of the Company.
YEAR 2000 COMPLIANCE
The efficient operations of the Company are dependent, in part, upon its computer software programs, systems and processes (collectively, the "Information Systems"). The Company's Information Systems are used in several key areas of the Company, including, but not limited to, supermarket operations, warehousing and distribution, merchandising and purchasing, inventory management, and accounting and financial reporting. The Company is in the process of updating its Information Systems for Year 2000 compliance requirements. Additionally, the Company has also been in communication with some of its vendors, financial institutions and others whose computer software, programs and information systems may interface with those of the Company to assess the status of their compliance with Year 2000 requirements. Failure of companies (that the Company conducts business with) to comply with the Year 2000 requirements could have an adverse effect on the Company's operations.
Based on the information currently available, the Company believes it will meet the Year 2000 compliance requirements through a combination of Information Systems modifications and through the acquisition of new equipment and technology that are Year 2000 compliant. The Company believes that costs required to replace or modify Information Systems, including scheduled replacements of in-store Point of Sale equipment, will approximate $8.4 million, of which $6.9 million will be capitalized and $1.5 million will be expensed. Through September 27, 1998, the Company has incurred capitalized expenditures of $3.2 million and expenses of $340,000. The Company believes that it will successfully achieve compliance with the year 2000 requirements, however, no assurances can be given that the Company's Information Systems and it's vendors, financial institutions and other will be successful in achieving Year 2000 compliance.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases its warehouse and distribution facilities located in Colton, California, and management believes that its warehouse and distribution facilities are well maintained and are adequate to serve the currently identified expansion plans of the Company.
The following schedule presents the Company's warehouse and distribution facilities by product classification and the size of each facility as of December 11, 1998.
As of December 11, 1998, the Company owned 24 of its supermarkets and leased the remaining 88 supermarkets. Management believes that its supermarkets are well maintained and adequately meet the expectations of its customers. The Company operates 112 supermarkets in the Southern California counties of San Bernardino, Riverside, Orange, Los Angeles and Kern. The following schedule reflects the Company's store counts by size, county, and the number of stores that are either leased or owned as of December 11, 1998.
Subsequent to fiscal year end, in December 1998, the Company opened a new 37,400 square foot replacement supermarket in Loma Linda, California, which is included in the table above.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, the Company is party to various legal actions which the Company believes are incidental to the operation of the business of the Company and its subsidiaries. The Company records an appropriate provision when the occurrence of loss is probable and can be reasonably estimated. The Company believes that the outcome of such legal proceedings to which the Company is currently a party will not have a material adverse effect upon its results of operations or its consolidated financial condition.
ITEM 3. LEGAL PROCEEDINGS (CONTD.)
On May 2, 1993, the Company was named as a defendant along with all of the other major supermarket chains located in the Los Angeles County area in a class action complaint filed in the California Superior Court in Los Angeles, California, alleging among other things that the milk pricing policies of each of the defendants violate certain antitrust laws and regulations under California law. In this class action lawsuit, Barela et al. v. Ralphs Grocery Co. et al., plaintiffs sought unspecified damages. The Company has recently entered into a settlement agreement of this case which settlement does not involve payment of monetary damages and is currently being processed through the courts for approval. Such settlement will not have an adverse material effect on the results of operations or financial condition of the Company.
On June 19, 1997, Stater Bros. Markets was named as a defendant in the case of Ufondu, et al. vs. Stater Bros. Markets filed in the Superior Court of the State of California for the County of San Bernardino. The complaint filed by twelve employees seeks unspecified damages alleging racial discrimination in the Company's employment practices. The Company believes the complaint is without merit and intends to vigorously defend the case. There can be no assurances, however, as to the outcome of this case.
ENVIRONMENTAL MATTERS
During fiscal 1998, the Company removed all of its underground gasoline fuel storage tanks and remediated the surrounding soils, where necessary. The costs incurred in 1998 to remove the underground gasoline storage tanks and to remediate the surrounding soils amounted to approximately $84,000. During fiscal 1997, the Company removed all of its underground diesel fuel storage tanks and related diesel refueling equipment from its Colton, California distribution facility. The costs incurred during fiscal 1997 to remove the underground diesel fuel storage tanks and to remediate the surrounding soils, amounted to approximately $330,000. The Company refuels its transportation equipment at several off-site locations which are owned and operated by an unrelated third party.
Environmental remediation costs incurred during the last five years have been approximately $684,000, in the aggregate, including remediation costs of approximately $8,000 in 1995, $80,000 in 1996, $330,000 in 1997 and $174,000 in 1998. Management believes that any such future remediation costs will not have an adverse material effect on the financial condition or results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information There is no established public trading market for the Company's common equity.
(b) Holders La Cadena Investments holds 50,000 shares, or 100% of the Company's Class A Common Stock.
(c) Dividends No dividends were paid in fiscal years 1998, 1997, and 1996 on the common equity of the Company and the Company does not intend to pay dividends on its common equity in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth historical financial data derived from the audited financial statements of the Company as of and for the fiscal years ended September 25, 1994, September 24, 1995, September 29, 1996, September 28, 1997 and September 27, 1998. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations", the Consolidated Financial Statements of the Company and related notes thereto contained elsewhere herein. The information included in "Other Operating and Financial Data" and "Store Data" is unaudited.
(FOOTNOTES ON FOLLOWING PAGE)
ITEM 6. SELECTED FINANCIAL DATA (CONTD.)
(1) Effective March 1994, the Company paid $1.5 million annually in consulting fees to Craig Corporation, subject to a certain five year Consulting Agreement entered into between the Company and Craig. The Company's agreement to pay Craig an annual consulting fee was terminated, at the election of the Company, in August 1997.
(FOOTNOTES CONTINUED ON FOLLOWING PAGE)
ITEM 6. SELECTED FINANCIAL DATA (CONTD.)
(2) Extraordinary charges in 1994 represent the after-tax charge from the early retirement of debt.
(3) EBITDA represents earnings before extraordinary charge, interest expense, depreciation and amortization, standstill fees and income tax expense. The Company has included information concerning EBITDA here as it is relevant for covenant analysis under the Notes and because it is used by certain investors as a measure of a company's ability to service its debt. EBITDA should not be used as an alternative to, or be construed as more meaningful than, operating profit or cash flows as an indicator of the Company's operating performance.
(4) For the purpose of determining the ratio of earnings to fixed charges, earnings consist of income before income taxes and the extraordinary charge, amortization of previously capitalized interest and undistributed earnings or loss from less than 50% owned subsidiaries and includes fixed charges. Fixed charges consist of interest expense whether expensed or capitalized, amortization of deferred debt expense, preferred stock dividends adjusted to represent pre-tax earnings requirements and such portion of rental expense as can be deemed by management to be representative of the interest factor in the particular case.
(5) The Company adopted SFAS No. 109 ("Accounting for Income Taxes") effective at the beginning of fiscal 1994 as a cumulative effect of a change in accounting principle.
(6) Certain amounts in prior periods have been reclassified to conform to the current period financial statement presentation.
(7) The year ending September 29, 1996 was a 53-week year, whereas fiscal years 1994, 1995, 1997 and 1998 were 52-week years.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Comparisons between the 1996, 1997 and 1998 fiscal years are difficult due to the additional week in the 1996 fiscal year and the additional long-term debt incurred in 1997. Fiscal year 1996 was a 53-week fiscal year, whereas fiscal years 1997 and 1998 consisted of 52 weeks.
OWNERSHIP OF THE COMPANY
Effective August, 1997, La Cadena became the sole shareholder of the Company and holds all of the shares of the Company's Class A Common Stock which are entitled to 1.1 votes per share. La Cadena Investments is a California General Partnership whose partners include Jack H. Brown, Chairman of the Board, President and Chief Executive Officer of the Company and other members of senior management of the Company. Jack H. Brown has a majority interest in La Cadena and is the managing general partner with the power to vote the shares of the Company held by La Cadena.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
RESULTS OF OPERATIONS
The following table sets forth certain income statement components expressed as a percent of sales for the 52-week fiscal years ended September 27, 1998 and September 28, 1997 and the 53-week fiscal year ended September 29, 1996.
Total sales amounted to $1.726 billion in the 52-week 1998 fiscal year compared to $1.718 billion in the 52-week 1997 fiscal year, and $1.705 billion in the 53-week 1996 fiscal year. Like-store sales for comparable 52-week periods decreased 1.0% in 1998 compared to increases of 2.6% in fiscal 1997 and 6.3% in fiscal 1996. The increase in like-store sales in fiscals 1997 and 1996 was due to many factors including slight improvements in the Southern California economy and favorable customer response to the Company's merchandising expansion and upgrading program which included expanding product offerings in the deli, bakery, frozen foods and dairy departments and continuing with the introduction of fresh cut flowers and prepackaged vegetables into most of the Company's supermarkets. Additionally, like store sales were impacted by the departure of a competitor from the market place.
