UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 27, 2018
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-15723
UNITED NATURAL FOODS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 05-0376157 | |
(State or Other Jurisdiction of | (I.R.S. Employer Identification No.) | |
Incorporation or Organization) | ||
313 Iron Horse Way, Providence, RI | 02908 | |
(Address of Principal Executive Offices) | (Zip Code) | |
Registrant’s Telephone Number, Including Area Code: (401) 528-8634
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No _
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes X No _
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer X | Accelerated filer __ | |
Non-accelerated filer __ | Smaller reporting company __ | |
Emerging growth company __ | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. __ | ||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes _ No X
As of November 26, 2018 there were 50,814,104 shares of the registrant’s common stock, $0.01 par value per share, outstanding.
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands, except for per share data)
October 27, 2018 | July 28, 2018 | |||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 53,910 | $ | 23,315 | ||||
Restricted cash | 566,353 | — | ||||||
Accounts receivable, net | 1,114,015 | 579,702 | ||||||
Inventories | 2,405,017 | 1,135,775 | ||||||
Prepaid expenses and other current assets | 158,967 | 50,122 | ||||||
Current assets of discontinued operations | 191,779 | — | ||||||
Total current assets | 4,490,041 | 1,788,914 | ||||||
Property and equipment, net | 1,543,952 | 571,146 | ||||||
Goodwill | 707,950 | 362,495 | ||||||
Intangible assets, less accumulated amortization of $68,133 and $64,438 | 1,278,205 | 193,209 | ||||||
Other assets | 145,138 | 48,708 | ||||||
Long-term assets of discontinued operations | 422,327 | — | ||||||
Total assets | $ | 8,587,613 | $ | 2,964,472 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Accounts payable | $ | 1,485,783 | $ | 517,125 | ||||
Accrued expenses and other current liabilities | 308,110 | 103,526 | ||||||
Accrued compensation and benefits | 167,889 | 66,132 | ||||||
Current portion of long-term debt and capital lease obligations | 730,401 | 12,441 | ||||||
Current liabilities of discontinued operations | 140,610 | — | ||||||
Total current liabilities | 2,832,793 | 699,224 | ||||||
Notes payable | 1,315,453 | 210,000 | ||||||
Deferred income taxes | 223,001 | 44,384 | ||||||
Other long-term liabilities | 227,032 | 27,200 | ||||||
Long-term debt and capital lease obligations, excluding current portion | 1,924,221 | 137,709 | ||||||
Pension and other postretirement benefit obligations | 233,436 | — | ||||||
Long-term liabilities of discontinued operations | 1,361 | — | ||||||
Total liabilities | 6,757,297 | 1,118,517 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, par value $0.01 per share, authorized 5,000 shares; issued none | — | — | ||||||
Common stock, par value $0.01 per share, authorized 100,000 shares; 51,426 shares issued and 50,811 shares outstanding at October 27, 2018, 51,025 shares issued and 50,411 shares outstanding at July 28, 2018 | 514 | 510 | ||||||
Additional paid-in capital | 489,103 | 483,623 | ||||||
Treasury stock at cost | (24,231 | ) | (24,231 | ) | ||||
Accumulated other comprehensive loss | (14,655 | ) | (14,179 | ) | ||||
Retained earnings | 1,381,215 | 1,400,232 | ||||||
Total United Natural Foods, Inc. stockholders’ equity | 1,831,946 | 1,845,955 | ||||||
Noncontrolling interests | (1,630 | ) | — | |||||
Total stockholders’ equity | 1,830,316 | 1,845,955 | ||||||
Total liabilities and stockholders’ equity | $ | 8,587,613 | $ | 2,964,472 | ||||
See Notes to Condensed Consolidated Financial Statements.
3
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(In thousands, except for per share data)
13-Week Period Ended | ||||||||
October 27, 2018 | October 28, 2017 | |||||||
Net sales | $ | 2,868,156 | $ | 2,457,545 | ||||
Cost of sales | 2,455,825 | 2,090,329 | ||||||
Gross profit | 412,331 | 367,216 | ||||||
Operating expenses | 363,165 | 312,109 | ||||||
Restructuring, acquisition, and integration related expenses | 68,004 | — | ||||||
Operating (loss) income | (18,838 | ) | 55,107 | |||||
Other expense (income): | ||||||||
Net periodic benefit income, excluding service cost | (844 | ) | — | |||||
Interest expense | 7,671 | 3,667 | ||||||
Interest income | (146 | ) | (91 | ) | ||||
Other, net | 97 | (863 | ) | |||||
Total other expense, net | 6,778 | 2,713 | ||||||
(Loss) income from continuing operations before income taxes | (25,616 | ) | 52,394 | |||||
(Benefit) provision for income taxes | (4,255 | ) | 21,889 | |||||
Net (loss) income from continuing operations | (21,361 | ) | 30,505 | |||||
Income from discontinued operations, net of tax | 2,070 | — | ||||||
Net (loss) income including noncontrolling interests | (19,291 | ) | 30,505 | |||||
Less net loss (income) attributable to noncontrolling interests | (3 | ) | — | |||||
Net (loss) income attributable to United Natural Foods, Inc. | $ | (19,294 | ) | $ | 30,505 | |||
Basic per share data: | ||||||||
Continuing operations | $ | (0.42 | ) | $ | 0.60 | |||
Discontinued operations | $ | 0.04 | $ | — | ||||
Basic (loss) income per share | $ | (0.38 | ) | $ | 0.60 | |||
Diluted per share data: | ||||||||
Continuing operations | $ | (0.42 | ) | $ | 0.60 | |||
Discontinued operations | $ | 0.04 | $ | — | ||||
Diluted (loss) income per share | $ | (0.38 | ) | $ | 0.60 | |||
Weighted average share outstanding: | ||||||||
Basic | 50,583 | 50,817 | ||||||
Diluted | 50,583 | 50,957 | ||||||
See Notes to Condensed Consolidated Financial Statements.
4
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (unaudited)
(In thousands)
13-Week Period Ended | ||||||||
October 27, 2018 | October 28, 2017 | |||||||
Net (loss) income including noncontrolling interests | $ | (19,291 | ) | $ | 30,505 | |||
Other comprehensive income (loss): | ||||||||
Change in fair value of swap agreements, net of tax | 196 | 664 | ||||||
Foreign currency translation adjustments, net of tax | (672 | ) | (2,206 | ) | ||||
Total other comprehensive loss | (476 | ) | (1,542 | ) | ||||
Less comprehensive loss (income) attributable to noncontrolling interests | (3 | ) | — | |||||
Total comprehensive (loss) income attributable to United Natural Foods, Inc. | $ | (19,770 | ) | $ | 28,963 | |||
See Notes to Condensed Consolidated Financial Statements.
5
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)
(In thousands)
Common Stock | Treasury Stock | Additional Paid-in Capital | Accumulated Other Comprehensive (Loss) Income | Retained Earnings | Total United Natural Foods, Inc. Stockholders’ Equity | Noncontrolling Interests | Total Stockholders’ Equity | ||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||
Balances at July 28, 2018 | 51,025 | $ | 510 | 615 | $ | (24,231 | ) | $ | 483,623 | $ | (14,179 | ) | $ | 1,400,232 | $ | 1,845,955 | $ | — | $ | 1,845,955 | |||||||||||||||||
Cumulative effect of change in accounting principle | 277 | 277 | 277 | ||||||||||||||||||||||||||||||||||
Stock option exercises and restricted stock vestings, net of tax | 401 | 4 | (3,012 | ) | (3,008 | ) | (3,008 | ) | |||||||||||||||||||||||||||||
Share-based compensation | 8,089 | 8,089 | 8,089 | ||||||||||||||||||||||||||||||||||
Other/share-based compensation | 403 | 403 | 403 | ||||||||||||||||||||||||||||||||||
Fair value of swap agreements, net of tax | 196 | 196 | 196 | ||||||||||||||||||||||||||||||||||
Foreign currency translation | (672 | ) | (672 | ) | (672 | ) | |||||||||||||||||||||||||||||||
Acquisition of noncontrolling interests | (1,633 | ) | (1,633 | ) | |||||||||||||||||||||||||||||||||
Net (loss) income | (19,294 | ) | (19,294 | ) | 3 | (19,291 | ) | ||||||||||||||||||||||||||||||
Balances at October 27, 2018 | 51,426 | $ | 514 | 615 | $ | (24,231 | ) | $ | 489,103 | $ | (14,655 | ) | $ | 1,381,215 | $ | 1,831,946 | $ | (1,630 | ) | $ | 1,830,316 | ||||||||||||||||
Common Stock | Treasury Stock | Additional Paid-in Capital | Accumulated Other Comprehensive (Loss) Income | Retained Earnings | Total Stockholders’ Equity | ||||||||||||||||||||||||
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||
Balances at July 29, 2017 | 50,622 | $ | 506 | — | $ | — | $ | 460,011 | $ | (13,963 | ) | $ | 1,235,367 | $ | 1,681,921 | ||||||||||||||
Cumulative effect of change in accounting principle | 1,314 | (805 | ) | 509 | |||||||||||||||||||||||||
Stock option exercises and restricted stock vestings, net of tax | 341 | 3 | (4,241 | ) | (4,238 | ) | |||||||||||||||||||||||
Share-based compensation | 7,275 | 7,275 | |||||||||||||||||||||||||||
Repurchase of common stock | 162 | (6,449 | ) | (6,449 | ) | ||||||||||||||||||||||||
Other/share-based compensation | 107 | 107 | |||||||||||||||||||||||||||
Fair value of swap agreements, net of tax | 664 | 664 | |||||||||||||||||||||||||||
Foreign currency translation | (2,206 | ) | (2,206 | ) | |||||||||||||||||||||||||
Net income | 30,505 | 30,505 | |||||||||||||||||||||||||||
Balances at October 28, 2017 | 50,963 | $ | 509 | 162 | $ | (6,449 | ) | $ | 464,466 | $ | (15,505 | ) | $ | 1,265,067 | $ | 1,708,088 | |||||||||||||
See Notes to Condensed Consolidated Financial Statements.
6
UNITED NATURAL FOODS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
13-Week Period Ended | ||||||||
(in thousands) | October 27, 2018 | October 28, 2017 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net (loss) income including noncontrolling interests | $ | (19,291 | ) | $ | 30,505 | |||
Income from discontinued operations, net of tax | 2,070 | — | ||||||
Net (loss) income from continuing operations | (21,361 | ) | 30,505 | |||||
Adjustments to reconcile net (loss) income from continuing operations to net cash (used in) provided by operating activities: | ||||||||
Depreciation and amortization | 24,793 | 22,442 | ||||||
Share-based compensation | 8,089 | 7,275 | ||||||
Loss on disposition of assets | 6 | 103 | ||||||
Gain associated with disposal of investments | — | (699 | ) | |||||
Restructuring charges | 412 | — | ||||||
Net pension and other postretirement benefit income | (844 | ) | — | |||||
Deferred income taxes | 1,214 | 891 | ||||||
Provision for doubtful accounts | 3,037 | 1,656 | ||||||
Loss on debt extinguishment | 1,114 | — | ||||||
Non-cash interest expense | 345 | 344 | ||||||
Changes in operating assets and liabilities, net of acquired businesses | (118,124 | ) | (102,674 | ) | ||||
Net cash used in operating activities of continuing operations | (101,319 | ) | (40,157 | ) | ||||
Net cash used in operating activities of discontinued operations | (5,701 | ) | — | |||||
Net cash used in operating activities | (107,020 | ) | (40,157 | ) | ||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Capital expenditures | (16,381 | ) | (5,257 | ) | ||||
Purchase of acquired businesses, net of cash acquired | (2,273,829 | ) | (11 | ) | ||||
Proceeds from dispositions of assets | 149,529 | 34 | ||||||
Proceeds from disposal of investments | — | 756 | ||||||
Long-term investment | (110 | ) | — | |||||
Net cash used in investing activities of continuing operations | (2,140,791 | ) | (4,478 | ) | ||||
Net cash used in investing activities of discontinued operations | (89 | ) | — | |||||
Net cash used in investing activities | (2,140,880 | ) | (4,478 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Proceeds from borrowings of long-term debt | 1,905,547 | — | ||||||
Proceeds from borrowings under revolving credit line | 1,805,300 | 173,581 | ||||||
Repayments of borrowings under revolving credit line | (688,000 | ) | (109,229 | ) | ||||
Repayments of long-term debt | (110,000 | ) | (2,985 | ) | ||||
Repurchase of common stock | — | (6,449 | ) | |||||
Proceeds from exercise of stock options | 118 | 151 | ||||||
Payment of employee restricted stock tax withholdings | (3,126 | ) | (4,389 | ) | ||||
Capitalized debt issuance costs | (60,309 | ) | — | |||||
Net cash provided by financing activities | 2,849,530 | 50,680 | ||||||
EFFECT OF EXCHANGE RATE CHANGES ON CASH | (49 | ) | (304 | ) | ||||
NET INCREASE IN CASH AND CASH EQUIVALENTS | 601,581 | 5,741 | ||||||
Cash and cash equivalents, at beginning of period | 23,315 | 15,414 | ||||||
Cash and cash equivalents, including restricted cash at end of period | 624,896 | 21,155 | ||||||
Less: cash and cash equivalents of discontinued operations | (4,633 | ) | — | |||||
Cash and cash equivalents, including restricted cash of continuing operations | $ | 620,263 | $ | 21,155 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Cash paid for interest | $ | 7,325 | $ | 3,667 | ||||
Cash paid for federal and state income taxes, net of refunds | $ | 462 | $ | 2,559 | ||||
See Notes to Condensed Consolidated Financial Statements.
