The Great Atlantic & Pacific Tea Company (GAP) F1Q09 (Qtr End 6/20/09) Earnings Call July 23, 2009 10:00 PM ET
William Moss - Vice President, Treasurer
Christian Wilhelm Erich Haub - Executive Chairman of the Board
Eric Claus - President, Chief Executive Officer
Brenda M. Galgano CPA - Chief Financial Officer, Senior Vice President
Welcome to the Great Atlantic & Pacific Tea Company conference call. I am Bill Moss, Vice President and Treasurer of A&P. In light of our recent financing announcement, this call has been prerecorded.
On today's call from A&P are Christian Haub, Executive Chairman of the Board, Eric Claus, President and Chief Executive Officer, and Brenda Galgano, Senior Vice President and Chief Financial Officer.
This presentation may contain forward looking statements about the future performance of the company and is based on management's assumptions and beliefs in light of information currently available. The company assumes no obligation to update this information. This forward looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements, including but not limited to, competitive pricing and pricing in the food industry, and particularly in the company's principle markets, the company's relationship with its employees, the terms of future collective bargaining agreements, the costs and other effects of lawsuits and administrative proceedings, the nature and extent of consolidation in the food industry, changes in the financial markets which may affect the company's cost of capital or the ability to access capital, supply or other quality-control problems with the company's vendors, and changes in economic conditions which may affect the buying patterns of the company's customers.
I will now introduce our Executive Chairman, Christian Haub.
Christian Wilhelm Erich Haub
Thank you, Bill. Hello, everyone, and welcome to our prerecorded message today. With me are Brenda and Eric and you'll hear from them shortly.
I'm pleased to share some terrific news with you. Today we announced the execution of two investment agreements, one with each of Yucaipa and Tengelmann whereby they will purchase an aggregate of $175 million of convertible preferred stock in a private placement transaction. Yucaipa will contribute $115 million and Tengelmann will contribute $60 million to this deal.
A&P also announced today the launch of a $225 million high-yield debt offering. The total proceeds of both financings will amount to at least $400 million, representing a significant strengthening of the company's balance sheet.
With these new funds, A&P should be able to increase liquidity, reduce its leverage, and possibly address upcoming debt maturities. I'm particularly excited by the decision of Tengelmann to solidify its commitment to A&P and continue its leading ownership position in the company following 30 years of successful investing in A&P.
At the same time, I'm thrilled about joining with Ron Burkle about determining the future of A&P with his very meaningful commitment of substantial new resources to the company. I've now known Ron for almost a decade and I'm excited about working with him on improving A&P's business and creating substantial shareholder value together.
Let me briefly review with you the key terms of the investment agreements. The convertible preferred stock matures in seven years and pays a cash dividend of 8% annually, or if the company's unable to make a dividend payment in cash, we'll make dividend payments in kind at a rate of 9.5% annually.
Yucaipa and Tengelmann will purchase 115,000 and 60,000 shares respectively of convertible preferred stock, each with an initial liquidation preference of $1,000. Each share may be converted at the option of Yucaipa and Tengelmann at an initial conversion rate of 200 shares of common stock per share, which is calculated using an initial conversion price of $5 per share of common stock.
This conversion stock represents an approximately 20% premium to the last 20 day average trading price of A&P stock.
Yucaipa's ownership position on a fully diluted basis will be approximately 27.6% and Tengelmann will continue to be the company's largest shareholder with a position of 38.6% of the shares.
A&P's Board of Directors will be comprised of the nine current directors, plus two additional directors to be nominated by Yucaipa. The closing of this convertible preferred pipe investment is contingent upon A&P successful raising at least $225 million in new senior-secured notes which the company launched today.
Yucaipa and Tengelmann believe that investing these funds in A&P, in combination with raising additional senior-secured notes, will put the company in an optimal position to pursue its format strategy and strengthen its strategic position in the northeast, while at the same time address its near-term financing needs and reduce its overall leverage.
Both Yucaipa and Tengelmann strongly believe in the strategic value of the company following the acquisition of Pathmark. And while the company's not yet performing at its full potential, we have identified together with management, all the necessary actions we need to take to drive performance and create shareholder value.
Let me also share with you my views of the company's first quarter performance. Clearly we're not satisfied with our current performance, but considering how challenging the economic environment has become, these are still respectable results, despite softer sales in total, our fresh gourmet and discount businesses performed well and grew bottom-line contributions. Pathmark continues to be our challenge, but despite the deteriorating performance in the quarter, we see many signs of progress and continue to believe in the significant potential of this business.
Changes in consumer behavior have been accelerating and trading down has become the new normal. We've also felt the impact of disinflation on the top line as prices have declined rather dramatically across many categories.
The company began to implement several of its business optimization initiatives during the first quarter and we fully expect to realize significant benefits from these activities during the second half of our fiscal year.