During the second quarter of the Company's fiscal 1996, Smith's Food & Drug ("Smith's"), announced the termination of its Southern California operations and began closing all of its supermarkets located in Southern California. Approximately fifteen Smith's supermarkets competed with the Company. As of September 29, 1996, nine Smith's supermarkets remained closed and as of September 28, 1997, five Smith's supermarkets remained closed. Accordingly, the Company's sales in fiscal 1996 were aided by a direct competitor leaving the market place. Sales for fiscal 1997 and 1998 were adversely effected as competitors periodically acquired and reopened the vacated Smith's supermarkets. Management believes it has been successful in attracting and retaining many of the previous Smith's customers to its supermarkets.
Gross profits increased to $402.6 million or 23.32% in 1998 compared to $391.5 million or 22.79% of sales in 1997 and $389.6 million or 22.85% of sales in 1996. The increase in gross profits, as a percent of sales in fiscal year 1998 was due to the introduction of higher gross margin products achieved through the Company's merchandising expansion and upgrading programs including significant investments in product display fixtures. The decrease in gross profits as a percentage of sales in 1997 when compared to 1996, was due to aggressive competitive pricing in selected areas of Southern California in the third and fourth quarters of fiscal 1997. The Company adjusts its pricing strategy as necessary to retain its every day low price marketing position.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
RESULTS OF OPERATIONS (CONTD.)
Operating expenses include selling, general and administrative expenses, depreciation and amortization, and consulting fees expenses. In fiscal year 1998, selling, general and administrative expenses amounted to $353.1 million or 20.46% of sales compared to $333.2 million or 19.40% of sales in 1997 and $328.2 million or 19.25% of sales in 1996. Selling, general and administrative expenses for fiscal 1998 included expenses incurred to operate two additional supermarkets and non-recurring advertising expenses of approximately $2.1 million incurred in the second and third quarters to re-affirm the Company's strategy of Every Day Low Price leadership in its primary marketing areas and to advertise the Company's successful No Club Card strategy. Additionally, commencing in April 1998, the Company was required to resume employer contributions of approximately $750,000 per month to a previously over-funded collective bargaining pension trust. Such employer contributions had been suspended since 1994. In fiscal 1997, selling, general and administrative expenses increased as a percentage of sales due to contractual increases in collective bargaining employees rates of pay and increases in fixed expenses such as rent expense, utilities, depreciation and supermarket supplies expenses. In fiscal 1996, selling, general and administrative expenses decreased as a percent of sales primarily due to the additional week in the 53-week 1996 fiscal year and a non-recurring reduction to expenses of approximately $3.8 million from a two month suspension of employer contributions to an over funded collective bargaining health and welfare benefit trust. Employer contributions and related suspensions of payments, if applicable, to the collective bargaining trusts are subject to, but not limited to, labor agreements funding requirements, regulatory statutes, actuarial calculations and performance of plan assets.
Depreciation and amortization expenses amounted to $15.4 million in 1998 compared to $13.3 million in 1997 and $12.6 million in 1996 and includes amortization of $1.0 million in 1998, 1997 and 1996, from a $5.0 million prepaid five-year covenant not to compete included in a Consulting Agreement between the Company and Craig, which became effective March 8, 1994 as part of the Recapitalization Transaction.
Since January 1, 1989, the Company has entered into various consulting agreements with its then stockholders, La Cadena and Craig, that required them to provide consultation and advice to the Company in connection with general business, financial, management consulting, real estate acquisition and development, and product diversification matters. These consulting agreements with its stockholders terminated on September 26, 1993. In March 1994, the Company entered into a new five-year Consulting Agreement with Craig Corporation, whereby the Company paid Craig $1.5 million per year and Craig provided the Company with consultation and advice in connection with general business issues, financial, management consulting, real estate acquisition and development and product diversification matters. Consulting fees expense amounted to $1.5 million in 1997 and 1996. The agreement to make annual consulting payments to Craig was terminated, at the election of the Company, in August 1997.
Operating profits amounted to $34.1 million or 1.97% of sales in 1998 compared to $43.6 million or 2.54% of sales in 1997 and $47.3 million or 2.77% of sales in 1996.
Interest expense amounted to $30.2 million, $21.6 million and $20.2 million for the 1998, 1997 and 1996 fiscal years, respectively. The increase in interest expense in 1998 was due to the issuance of $100 million of 9% Senior Subordinated Notes due 2004 which were issued in July 1997 and remain outstanding. Interest expense included amortization of fees and expenses incurred to acquire debt of $2.8 million in 1998, $1.5 million in 1997 and $1.2 million in 1996.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
RESULTS OF OPERATIONS (CONTD.)
The increase in the Company's equity in loss from unconsolidated affiliate in fiscal years 1998, 1997 and 1996 resulted from increased depreciation expense as a result of Santee's decision to not exercise an option to extend the lease of the old facility located in Los Angeles, California for ten years, but to vacate the facility which reduced the economic lives of certain assets and negotiated a two year lease extension in that facility which increased rent expense during the two year lease extension for the Los Angeles, California facility. Santee vacated the Los Angeles, California facility in March 1998 and thereafter occupied a new facility which is located in City of Industry, California. Additionally, during fiscal 1998, the Company's equity in loss from unconsolidated affiliate included costs and expenses incurred to relocate to the new City of Industry facility and costs incurred to start up and commission the new plant. Since June 1998, the Company has accepted and paid approximately $4.3 million (approximately $1.0 million per month) from a temporary increase in the cost of dairy products purchased from Santee by the Company. The temporary increase in the costs of products purchased from Santee is included in cost of goods sold. Senior Management of Santee has informed the Company, and the Company believes, that the temporary price increases will continue through March 1999, but no assurances can be provided that the temporary price increases will cease on or before March 1999. The Company continues to explore alternatives available to it regarding its investment in Santee.
Income before income taxes amounted to $4.0 million, $22.8 million and $27.1 million for the 1998, 1997 and 1996 fiscal years, respectively.
Net income amounted to $2.5 million in 1998, $13.5 million in 1997 and $16.0 million in 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company historically has funded its daily cash flow requirements through funds generated from operations and from borrowings from short-term revolving credit facilities. The Company's credit agreement as amended, expires in June 2000, and consists of a revolving credit facility for working capital of $15.0 million, which was available at September 27, 1998 and a standby letter of credit facility with a maximum availability of $25.0 million, of which $14.2 million was available at September 27, 1998. Such standby letter of credit facility is maintained pursuant to the Company's workers' compensation and general liability self-insurance requirements.
The Company had no short-term borrowings outstanding at fiscal years end 1998, 1997 and 1996, and the Company did not incur short-term borrowings during fiscal years 1998, 1997 and 1996.
Working capital amounted to $90.7 million at September 27, 1998 and $92.0 million at September 28, 1997 and $63.5 million at September 29, 1996. The Company's current ratios were 1.78:1, 1.81:1 and 1.50:1, respectively. Fluctuations in working capital and current ratios are not unusual in the industry.
Net cash provided by operating activities amounted to $26.4 million in 1998, $9.6 million in 1997 and $27.9 million in 1996. Fluctuations in operating assets and liabilities are not unusual in the industry. The change in net cash provided by operating activities between 1998, 1997 and 1996 is primarily due to fluctuations in inventories and related accounts payable. In September 1996, the Company increased its inventory and related accounts payable in anticipation of the implementation of the Company's 60th Anniversary Marketing Program in the first quarter of fiscal 1997 and the subsequent decrease in accounts payable in the first quarter of 1997. Fiscal 1998 reflects a return to a more traditional year end balance of accounts payable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
LIQUIDITY AND CAPITAL RESOURCES (CONTD.)
Net cash used in financing activities during fiscal 1998 amounted to $1.3 million and consisted of reductions in capitalized lease obligations. Net cash provided by financing activities in fiscal 1997 amounted to $12.8 million and consisted of the issuance of $100 million of 9% Notes, redemption of the Series B Preferred Stock for $69.365 million, costs and expenses to issue debt of $10.5 million, payment of dividends on the Series B Preferred Stock of $6.2 million and reduction to amounts due on capitalized lease obligations of $1.2 million.