7
UNITED NATURAL FOODS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
October 27, 2018 (unaudited)
1. SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
United Natural Foods, Inc. and its subsidiaries (the “Company”, “we”, “us”, or “our”) is a leading distributor of natural, organic, specialty, and conventional grocery and non-food products, and provider of support services. On October 22, 2018, the Company acquired all of the outstanding equity securities of SUPERVALU INC. (“Supervalu”); refer to Note 4. “Acquisitions” for further information. The Company sells its products primarily throughout the United States and Canada.
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Certain prior year amounts within the Condensed Consolidated Balance Sheets, including the reclassification of Accrued compensation and benefits to present separately from Accrued expenses and other current liabilities, has been reclassified to conform to the current period’s presentation. These reclassifications had no impact on reported net income, cash flows, or total assets and liabilities.
Unless otherwise indicated, references to the Condensed Consolidated Statements of Income and the Condensed Consolidated Balance Sheets in the Notes to the Condensed Consolidated Financial Statements exclude all amounts related to discontinued operations. Refer to Note 17. “Discontinued Operations” for additional information, including accounting policies, about our discontinued operations.
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial information, including the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and note disclosures normally required in complete financial statements prepared in conformity with accounting principles generally accepted in the United States have been condensed or omitted. In the Company’s opinion, these Condensed Consolidated Financial Statements include all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. However, the results of operations for interim periods may not be indicative of the results that may be expected for a full year. These Condensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 28, 2018. Except as described below, there were no material changes in significant accounting policies from those described in the Company’s Annual Report on Form 10-K for the fiscal year ended July 28, 2018.
Net sales consist primarily of sales of natural, organic, specialty, conventional and non-food products to retailers, adjusted for customer volume discounts, returns, and allowances, and professional services revenue. Net sales also include amounts charged by the Company to customers for shipping and handling and fuel surcharges. The Company recognizes freight revenue related to transportation of its products when control of the product is transferred, which is typically upon delivery. The principal components of cost of sales include the amounts paid to suppliers for product sold, plus the cost of transportation necessary to bring the product to, or move product between, the Company’s distribution facilities, offset by consideration received from suppliers in connection with the purchase, transportation, or promotion of the suppliers’ products. Cost of sales also includes amounts incurred by the Company’s manufacturing subsidiary, United Natural Trading, LLC, which does business as Woodstock Farms Manufacturing, for inbound transportation costs. Operating expenses include salaries and wages, employee benefits, warehousing and delivery, selling, occupancy, insurance, administrative, share-based compensation, depreciation, and amortization expense. Other expense (income), net includes interest on outstanding indebtedness, including direct financing and capital lease obligations, net periodic benefit plan income, excluding service costs, interest income and miscellaneous income and expenses.
As noted above, the Company includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with inbound freight are generally recorded in cost of sales, whereas shipping and handling costs for receiving, selecting, quality assurance, and outbound transportation are recorded in operating expenses. Outbound shipping and handling costs, including allocated employee benefit expenses that are recorded in Operating expenses, totaled $174.0 million and $138.0 million for the first quarter of fiscal 2019 and 2018, respectively. The first quarter of fiscal 2019 included $14.3 million of expenses related to Supervalu shipping and handling costs.
8
Inventories
Inventories are valued at the lower of cost or market. For historical United Natural Foods, Inc. inventory, cost is determined using the first-in, first-out (“FIFO”) method. For a substantial portion of legacy Supervalu inventory, cost was determined using the last in, last out (“LIFO”) method, with the rest primarily determined using FIFO. Inventories acquired as part of the Supervalu acquisition were recorded at their fair market values as of the acquisition date. The Company is currently evaluating its combined inventory accounting policies and expects to finalize this evaluation during the second quarter of fiscal 2019. The impact of using LIFO for a portion of the Company’s inventory as of and for the first fiscal quarter did not have a material impact on the results of operations or the ending inventory balance as of and for the 13-week period ended October 27, 2018.
Vendor Funds
The Company receives funds from many of the vendors whose products it buys for resale. These vendor funds are provided to increase the sell-through of the related products. The Company receives vendor funds for a variety of merchandising activities; placement of the vendors’ products in its advertising; display of the vendors’ products in prominent locations in its stores; supporting the introduction of new products into its stores and distribution centers; exclusivity rights in certain categories; and to compensate for temporary price reductions offered to customers on products held for sale. The Company also receives vendor funds for buying activities such as volume commitment rebates, credits for purchasing products in advance of their need and cash discounts for the early payment of merchandise purchases. The majority of the vendor fund contracts have terms of less than a year, with a small proportion of the contracts longer than one year.
The Company recognizes vendor funds for merchandising activities as a reduction of Cost of sales when the related products are sold. Vendor funds that have been earned as a result of completing the required performance under the terms of the underlying agreements but for which the product has not yet been sold are recognized as a reduction to the cost of inventory.
Business Dispositions
The Company reviews the presentation of planned business dispositions in the Condensed Consolidated Financial Statements based on the available information and events that have occurred. The review consists of evaluating whether the business meets the definition of a component for which the operations and cash flows are clearly distinguishable from the other components of the business, and if so, whether it is anticipated that after the disposal the cash flows of the component would be eliminated from continuing operations and whether the disposition represents a strategic shift that has a major effect on operations and financial results. In addition, the Company evaluates whether the business has met the criteria as a business held for sale. In order for a planned disposition to be classified as a business held for sale, the established criteria must be met as of the reporting date, including an active program to market the business and the expected disposition of the business within one year.
Planned business dispositions are presented as discontinued operations when all the criteria described above are met. Operations of the business components meeting the discontinued operations requirements are presented within Income from discontinued operations, net of tax in the Condensed Consolidated Statements of Income, and assets and liabilities of the business component planned to be disposed of are presented as separate lines within the Condensed Consolidated Balance Sheets. See Note 17. “Discontinued Operations” for additional information.
The carrying value of the business held for sale is reviewed for recoverability upon meeting the classification requirements. Evaluating the recoverability of the assets of a business classified as held for sale follows a defined order in which property and intangible assets subject to amortization are considered only after the recoverability of goodwill, indefinite lived intangible assets and other assets are assessed. After the valuation process is completed, the held for sale business is reported at the lower of its carrying value or fair value less cost to sell, and no additional depreciation or amortization expense is recognized.
There are inherent judgments and estimates used in determining the fair value less costs to sell of a business and any impairment charges. The sale of a business can result in the recognition of a gain or loss that differs from that anticipated prior to closing.
9
Benefit Plans
The Company recognizes the funded status of its company-sponsored defined benefit plans, which it acquired in the first quarter of fiscal 2019 through the acquisition of Supervalu, in the Condensed Consolidated Balance Sheets and gains or losses and prior service costs or credits not yet recognized as a component of Accumulated other comprehensive loss, net of tax, in the Condensed Consolidated Balance Sheets. The Company sponsors pension and other postretirement plans in various forms covering employees who meet eligibility requirements. The determination of the Company’s obligation and related income or expense for Company-sponsored pension and other postretirement benefits is dependent, in part, on management’s selection of certain actuarial assumptions in calculating these amounts. These assumptions include, among other things, the discount rate, the expected long-term rate of return on plan assets and the rates of increase in healthcare and compensation costs. These assumptions are disclosed in Note 15. “Benefit Plans”. Actual results that differ from the assumptions are accumulated and amortized over future periods.
The Company contributes to various multiemployer pension plans under collective bargaining agreements, primarily defined benefit pension plans. Pension expense for these plans is recognized as contributions are funded. See Note 15. “Benefit Plans” for additional information on participation in multiemployer plans.
The Company also contributes to 401(k) retirement savings plans for its employees.
Change in Accounting Policy
In the first quarter of fiscal 2019, the Company changed its accounting policy for reporting book overdrafts in the Condensed Consolidated Statements of Cash Flows. Amounts previously reported as increase in bank overdrafts on the Condensed Consolidated Statements of Cash Flows represent outstanding checks issued but not yet presented to financial institutions for disbursement in excess of positive balances held at financial institutions, and as such represent book overdrafts. Book overdrafts are included within the Accounts payable balance in the Condensed Consolidated Balance Sheets. The change in these book overdraft amounts were previously reported as financing activities cash flows on the Condensed Consolidated Statements of Cash Flows, on a line item titled Increase in bank overdrafts. The Company has elected a preferable accounting policy presentation for classifying the change in book overdrafts from financing activities to operating activities, which resulted in the reclassification of prior period amounts to conform to the current period presentation. The Company concluded that operating activity classification is preferable, as book overdrafts do not result in financial institution borrowing or repayment activity at the end of respective reporting periods and the presentation presents a more accurate disclosure of its cash generation and consumption activities. The reclassification resulted in a decrease to cash used in operating activities of $31.9 million and a corresponding increase in cash provided by financing activities for the 13-week period ended October 28, 2017. The reclassification had no effect on previously reported Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Income, or Condensed Consolidated Statements of Stockholders’ Equity.
2. RECENTLY ADOPTED AND ISSUED ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Pronouncements
In March 2017, the Financial Accounting Standards Board (“FASB”) issued accounting standard update (“ASU”) 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. ASU 2017-07 changes how benefit plan costs for defined benefit pension and other postretirement benefit plans are presented in the statement of operations. The Company adopted this guidance in the first quarter of fiscal 2019, and it presents non-service cost components of net periodic benefit income, as disclosed in Note 15. “Benefit Plans”, in an other income and expense line titled “Net periodic benefit income, excluding service cost” in the Condensed Consolidated Statements of Income. The service cost components are recorded within Operating expenses. The adoption of this standard did not have an impact on the Company’s prior period Condensed Consolidated Statements of Income, as all benefit plan costs for defined benefit pension and other postretirement benefit plans incurred are attributable to the Supervalu business, which was acquired in the first quarter of fiscal 2019.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force). This ASU clarifies the presentation of restricted cash on the statement of cash flows by requiring that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amount generally described as restricted cash or restricted cash equivalents. This ASU is effective for annual reporting periods, and interim reporting periods contained therein, beginning after December 15, 2017, with retrospective application required. The Company adopted this ASU in the first quarter of fiscal 2019, and included restricted cash within its reconciliation of the beginning and ending amounts in the Condensed Consolidated Statements of Cash Flows. The only restricted cash the Company has is $566.4 million within Restricted cash balance on the Condensed Consolidated Balance Sheets as of October 27, 2018. The adoption of this ASU had no impact to the Condensed Consolidated Statements of Cash Flows for the 13-week period ended October 28, 2017, as the Company did not previously have a restricted cash balance.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”), which requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. The Company adopted the new standard in the first quarter of fiscal 2019, with no impact to its financial position, results of operations, or cash flows.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to address eight specific cash flow issues with the objective of reducing the existing diversity in practice. The eight specific issues are (1) Debt Prepayment or Debt Extinguishment Costs; (2) Settlement of Zero-Coupon Debt Instruments or Other Debt Instruments with Coupon Interest Rates That Are Insignificant in Relation to the Effective Interest Rate of the Borrowing; (3) Contingent Consideration Payments Made after a Businesses Combination; (4) Proceeds from the Settlement of Insurance Claims; (5) Proceeds from the Settlement of Corporate-Owned Life Insurance Policies, including Bank-Owned Life Insurance Policies; (6) Distributions Received from Equity Method Investees; (7) Beneficial Interests in Securitization Transactions; and (8) Separately Identifiable Cash and Application of the Predominance Principle. This ASU is effective for public companies with interim periods and fiscal years beginning after December 15, 2018. The Company adopted this standard in the first quarter of fiscal 2019, with no impact to its Condensed Consolidated Statements of Cash Flows.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, (Topic 606), which has been updated by multiple amending ASUs (collectively “ASC 606”) and supersedes previous revenue recognition requirements (“ASC 605”). The core principle of the new guidance is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additionally, the ASU requires new, enhanced quantitative and qualitative disclosures related to the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The collective guidance is effective for public companies with annual periods, and interim periods within those periods, beginning after December 15, 2017. The new standard permits either of the following adoption methods: (i) a full retrospective application with restatement of each period presented in the financial statements with the option to elect certain practical expedients, or (ii) a retrospective application with the cumulative effect of adopting the guidance recognized as of the date of initial application (“modified retrospective method”). The Company has adopted this new guidance in the first quarter of fiscal 2019 using the modified retrospective method, with no significant impact to our Condensed Consolidated Balance sheets, Condensed Consolidated Statements of Income or Condensed Consolidated Statements of Cash flows.