Looking ahead, I am confident that with a much stronger balance sheet and the support of Yucaipa, we will be able to accelerate the performance improvements we are working on, add new business improvement initiatives, and pursue our format strategy.
Considering the different consumer mindset we are experiencing today, I see tremendous potential for our price impact and discount formats which should thrive in the new more frugal consumer environment caused by the recession and most likely continuing even when the economy recovers.
And that concludes my remarks. I would now like to turn it over to Brenda.
Brenda M. Galgano
Thank you, Christian. Today we reported first quarter sales of $2.8 billion and a loss from continuing operations of $58 million. Comparable store sales were negative 3.3% in the quarter and we continued to experience negative sales trends during the first month of the second quarter.
Excluding non operating items of $4.1 million this quarter, adjusted EBITDA was $80 million versus $96 million last year. Schedules three and four of our press release detail the non operating items for both years.
First quarter ongoing growth margin excluding LIPO provisions of $1.2 million and $1.4 million respectively, increased four basis points to 30.32%. Gross margins were positively impacted by improvements in our fresh business and partially offset by lower margins in our price impact business due to more promotional sales and price investments
First quarter adjusted SG&A increased 59 basis points from 29.65% to 30.24%, drive-in primarily by lower sales leverage on fixed costs, including labor and occupancy, partially offset by lower administrative expenses. Noncash stock compensation expense for the first quarter was $2.9 million this year versus $4.8 million last year.
Capital spending totalled $27 million. Depreciation expense was about $78 million. This compares to $30 million of capital expenditures during last year's first quarter with depreciation of $80 million. During the quarter we completed three fresh remodels, one price impact conversion, and one new price impact, one Food Basics conversion, and one new liquor store.
Turning to our balance sheet, we ended the quarter with net debt of $1.366 billion, including capital leases and real-estate liabilities, and net of $25 million in excess cash, restricted cash, and short-term investments. For the quarter, free cash flow was $5 million, consisting of adjusted EBITDA of $80 million, net cash interest paid of $44 million, taxes of $4 million, and CapEx of $27 million.
The $2 million increase in net debt from last quarter resulted from the following: free cash flow of $5 million plus real estate proceeds of $8 million, and working capital changes and other of $10 million, offset by payments against the drug store liability of approximately $22 million and integration cash payments of $3 million which primarily relates to severance.
Revolver liquidity at the end of the quarter was about $122 million comprised of borrowing base availability of $103 million and excess cash on hand of $19 million. Outstanding loans totalled $302 million and letters of credit totalled $201 million.
As of the end of the quarter we had a tax net operating loss carryforward of approximately $503 million to offset future tax profits, including operating profits and capital gains. Our closed-door reserve was $189 million.
In conclusion I would like to make the following comments. While the quarter was a challenge, we continue to expect to be cash flow positive from operations for fiscal 2009. Since Christian already covered our planned raise of capital in detail, I will only add that with this expected investment, our refinancing risks are significantly reduced and our strength and liquidity provides additional flexibility to effectively compete in this difficult environment.
I will now turn it over to Eric.
Hello, and thank you, Brenda. The first quarter of our fiscal 2009 was certainly one of the most challenging quarters that we have experienced. We are operating in a market that was hit hard, with Wall Street and the financial sector residing in the heart of our core market.
As you have heard by Brenda and Christian, overall sales for the quarter on a comparative year-over-year basis declined 3.3% with EBITDA coming in at $80 million versus $96 million a year ago.
The decline of inflation on our retail prices contributed to the sales decline, let by severe deflation in dairy and produce, further driven by high promotional sales and our investment in a more competitive pricing strategy.
Three of our four formats, fresh, gourmet, and discount, produced bottom line results that were better than prior year as we managed costs and margins.
In our fresh segment, clearly the equity which we've built over the past few years is paying off as our offer and mix carried the day, allowing us once again to produce solidly improved year-over-year EBITDA.
Gourmet, our Food Emporium stores in Manhattan, once again delivered positive top and bottom line improvement as Manhattanites continues to savor the enhanced gourmet selection that the team's been building on over the past few years.
Discount, or Food Basics, not surprisingly continues to grow at a very impressive level, once again delivering a strong year-over-year top line with solid improvement to EBITDA. Our most recent discount store opening in Fairview, New Jersey, opened in a market that is broader in demographic range than our usual demographic profile for a discount market. Right out of the gate this store has been a homerun, solidly exceeding pro forma sales. This once again is evidence that the acceptance of this powerful format is growing across an increasing demographic.
Our price impact for Pathmark business caused the entire miss to the quarter in EBITDA as compared to prior year. This value-oriented business has a more economically tressed consumer and we needed to make our offer much more competitive. To this end, we've been executing a new more competitive price impact pricing strategy on a market by market basis.