The 9% Notes are due in 2004 and are general unsecured obligations of the Company, subordinated in right of payment to the 11% Senior Notes and all other present and future Senior Indebtedness of the Company, including the Company's obligations under the revolving credit agreement and effectively subordinated to all indebtedness and other obligations of the subsidiaries of the Company. Interest on the 9% Notes is payable semi-annually in arrears on January 1 and July 1 of each year. The proceeds from the issuance of the 9% Notes were used (approximately) as follows; (a) $69.4 million to redeem all of the outstanding shares of the Company's Series B Preferred Stock, (b) $4.6 million to pay accrued dividends on the Series B Preferred Stock, (c) $4.9 million to obtain the consent from the holders of the Company's 11% Notes to permit the issue of the 9% Notes, (d) $2.0 million to La Cadena for financial advise relating to the transaction, and (e) $3.4 million for fees and expenses of the transaction. The remaining proceeds from the 9% Notes were used for general corporate purposes, including capital expenditures.
Net cash used in financing activities in fiscal year 1996 amounted to $5.2 million. Net cash used in financing activities in 1996 reduced amounts due under capitalized lease obligations by $1.1 million. Effective March 8, 1996, the Company converted its outstanding Common Stock for 693,650 shares of its 10.5% Series B Preferred Stock, stated value $100 per share. Dividends paid or accrued for the 10.5% Series B Preferred Stock amounted to $4.1 million in 1996.
Net cash used in investing activities for the 1998, 1997 and 1996 fiscal years, amounted to $27.0 million, $8.6 million and $3.8 million, respectively. The difference in net cash used in investing activities between the comparable periods in 1998, 1997 and 1996 was due to the Company's capital expenditures during such periods, net of proceeds from asset dispositions. Capital expenditures amounted to $26.3 million in 1998, $20.3 million in 1997 and $22.4 million in 1996. Capital expenditures for 1998 included costs to complete construction and to open two supermarkets, to begin construction on a third supermarket (which opened in December 1998) and to complete five minor and six major remodels. Additionally, during fiscal 1998, the Company installed 15 new NCR 7452 scan systems in its supermarkets. Capital expenditures for 1998 were funded through cash flow from operations.
Capital expenditures for 1997 amounted to $20.3 million and included costs incurred to complete thirteen minor remodels and one major remodel, acquire one supermarket site and to remodel a perishable products warehouse. Two supermarkets were under construction during fiscal 1997. Capital expenditures for fiscal 1997 were funded from the proceeds of the October 1996 sale and leaseback transaction and from a portion of the net proceeds from the July 1997 issuance of the 9% Notes.
In October 1996 (fiscal 1997), the Company completed a sale and leaseback transaction with an unrelated third party for four of the Company's supermarkets. The net proceeds from the sale of the four supermarkets amounted to approximately $16.0 million, which approximated fair market value. The Company entered into leases for the four supermarkets with initial terms of 20 years and with options available to the Company which extend the lease terms up to an additional 20 years. The Company believes the rents due under the leases approximate fair market rents. The
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
LIQUIDITY AND CAPITAL RESOURCES (CONTD.)
gains from the sale of the supermarkets were approximately $2.5 million and will be deferred and amortized into income over the initial term of the leases. As a result of the additional rent expenses, net of reductions in depreciation expense, due on the four supermarkets, operating expenses increased by approximately $1.2 million in fiscal 1997.
Capital expenditures for 1996 amounted to $22.4 million and included costs incurred to construct a replacement supermarket and to complete eight major remodels and eight minor remodels and capital expenditures incurred to acquire store equipment to support the 1996 merchandising expansion and upgrade program. Capital expenditures in 1996 were financed primarily by proceeds from the January 1996 sale and leaseback of five supermarkets.
In January 1996 (fiscal 1996), the Company completed a sale and leaseback transaction with an unrelated third party for five of the Company's supermarkets. Gross proceeds from the sale of the five supermarkets amounted to approximately $18.5 million, which approximated fair market value. The Company entered into leases for the five supermarkets with initial terms of 20 years and with options available to the Company which extend the lease terms up to an additional 20 years. The Company believes the rents due in accordance with the terms of the leases approximate fair market rents. The gains from the sale of the supermarkets are deferred and will be amortized into income over the initial term of the leases. As a result of the additional rent expenses, net of reductions in depreciation expense, paid on the five supermarkets, operating expenses increased by approximately $900,000 in fiscal 1996 and by $259,000 in fiscal 1997.
In November 1996, for approximately $200,000, the Company increased its ownership in Santee Dairies, Inc. to 50%. Additionally, during the first quarter of fiscal 1997, the Company increased its investment in Santee Dairies, Inc. by approximately $4.8 million. Hughes Family Markets ("Hughes"), located in Irwindale, California retained a 50% ownership in Santee. Both the Company and Hughes subsequently exchanged all of the Common Stock of Santee Dairies, Inc. for equal interests in Santee Dairies Limited Liability Company. In May 1998, the Company increased its investment in Santee Dairies LLC by contributing $1.1 million into Santee's capital structure. Santee Dairies, Inc. is a wholly owned subsidiary of Santee Dairies LLC. Santee Dairies, Inc. operates a fluid milk processing plant in City of Industry, California. Santee provides the Company's supermarkets with a significant amount of high quality fluid milk and other dairy products.
Management believes that cash capital expenditures for fiscal 1999 will be approximately $22.0 million.
Management believes that operating cash flow, supplemented by capital expenditures financings obtained through capital and operating leases, will be sufficient to meet the Company's currently identified operating needs and scheduled capital expenditures. However, there can be no assurance that such lease financings will be available to the Company.
The Company operated 112 supermarkets at September 27, 1998 and operated 110 supermarkets at September 28, 1997 and September 29, 1996.
The Company's supermarkets had approximately 3.3 million retail square feet at September 27, 1998 and approximately 3.2 million retail square feet at September 28, 1997 and September 29, 1996.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
LIQUIDITY AND CAPITAL RESOURCES (CONTD.)
THE BANK FACILITIES
Stater Bros. Markets, the Company's operating subsidiary, and Bank of America National Trust and Savings Association (the "Bank") entered into a Credit Agreement in March 1994, as amended and effective June 1, 1996, whereby the Bank provides Stater Bros. Markets with a revolving operating line of credit (the "Operating Facility") with a maximum availability of $15.0 million which was available at September 27, 1998 and a revolving letter of credit facility (the "LC Facility") with a maximum availability of $25.0 million (collectively, the "Bank Facilities"). As of September 27, 1998, approximately $14.2 million of the LC Facility was available to the Company. The Bank Credit Agreement expires on June 1, 2000.
The Bank Facilities also contain certain financial and other covenants applicable to Stater Bros. Markets, including without limitation, requirements to (i) maintain a minimum current ratio of at least 1.20:1; (ii) maintain minimum tangible net worth plus debt subordinated to the Bank (as defined) of at least $190.0 million; (iii) maintain a ratio of total liabilities to tangible net worth plus debt subordinated to the Bank of not in excess of 1.30:1; (iv) maintain a minimum fixed charge coverage ratio (as defined) of at least 1.10:1 for each consecutive four fiscal quarters beginning with the four fiscal quarters ending on Stater Bros. Markets' 1996 fiscal year end; (v) limit the sale of assets; (vi) prohibit additional indebtedness except for normal trade credit and indebtedness secured only by real property constructed or acquired within the prior twelve months; (vii) prohibit additional liens except for liens for indebtedness secured by real property pursuant to clause (v); (viii) prohibit the acquisition of other business entities; (ix) restrict the payment of dividends (as discussed below); (x) prohibit changes of ownership; (xi) prohibit the liquidation, consolidation or merger of the business; and (xii) repay all advances outstanding under the Operating Facility and not draw any new advances for at least 5 calendar days each month.
As of September 27, 1998, for purposes of the Bank Facilities, Stater Bros. Markets was in compliance with all restrictive convenants and had (i) a current ratio of 1.86:1, (ii) tangible net worth and debt subordinated to the Bank of $234.4 million; (iii) a ratio of total liabilities to tangible net worth and debt subordinated to the Bank of 0.55:1 and (iv) a fixed charge coverage ratio (as defined in the Bank Facilities) of 1.51:1. If for any reason Stater Bros. Markets is unable to comply with the terms of the Bank Facilities, including the covenants contained therein, such noncompliance would result in an event of default under the Bank Facilities, and could result in acceleration of the payment of indebtedness then outstanding under Bank Facilities or, in certain situations, the prohibition of payments of dividends or advances to the Company. In addition, no amendment, waiver or supplement may be made to the Indenture without the prior written consent of the Bank if such amendment, waiver or supplement adversely affects the rights of the Bank as lender to Stater Bros. Markets.