The primary impact of adopting the new standard, contained within the wholesale distribution reportable segment, is related to the sale of certain private label products for which revenue is recognized over time under the new standard as opposed to at a point in time under ASC 605. Private label products are specific to the customer to which they are sold, and are typically packaged with the customer’s logo or other products for which the customer has an exclusive right to sell. The Company is contractually restricted from selling private label products with the customer’s logo or other exclusive products to other third-party customers. As a result, the underlying good has no alternative use to the Company. In some instances, the Company’s contracts also require the customer to purchase private label inventory held by the Company if the agreement is terminated, the customer discontinues selling the specific product, or the product is nearing its expiration date. This gives the Company an enforceable right to payment for performance completed to date from certain customers, once it has procured private label product. As a result, the Company now recognizes revenue from these product sales over time, as control is transferred to the customer, using a cost-incurred input measure of progress, as opposed to at a point in time, typically upon delivery, under ASC 605. Control of these products is transferred to the customer upon incurrence of substantially all of the Company’s costs related to the product, and therefore the cost-incurred input method is determined to be a faithful depiction of the transfer of goods.
The effect of adopting this change resulted in an increase to Retained earnings of $0.3 million, which was recorded in the first quarter of fiscal 2019. This change did not materially impact our Condensed Consolidated Statements of Income for the first quarter of fiscal 2019. Refer to Note 3. “Revenue Recognition” for further discussion of our adoption of the new standard.
Recently Issued Accounting Pronouncements
In October 2018, the FASB issued authoritative guidance under ASU No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This ASU adds the Overnight Index Swap (OIS) rate based on Secured Overnight Financing Rate (SOFR) as a benchmark interest rate for hedge accounting purposes. This ASU is effective for public companies with interim and fiscal years beginning after December 15, 2018, which for the Company is the first quarter of fiscal year 2020. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. ASU 2018-05 requires implementation costs incurred by customers in cloud computing arrangements (i.e., hosting arrangements) to be capitalized under the same premises of authoritative guidance for internal-use software, and deferred over the noncancellable term of the cloud computing arrangements plus any option renewal periods that are reasonably certain to be exercised by the customer or for which the exercise is controlled by the service provider. The Company is required to adopt this new guidance in the first quarter of fiscal 2021. The Company has outstanding cloud computing arrangements and continues to incur costs that it believes would be required to be capitalized under ASU 2018-05. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans. ASU 2018-14 eliminates requirements for certain disclosures and requires additional disclosures under defined benefit pension plans and other postretirement plans. The Company is required to adopt this guidance in the first quarter of fiscal 2021. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017. This ASU is effective for all entities for annual and interim periods in fiscal years beginning after December 15, 2018, which for the Company will be the first quarter of fiscal 2020, with early adoption permitted. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 changes the impairment model for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other instruments, entities will be required to use a new forward-looking “expected loss” model that will replace the current “incurred loss” model and generally will result in the earlier recognition of allowances for losses. For available-for-sale debt securities with unrealized losses, entities will measure credit losses in a manner similar to current practice, except that the losses will be recognized as an allowance. The Company is required to adopt this new guidance in the first quarter of fiscal 2021. The Company is currently reviewing the provisions of the new standard and evaluating its impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which provides new comprehensive lease accounting guidance that supersedes existing lease guidance. The objective of this ASU is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. Criteria for distinguishing leases between finance and operating are substantially similar to criteria for distinguishing between capital leases and operating leases in existing lease guidance. Lease agreements that are 12 months or less are permitted to be excluded from the balance sheet. In addition, this ASU expands the disclosure requirements of lease arrangements. This ASU will require the Company to recognize most current operating lease obligations as right-of-use assets with a corresponding liability based on the present value of future operating leases, which the Company believes will result in a significant impact to its consolidated balance sheets. The Company is evaluating the additional transition method under ASU 2018-11, which allows for a cumulative effect adjustment within retained earnings in the period of adoption, as well as a number of optional practical expedients, which the Company may elect to apply. The ASU is effective for public companies in fiscal years beginning after December 15, 2018, which for the Company will be the first quarter of fiscal 2020, with early adoption permitted. The Company expects to adopt this standard in the first quarter of fiscal 2020 and has begun an assessment of the impacts of this ASU on the Company’s consolidated financial statements and any necessary changes to our accounting policies, processes and controls, and systems. Information about the amounts and timing of our undiscounted future lease payments can be found in Note 14. “Leases.”
3. REVENUE RECOGNITION
Revenue Recognition Accounting Policy
The Company recognizes revenue in an amount that reflects the consideration that is expected to be received for goods or services when its performance obligations are satisfied by transferring control of those promised goods or services to its customers. ASC 606 defines a five-step process to recognize revenue that requires judgment and estimates, including identifying the contract with the customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations in the contract and recognizing revenue when or as the performance obligation is satisfied.
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This footnote addresses the Company’s revenue recognition policies for its continuing operations only; refer to Note 17. “Discontinued Operations” for additional information about our revenue recognition policies of discontinued operations.
Revenues from wholesale product sales are recognized when control is transferred, which typically happens upon either shipment or delivery, depending on the contract terms with the customer. Typically, shipping and customer receipt of wholesale products occur on the same business day. Discounts and allowances provided to customers are recognized as a reduction in Net sales as control of the products is transferred to customers. The Company recognizes freight revenue related to transportation of its products when control of the product is transferred, which is typically upon delivery.
Sales tax is excluded from Net sales. Limited rights of return or product warranties exist with the Company’s customers due to the nature of the products it sells.
Product sales
The Company enters into wholesale customer distribution agreements that provide terms and conditions of our order fulfillment. The Company’s distribution agreements often specify levels of required minimum purchases in order to earn certain rebates or incentives. Certain contracts include rebates and other forms of variable consideration, including consideration payable to the customer up-front, over time or at the end of a contract term.
In transactions for goods or services where the Company engages third-parties to participate in its order fulfillment process, it evaluates whether it is the principal or an agent in the transaction. The Company’s analysis considers whether it controls the goods or services before they are transferred to its customer, including an evaluation of whether the Company has the ability to direct the use of, and obtain substantially all the remaining benefits from, the specified good or service before it is transferred to the customer. Agent transactions primarily reflect circumstances where the Company is not involved in order fulfillment or where it is involved in the order fulfillment but is not contractually obligated to purchase the related goods or services from vendors, and instead extends wholesale customers credit by paying vendor trade accounts payable and do not control products prior to their sale. Under ASC 606, if the Company determines that it is acting in an agent capacity, transactions are recorded on a net basis. If the Company determines that it is acting in a principal capacity, transactions are recorded on a gross basis.
The Company also evaluates vendor sales incentives to determine whether they reduce the transaction price with its customers. The Company’s analysis considers which party tenders the incentive, whether the incentive reflects a direct reimbursement from a vendor, whether the incentive is influenced by or negotiated in conjunction with any other incentive arrangements and whether the incentive is subject to an agency relationship with the vendor, whether expressed or implied. Typically, when vendor incentives are offered directly by vendors to the Company’s customers, require the achievement of vendor-specified requirements to be earned by customers, and are not negotiated by the Company or in conjunction with any other incentive agreement whereby it does not control the direction or earning of these incentives, then Net sales are not reduced as part of the Company’s determination of the transaction price. In circumstances where the vendors provide the Company consideration to promote the sale of their goods and the Company determines the specific performance requirements for its customers to earn these incentives, Net sales are reduced for these customer incentives as part of the determination of the transaction price.
Certain customer agreements provide for the right to license one or more of the Company’s tradenames, such as FESTIVAL FOODS®, SENTRY®, COUNTY MARKET®, NEWMARKET®, FOODLAND®, JUBILEE® and SUPERVALU®. The Company typically does not separately charge for the right to license its tradenames. The Company believes that these tradenames are capable of being distinct, but are not distinct within the context of the contracts with its customers. Accordingly, the Company does not separately recognize revenue related to tradenames utilized by its customers. In addition, the Company enters into franchise agreements to separately charge its customers, who the Company also sells wholesale products to, for the right to use its CUB FOODS® tradename.
The Company enters into distribution agreements with manufacturers to provide wholesale supplies to the Defense Commissary Agency (“DeCA”) and other government agency locations. DeCA contracts with manufacturers to obtain grocery products for the commissary system. The Company contracts with manufacturers to distribute products to the commissaries after being authorized by the manufacturers to be a military distributor to DeCA. The Company must adhere to DeCA’s delivery system procedures governing matters such as product identification, ordering and processing, information exchange and resolution of discrepancies. DeCA identifies the manufacturer with which an order is to be placed, determines which distributor is contracted by the manufacturer for a particular commissary or exchange location, and then places a product order with that distributor that is covered under DeCA’s master contract with the applicable manufacturer. The Company supplies product from its existing inventory, delivers it to the DeCA designated location, and bills the manufacturer for the product price plus a drayage fee. The manufacturer then bills DeCA under the terms of its master contract. The Company has determined that it controls the goods before they are transferred to the customer, and as such it is the principal in the transaction. Revenue is recognized on a gross basis when control of the product passes to the DeCA designated location.
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Professional Services, Equipment Sales and Other Promises
Many of the Company’s agreements with customers include various professional services and other promises to customers, in addition to the sale of the product itself, such as retail store support, advertising, store layout and design services, merchandising support, couponing, e-commerce, network and data hosting solutions, training and certifications classes, and administrative back-office solutions. These professional services may contain a single performance obligation for each respective service, in which case such services revenues are recognized when delivered. The Company determined that certain services provided are immaterial within the overall context of the respective contract, and as such has not allocated the transaction price to these obligations.
Wholesale equipment sales are recorded as direct sales to customers when shipped or delivered, consistent with the recognition of product sales.
Customer incentives
The Company provides incentives to its wholesale customers in various forms established under the applicable agreement, including advances, payments over time that are earned by achieving specified purchasing thresholds, and upon the passage of time. The Company typically records customer advances within Other assets and Other current assets and typically recognizes customer incentive payments that are based on expected purchases over the term of the agreement as a reduction to Net sales. To the extent that the transaction price for product sales includes variable consideration, such as certain of these customer incentives, the Company estimates the amount of variable consideration that should be included in the transaction price primarily by utilizing the expected value method. Variable consideration is included in the transaction price if it is probable that a significant future reversal of cumulative revenue under the agreement will not occur. The Company believes that there will not be significant changes to its estimates of variable consideration, as the uncertainty will be resolved within a relatively short time and there is a significant amount of historical data that is used in the estimation of the amount of variable consideration to be received. Therefore, the Company has not constrained its estimates of variable consideration.
Customer incentive assets are reviewed for impairment when circumstances exist for which the Company no longer expects to recover the applicable customer incentives.
Disaggregation of Revenues
The following table details the Company’s revenue recognition for the periods presented by type of customer for each of its segments. The Company does not record its revenues within its wholesale reportable segment for financial reporting purposes by product group, and it is therefore impracticable for it to report them accordingly.