We had similar challenges in our legacy A&P business nearly four years ago, but had the luxury of more time to fix the pricing proposition. The severe recessionary environment has forced us to move more quickly to improve our offer and this has been a costly endeavor. Although painful in the short term, this is clearly the right thing to do for the long-term benefit of the company.
I have said this before and I will say it again, I am extremely confident in our ability to fix price impact. We have done this before, fixing our fresh, gourmet, and discount stores, bringing them to new heights quarter after quarter over the last three years. We have a tremendous group of Pathmark managers, many with much tenure. They are feeling the pain, yet they are on board, knowing that we are making the investments required to fix their business for the long-term sustainability.
That said, there are several important bright lights in our future that are also worthy of mention. Our price impact pricing strategy is starting to take hold, based on recent unit growth results. Our conversion of conventional stores to both price impact and discount are showing strong and bottom line results, and it looks like the item count decline that we've been experiencing of late is starting to level off.
Our price impact resigning initiative was completed at the end of June. Our format conversion success bodes very well for a format optimization strategy as it gives us the ability to convert our most underperforming assets to productive ones. Additionally, these conversions will provide the best return on capital as price impact and discount conversions are far less capital intensive than fresher innovations.
As we all feel the strain of the recession, competitive activity has heated up and so have we. This does put additional pressure on margins, but we need to protect market share for the long-term. We have spent more this quarter on electronic media and will continue to maintain a strong voice in the market. In this economy we need to combat the natural tendency for consumers to gravitate to the perceived price leaders in each market.
On the cost side of things we've embarked upon our business optimization plan. I spoke to this on the last quarterly call. Not to be repetitive, but I will review these initiatives again from a higher level as we have started our work on these.
The plan focuses on the areas of format optimization which is converting stores and/or growing new stores to optimize on the demographic makeup of a particular community. Format growth will primarily come from price impact and discount.
Private label, we are well on our way to growing penetration to target levels with our most recent levels hitting the 18% penetration mark. This will allow us to further drive pricing down while maintaining healthy income levels.
In supply and logistics, working with our logistics partners we have started, through the use of technology and new planning and process tools, to drive costs down. Store operating cost reductions are under way, consisting of initiatives that will improve performance in labor productivity, stock loss rates, customer and employee accident claims, and occupancy costs.
Once again these are multi-year projects that we've embarked upon with specific plans, targets, and management sponsors for each. Our project management tools and processes are similar to those used for the Pathmark integration and synergy attainment project.
These initiatives are meaningful and we are confident that our financial objectives are attainable.
Let me now say a few words about current trends. As unemployment continues to grow, weak sales trends continue into the second quarter. We are operating in a very competitive market and we are remaining aggressive in the promotional arena. Deflation continues in some major categories like dairy and produce. We are seeing signs of a leveling off in unit and customer count which is encouraging. We are very focused on cash management EBITDA and providing more value to our customers.
Although we believe that the environment should improve in the back half of the fiscal year, we are not banking on that. We are changing our mix, our offer, and many of our tactics in order to better respond to a new customer living in this new economic reality.
Now a few words about the big news this week. As Christian previously spoke to, Tengelmann has reconfirmed its longstanding commitment to the company, agreeing to invest a new $60 million into the company. Yucaipa, the well know and retail savvy private equity investor has agreed to invest $115 million into the company.
We plan to issue high-yield bonds to raise $225 million of additional capital. This capital raise and new investment totaling $400 million will bode well for the financial stability and future of the company, allowing us to navigate through these difficult economic times with the confidence that we have the resources to execute on a strategic plan, one that is designed to deliver industry-level EBITDA over time.
With that, I'd like to say thank you to my team, our thousands of dedicated associates, Christian, and our Board of Directors, for their support and contribution in the challenging the year, especially for everyone's commitment and can-do attitude in these difficult economic times.
Additionally, I would like to thank Tengelmann and Yucaipa for their investment in this great company.
I will now pass it back to Christian.
Christian Wilhelm Erich Haub
Thank you, Eric. I want to close our call today with a brief summary of the key points. With the investments by Tengelmann and Yucaipa, the company has made a major step towards improving its balance sheet, securing additional liquidity, and addressing its financing needs. Now A&P will be able to focus on improving its operation and realizing the benefits of its many optimization opportunities and driving its format strategy.
A&P remains in a very strong strategic position and believes that with the support of Yucaipa and Tengelmann, it will successful manage through the current major recession and emerge a much stronger player in the northeast supermarket industry once the economy recovers.
While the most recent operating performance is not meeting our expectations, we have identified numerous improvement initiatives that will yield positive results in the second half of the year.
I am today very confident about A&P's future and look forward to realizing the full potential of the company and working together with Ron Burkle and Yucaipa to create significant shareholder value in the next several years.
Thanks as always for listening, and we look forward to speaking with you next time.
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