The financial and operational covenants contained in the Bank Facilities significantly limit Stater Bros. Markets' ability to pay dividends and make loans or advances to the Company, the primary source of anticipated cash for the Company, and could limit the Company's ability to respond to changing business and economic conditions, and to finance future operations or capital needs including the Company's ability to achieve its plans to remodel and expand existing supermarkets and open new supermarkets.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
LIQUIDITY AND CAPITAL RESOURCES (CONTD.)
THE BANK FACILITIES (CONTD.)
The Company is also subject to certain covenants associated with its 11% Senior Notes due 2001 and its 9% Senior Subordinated Notes due 2004. As of September 27, 1998, the Company was in compliance with all such covenants. However, there can be no assurance that the Company will be able to achieve the expected operating results or implement the capital expenditure strategy upon which future compliance with such covenants is based.
THE CONVERSION AND REDEMPTION OF SERIES B PREFERRED STOCK
In March 1994, the Company acquired, for $14.7 million, an option available to the Company to convert the Company's 50,000 shares of Common Stock held by Craig Corporation into 693,650 shares of 10.5% Series B Preferred Stock on or before March 8, 1996.
Effective March 8, 1996, the Company exercised its option to convert the Company's 50,000 shares of Common Stock held by Craig Corporation into 693,650 shares of the Company's Series B Preferred Stock. The Series B Preferred Stock was redeemed by the Company, in August 1997, for $69.4 million plus accrued and unpaid dividends.
LABOR RELATIONS
The Company and other major supermarket employers in Southern California negotiated a four-year contract, beginning October 1995, with the United Food and Commercial Workers Union. The Company's collective bargaining agreement with the International Brotherhood of Teamsters was renewed in 1998 and expires in September 2002. Management believes it has good relations with its employees.
YEAR 2000 COMPLIANCE
The efficient operations of the Company are dependent, in part, upon its computer software programs, systems and processes (collectively, the "Information Systems"). The Company's Information Systems are used in several key areas of the Company, including, but not limited to, supermarket operations, warehousing and distribution, merchandising and purchasing, inventory management, and accounting and financial reporting. The Company is in the process of updating its Information Systems for Year 2000 compliance requirements. Additionally, the Company has also been in communication with some of its vendors, financial institutions and others whose computer software, programs and information systems may interface with those of the Company to assess the status of their compliance with Year 2000 requirements. Failure of companies (that the Company conducts business with) to comply with the Year 2000 requirements could have an adverse effect on the Company's operations.
Based on the information currently available, the Company believes it will meet the Year 2000 compliance requirements through a combination of Information Systems modifications and through the acquisition of new equipment and technology that are Year 2000 compliant. The Company believes that costs required to replace or modify Information Systems, including scheduled replacements of in-store Point of Sale equipment, will approximate $8.4 million, of which $6.9 million will be capitalized and $1.5 million will be expensed. Through September 27, 1998, the Company has incurred capitalized expenditures of $3.2 million and expenses of $340,000. The Company believes that it will successfully achieve compliance with the year 2000 requirements, however, no assurances can be given that the Company's Information Systems and it's vendors, financial institutions and other will be successful in achieving Year 2000 compliance.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTD.)
RECENT ACCOUNTING STANDARDS
The Financial Accounting Standards Board has issued Statements of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share"; No. 130, "Reporting on Comprehensive Income"; and No. 131, "Disclosures about Segments of an Enterprise and Related Information", all of which were adopted by the Company in its fiscal year ending on September 27, 1998 (fiscal 1998). The adoption of SFAS No. 128, No. 130 and No. 131 did not have material effect on its financial position or its results of operations in fiscal 1998.
EFFECT OF INFLATION AND COMPETITION
The Company's performance is affected by inflation. In recent years the impact of inflation on the operations of the Company has been moderate. As inflation has increased expenses, the Company has recovered, to the extent permitted by competition, the increase in expenses by increasing prices over time. However, the economic environment in Southern California continues to challenge the Company to become more cost efficient as its ability to recover increases in expenses through price increases is diminished. The future results of operations of the Company will depend upon the ability of the Company to adapt to the current economic environment as well as to the current competitive conditions.
The Company conducts business in one industry segment, the operation of retail food supermarkets, which offer for sale to the public most merchandise typically found in supermarkets. The supermarket industry is highly competitive and is characterized by low profit margins. The Company's primary competitors include Lucky, Vons, Albertson's, Ralphs, and a number of independent supermarket operators. Competitive factors typically include the price, quality and selection of products offered for sale, customer service, and the convenience and location of retail facilities. The Company monitors competitive activity and Senior Management regularly reviews the Company's marketing and business strategy and periodically adjusts them to adapt to changes in the Company's primary trading area.
CAUTIONARY STATEMENT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained in the Company's filings with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) includes statements that are forward-looking, such as statements relating to plans for future activities. Such forward-looking information involves important risks and uncertainties that could significantly affect results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to domestic economic conditions, seasonal and weather fluctuations, expansion and other activities of competitors, changes in federal or state laws and the administration of such laws and the general condition of the economy.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information called for by this item is set forth in the Company's financial statements and supplementary data contained in this report. Specific financial statements and supplementary data can be found on the pages listed in the following index.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the current executive officers and directors of the Company, their ages and principal occupations for at least the past five years. Directors of the Company each serve for a term of one year, or until their successors are elected. The officers serve at the discretion of the Board of Directors of the Company.
BACKGROUND OF DIRECTORS AND EXECUTIVE OFFICERS
Jack H. Brown has been President and Chief Executive Officer of the Company since June 1981 and Chairman of the Board since 1986. From September 1978 to June 1981, Mr. Brown served as President of Pantry Food Markets, Inc. and American Community Stores Corporation, Inc., both wholly-owned subsidiaries of Cullum Companies, Inc., a publicly held corporation. From 1972 to 1978, Mr. Brown served as Corporate Vice President of Marsh Supermarkets, Inc., a publicly held corporation. Mr. Brown has been employed in various capacities in the supermarket industry for 46 years. Mr. Brown has a majority interest and is the managing general partner of La Cadena Investments.
Donald I. Baker has been Executive Vice President of the Company since October 1998. Mr. Baker joined the Company in November 1983 as Vice President-Warehouse and Transportation and was Group Senior Vice President-Administration from July 1996 to October 1998. From July 1992 to July 1996, Mr. Baker was Group Senior Vice President-Human Resources and Distribution. From August 1986 to July 1992, Mr. Baker was Senior Vice President-Human Resources and Distribution. Mr. Baker has approximately 32 years of experience in the supermarket industry. Prior to joining the Company, Mr. Baker was employed by American Community Stores Corporation, Inc., a subsidiary of Cullum Companies, Inc., a publicly held corporation, from 1972 to 1983 in various capacities including Vice President of Retail Operations, and was also employed by Kroger Company from 1966 to 1972.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTD.)
BACKGROUND OF DIRECTORS AND EXECUTIVE OFFICERS (CONTD.)
H. Harrison Lightfoot has been Group Senior Vice President-Development since May 1998 and was Group Senior Vice President-Retail Operations of the Company from June 1986 to May 1998. Mr. Lightfoot has served the Company for 44 years in various capacities, including store manager, buyer, general supervisor and Vice President. Mr. Lightfoot is a general partner of La Cadena Investments.
A. Gayle Paden has been Group Senior Vice President-Human Resources since May 1998 and was Group Senior Vice President-Distribution from July 1996 to May 1998. Mr. Paden joined the Company in 1986 as Group Senior Vice President-Administration and served in that capacity until July 1996. Mr. Paden was previously with Lucky Stores for 35 years where he served in various capacities, the most recent of which was President of the Southern California Food Division.
Dennis N. Beal has been Senior Vice President-Finance and Chief Financial Officer since May 1998 and was Vice President of Finance and Chief Financial Officer of the Company from September 1992 to May 1998. Mr. Beal was Vice President and Controller of American Stores Company from 1989 to 1992 and Vice President and Controller of subsidiaries of American Stores Company from 1987 to 1989 and served in various financial positions since 1981. Mr. Beal, a certified public accountant, was also a partner in the accounting firm of Bushman, Daines, Rasmussen & Wisan and served in various capacities with the firm from 1974 to 1981.
Bruce D. Varner has been a director of Stater Bros. Markets since September 1985 and director of Stater Bros. Holdings Inc. since May 1989. Since February 1997, Mr. Varner has been a partner in the law firm of Varner, Saleson & Dobler LLP. From 1967 to February 1997, Mr. Varner was a partner in the law firm of Gresham, Varner, Savage, Nolan & Tilden. Mr. Varner specializes in business and corporate matters. Mr. Varner and the law firm of Varner, Saleson & Dobler LLP have performed legal services in the past for the Company and the Company expects such services to continue in the future.