Net Sales for the 13-Week Period Ended | ||||||||||||||||
(in millions) | October 27, 2018 | |||||||||||||||
Customer Type | Wholesale | Other | Eliminations | Consolidated | ||||||||||||
Supernatural | $ | 1,027 | $ | — | $ | — | $ | 1,027 | ||||||||
Independents | 667 | — | — | 667 | ||||||||||||
Supermarkets | 707 | — | — | 707 | ||||||||||||
Supervalu | 223 | 1 | — | 224 | ||||||||||||
Other | 233 | 48 | (38 | ) | 243 | |||||||||||
Total | $ | 2,857 | $ | 49 | $ | (38 | ) | $ | 2,868 | |||||||
Net Sales for the 13-Week Period Ended | ||||||||||||||||
(in millions) | October 28, 2017 | |||||||||||||||
Customer Type | Wholesale | Other | Eliminations | Consolidated | ||||||||||||
Supernatural | $ | 853 | $ | — | $ | — | $ | 853 | ||||||||
Independents | 639 | — | — | 639 | ||||||||||||
Supermarkets | 704 | — | — | 704 | ||||||||||||
Other | 250 | 57 | (45 | ) | 262 | |||||||||||
Total | $ | 2,446 | * | $ | 57 | $ | (45 | ) | $ | 2,458 | ||||||
* Reflects rounding
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The Company serves customers in the United States and Canada, as well as customers located in other countries. However, all of the Company’s revenue is earned in the U.S. and Canada and international distribution occurs through freight-forwarders. The Company does not have any performance obligations on international shipments subsequent to delivery to the domestic port.
Contract Balances
The Company does not typically incur costs that are required to be capitalized in connection with obtaining a contract with a customer. Expenses related to contract origination primarily relate to employee costs that the Company would incur regardless of whether the contract was obtained with the customer.
The Company typically does not have any performance obligations to deliver products under its contracts until its customers submit a purchase order, as it stands ready to deliver product upon receipt of a purchase order under contracts with its customers. These performance obligations are generally satisfied within a very short period of time. Therefore, the Company has utilized the practical expedient that provides an exemption from disclosure of the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less. The Company does not typically receive pre-payments from its customers.
Customer payments are due when control of goods or services are transferred to the customer and are typically not conditional on anything other than payment terms, which typically range less than 30 days. Since no significant financing components exist between the period of time the Company transfers goods or services to the customer and when it receives payment for those goods or services, the Company has elected not to adjust its revenue recognition policy to recognize financing components. Customer incentives are not considered contract assets as they are not generated through the transfer of goods or services to the customers. No material contract assets exist for any period reported within these Condensed Consolidated Financial Statements.
Accounts and notes receivable are as follows:
(in thousands) | October 27, 2018 | July 28, 2018 | ||||||
Customer accounts receivable | $ | 1,093,907 | $ | 595,698 | ||||
Customer notes receivable | 18,336 | — | ||||||
Allowance for uncollectible receivables | (15,388 | ) | (15,996 | ) | ||||
Other receivables, net | 17,160 | — | ||||||
Accounts receivable, net | $ | 1,114,015 | $ | 579,702 | ||||
Long-term notes receivable, included within Other assets | $ | 45,904 | $ | — | ||||
4. ACQUISITIONS
Supervalu Acquisition
On July 25, 2018, the Company entered into an agreement and plan of merger (the “Merger Agreement”) to acquire all of the outstanding equity securities of Supervalu, which was then the largest publicly traded food wholesaler in the United States. The acquisition of Supervalu diversifies the Company’s customer base, enables cross-selling opportunities, expands market reach and scale, enhances technology, capacity and systems, and is expected to deliver significant synergies and accelerate potential growth. The merger was completed on October 22, 2018. At the effective time of the acquisition, each share of Supervalu common stock, par value $0.01 per share, issued and outstanding, was canceled and converted into the right to receive a cash payment equal to $32.50 per share, without interest. Total consideration related to this acquisition was approximately $2.3 billion, $1.3 billion of which was paid in cash to Supervalu shareholders and $1.0 billion of which was used to satisfy Supervalu’s outstanding debt obligations.
The assets and liabilities of Supervalu were recorded in the Company’s consolidated financial statements on a provisional basis at their estimated fair values as of the acquisition date. In conjunction with the Supervalu acquisition, the Company announced its plan to sell the remaining acquired retail operations of Supervalu. Refer to Note 17. “Discontinued Operations” for more information.
The following table summarizes the consideration paid, preliminary fair values of the Supervalu assets acquired and liabilities assumed, and the resulting preliminary goodwill. Due to the recent closing of the transaction, as of October 27, 2018, the purchase price allocation was preliminary and will be finalized when valuations are complete and final assessments of the fair value of other acquired assets and assumed liabilities are completed. There can be no assurance that such finalizations will not result in material
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changes from the preliminary purchase price allocations. The Company’s estimates and assumptions are subject to change during the measurement period (up to one year from the acquisition date), as the Company finalizes the valuations of certain tangible and intangible asset acquired and liabilities assumed.
(in thousands) | As of October 22, 2018 | ||
Cash and cash equivalents | $ | 25,102 | |
Accounts receivable | 557,680 | ||
Inventories | 1,162,360 | ||
Prepaid expenses and other current assets | 66,440 | ||
Current assets of discontinued operations(1) | 196,615 | ||
Property, plant and equipment | 1,148,001 | ||
Goodwill | 347,485 | ||
Intangible assets | 1,077,541 | ||
Other assets | 109,445 | ||
Long-term assets of discontinued operations(1) | 404,301 | ||
Accounts payable | (967,429 | ) | |
Other current liabilities | (282,692 | ) | |
Current portion of long term debt and capital lease obligations | (579,677 | ) | |
Current liabilities of discontinued operations(1) | (150,611 | ) | |
Long-term debt and capital lease obligations | (179,262 | ) | |
Pension and other postretirement benefit obligations | (234,324 | ) | |
Deferred income taxes | (177,231 | ) | |
Other long-term liabilities assumed | (200,913 | ) | |
Long-term liabilities of discontinued operations(1) | (1,401 | ) | |
Noncontrolling interests | 1,633 | ||
Total fair value of net assets acquired | 2,323,063 | ||
Less: cash and cash equivalents acquired(2) | (30,596 | ) | |
Less: unpaid consideration(3) | (18,638 | ) | |
Total consideration for acquisition, less cash acquired and unpaid consideration | $ | 2,273,829 | |
(1) | Refer to Note 17. “Discontinued Operations” for additional Condensed Consolidated Balance Sheet information regarding the carrying value of discontinued operations at the end of the first quarter of fiscal 2019, subsequent to the acquisition date. |
(2) | Includes cash and cash equivalents acquired attributable to discontinued operations. |
(3) | Includes equity consideration for share-based awards that have not yet been paid, which reflects non-cash consideration for the first quarter of fiscal 2019 that will become cash consideration in subsequent periods. |
Preliminary goodwill represents the future economic benefits arising largely from the synergies expected from combining the operations of the Company and Supervalu that could not be individually identified and separately recognized. The Company is currently evaluating the tax deductibility of the provisional goodwill amount, however it currently expects a substantial portion of its goodwill to be deductible for income tax purposes. Based on the preliminary valuation, goodwill resulting from the acquisition was primarily attributed to the Company’s wholesale segment, which is presented in Goodwill in the table above. In addition, $45 million preliminary goodwill was attributed to the retail reporting unit within discontinued operations, which the Company attributed to assembled workforce.
The following table summarizes the identifiable intangible assets recorded based on provisional valuations. The identifiable intangible assets are expected to be amortized on a straight-line basis over the estimated useful lives indicated. The preliminary fair value of identifiable intangible assets acquired was determined using income approaches. Significant assumptions utilized in the income approach were based on Company-specific information and projections, which are not observable in the market and are thus considered Level 3 measurements as defined by authoritative guidance.
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(in thousands) | Estimated Useful Life | As of October 22, 2018 | |||
Customer relationship assets(1) | 11–19 years | $ | 985,000 | ||
Favorable operating leases(1) | 3–25 years | 24,455 | |||
Trade names(2) | 2-9 years | 98,000 | |||
Pharmacy prescription files(3) | 5–7 years | 59,700 | |||
Non-compete agreement(1) | 2 years | 13,000 | |||
Unfavorable operating leases(1) | 2 years | (13,623 | ) | ||
Total Supervalu finite-lived intangibles acquired | $ | 1,166,532 | |||
(1) | Includes continuing operations intangible assets. |
(2) | Includes continuing and discontinued operations intangible assets |
(3) | Includes discontinued operations intangible assets. |
In addition to the acquisition of assets and assumption of liabilities above, the Company also began a restructuring plan which resulted in additional costs and expenses recorded in its Condensed Consolidated Statements of Income for the 13-week period ended October 27, 2018. Refer to Note 5. “Restructuring, Acquisition, and Integration Related Expenses” and Note 11. “Share-Based Awards” for further information.
The Company recorded $25.6 million and $6.3 million in pre-tax acquisition and integration costs, respectively, for the 13-week period ended October 27, 2018, which are discussed in Restructuring, acquisition, and integration related expenses in the Company’s Condensed Consolidated Statements of Income.
The accompanying Condensed Consolidated Statements of Income include the results of operations of Supervalu since the October 22, 2018 acquisition date through October 27, 2018. Supervalu’s net sales for this time period are reported in Note 3. “Revenue Recognition” for continuing operations and in Note 17. “Discontinued Operations” for discontinued operations.
The following table presents unaudited supplemental pro forma consolidated Net sales and Net income from continuing operations based on Supervalu’s historical reporting periods as if the acquisition had occurred as of July 30, 2017:
13-Week Period Ended | |||||||
(in thousands, except per share data) | October 27, 2018(1) | October 28, 2017(2) | |||||
Net sales | $ | 5,983,208 | $ | 5,910,484 | |||
Net loss from continuing operations | $ | (54,716 | ) | $ | (53,367 | ) | |
Basic net loss from continuing operations per share | $ | (1.08 | ) | $ | (1.05 | ) | |
Diluted net loss from continuing operations per share | $ | (1.08 | ) | $ | (1.05 | ) | |
(1) | These pro forma results reflect an additional 12 weeks from Supervalu for the period ended, September 8, 2018. |
(2) | These pro forma results reflect Supervalu’s and Associated Grocers of Florida, Inc.’s, which was acquired by Supervalu on December 8, 2017, 13-week periods ended September 16, 2017 and August 5, 2017, respectively. |
These unaudited pro forma results are presented for informational purposes only and are not necessarily indicative of what the actual results of operations of the combined companies would have been had the acquisitions occurred at the beginning of the periods being presented, nor are they indicative of future results of operations.
5. RESTRUCTURING, ACQUISITION, AND INTEGRATION RELATED EXPENSES
2019 SUPERVALU INC. As part of its acquisition of Supervalu and in order to achieve synergies from this combination, the Company is taking certain actions, which began during the first quarter of fiscal 2019 and will continue through at least fiscal 2020 to: (i) review its organizational structure and the strategic needs of the business going forward to identify and place talent with the appropriate skills, experience and qualifications to meet these needs; and (ii) dispose of and exit the Supervalu legacy retail operations, as efficiently and economically as possible in order to focus on the Company’s core wholesale distribution business. Actions associated with retail divestitures and adjustments to the Company’s core cost-structure for its wholesale food distribution business are expected to result in headcount reductions and other costs and charges.
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The following is a summary of the restructuring costs the Company recorded related to the actions in fiscal 2019, the payments and other adjustments related to these costs and the remaining liability as of October 27, 2018 (in thousands):
Restructuring Costs Recorded in Fiscal 2019 | Acquired Restructuring Liability | Payments and Other Adjustments | Restructuring Cost Liability as of October 27, 2018 | |||||||||||||
Severance and other employee separation and transition costs(1) | $ | 34,966 | $ | 6,193 | $ | — | $ | 41,159 | ||||||||
Tax payments | 1,028 | — | — | 1,028 | ||||||||||||
Other | 75 | — | — | 75 | ||||||||||||
Total | $ | 36,069 | $ | 6,193 | $ | — | $ | 42,262 | ||||||||
(1) | Includes $33.8 million of charges related to change-in-control expense to satisfy outstanding equity awards and severance related costs. |
The Company also incurred acquisition costs of approximately $25.6 million and integration costs of $6.3 million, during the first quarter of fiscal 2019. The Company expects to incur approximately $12 million of additional restructuring expense throughout the remainder of fiscal 2019.