Thomas W. Field, Jr. has been Vice Chairman of the Board of Directors of the Company since May 1998 and a Director of the Company since 1994. He has been President of Field and Associates since 1989. From 1988 to 1989, Mr. Field was Chairman of the Board, President and Chief Executive Officer of McKesson Corporation and was its President since 1984, and President and Chief Executive Officer from 1986 to 1988. Mr. Field was President of American Stores Company from 1981 to 1984 and was President of Alpha Beta Company from 1976 to 1984. Mr. Field was a Director of American Stores Company from 1979 to 1984. Mr. Field is a nationally recognized and highly regarded supermarket executive. Mr. Field has held various positions in the Supermarket Industry for over 40 years and serves as a Director for several companies including, Campbell Soup Company and Maxicare.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table summarizes the compensation for services rendered during the prior three fiscal years paid to the CEO and the four most highly compensated executive officers other than the CEO of the Company:
(1) The dollar value of perquisites and other personal benefits, if any, for each of the Named Executive Officers was less than the reporting thresholds established by the Securities and Exchange Commission.
(2) Amounts shown for the Named Executive Officers represent the Company's contributions to the Company's Profit Sharing Plan, a defined contribution plan, for the account of each Named Executive Officer. Plan participants become fully vested in the plan after seven years of service.
(3) Includes Mr. Brown's Director Fees for 1996, 1997 and 1998 which amounted to $25,500, $25,500, and $26,000, respectively.
(4) Bonuses to be paid to the Named Executive Officers for fiscal 1998 had neither been calculated nor awarded as of December 18, 1998, the latest practical date.
(5) The Board of Directors of Stater Bros. Holdings Inc. unanimously awarded Mr. Brown a one-time bonus for his expertise in handling the July 1997 issuance of the 9% Senior Subordinated Notes. The amount is included in his 1997 Bonus.
STOCK OPTIONS AND SARs
None
ITEM 11. EXECUTIVE COMPENSATION (CONTD.)
PENSION PLAN
The Company's Pension Plan for Salaried Employees (the "Pension Plan") is a non-contributory, defined benefit plan which applies to all salaried employees who have completed one year of qualified service, including directors who are employees. For each year of credited service, the annual pension to which an employee is entitled under the Pension Plan upon normal retirement at age 65 is an amount equal to three quarters of one percent of the employee's compensation for each year up to the social security wage base, plus 2.15 percent of the employee's compensation for each year in excess of the social security wage base. The Named Executive Officers have the following years of credited service under the Pension Plan as of September 27, 1998: Jack H. Brown - 17 years, H. Harrison Lightfoot - 44 years, A. Gayle Paden - 12 years, Donald I. Baker - 15 years and Dennis N. Beal - 5 years.
The amounts shown in the following table are estimated annual retirement benefits under the Pension Plan (assuming payments are made on the normal life annuity and not under any of the various survivor forms of benefits) based upon retirement at age 65, after various years of service at selected salary levels. Benefits under the Pension Plan do not become fully vested until the employee has five years of credited service with the Company. The Internal Revenue Code of 1986, as amended, places certain limitations on pension benefits that can be paid from a tax-qualified pension plan and trust, as well as the compensation that may be taken into account in determining such benefits. Such limitations are not reflected in the table below. The maximum annual benefit for 1998 retirees with ten or more years of service at retirement is $130,000. The maximum annual compensation that may be considered for 1998 retirees is $160,000.
COMPENSATION OF DIRECTORS
Directors of the Company are paid an annual fee of $25,000 plus $500 for each board meeting attended.
EMPLOYMENT AND SEVERANCE AGREEMENTS
There are no written employment contracts between the Company and any Named Executive Officer. The Company's severance policies generally provide for two weeks of severance pay to full-time, non-bargaining unit employees for every year of service to the Company, up to a maximum of twelve weeks.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 11, 1998, the number and percentage of outstanding shares of Class A Common Stock beneficially owned by (a) each person known by the Company to beneficially own more than 5% of such stock, (b) each director of the Company, (c) each of the Named Executive Officers, and (d) all directors and executive officers of the Company as a group:
- - ---------------
(1) The 50,000 outstanding shares of the Company's Class A Common Stock are owned by La Cadena Investments and may be deemed to be beneficially owned by the partners of La Cadena Investments. The general partners of La Cadena Investments are Jack H. Brown, Richard C. Moseley and H. Harrison Lightfoot. Mr. Brown has the majority interest and is the managing general partner of La Cadena Investments and has the power to vote the shares of the Company owned by La Cadena Investments on all matters. Certain La Cadena issues, such as the disposition of such shares of the Company, may require approval of 60% of the voting power of La Cadena Investments. Accordingly, Messrs. Brown, Moseley and Lightfoot may be deemed to have shared voting power or shared investment power with respect to the shares owned by La Cadena Investments, and such individuals therefore may be deemed to be the beneficial owners thereof. The address of La Cadena Investments is 3750 University Avenue, Suite 610, Riverside, California 92501.
(2) The address of Messrs. Brown, Lightfoot, Moseley, Paden, Baker, Beal, Varner and Field is c/o the Company at 21700 Barton Road, Colton, California 92324.
CHANGE OF CONTROL ARRANGEMENTS
As of September 3, 1993, the Company, La Cadena, Craig and certain of their affiliates entered into a series of separate agreements, as subsequently amended, and took certain actions, for the purpose of reclassifying the Company's outstanding equity, providing for effective operating control of the Company by La Cadena, making certain cash payments and distributions to Craig, and providing the Company with the option to acquire Craig's equity interest in the Company, all of which were completed simultaneously with the closing of the Recapitalization Transaction. In August 1997, the Company redeemed all of the outstanding shares of its Series B Preferred Stock and La Cadena became the sole shareholder of the Company.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Mr. Bruce D. Varner and the law firm of Varner, Saleson & Dobler LLP, of which Mr. Varner is a partner, have performed legal services in the past for the Company. The total cost of such legal services incurred by the Company during fiscal 1998 was approximately $1.6 million. The Company believes that the terms and costs of such legal services provided by Mr. Varner and the law firm of Varner, Saleson & Dobler LLP were at least as fair to the Company as could have been obtained from unaffiliated law firms. The Company expects such services to continue in the future.
Prior to March 24, 1994, the Company's common stock was owned equally by La Cadena and Craig. In March 1994, the Company completed the 1994 Recapitalization, which transferred effective voting control of the Company to La Cadena, reclassified the Company's outstanding equity, provided for certain cash payments and distributions to Craig and provided the Company with an option to acquire Craig's remaining equity in the Company. The 1994 Recapitalization was funded through the offering of the 11% Senior Notes. The following paragraphs describe the 1994 Recapitalization.
The Company amended its Certificate of Incorporation to provide for two classes of common stock designated "Common Stock" and "Class A Common Stock", and two series of preferred stock designated "Series A Preferred Stock" and "Series B Preferred Stock." The then existing shares of outstanding common stock were classified as Common Stock, and holders of such stock were afforded the right to exchange all such shares into a like number of shares of Class A Common Stock. La Cadena exchanged its shares of Common Stock for shares of Class A Common Stock and Craig initially retained its shares of Common Stock (subject to the Company's right to convert such shares of Common Stock into shares of Series B Preferred Stock, and subject to the Company's option to acquire such shares of Common Stock, as described below). For a period of five years following the 1994 Recapitalization, each share of Class A Common Stock was entitled to 1.1 votes while each share of Common Stock was entitled to one vote, thereby giving La Cadena approximately 52% and Craig approximately 48% of the total voting power of the Company.
The Board of Directors of the Company declared a dividend of $400 per share on the Common Stock, payable to holders of record at the close of business on the day following the closing of the 1994 Recapitalization. As a result of the amendment of the Company's Certificate of Incorporation and the exchange by La Cadena of its shares of Common Stock for Class A Common Stock, the aggregate amount of the dividend on the Common Stock amounted to $20.0 million, and the entire dividend was paid to Craig.
Pursuant to the Option Agreement dated as of September 3, 1993 between the Company and Craig, as amended (the "Option Agreement"), the Company was given the right, at its option, for a period of two years from the 1994 Recapitalization, to convert the Common Stock into 693,650 shares of Series B Preferred Stock. The Company exercised the option effective March 8, 1996.
The Series B Preferred Stock provided for dividends at the rate of 10.5% per annum through September 2002, increasing to 12% per annum beginning October 2002 and by 100 basis points per year thereafter to a maximum rate of 15% per annum.
Under the Option Agreement, holders of the Series B Preferred Stock were entitled to certain registration rights. In addition, the Option Agreement provided holders of the Series B Preferred Stock with the right to require the redemption of all, but not less than all, the Series B Preferred Stock owned by such holder in the event of certain changes of control of the Company or in the event Jack H. Brown shall cease to be the Chief Executive Officer of the Company, other than by reason of death, disability or retirement in accordance with the Company's normal retirement policies.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTD.)