2018 Earth Origins Market. During the fiscal year ended July 28, 2018, the Company recorded restructuring and asset impairment expenses of $16.1 million, including a loss on the disposition of assets of approximately $2.7 million, related to the Company’s Earth Origins Market retail business. During the second quarter of fiscal 2018 the Company made the decision to close three non-core, under-performing stores of its total twelve stores. Based on this decision, coupled with the decline in results in the first half of fiscal 2018 and the future outlook as a result of competitive pressure, the Company determined that both a test for recoverability of long-lived assets and a goodwill impairment analysis should be performed. The determination of the need for a goodwill analysis was based on the assertion that it was more likely than not that the fair value of the reporting unit was below its carrying amount. As a result of both these analyses, the Company recorded a total impairment charge of $3.4 million on long-lived assets and $7.9 million to goodwill, respectively, during the second quarter of fiscal 2018. During the fourth quarter of fiscal 2018 the Company disposed of its Earth Origins retail business. The Company recorded restructuring costs of $2.2 million during fiscal 2018.
The following is a summary of the restructuring costs the Company recorded related to Earth Origins in fiscal 2018, the payments and other adjustments related to these costs and the remaining liability as of October 27, 2018 (in thousands):
Restructuring Costs Recorded in Fiscal 2018 | Payments and Other Adjustments | Restructuring Cost Liability as of October 27, 2018 | ||||||||||
Severance and closure costs | $ | 819 | $ | (626 | ) | $ | 193 | |||||
Lease termination and facility closing costs | 1,400 | (1,400 | ) | — | ||||||||
Total | $ | 2,219 | $ | (2,026 | ) | $ | 193 | |||||
2017 Cost Saving and Efficiency Initiatives. During fiscal 2017, the Company announced a restructuring program in conjunction with various cost saving and efficiency initiatives, including the planned opening of a shared services center. The Company recorded total restructuring costs of $6.9 million during the fiscal year ended July 29, 2017, all of which was recorded in the second half of fiscal 2017. Of the total restructuring costs recorded, $6.6 million was primarily related to severance and other employee separation and transition costs and $0.3 million was due to an early lease termination and facility closing costs for the Company’s Gourmet Guru facility in Bronx, New York. During fiscal 2018, the Company performed an analysis on the remaining restructuring cost liability and as a result, recorded a benefit of $0.1 million which is included in “payments and other adjustments” in the table below.
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The following is a summary of the restructuring costs the Company recorded in fiscal 2017, the payments and other adjustments related to these costs and the remaining liability as of October 27, 2018 (in thousands):
Restructuring Costs Recorded in Fiscal 2017 | Payments and Other Adjustments | Restructuring Cost Liability as of October 27, 2018 | ||||||||||
Severance and other employee separation and transition costs | $ | 6,606 | $ | (6,341 | ) | $ | 265 | |||||
Early lease termination and facility closing costs | 258 | (258 | ) | — | ||||||||
Total | $ | 6,864 | $ | (6,599 | ) | $ | 265 | |||||
6. EARNINGS PER SHARE
The following is a reconciliation of the basic and diluted number of shares used in computing earnings per share:
13-Week Period Ended | ||||||||
(in thousands, except per share data) | October 27, 2018 | October 28, 2017 | ||||||
Basic weighted average shares outstanding | 50,583 | 50,817 | ||||||
Net effect of dilutive stock awards based upon the treasury stock method(1) | — | 140 | ||||||
Diluted weighted average shares outstanding(1) | 50,583 | 50,957 | ||||||
Basic per share data: | ||||||||
Continuing operations | $ | (0.42 | ) | $ | 0.60 | |||
Discontinued operations(1) | $ | 0.04 | $ | — | ||||
Basic (loss) earnings per share | $ | (0.38 | ) | $ | 0.60 | |||
Diluted per share data: | ||||||||
Continuing operations | $ | (0.42 | ) | $ | 0.60 | |||
Discontinued operations(1) | $ | 0.04 | $ | — | ||||
Diluted (loss) earnings per share | $ | (0.38 | ) | $ | 0.60 | |||
Anti-dilutive stock-based awards excluded from the calculation of diluted earnings per share | 275 | 155 | ||||||
(1) | The computation of diluted earnings per share from discontinued operations is calculated using diluted weighted average shares outstanding which includes the net effect of dilutive stock awards, or approximately 598 thousand shares. |
7. DERIVATIVES AND FAIR VALUE MEASUREMENTS OF FINANCIAL INSTRUMENTS
Management of Interest Rate Risk
The Company enters into interest rate swap contracts from time to time to mitigate its exposure to changes in market interest rates as part of its overall strategy to manage its debt portfolio to achieve an overall desired position of notional debt amounts subject to fixed and floating interest rates. Interest rate swap contracts are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. The Company’s interest rate swap contracts are designated as cash flow hedges at October 27, 2018, except for one interest rate swap contract which matures on March 21, 2019 and is described in more detail below. Interest rate swap contracts are reflected at their fair values in the Condensed Consolidated Balance Sheets.
Details of outstanding swap contracts as of October 27, 2018, which are all pay fixed and receive floating, are as follows:
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Swap Maturity | Notional Value (in millions) | Pay Fixed Rate | Receive Floating Rate | Floating Rate Reset Terms | |||||||
March 21, 2019(1) | $ | 300.0 | 2.0075 | % | One-Month LIBOR | Monthly | |||||
June 9, 2019(2) | $ | 50.0 | 0.8725 | % | One-Month LIBOR | Monthly | |||||
June 28, 2019(2) | $ | 50.0 | 0.7265 | % | One-Month LIBOR | Monthly | |||||
April 29, 2021(2) | $ | 25.0 | 1.0650 | % | One-Month LIBOR | Monthly | |||||
April 29, 2021(2) | $ | 25.0 | 0.9260 | % | One-Month LIBOR | Monthly | |||||
August 15, 2022(3) | $ | 66.0 | 1.7950 | % | One-Month LIBOR | Monthly | |||||
August 15, 2022(3) | $ | 44.0 | 1.7950 | % | One-Month LIBOR | Monthly | |||||
October 30, 2020(4) | $ | 100.0 | 2.8240 | % | One-Month LIBOR | Monthly | |||||
October 31, 2022(4) | $ | 100.0 | 2.8915 | % | One-Month LIBOR | Monthly | |||||
October 31, 2023(4) | $ | 100.0 | 2.9210 | % | One-Month LIBOR | Monthly | |||||
October 22, 2025(4) | $ | 50.0 | 2.9550 | % | One-Month LIBOR | Monthly | |||||
(1) | On October 22, 2018, as a result of the acquisition of Supervalu, the Company assumed a pay fixed and receive floating interest rate swap agreement originally entered into by Supervalu to effectively convert $300 million of its variable rate debt to a fixed rate by swapping the variable LIBOR rate component to a fixed rate of 2.0075%. The Company entered into a novation agreement with the counterparty to novate this agreement to the Company, keeping it in place through its scheduled maturity date of March 2019. This interest rate swap contract was kept in place to fix the underlying variability in expected interest payment cash outflows on $300 million notional amount of its LIBOR based debt. This interest rate swap contract is not designated as a hedging instrument as of October 27, 2018, and as such gains or losses resulting from the change in fair value of the contract are reported as Interest expense within the Condensed Consolidated Statements of Income. |
(2) | In June 2016, the Company entered into four pay fixed and receive floating interest rate swap contracts to effectively fix the underlying variability in expected interest payment cash outflows on its LIBOR based debt. The agreements were effective in June 2016 and expire at varied dates between June 2019 and April 2021. These interest rate swap contracts have an aggregate notional principal amount of $150 million and require the Company to pay interest payments during the duration of the respective contracts at fixed annual rates between 0.7265% and 1.0650%, while receiving interest for the same respective contract periods at one-month LIBOR on the same aggregate notional principal amounts. |
(3) | On January 23, 2015, the Company entered into two pay fixed and receive floating interest rate swap contracts with effective dates in August 2015, which expire in August 2022. The interest rate swap contracts have amortizing notional amounts which adjust down on a quarterly basis. These interest rate swap contracts require the Company to pay interest payments during the duration of the respective contracts at fixed annual rates of 1.7950%, while receiving interest for the same respective contract periods at one-month LIBOR on the same aggregate notional principal amounts. |
(4) | On October 26, 2018, the Company entered into four pay fixed receive floating interest rate swap contracts to effectively fix the underlying variability in expected interest payment cash outflows on its LIBOR based debt. The agreements have an effective date of October 26, 2018 and expire at varied dates between October 2020 and October 2025. These interest rate swap contracts have an aggregate notional principal amount of $350 million and require the Company to pay interest payments during the duration of the respective contracts at fixed annual rates between 2.8240% and 2.9550%, while receiving interest for the same respective contract periods at one-month LIBOR on the same aggregate notional principal amounts. |
The fair values of interest rate swap contracts are measured using Level 2 inputs. The interest rate swap contracts are valued using an income approach interest rate swap valuation model incorporating observable market inputs including interest rates, LIBOR swap rates and credit default swap rates. October 27, 2018, a 100 basis point increase in forward LIBOR interest rates would increase the fair value of the interest rate swaps by approximately $19.1 million; a 100 basis point decrease in forward LIBOR interest rates would decrease the fair value of the interest rate swaps by approximately $19.9 million.
The Company performs an initial quantitative assessment of hedge effectiveness using the “Hypothetical Derivative Method” in the period in which the hedging transaction is entered. Under this method, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. In future reporting periods, the Company performs a qualitative analysis for quarterly prospective and retrospective assessments of hedge effectiveness. The Company also monitors the risk of counterparty default on an ongoing
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basis and noted that the counterparties are reputable financial institutions. The entire change in the fair value of the derivative is initially reported in Other comprehensive income (outside of earnings) and subsequently reclassified to earnings in interest expense when the hedged transactions affect earnings.
The location and amount of gains or losses recognized in the Condensed Consolidated Statements of Income for interest rate swap contracts for each of the periods, presented on a pretax basis, are as follows:
13-Week Period Ended | ||||||||
October 27, 2018 | October 28, 2017 | |||||||
(In thousands) | Interest Expense | Interest Expense | ||||||
Total amounts of expense presented in the consolidated results of operations in which the effects of cash flow hedges are recorded | $ | 7,671 | $ | 3,667 | ||||
Gain or (loss) on cash flow hedging relationships: | ||||||||
Gain or (loss) reclassified from comprehensive income into income | $ | 551 | $ | (30 | ) | |||
Gain or (loss) on interest rate swap contracts not designated as hedging instruments: | ||||||||
Gain or (loss) recognized as interest expense | $ | (88 | ) | $ | — | |||
Recurring Fair Value Measurements
The following table provides the fair value for financial assets and liabilities under the fair value hierarchy that are measured on a recurring basis:
Fair Value at October 27, 2018 | ||||||||||||||
(In thousands) | Balance Sheet Location | Level 1 | Level 2 | Level 3 | ||||||||||
Assets: | ||||||||||||||
Interest rate swaps designated as hedging instruments | Prepaid expenses and other current assets | $ | — | $ | 1,148 | $ | — | |||||||
Interest rate swap not designated as a hedging instrument | Prepaid expenses and other current assets | $ | — | $ | 570 | $ | — | |||||||
Mutual funds | Prepaid expenses and other current assets | $ | 1,541 | $ | — | $ | — | |||||||
Interest rate swaps designated as hedging instruments | Other Assets | $ | — | $ | 5,886 | $ | — | |||||||
Mutual funds | Other Assets | $ | 1,856 | $ | — | $ | — | |||||||
Fair Value at July 28, 2018 | ||||||||||||||
(in thousands) | Balance Sheet Location | Level 1 | Level 2 | Level 3 | ||||||||||
Assets: | ||||||||||||||
Interest rate swaps designated as hedging instruments | Prepaid expenses and other current assets | $ | — | $ | 1,459 | $ | — | |||||||
Interest rate swaps designated as hedging instruments | Other Assets | $ | — | $ | 5,860 | $ | — | |||||||
Mutual Funds
Mutual fund assets consist of balances held in investments to fund certain deferred compensation plans. The fair values of mutual fund assets are based on quoted market prices of the mutual funds held by the plan at each reporting period. Mutual funds traded in active markets are classified within Level 1 of the fair value hierarchy. Deferred compensation liabilities consist of obligations to participants in deferred compensation plans, and are determined based on the fair value of the related deferred compensation plan investments or designated phantom investments of the plan at each reporting period.
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Fair Value Estimates
For certain of the Company’s financial instruments including cash and cash equivalents, restricted cash, receivables, accounts payable, accrued vacation, compensation and benefits, and other current assets and liabilities the fair values approximate carrying amounts due to their short maturities. The carrying amount of notes payable approximates fair value as interest rates on the ABL Credit Facility approximate current market rates (level 2 criteria).
Notes receivable estimated fair value is determined by a discounted cash flow approach applying a market rate for similar instruments that is determined using Level 3 inputs. Long-term debt, including current portion, estimated fair value is determined by using available market information and appropriate valuation methodologies taking into account the instruments’ interest rate, terms, maturity date and collateral, if any, in comparison to the Company’s incremental borrowing rate for similar financial instruments and are therefore deemed Level 2 inputs. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.
October 27, 2018 | July 28, 2018 | |||||||||||||||
(In thousands) | Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||
Assets: | ||||||||||||||||
Notes receivable | $ | 64,240 | $ | 64,240 | $ | — | $ | — | ||||||||
Liabilities: | ||||||||||||||||
Long-term debt and capital lease obligations, including current portion | $ | 2,654,622 | $ | 2,674,688 | $ | 150,150 | $ | 155,317 | ||||||||
Subsequent Events
On November 16, 2018, the Company entered into three pay fixed receive floating interest rate swap contracts to fix the underlying variability in expected interest payment cash outflows on its LIBOR based debt. The agreements have an effective date of November 16, 2018 and expire at varied dates between March 2023 and October 2025. These interest rate swap contracts have an aggregate notional principal amount of $250 million and require the Company to pay interest payments during the duration of the respective contracts at fixed annual rates between 2.8950% and 2.9590%, while receiving interest for the same respective contract periods at one-month LIBOR on the same aggregate notional principal amounts.
On November 30, 2018, the Company entered into three pay fixed receive floating interest rate swap contracts to fix the underlying variability in expected interest payment cash outflows on its LIBOR based debt. The agreements have an effective date of November 30, 2018 and expire at varied dates between October 2021 and October 2024. These interest rate swap contracts have an aggregate notional principal amount of $250 million and require the Company to pay interest payments during the duration of the respective contracts at fixed annual rates between 2.8084% and 2.8480%, while receiving interest for the same respective contract periods at one-month LIBOR on the same aggregate notional principal amounts.
8. TREASURY STOCK
On October 6, 2017, the Company announced that its Board of Directors authorized a share repurchase program for up to $200.0 million of the Company’s outstanding common stock. The repurchase program is scheduled to expire upon the Company’s repurchase of shares of the Company’s common stock having an aggregate purchase price of $200.0 million. Repurchases will be made in accordance with applicable securities laws from time to time in the open market, through privately negotiated transactions, or otherwise. The Company may also implement all or part of the repurchase program pursuant to a plan or plans meeting the conditions of Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.
The Company records the repurchase of shares of common stock at cost based on the settlement date of the transaction. These shares are classified as treasury stock, which is a reduction to stockholders’ equity. Treasury stock is included in authorized and issued shares but excluded from outstanding shares. The Company repurchased 614,660 shares of its common stock at an aggregate cost of $24.2 million in the fiscal year ended July 28, 2018. The Company did not purchase any shares of the Company’s common stock in the first quarter of fiscal 2019.
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9. INCOME TAXES
Effective Tax Rate
Our effective income tax rate for continuing operations was 16.6% and 41.8% for the 13-week periods ended October 27, 2018 and October 28, 2017, respectively. The first quarter of fiscal 2019 effective tax rate reflects a tax benefit based on a consolidated pre-tax loss from continuing operations. The decrease in the effective income tax rate was primarily driven by a full year of tax savings due to Tax Reform. The decrease is primarily offset by an increase in non-deductible compensation expense.
The total provision for income taxes included in the consolidated statements of income consisted of the following:
13-Week Period Ended | ||||||||
(in thousands) | October 27, 2018 | October 28, 2017 | ||||||
Continuing operations | $ | (4,255 | ) | $ | 21,889 | |||
Discontinued operations | 749 | — | ||||||
Total | $ | (3,506 | ) | $ | 21,889 | |||
Effects of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (“TCJA”) was enacted on December 22, 2017. Given the significance of the legislation, the SEC staff issued SAB 118, which allowed registrants to record provisional or estimated amounts concerning TCJA impacts during a one year “measurement period” similar to that used when accounting for business combinations. The measurement period was deemed to end when the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting.
As of the current quarterly period, the Company has closed the measurement period relating to the effects of TCJA. The final amounts the Company has reported may change further only in the event of return to provision adjustments.
Uncertain Tax Positions
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits is as follows:
13-Week Period Ended | |||
(in thousands) | October 27, 2018 | ||
Unrecognized tax benefits at beginning of year | $ | 1,104 | |
Unrecognized tax benefits assumed in a business combination | 41,321 | ||
Unrecognized tax benefits at end of period | $ | 42,425 | |
The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense. As of October 27, 2018 total gross interest and penalties accrued was $14.7 million.
The Company is currently under examination in several taxing jurisdictions and remains subject to examination until the statute of limitations expires for the respective taxing jurisdiction or an agreement is reached between the taxing jurisdiction and the Company. As of October 27, 2018, the Company is no longer subject to federal income tax examinations for fiscal years before 2015 and in most states is no longer subject to state income tax examinations for fiscal years before 2008 and 2014 for Supervalu and United Natural Foods, Inc., respectively.
Based on the possibility of the closing of pending audits and appeals, or expiration of the statute of limitations, it is reasonably possible that the amount of unrecognized tax benefits will decrease by up to $11 million during the next 12 months.
Other
Under ASU 2016-09, the Company accounts for excess tax benefits or tax deficiencies related to share-based payments in its provision for income taxes as opposed to additional paid-in capital. The Company recognized $1.2 million of income tax expense related to excess tax deficiencies for share-based payments for the 13-week period ended October 27, 2018 and $0.9 million of income tax expense related to tax deficiencies for share-based payments for the 13-week period ended October 28, 2017.
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10. BUSINESS SEGMENTS
The Company has three operating segments, legacy Company wholesale, Supervalu wholesale and Canada wholesale, aggregated under the wholesale reportable segment. In addition, the Company’s Retail operating segment is a separate reportable segment, which is primarily comprised of discontinued operations activities. The legacy Company wholesale, Supervalu wholesale and Canada wholesale operating segments have similar products and services, customer channels, distribution methods and economic characteristics. The wholesale reportable segment is engaged in the national distribution of natural, organic, specialty, and conventional grocery and non-food products, and in the provision of support services in the United States and Canada. The Company has additional operating segments that do not meet the quantitative thresholds for reportable segments and are therefore aggregated under the caption of “Other.” “Other” includes a former retail division, that engaged in the sale of natural foods and related products to the general public through retail storefronts on the east coast of the United States, a manufacturing division, which engages in the importing, roasting, packaging, and distributing of nuts, dried fruit, seeds, trail mixes, granola, natural and organic snack items and confections, the Company’s branded product lines, and the Company’s brokerage business, which markets various products on behalf of food vendors directly and exclusively to the Company’s customers. “Other” also includes certain corporate operating expenses that are not allocated to operating segments, which include, among other expenses, share-based compensation, and salaries, retainers, and other related expenses of certain officers and all directors. Non-operating expenses that are not allocated to the operating segments are under the caption of “Unallocated (Income)/Expenses.”
(in thousands) | Wholesale | Other | Eliminations | Unallocated (Income)/Expenses | Consolidated | |||||||||||||||
13-Week Period Ended October 27, 2018: | ||||||||||||||||||||
Net sales(1) | $ | 2,856,966 | $ | 48,754 | $ | (37,564 | ) | $ | — | $ | 2,868,156 | |||||||||
Restructuring, acquisition, and integration related expenses | — | 68,004 | — | — | 68,004 | |||||||||||||||
Operating income (loss) | 60,237 | (78,329 | ) | (746 | ) | — | (18,838 | ) | ||||||||||||
Total other expense, net | — | — | — | 6,778 | 6,778 | |||||||||||||||
(Loss) income from continuing operations before income taxes | — | — | — | — | (25,616 | ) | ||||||||||||||
Depreciation and amortization | 23,517 | 1,276 | — | — | 24,793 | |||||||||||||||
Capital expenditures | 15,737 | 644 | — | — | 16,381 | |||||||||||||||
Goodwill | 697,797 | 10,153 | — | — | 707,950 | |||||||||||||||
Total assets of continuing operations | 7,164,623 | 847,897 | (39,013 | ) | — | 7,973,507 | ||||||||||||||
13-Week Period Ended October 28, 2017: | ||||||||||||||||||||
Net sales | $ | 2,444,658 | $ | 57,432 | $ | (44,545 | ) | $ | — | $ | 2,457,545 | |||||||||
Operating income (loss) | 59,956 | (4,591 | ) | (258 | ) | — | 55,107 | |||||||||||||
Total other expense, net | — | — | — | 2,713 | 2,713 | |||||||||||||||
Income from continuing operations before income taxes | — | — | — | — | 52,394 | |||||||||||||||
Depreciation and amortization | 21,539 | 903 | — | — | 22,442 | |||||||||||||||
Capital expenditures | 4,177 | 1,080 | — | — | 5,257 | |||||||||||||||
Goodwill | 352,786 | 18,025 | — | — | 370,811 | |||||||||||||||
Total assets of continuing operations | 2,919,476 | 171,239 | (44,403 | ) | — | 3,046,312 | ||||||||||||||
(1) | For the first quarter of fiscal 2019, the Company recorded $21.8 million within Net sales in its wholesale reportable segment attributable to discontinued operations inter-company product purchases from its Retail operating segment, which it expects will continue subsequent to the sale of certain retail banners. |
11. SHARE-BASED AWARDS
Pursuant to the Merger Agreement, dated as of July 25, 2018, as amended, each outstanding Supervalu stock option, whether vested or unvested, that was unexercised as of immediately prior to the effective time of the Merger (“SVU Option”) was converted, effective as of the effective time of the Merger, into a stock option exercisable for shares of common stock of the Company (“Replacement Option”) under the Company’s 2012 Equity Incentive Plan (the “2012 Plan”) in accordance with the adjustment provisions of the Supervalu stock plan pursuant to which such SVU Option was granted and the Merger Agreement, with such Replacement Option generally having the same terms and conditions as the underlying SVU Option. In addition, pursuant to the Merger Agreement, each outstanding Supervalu restricted share award, restricted stock unit award, deferred share unit award and
performance share unit award (“SVU Equity Award”) was converted, effective as of the effective time of the Merger, into time-vesting awards (“Replacement Award”) under the 2012 Plan with a settlement value equal to the merger consideration ($32.50 per share) multiplied by the number of shares of Supervalu common stock subject to such SVU Equity Award, and generally upon the same terms of the SVU Equity Award including the applicable change in control termination protections. The Merger Agreement originally provided that the Replacement Awards were payable in cash, however, the Merger Agreement was amended on October 10, 2018, to provide that the Replacement Awards could be settled at the Company’s election, in cash and/or an equal value in shares of common stock of the Company.
During the first quarter of fiscal 2019, the Company authorized for issuance and registered on a Registration Statement on Form S-8 filed with the SEC on October 22, 2018 (the “Form S-8”) an additional 5,000,000 shares for issuance in order to satisfy the Replacement Options and Replacement Awards. As of October 27, 2018, there were 1,786,610 shares available for issuance under the 2012 Plan and an additional 5,000,000 shares for issuance solely to satisfy the Replacement Options and the Replacement Awards. In accordance with ASC 718, Compensation- Stock Compensation, the Replacement Awards are liability classified awards as they may ultimately be settled in cash or shares at the discretion of the employee because employees holding such equity awards were offered the opportunity to participate in an immediate sale program established by the Company on their behalf. The liability will not be marked-to-market each reporting period as the share-based awards will be settled in cash or shares based on the fixed value of $32.50 per share.
The Company recognized total share-based compensation expense of $8.1 million during the first quarter of fiscal 2019 which included share-based compensation expense of $0.6 million for Supervalu Replacement Awards related to the post-combination period, beginning on the acquisition date through October 27, 2018. Share-based compensation expense does not include $21.4 million of charges for the settlement of share-based awards recorded as part of restructuring costs, described in Note 5. “Restructuring, Acquisition, and Integration Related Expenses” of which $20.6 million relates to change-in-control payments. The Company recorded share-based compensation expense of $7.3 million in the first quarter of fiscal 2018. The total income tax benefit for share-based compensation arrangements was $1.9 million and $2.2 million for the first quarters of fiscal 2019 and fiscal 2018, respectively.