The Option Agreement provided the Company an option to purchase all shares of the Series B Preferred Stock held by Craig for a purchase price, in cash, of $69.4 million, plus accrued and unpaid dividends. The Company paid Craig $14.7 million in consideration of the grant of the option, which amount was not credited toward the exercise price of the option.
In August 1997, the Company redeemed all outstanding shares of the Series B Preferred Stock. The Company used a portion of the net proceeds from the issuance and sale of $100 million of 9% Senior Subordinated Notes Due 2004 to redeem the outstanding Series B Preferred Stock.
The Company entered into a prepaid five year covenant not to compete and a consulting agreement with Craig, pursuant to which the Company paid Craig $5.0 million at the closing of the 1994 Recapitalization. Additionally, the Company had been paying an annual consulting fee of $1.5 million. The covenant not to compete and consulting arrangements with Craig were unique, based upon the confidential information available to Craig and its experience with, and relationship to the Company. Accordingly, the Company had no basis to determine whether comparable services could be obtained from unaffiliated third parties on similar or more favorable terms. On July 31, 1997, the Company gave notice to Craig to terminate the Consulting Agreement.
Pursuant to the Option Agreement, at the 1994 Recapitalization closing, the Company purchased from Craig 72,000 shares of the Company's Series A Preferred Stock, held by Craig, for a total purchase price of $1.8 million plus accrued and unpaid dividends of approximately $306,000, and paid approximately $79,000 to Craig as payment of all unpaid interest owing to Craig on a shareholder note. In addition, the Company purchased from La Cadena 72,000 shares of the Company's Series A Preferred Stock, held by La Cadena, for a total purchase price of $1.8 million, plus accrued and unpaid dividends of approximately $306,000 and paid approximately $79,000 to La Cadena as payment of all unpaid interest owing to La Cadena on a shareholder's note. In September 1993, the Company issued 40,000 shares of the Company's Series A Preferred Stock to each of Craig and La Cadena in payment of all principal owing on such notes.
Pursuant to the Second Amended and Restated Stock Agreement dated as of January 12, 1994 (the "Craig Stock Agreement"), among the Company, Craig, La Cadena and James J. Cotter, in consideration for a standstill agreement by Craig, the Company transferred to Craig 311,404 shares of Craig's Common Stock owned by the Company at such time following the 1994 Recapitalization, as the Company determined it was legally entitled to do so under applicable California law governing distributions to shareholders. Such agreement resulted in a pre-tax charge to earnings of $4.0 million in the second quarter of fiscal 1994.
Pursuant to the Amendment to the Agreement of Stockholders of Stater Bros. Holdings Inc. dated as of September 3, 1993, the Agreement of Stockholders of Stater Bros. Holdings Inc. dated as of May 10, 1989 among the Company, La Cadena, Craig and an affiliate of Craig (as amended, the "Stockholders Agreement") was amended effective as of the 1994 Recapitalization closing to provide that, among other things: (a) the Stockholders Agreement may be terminated by any party upon exercise by the Company of its right to convert the Common Stock into the Series B Preferred Stock as described above, and (b) certain rights of the stockholders to purchase shares of Common Stock owned by other stockholders would be suspended until after the expiration of the Company's right to convert the Common Stock into the Series B Preferred Stock. Under the Stockholders Agreement, the Company and the holders of the Class A Common Stock and Common Stock were granted certain rights of first refusal with respect to transfers of such stock. The Stockholders Agreement was terminated effective October 15, 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTD.)
In connection with the 1994 Recapitalization, the Company utilized approximately $88.9 million of the net proceeds from the 1994 debt offering to redeem its 9.8% Senior Notes due 2001, including an estimated $13.4 million (pre-tax) for a redemption premium associated with the early retirement of such notes (including accrued interest thereon). In addition, the Company utilized approximately $12.2 million of the net proceeds of the 1994 offering to repay certain notes payable secured by real property, and approximately $9.0 million of the net proceeds of the 1994 offering to repay outstanding balances owing under the Company's existing capital expenditures credit facility.
In June 1997, in connection with the Consent Solicitation, the Company retained La Cadena to provide financial advisory services for a fee of $2.0 million.
The 50,000 outstanding shares of the Company's Class A Common Stock are owned by La Cadena Investments and may be deemed to be beneficially owned by the partners of La Cadena Investments. The general partners of La Cadena are Jack H. Brown, Richard C. Moseley and H. Harrison Lightfoot. Mr. Brown has a majority interest and is the managing general partner. Mr. Brown is a director of the Company and Messrs. Brown and Lightfoot are Named Executive Officers of the Company. Mr. Brown has the power to vote the shares of the Company owned by La Cadena, except with respect to certain fundamental corporate changes of the Company, including the disposition of such shares. Accordingly, Messrs. Brown, Moseley and Lightfoot may be deemed to have shared voting power with respect to shares of the Company owned by La Cadena. Mr. Moseley served the Company for over 44 years and in many executive capacities, most recently and from September 1995 until his retirement from the Company in January 1996, Mr. Moseley served as Executive Vice President of the Company.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Document list
(1) Financial Statements See Financial Statement Index included in Item 8 of Part II of this Form 10-K.
(2) Financial Statement Schedules The Financial Statement Schedules required by Item 14(d) for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission, are not required under the related instructions or are inapplicable and therefore, have been omitted.
(3) Exhibits Exhibits as required by Item 14(c) are as follows:
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTD.)
(a)(3) Exhibits (contd.)
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (CONTD.)
(a)(3) Exhibits (contd.)
--------------------------------------------------------
(1) Previously filed with the Securities and Exchange Commission as an exhibit to the Registration Statement S-4 No. 33-77296 dated July 21, 1994.
(2) Previously filed with the Securities and Exchange Commission as an exhibit to the Registrant's Quarterly Report on Form 10-Q dated June 25, 1995 and filed on August 8, 1995.
(3) Previously filed with the Securities and Exchange Commission as exhibit 10.12(b) with the Annual Report on Form 10-K for the fiscal year ended September 29, 1996.
(4) Previously filed with the Securities and Exchange Commission as exhibits to the Registration Statement S-4, No. 333-34113 dated October 17, 1997.
Copies of Exhibits listed herein can be obtained by writing and requesting such Exhibits from: Corporate Secretary, P. O. Box 150, Colton, California 92324.
(b) Reports on Form 8-K None
STATER BROS. HOLDINGS INC. FOR THE FISCAL YEAR ENDED SEPTEMBER 27, 1998 FORM 10-K
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
December 18, 1998 Stater Bros. Holdings Inc. - - ----------------------------- Date
By: /s/ Jack H. Brown ------------------------------------- Jack H. Brown Chairman of the Board, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors of Stater Bros. Holdings Inc.
We have audited the accompanying consolidated balance sheets of Stater Bros. Holdings Inc. and subsidiaries as of September 29, 1996, September 28, 1997 and September 27, 1998, and the related consolidated statements of income, stockholders' equity (deficit), and cash flows for the 53-week period then ended for 1996 and for each of the 52-week periods then ended for 1997 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Stater Bros. Holdings Inc. and subsidiaries as of September 29, 1996, September 28, 1997 and September 27, 1998, and the consolidated results of their operations and their cash flows for the 53-week period then ended for 1996 and for each of the 52-week periods then ended for 1997 and 1998 in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP Riverside, California December 1, 1998
STATER BROS. HOLDINGS INC. CONSOLIDATED BALANCE SHEETS (In thousands)
ASSETS
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC. CONSOLIDATED BALANCE SHEETS (CONTD.) (In thousands, except share amounts)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC. CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share and share amounts)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTD.) (In thousands)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands)
See accompanying notes to consolidated financial statements.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 27, 1998
NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Stater Bros. Holdings Inc. (the "Company") is engaged primarily in the operation of retail supermarkets. As of September 27, 1998, the Company operated 112 retail food supermarkets under the name "Stater Bros." The Company's supermarkets are located principally in the "Inland Empire" area of Southern California - San Bernardino, Riverside and the eastern portions of Los Angeles, Orange and Kern counties. The Company and its predecessor companies have operated retail grocery stores under the "Stater Bros." name in the Inland Empire since 1936.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Stater Bros. Markets ("Markets") and Stater Bros. Development, Inc. All significant inter-company transactions have been eliminated in consolidation.
Fiscal Year
The Company's fiscal year ends on the last Sunday in September. The fiscal years ended September 28, 1997 and September 27, 1998 were 52-week years and the fiscal year ended September 29, 1996 was a 53-week year.