Supervalu Replacement Awards generally vest in three equal installments or cliff-vest after three years from the date they were originally granted by Supervalu. The Company’s other time vesting awards are typically four equal annual installments for employees and two equal installments for non-employee directors with the first installment on the date of grant and the second installment on the six month anniversary of the grant date. As of October 27, 2018, there was $106.8 million of total unrecognized compensation cost related to outstanding share-based compensation arrangements (including stock options, restricted stock units and performance-based restricted stock units) of which $50.2 million relates to Supervalu Replacement Awards. Unrecognized compensation cost related to Replacement Options is de minimis. The total unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.5 years
New Retirement Provision
Subsequent to the first fiscal quarter of fiscal 2019, after reviewing retirement provisions and practices for the treatment of equity awards at comparable companies, the Compensation Committee of the Company’s Board of Directors determined to change the terms of its long-term compensation awards to accommodate executives who might consider retiring and to better assure that their awards provided an incentive to work for the long term best interests of the Company up to their termination date, and regardless of their retirement plans. Accordingly, the Compensation Committee determined that time-based vesting restricted stock units, with the exception of Replacement Awards, will continue to vest during retirement after termination of employment on the same terms as they would if the executive had not retired, but without the requirement that they remain employed. Performance share-units will be treated similarly on retirement, but subject to actual performance at the time achievement of performance objectives is measured. In addition, an executive’s equity awards granted in the year of retirement will be prorated to reflect the service period prior to the date of retirement. Retirement vesting will only be available to employees age 59 or older who voluntarily terminate employment after at least 10 years of service to the Company. As a result of these retirement provisions, the Company expects to record an additional share-based compensation charge of approximately $10 million during the remainder of fiscal 2019, with the majority of this expense to be recorded in the second fiscal quarter.
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12. NOTES PAYABLE
ABL Credit Facility
On August 30, 2018, the Company entered into a loan agreement (as amended by that certain First Amendment to Loan Agreement, dated as of October 19, 2018, the “ABL Loan Agreement”), by and among the Company and United Natural Foods West, Inc. (together with the Company, the “U.S. Borrowers”) and UNFI Canada, Inc. (the “Canadian Borrower” and, together with the U.S. Borrowers, the “Borrowers”), the financial institutions that are parties thereto as lenders (collectively, the “ABL Lenders”), Bank of America, N.A. as administrative agent for the ABL Lenders (the “ABL Administrative Agent”), Bank of America, N.A. (acting through its Canada branch), as Canadian agent for the ABL Lenders (the “Canadian Agent”), and the other parties thereto.
The ABL Loan Agreement provides for an asset-based revolving credit facility (the “ABL Credit Facility” and the loans thereunder, the “ABL Loans”), of which up to (i) $2,050.0 million is available to the U.S. Borrowers and (ii) $50.0 million is available to the Canadian Borrower. The ABL Loan Agreement also provides for (i) a $125.0 million sublimit of availability for letters of credit of which there is a further $5.0 million sublimit for the Canadian Borrower, and (ii) a $100.0 million sublimit for short-term borrowings on a swingline basis of which there is a further $3.5 million sublimit for the Canadian Borrower. The ABL Credit Facility replaced the Company’s $900.0 million prior asset-based revolving credit facility (the “Former ABL Credit Facility”), and $1,475.0 million of proceeds from the ABL Credit Facility were primarily used to finance the Supervalu acquisition and related transaction costs.
Under the ABL Loan Agreement, the Borrowers may, at their option, increase the aggregate amount of the ABL Credit Facility in an amount of up to $600.0 million without the consent of any ABL Lenders not participating in such increase, subject to certain customary conditions and applicable lenders committing to provide the increase in funding. There is no assurance that additional funding would be available.
The Borrowers’ obligations under the ABL Credit Facility are guaranteed by most of the Company’s wholly-owned subsidiaries who are not also Borrowers (collectively, the “ABL Guarantors”), subject to customary exceptions and limitations. The Borrowers’ obligations under the ABL Credit Facility and the ABL Guarantors’ obligations under the related guarantees are secured by (i) a first-priority lien on all of the Borrowers’ and ABL Guarantors’ accounts receivable, inventory and certain other assets arising therefrom or related thereto (including substantially all of their deposit accounts, collectively, the “ABL Assets”) and (ii) a second-priority lien on all of the Borrowers’ and ABL Guarantors’ assets that do not constitute ABL Assets, in each case, subject to customary exceptions and limitations.
Availability under the ABL Credit Facility is subject to a borrowing base (the “Borrowing Base”), which is based on 90% of eligible accounts receivable, plus 90% of eligible credit card receivable, plus 90% of the net orderly liquidation value of eligible inventory, plus 90% of eligible pharmacy receivables, plus certain pharmacy scripts availability of the Borrowers, after adjusting for customary reserves. The aggregate amount of the ABL Loans made and letters of credit issued under the ABL Credit Facility shall at no time exceed the lesser of the aggregate commitments under the ABL Credit Facility (currently $2,100.0 million or, if increased at the Borrowers’ option as described above, up to $2,700.0 million) or the Borrowing Base. To the extent that the Borrowers’ Borrowing Base declines, the availability under the ABL Credit Facility may decrease below $2,100.0 million; provided that, on October 22, 2018 (the “Closing Date”) and until the ninetieth day after the Closing Date, regardless of the calculation of the Borrowing Base on the Closing Date, the Borrowing Base shall be deemed to be no less than $1,500.0 million.
As of October 27, 2018, the U.S. Borrowers’ Borrowing Base, net of $83.2 million of reserves, was $2,278.6 million, which exceeds the $2,050.0 million limit of availability to the U.S. Borrowers under the ABL Credit Facility. As of October 27, 2018, the Canadian Borrower’s Borrowing Base, net of $3.8 million of reserves, was $38.6 million, resulting in total Borrowing Base of $2,088.6 million supporting the ABL Loans. The Company had $1,327.3 million of ABL Loans as of October 27, 2018, which are presented net of debt issuance costs of $11.9 million and are included in Notes payable in the Condensed Consolidated Balance Sheet. As of October 27, 2018, the Company had $78.9 million in letters of credit outstanding under the ABL Credit Facility. The Company’s resulting remaining availability under the ABL Credit Facility was $682.4 million as of October 27, 2018.
The borrowings of the U.S. Borrowers under the ABL Credit Facility bear interest at rates that, at the U.S. Borrowers’ option, can be either: (i) a base rate and an applicable margin, or (ii) a LIBOR rate and an applicable margin. The initial applicable margin for base rate loans is 0.25%, and the initial applicable margin for LIBOR loans is 1.25%. The borrowings of the Canadian Borrower under the ABL Credit Facility bear interest at rates that, at the Canadian Borrower’s option, can be either: (i) prime rate and an applicable margin, or (ii) a Canadian dollar bankers’ acceptance equivalent rate and an applicable margin. The initial applicable margin for prime rate loans is 0.25%, and the initial applicable margin for Canadian dollar bankers’ acceptance equivalent rate loans is 1.25%. Commencing on the first day of the calendar month following the ABL Administrative Agent’s receipt of the Company’s financial statements for the fiscal quarter ending on October 27, 2018, and quarterly thereafter, the applicable margins for borrowings by the U.S. Borrowers and Canadian Borrower will be subject to adjustment based upon the aggregate availability under the ABL Credit Facility. Unutilized commitments under the ABL Credit Facility are subject to a per annum fee of (i) from
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and after the Closing Date through and including the first day of the calendar month that is three months following the Closing Date, 0.375% and (ii) thereafter, (x) 0.375% if the total outstandings were less than 25% of the aggregate commitments, or (y) 0.25% if such total outstandings were 25% or more of the aggregate commitments. The Borrowers are also required to pay a letter of credit fronting fee to each letter of credit issuer equal to 0.125% per annum of the amount available to be drawn under each such letter of credit, as well as a fee to all lenders equal to the applicable margin for LIBOR or Canadian dollar bankers’ acceptance equivalent rate loans, as applicable, times the average daily amount available to be drawn under all outstanding letters of credit.
The ABL Loan Agreement subjects the Company to a fixed charge coverage ratio (as defined in the ABL Loan Agreement) of at least 1.0 to 1.0 calculated at the end of each of our fiscal quarters on a rolling four quarter basis when the adjusted aggregate availability (as defined in the ABL Loan Agreement) is less than the greater of (i) $235.0 million and (ii) 10% of the aggregate borrowing base. We were not subject to the fixed charge coverage ratio covenant under the ABL Loan Agreement during the first quarter of fiscal 2019.
The assets included in the Condensed Consolidated Balance Sheets securing the outstanding borrowings under the ABL Credit Facility on a first-priority basis, and the unused available credit and fees under the ABL Credit Facility, were as follows:
Assets securing the ABL Credit Facility (in thousands)(1): | October 27, 2018 | ||
Certain inventory assets included in Inventories and Current assets of discontinued operations | $ | 2,582,397 | |
Certain receivables included in Receivables and Current assets of discontinued operations | $ | 1,052,313 | |
(1) | The ABL Credit Facility is also secured by all of the Company’s pharmacy scripts, which are included in Long-term assets of discontinued operations in the Condensed Consolidated Balance Sheets as of October 27, 2018. |
Unused available credit and fees under the ABL Credit Facility (in thousands, except percentages): | October 27, 2018 | ||
Outstanding letters of credit | $ | 78,926 | |
Letter of credit fees | 1.375 | % | |
Unused available credit | $ | 682,362 | |
Unused facility fees | 0.375 | % | |
13. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
As of October 27, 2018 and July 28, 2018, the Company’s long-term debt and capital lease obligations consisted of the following:
(in thousands) | October 27, 2018 | July 28, 2018 | |||||
Term Loan Facility | $ | 1,950,000 | $ | — | |||
Supervalu Senior Notes | 546,601 | — | |||||
Capital lease obligations | 181,529 | 12,196 | |||||
Other secured loans | 42,212 | — | |||||
Direct financing lease obligations | 29,280 | 29,118 | |||||
Former Term Loan Facility | — | 110,000 | |||||
Debt issuance costs, net | (50,097 | ) | (1,164 | ) | |||
Original issue discount on debt | (44,903 | ) | — | ||||
Long-term debt and capital lease obligations, including current portion | $ | 2,654,622 | $ | 150,150 | |||
Less: Current portion of long-term debt and capital lease obligations | (730,401 | ) | (12,441 | ) | |||
Long-term debt and capital lease obligations, excluding current portion | $ | 1,924,221 | $ | 137,709 | |||
Term Loan Facility
On August 14, 2014, the Company and certain of its subsidiaries entered into a real estate-backed term loan agreement (as amended by the First Amendment Agreement, dated April 29, 2016, and the Second Amendment Agreement, dated September 1, 2016, the “Former Term Loan Agreement”). The Former Term Loan Agreement provided for secured first lien term loans in an aggregate amount of $150.0 million (the “Former Term Loan Facility”). Proceeds from this Former Term Loan Facility were used to pay down borrowings under the Former ABL Credit Facility.
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Borrowings under the Former Term Loan Facility bore interest at rates that, at the Company’s option, could have been either: (1) a base rate and a margin of 0.75%; or, (2) a LIBOR rate and a margin of 1.75%. The borrowers’ obligations under the Former Term Loan Facility were secured by certain parcels of the Company’s real property.
The Former Term Loan Agreement included financial covenants that required (i) the ratio of the Company’s consolidated EBITDA (as defined in the Former Term Loan Agreement) minus the unfinanced portion of Capital Expenditures (as defined in the Former Term Loan Agreement) to the Company’s consolidated Fixed Charges (as defined in the Former Term Loan Agreement) to be at least 1.20 to 1.00 as of the end of any period of four fiscal quarters, (ii) the ratio of the Company’s Consolidated Funded Debt (as defined in the Former Term Loan Agreement) to the Company’s EBITDA for the four fiscal quarters most recently ended to be not more than 3.00 to 1.00 as of the end of any fiscal quarter and (iii) the ratio, expressed as a percentage, of the Company’s outstanding borrowings under the Former Term Loan Facility), divided by the Mortgaged Property Value (as defined in the Former Term Loan Agreement) to be not more than 75% at any time.
On August 22, 2018, the Company notified its lenders of its intention to prepay its borrowings outstanding under its Former Term Loan Facility on October 1, 2018, which were approximately $110.0 million as of July 28, 2018. The Former Term Loan Facility was previously scheduled to terminate on the earlier of (a) August 14, 2022 and (b) the date that is ninety days prior to the termination date of the Former ABL Loan Agreement. On October 1, 2018, the Company prepaid the $110.0 million of borrowings outstanding under the Former Term Loan Agreement utilizing borrowings under its Former ABL Credit Facility and terminated the Former Term Loan Agreement. In connection with the prepayment, the Company incurred a loss on debt extinguishment related to unamortized debt issuance costs of $1.1 million, which was recorded in Other, net in the Condensed Consolidated Statements of Income for the first quarter of fiscal 2019.
On the Closing Date, the Company entered into a new term loan agreement (the “Term Loan Agreement”), by and among the Company and Supervalu (collectively, the “Term Borrowers”), the financial institutions that are parties thereto as lenders (collectively, the “ Term Lenders”), Goldman Sachs Bank USA, as administrative agent for the Lenders (the “TLB Administrative Agent”), and the other parties thereto. The Term Loan Agreement provides for senior secured first lien term loans in an aggregate principal amount of $1,950.0 million, consisting of a $1,800.0 million seven-year tranche (the “Term B Tranche”) and a $150.0 million tranche (the “364-day Tranche” and, together with the Term B Tranche, collectively, the “Term Loan Facility”). The entire amount of the net proceeds from the Term Loan Facility were used to finance the Supervalu acquisition and related transaction costs.
The loans under the Term B Tranche will be payable in full on October 22, 2025; provided that if on or prior to December 31, 2024 that certain Agreement for Distribution of Products, dated as of October 30, 2015, by and between Whole Foods Market Distribution, Inc., a Delaware corporation, and the Company has not been extended until at least October 23, 2025 on terms not materially less favorable, taken as a whole, to the Company and its subsidiaries than those in effect on the date of the Acquisition, then the loans under the Term B Tranche will be payable in full on December 31, 2024. The loans under the 364-day Tranche will be payable in full on October 21, 2019.
Under the Term Loan Agreement, the Term Borrowers may, at their option, increase the amount of the Term B Tranche, add one or more additional tranches of term loans or add one or more additional tranches of revolving credit commitments, without the consent of any Term Lenders not participating in such additional borrowings, up to an aggregate amount of $656.25 million plus additional amounts based on satisfaction of certain leverage ratio tests, subject to certain customary conditions and applicable lenders committing to provide the additional funding. There can be no assurance that additional funding would be available.
The Term Borrowers’ obligations under the Term Loan Facility are guaranteed by most of the Company’s wholly-owned domestic subsidiaries who are not also Term Borrowers (collectively, the “Term Guarantors”), subject to customary exceptions and limitations, including an exception for immaterial subsidiaries designated by the Company from time to time. The Term Borrowers’ obligations under the Term Loan Facility and the Term Guarantors’ obligations under the related guarantees are secured by (i) a first-priority lien on substantially all of the Term Borrowers’ and the Term Guarantors’ assets other than the ABL Assets and (ii) a second-priority lien on substantially all of the Term Borrowers’ and the Term Guarantors’ ABL Assets, in each case, subject to customary exceptions and limitations, including an exception for owned real property with net book values of less than $10.0 million.
The borrowings under the Term Loan Facility bear interest at rates that, at the Term Borrowers’ option, can be either: (i) a base rate and a margin of (ii) (A) with respect to the Term B Tranche, 3.25% and (B), with respect to the 364-day Tranche, 1.00%, or (ii) a LIBOR rate and a margin of (ii) (A) with respect to the Term B Tranche, 4.25% and (B), with respect to the 364-day Tranche, 2.00%; provided that the LIBOR rate shall never be less than 0.0%.
The Term Loan Agreement does not include any financial maintenance covenants.
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As of October 27, 2018, the Company had borrowings of $1,800.0 million and $150.0 million under the Term B Tranche and 364-day Tranche, respectively, which are presented net of debt issuance costs of $50.1 million and an original issue discount on debt of $44.9 million, of which $15.9 million, net is included in Current portion of long-term debt and capital lease obligations in the Condensed Consolidated Balance Sheets.
Supervalu Senior Notes
On October 22, 2018, the Company delivered an irrevocable redemption notice for the remaining $350.0 million of 7.75% Supervalu Senior Notes and the remaining $180.0 million of 6.75% Supervalu Senior Notes assumed in conjunction with the Supervalu acquisition. In connection with the redemption notice, the Company placed $566.4 million on account with the trustee of the Supervalu Senior Notes to satisfy and discharge its obligations under the indenture governing the Supervalu Senior Notes. As of October 27, 2018, this amount is reflected as Restricted cash on the Condensed Consolidated Balance Sheets. On November 21, 2018, following the required 30-day notice period, the trustee used this restricted cash to extinguish the remaining principal balances, to pay the required redemption premiums and to pay accrued and unpaid interest on the redeemed Supervalu Senior Notes. As a result of the satisfaction and discharge of the indenture governing the redemption of the Supervalu Senior Notes and of the Supervalu Senior Notes, the Company has fully satisfied and discharged its obligations under the Supervalu Senior Notes.
14. LEASES
On October 23, 2018, the Company received $101.0 million in aggregate proceeds, excluding taxes and closing costs, for the sale and leaseback of its final distribution center of eight distribution center sale-leaseback transactions entered into by Supervalu in April 2018. On October 26, 2018, the Company received $48.5 million in aggregate proceeds, excluding taxes and closing costs, for the sale and leaseback of a separate distribution center under an agreement entered into by Supervalu in March 2018, as amended. Both distribution center sale-leasebacks qualified for sale accounting, with the lease-backs being classified as operating leases. No gain or loss was recognized or deferred on the sale of these facilities, as these facilities were valued at their contractual sales price as of the Supervalu acquisition date.
Subsequent to the first quarter of fiscal 2019, the Company closed the remaining Shop ‘n Save St. Louis-based retail stores and the dedicated distribution center, and we continue to hold the owned real estate assets related to these locations for sale. The Company estimates it will record a closed store reserve charge of approximately $17 million in the second quarter of fiscal 2019 based on the retail stores’ November cease-use date.
The Company leases certain of its distribution centers and leases most of its retail stores, and leases certain office facilities and equipment from third parties. Many of these leases include renewal options and, in certain instances, also include options to purchase. Rent expense, other operating lease expense and subtenant rentals all under operating leases included within Operating expenses consisted of the following (in thousands):
13-Week Period Ended | |||||||
October 27, 2018 | October 28, 2017 | ||||||
Minimum rent | $ | 26,340 | $ | 18,904 | |||
Contingent rent | (11 | ) | — | ||||
Rent expense(1) | 26,329 | 18,904 | |||||
Less subtenant rentals | (660 | ) | — | ||||
Total net rent expense | $ | 25,669 | $ | 18,904 | |||
(1) | Rent expense as presented here includes $0.9 million of operating lease rent expense in the first quarter of fiscal 2019 related to stores within discontinued operations, but for which GAAP requires the expense to be included within continuing operations, as we expect to remain primarily obligated under these leases. |
Future minimum lease payments to be made by the Company or certain third parties in the case of assigned leases for noncancellable operating leases and capital leases have not been reduced for future minimum subtenant rentals under certain operating subleases, including assignments. As of October 27, 2018 these lease obligations consisted of following amounts (in thousands):
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Lease Obligations | |||||||
Fiscal Year | Operating Leases | Capital Leases | |||||
Remaining fiscal 2019 | $ | 147,680 | $ | 38,465 | |||
2020 | 170,557 | 43,122 | |||||
2021 | 130,675 | 37,565 | |||||
2022 | 112,039 | 36,530 | |||||
2023 | 97,658 | 32,193 | |||||
Thereafter | 688,692 | 112,723 | |||||
Total future minimum obligations | $ | 1,347,301 | 300,598 | ||||
Less interest | (89,791 | ) | |||||
Present value of net future minimum obligations | 210,807 | ||||||
Less current capital lease obligations | (28,068 | ) | |||||
Long-term capital lease obligations | $ | 182,739 | |||||
The Company leases certain property to third parties under operating, capital and direct financing leases, including assigned leases for which we have future minimum lease payment obligations that are included in the table above. Future minimum lease and subtenant rentals to be received under lease assignments and noncancellable operating and deferred financing income leases, under which the Company is the lessor, as of October 27, 2018, consisted of the following (in thousands):
Lease Receipts | |||||||
Fiscal Year | Operating Leases | Direct Financing Leases | |||||
Remaining fiscal 2019 | $ | 26,055 | $ | 322 | |||
2020 | 29,242 | 225 | |||||
2021 | 22,120 | — | |||||
2022 | 19,611 | — | |||||
2023 | 12,892 | — | |||||
Thereafter | 38,033 | — | |||||
Total minimum lease receipts | $ | 147,953 | $ | 547 | |||
15. BENEFIT PLANS
The Company acquired various pension and other post retirement benefit plans with the acquisition of Supervalu, which resulted in the revaluation of pension and other postretirement benefit plan obligations as of the acquisition date.
The Company’s employees who participate are covered by various contributory and non-contributory pension, profit sharing or 401(k) plans. The Company’s primary defined benefit pension plan, the SUPERVALU INC. Retirement Plan, and certain supplemental executive retirement plans were closed to new participants and service crediting ended for all participants as of December 31, 2007. Pay increases were reflected in the amount of benefits accrued in these plans until December 31, 2012. More than one-half of the union employees participate in multiemployer retirement plans under collective bargaining agreements. The remaining either participate in plans sponsored by the Company or are not currently eligible to participate in a retirement plan. In addition to sponsoring both defined benefit and defined contribution pension plans, the Company provides healthcare and life insurance benefits for eligible retired employees under postretirement benefit plans. The Company also provide certain health and welfare benefits, including short-term and long-term disability benefits, to inactive disabled employees prior to retirement. The terms of the postretirement benefit plans vary based on employment history, age and date of retirement. For many retirees, the Company provides a fixed dollar contribution and retirees pay contributions to fund the remaining cost.
Net periodic benefit (income) cost and other changes in plan assets and benefit obligations recognized in Net periodic benefit income, excluding service cost for defined benefit pension and other postretirement benefit plans consist of the following (in thousands):
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13-Week Period Ended October 27, 2018 | |||||||
Pension Benefits | Other Postretirement Benefits | ||||||
Service cost | $ | — | $ | 4 | |||
Interest cost | 1,847 | 38 | |||||
Expected return on plan assets | (2,724 | ) | (5 | ) | |||
Net periodic benefit (income) cost | $ | (877 | ) | $ | 37 | ||
Contributions to benefit plans | $ | (37 | ) | $ | (9 | ) | |
The benefit obligation, fair value of plan assets and funded status of our defined benefit pension plans and other postretirement benefit plans assumed with the Supervalu acquisition consisted of the following as of the acquisition date (in thousands):
October 22, 2018 | |||||||
Pension Benefits | Other Postretirement Benefits | ||||||
Benefit obligation as of October 22, 2018 | $ | 2,499,954 | $ | 52,276 | |||
Fair value of plan assets at October 22, 2018 | 2,305,020 | 11,586 | |||||
Unfunded status at October 22, 2018 | $ | (194,934 | ) | $ | (40,690 | ) | |
For the defined benefit pension plans, the accumulated benefit obligation is equal to the projected benefit obligation.
Amounts recognized in the Condensed Consolidated Balance Sheets as of the acquisition date consist of the following (in thousands):
October 22, 2018 | |||||||
Pension Benefits | Other Postretirement Benefits | ||||||
Accrued compensation and benefits | $ | 1,300 | $ | — | |||
Pension and other postretirement benefit obligations | 193,634 | 40,690 | |||||
Total | $ | 194,934 | $ | 40,690 | |||
Assumptions
Weighted average assumptions used to determine benefit obligations and net periodic benefit cost consisted of the following:
October 22, 2018 | |
Benefit obligation assumptions: | |
Discount rate | 4.30% - 4.42% |
The Company reviews and select the discount rate to be used in connection with measuring our pension and other postretirement benefit obligations annually. In determining the discount rate, the Company uses the yield on corporate bonds (rated AA or better) that coincides with the cash flows of the