Cash and Cash Equivalents
Cash and cash equivalents are reflected at cost, which approximates their fair value, and consist primarily of overnight repurchase agreements, certificates of deposit and money market funds with maturities of less than three months when purchased.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market.
Receivables
Receivables represents amounts expected to be received during the next operating cycle of the Company. The carrying amount reported in the balance sheet for receivables approximates their fair value.
Properties Held for Sale
Properties expected to be sold within one year are classified as current assets and are stated at the lower of cost or estimated net realizable value and consist of land, buildings and equipment.
Deferred Debt Issuance Costs
Direct costs incurred as a result of financing transactions are capitalized and amortized to interest expense over the terms of the applicable debt agreements.
Self-insurance Reserves
The Company provides reserves, subject to certain retention levels, for workers' compensation, general and automobile liability claims. Consulting actuaries assist the Company in developing reserve estimates for its self-insured liabilities. Such reserves are discounted using an 8% rate. The Company is self-insured, subject to certain retention levels, for healthcare costs of eligible non-bargaining unit employees. Such healthcare reserves are not discounted.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
Recent Accounting Pronouncements
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share"; No. 130, "Reporting on Comprehensive Income"; and No. 131, "Disclosures about Segments of an Enterprise and Related Information", all of which were adopted by the Company at the beginning of its fiscal year ending on September 27, 1998 (fiscal 1998). Adoption of SFAS No. 128, No. 130 and No. 131 did not have a material adverse effect on the Company's financial position or its results of operations in fiscal 1998.
Property and Equipment
Property and equipment are stated at cost and are depreciated or amortized, principally on the straight-line method over the estimated useful lives of the assets, and for capitalized leases over the initial lease term or the estimated economic life of the asset.
The average economic lives are as follows:
Income Taxes
The Company provides for deferred income taxes as timing differences arise between income and expenses recorded for financial and income tax reporting purposes.
Cost of Goods Sold
Costs of goods sold include certain warehousing, transportation and distribution costs.
Reclassifications
Certain amounts in the prior periods have been reclassified to conform to the current period financial statement presentation.
Use of Estimates
The preparation of financial statements in conformity with Generally Accepted Accounting Principles requires management to make estimates and assumptions that effect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
NOTE 2 - DEBT
Long-term debt consisted of the following:
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 2 - DEBT (CONTD.)
As of September 27, 1998, principal payments amounting to $165 million were due in the next three years. Interest on the 11% Senior Notes due 2001 is payable semi-annually on September 1 and March 1. Interest on the 9% Senior Subordinated Notes due 2004 is payable semi-annually on July 1 and January 1.
Interest capitalized during fiscal years 1996, 1997 and 1998 amounted to $116,000, $251,000 and $224,000, respectively. Interest expense incurred, before the effect of capitalized interest, during 1996, 1997 and 1998 amounted to $20,374,000, $21,814,000 and $30,430,000, respectively.
The Company did not have short-term borrowings outstanding at September 29, 1996, September 28, 1997 and September 27, 1998. The Company did not incur any short-term borrowings during fiscal years 1996, 1997 and 1998.
The Company is subject to certain covenants associated with its 11% Senior Notes due 2001 and 9% Senior Subordinated Notes due 2004 and its bank credit agreement. As of September 27, 1998, the Company was in compliance with all such covenants.
NOTE 3 - UNCONSOLIDATED AFFILIATE
The Company owns 50% of Santee Dairies LLC. Through its wholly owned subsidiary, Santee Dairies, Inc. ("Santee"), it operated a fluid milk processing plant located in Los Angeles, California, and as of May 1, 1998, Santee moved its operations to a newly constructed fluid milk processing plant in City of Industry. The Company is not the controlling stockholder. Accordingly, the Company accounts for its investment in Santee Dairies LLC using the equity method of accounting and recognized losses of $1,624,000, $2,313,000, and $2,941,000 for fiscal years 1996, 1997 and 1998, respectively. The Company is a significant customer of Santee which supplies the Company with a substantial portion of its fluid milk and dairy products.
Summary of unaudited financial information for Santee Dairies LLC is as follows:
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 3 - UNCONSOLIDATED AFFILIATE (CONTD.)
The Company accepted and paid a temporary increase in costs of product purchased from Santee of approximately $4.3 million for product delivered by Santee to the Company during the last eighteen weeks of fiscal 1998. The temporary increase in cost of product is included in cost of goods sold for the year to date period ended September 27, 1998. The Company believes the temporary increase in the cost of product purchased from Santee by the Company will continue through March 1999, however, no assurances can be provided that the temporary increase in the cost of product will terminate on or before March 1999.
NOTE 4 - BANK FACILITIES
Stater Bros. Markets and Bank of America National Trust and Savings Association (the "Bank") have entered into a credit agreement (as amended) whereby the Bank provides Stater Bros. Markets with a revolving operating line of credit (the "Operating Facility") with a maximum availability of $15.0 million, which was available on September 27, 1998, and a revolving letter of credit facility (the "LC Facility") with a maximum availability of $25.0 million, of which $14.2 was available on September 27, 1998 (collectively, the "Bank Facilities"). The Bank Facilities will expire on June 1, 2000. Interest on the outstanding principal balance of the Operating Facility is payable monthly at either the Bank's reference rate plus one percent per annum or at a fixed rate of interest. Borrowings under the Bank Facilities are unsecured general obligations of Stater Bros. Markets and are guaranteed by Stater Bros. Development, Inc. The Bank Facilities contain customary cross-default provisions with respect to the Company's 11% Senior Notes due 2001 and 9% Senior Subordinated Notes due 2004.
The Bank Facilities also contain certain financial and other covenants applicable to Stater Bros. Markets, including without limitation, requirements to (i) maintain a minimum current ratio of at least 1.20:1; (ii) maintain minimum tangible net worth plus debt subordinated to the Bank (as defined) of at least $190.0 million; (iii) maintain a ratio of total liabilities to tangible net worth plus debt subordinated to the Bank of not in excess of 1.30:1; (iv) maintain a minimum fixed charge coverage ratio (as defined) of at least 1.10:1 for each consecutive four fiscal quarters beginning with the four fiscal quarters ending on Stater Bros. Markets' 1996 fiscal year end; (v) limit the sale of assets; (vi) prohibit additional indebtedness except for normal trade credit and indebtedness secured only by real property constructed or acquired within the prior twelve months; (vii) prohibit additional liens except for liens for indebtedness secured by real property pursuant to clause (v); (viii) prohibit the acquisition of other business entities; (ix) restrict the payment of dividends (as discussed below); (x) prohibit changes of ownership; (xi) prohibit the liquidation, consolidation or merger of the business; and (xii) repay all advances outstanding under the Operating Facility and not draw any new advances for at least 5 calendar days each month. As of September 27, 1998, for purposes of the Bank Facilities, Stater Bros. Markets was in compliance with all restrictive convenants and had (i) a current ratio of 1.86:1, (ii) tangible net worth and debt subordinated to the Bank of $234.4 million; (iii) a ratio of total liabilities to tangible net worth and debt subordinated to the Bank of .55:1 and (iv) a fixed charge coverage ratio (as defined in the Bank Facilities) of 1.51:1. If for any reason Stater Bros. Markets is unable to comply with the terms of the Bank Facilities, including the covenants contained therein, such noncompliance would result in an event of default under the Bank Facilities, and could result in acceleration of the payment of indebtedness then outstanding under Bank Facilities or, in certain situations, the prohibition of the payment of dividends or advances to the Company. In addition, no amendment, waiver or supplement may be made to the Indenture without the prior written consent of the Bank if such amendment, waiver or supplement adversely affects the rights of the Bank as lender to Stater Bros. Markets.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 4 - BANK FACILITIES (CONTD.)
The financial and operational covenants contained in the Bank Facilities significantly limit Stater Bros. Markets' ability to pay dividends and make loans or advances to the Company, the primary source of anticipated cash for the Company, and could limit the Company's ability to respond to changing business and economic conditions, and to finance future operations or capital needs including the Company's ability to achieve its plans to remodel and expand existing supermarkets and open new supermarkets.
NOTE 5 - LEASES
The Company leases the majority of its retail stores, offices, warehouses and distribution facilities. Certain leases provide for additional rents based on sales. Primary lease terms range from 10 to 99 years and substantially all leases provide for renewal options.
A portion of the Company's lease obligations are guaranteed by Petrolane Incorporated ("Petrolane") or its successor (see Note 6). The leases guaranteed by Petrolane had initial terms of 20 years and expire in the year 2003. Lease payments for the properties subject to the Petrolane guarantees are approximately $10.0 million per year. Under the terms of the agreement related to the Company's acquisition of Stater Bros. Markets from Petrolane in 1983, as amended in 1985, Stater Bros. Markets is required to make annual deposits into a lease guarantee escrow account. The amount of each annual deposit is to be based on (a) a percentage of sales of 20 supermarkets, as specified in the agreement, to the extent they exceed a defined base; and (b) a percentage of rents adjusted for increases in the Consumer Price Index for certain rental property, including the Company's office and warehouse complex. The Company deposited $738,000, $1,064,000 and $1,113,000 into the lease guarantee escrow account during fiscal years 1996, 1997 and 1998, respectively.
Upon termination of the leases, or the termination of the Petrolane lease guarantees, all amounts deposited into the lease guarantee escrow account, plus interest thereon, less any amounts disbursed, will be returned to the Company. At September 27, 1998, the lease guarantee escrow account had a cumulative balance of $9,629,000, compared to $8,069,000 and $6,701,000 as of September 28, 1997 and September 29, 1996, respectively.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 5 - LEASES (CONTD.)
Petrolane, or its successor, has the right to cause the escrow holder to disburse funds from the amounts held in the lease guarantee escrow account for any amounts which Petrolane or its successor may be required to pay as guarantor of the lease obligations of Stater Bros. Markets.
Following is a summary of future minimum lease payments as of September 27, 1998:
Rental expense and sublease income were as follows:
Aggregate sublease income to be received subsequent to September 27, 1998 is approximately $5,481,000.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 6 - PREFERRED STOCK
Stater Bros. Markets has issued and outstanding 10 shares of its $11.00 Cumulative Redeemable Preferred Stock due in 2003 for $1,000 plus accrued and unpaid dividends. Dividends are accrued at the rate of $11.00 per share per annum. The preferred stock was issued in conjunction with a guarantee of Stater Bros. Markets lease obligations by Petrolane Incorporated or its successors (see Note 5). For as long as shares of the $11.00 Cumulative Redeemable Preferred Stock remain outstanding, Stater Bros. Markets is subject to certain covenants. The most restrictive covenant limits the amount of dividends that may be paid to amounts that may be legally paid under applicable state laws. At September 27, 1998, accumulated earnings available for dividend distributions were approximately $221.9 million. In the event of non-compliance by Stater Bros. Markets, the holders of the Stater Bros. Markets preferred stock may elect the Board of Directors of Stater Bros. Markets. At September 27, 1998, Stater Bros. Markets was in compliance with these covenants.
Effective March 8, 1996, pursuant to options available to the Company, the Company exercised its right to convert all of its outstanding shares of Common Stock previously held by Craig Corporation ("Craig") into 693,650 shares of its Series B Preferred Stock. The Series B Preferred Stock had a redemption value of approximately $69.4 million and currently paid dividends at the rate of 10.5% per annum. In August 1997, the Company redeemed all of the outstanding shares of its Series B Preferred Stock for $69.4 million plus accrued and unpaid dividends.
NOTE 7 - INCOME TAXES
The provision for income taxes consisted of the following:
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 7 - INCOME TAXES (CONTD.)
A reconciliation of the provision for income taxes to amounts computed at the federal statutory rate is as follows:
Deferred income taxes resulted from timing differences in recognizing revenue and expense for tax and financial statement purposes. The sources of these timing differences and the income tax (benefit) of each were as follows:
Components of deferred income taxes are as follows:
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 7 - INCOME TAXES (CONTD.)
Although there can be no assurances as to future taxable income of the Company, the Company believes that its expectations of future taxable income, when combined with the income taxes paid in prior years, will be adequate to realize the deferred income tax assets.
NOTE 8 - RELATED PARTY TRANSACTIONS
Consulting Agreements and Covenant Not to Compete
Since January 1, 1989, the Company has entered into various consulting agreements with its stockholders, La Cadena Investments ("La Cadena") and Craig, that required them to provide consultation and advice to the Company in connection with general business, financial, management consulting, real estate acquisition and development, and product diversification matters. These consulting agreements with its stockholders terminated on September 26, 1993. In March 1994, the Company entered into a new five-year Consulting Agreement with Craig, whereby the Company paid Craig $1.5 million per year and Craig provided the Company with consultation and advise in connection with general business issues, financial management consulting, real estate acquisition and development and product diversification matters. Consulting fees expense amounted to $1.5 million in 1997 and 1996. The agreement to make annual consulting payments to Craig was terminated, at the election of the Company, in August 1997. Additionally, on March 8, 1994, the Company paid Craig $5.0 million which is amortized to earnings over the five-year term of the covenant not to compete included in the Consulting Agreement.
NOTE 9 - RETIREMENT PLANS
Pension Plan
The Company has a noncontributory defined benefit pension plan covering substantially all non-union employees. The plan provides for benefits based on an employee's compensation during the three years before retirement. The Company's funding policy for this plan is to contribute annually at a rate that is intended to provide sufficient assets to meet future benefit payment requirements.
Net periodic pension cost included the following components:
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 9 - RETIREMENT PLANS (CONTD.)
Pension Plan (contd.)
The following table sets forth the plan's funded status and amounts recognized in the Company's balance sheet at:
Expenses recognized for this retirement plan were $1,290,000, $1,392,000 and $1,499,000 in 1996, 1997 and 1998, respectively.
Profit Sharing Plan
The Company has a noncontributory defined contribution profit sharing plan covering substantially all non-union employees. Union employees may participate if their collective bargaining agreement specifically provides for their inclusion. The Company may contribute up to 7.5% of total compensation paid or accrued during the year to each plan participant subject to limitations imposed by the Internal Revenue Code. The Company recognized expenses for this plan in the amount of $347,000, $396,000 and $420,000 in 1996, 1997 and 1998, respectively.
Multi-Employer Plans
The Company also contributes to multi-employer defined benefit retirement plans in accordance with the provisions of the various labor agreements that govern the plans. Contributions to these plans are generally based on the number of hours worked. Information for these plans as to vested and non-vested accumulated benefits and net assets available for benefits is not available.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 9 - RETIREMENT PLANS (CONTD.)
Multi-Employer Plans (contd.)
The Company's expense for these retirement plans and health and welfare plans consisted of the following:
The Company's employer contributions increased in fiscal 1998 as a result of the resumption of employer contributions to a collective bargaining pension trust, such employer contributions had previously been suspended since 1994.
NOTE 10 - LABOR RELATIONS
The Company entered into a four-year collective bargaining agreement with the United Food & Commercial Workers collective bargaining units in October 1995 and entered into a four-year collective bargaining agreement in September 1998 with the International Brotherhood of Teamsters collective bargaining units.
NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short-term maturity of these instruments.
Receivables
The carrying amount approximates fair value because of the short-term maturity of these instruments.
Long-Term Debt
The fair value of the 11% Senior Notes due 2001 and 9% Senior Subordinated Notes due 2004, is based on quoted market prices. Although market quotes for the fair value of the Company's capitalized lease obligations are not readily available, the Company believes the stated value approximates fair value.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTD.)
The estimated fair values of the Company's financial instruments are as follows:
NOTE 12 - LITIGATION MATTERS
In the ordinary course of its business, the Company is party to various legal actions which the Company believes are incidental to the operation of the business of the Company and its subsidiaries. The Company records an appropriate provision when the occurrence of loss is probable and can be reasonably estimated. The Company believes that the outcome of such legal proceedings to which the Company is currently a party will not have a material adverse effect upon its results of operations or its consolidated financial condition.
On May 2, 1993, the Company was named as a defendant along with all of the other major supermarket chains located in the Los Angeles County area in a class action complaint filed in the California Superior Court in Los Angeles, California, alleging among other things that the milk pricing policies of each of the defendants violate certain antitrust laws and regulations under California law. In this class action lawsuit, Barela et al. v. Ralphs Grocery Co. et al., plaintiffs sought unspecified damages. The Company has recently entered into a settlement agreement with this case and such settlement does not involve payment of monetary damages and is currently being processed through the courts for approval and will not have an adverse material effect on the Company.
On June 19, 1997, Stater Bros. Markets was named as a defendant in the case of Ufondu, et al. vs. Stater Bros. Markets filed in the Superior Court of the State of California for the County of San Bernardino. The complaint filed by twelve employees seeks unspecified damages alleging racial discrimination in the Company's employment practices. The Company believes the complaint is without merit and intends to vigorously defend the case. There can be no assurances, however, as to the outcome of this case.
STATER BROS. HOLDINGS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTD.)
NOTE 13 - QUARTERLY RESULTS (UNAUDITED)
Quarterly results for fiscal 1996, 1997 and 1998 are as follows: (In thousands)