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HTSI > SEC Filings for HTSI > Form 10-K on 21-Nov-2012All Recent SEC Filings

Show all filings for HARRIS TEETER SUPERMARKETS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for HARRIS TEETER SUPERMARKETS, INC.


21-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements. We have based these forward-looking statements on our current plans, expectations and beliefs about future events. In light of the risks, uncertainties and assumptions discussed under "Risk Factors" in Item 1A of this Annual Report on Form 10-K and other factors discussed in this section, there are risks that our actual experience will differ materially from the expectations and beliefs reflected in the forward-looking statements in this section and throughout this report. For more information regarding what constitutes a forward-looking statement, please refer to "Risk Factors" in Item 1A hereof.

Overview

The Company operates one primary business segment, retail grocery (including related real estate and store development activities) through its wholly-owned subsidiary Harris Teeter. Harris Teeter is a regional supermarket chain operating primarily in the southeastern and mid-Atlantic United States, and the District of Columbia.

Historically, the Company also engaged in industrial sewing thread (textile primarily), including embroidery thread and technical textiles, through its A&E business. In the first quarter of fiscal 2012, the Company sold all of its ownership interest in A&E to two newly formed affiliates of KPS Capital Partners, LP. A definitive agreement to sell A&E was entered into on October 27, 2011 and the closing occurred on November 7, 2011. The sale price for A&E was $180 million in cash, subject to adjustments for working capital and certain liabilities including underfunded pension liability and foreign debt. In connection with the sale, the Company recorded pre-tax losses on disposition of discontinued operations of $3.7 million in fiscal 2012 and $48.8 million in fiscal 2011. As a result of this disposition, the sales and operating results of A&E are categorized as discontinued operations in the discussion that follows and in the financial statements included in Item 8 hereof for all periods presented. For additional information regarding discontinued operations, see Note 17 to the Consolidated Financial Statements in Item 8 hereof.

The economic environment over the past few years has motivated changes in the consumption habits of the retail consumer which continues to impact our financial results. Economic uncertainty, tumultuous market conditions and low levels of consumer confidence have created changes in the type of products purchased by our customers and increased the competitive environment in our primary markets. We compete with other traditional grocery retailers, as well as other retail outlets including, but not limited to, discount retailers such as "neighborhood or supercenters" and "club and warehouse stores," specialty supermarkets and drug stores. Generally, our markets continue to experience new store opening activity and increased feature pricing or everyday low prices by competitors. We utilize information gathered from various sources, including our Very Important Customer ("VIC") loyalty card program, and work with suppliers to deliver effective retail pricing and targeted promotional spending programs that drive customer traffic and create value for our customers. In addition, our product selection, assortment and variety, and our focus on customer service differentiate us from our competitors.

In June 2012, the Company completed its purchase and sale agreement with Lowe's Food Stores, Inc. (the "Lowes Foods Transaction"). Per the agreement Harris Teeter acquired ten Lowes Foods store locations in the central Carolinas region and Lowes Foods acquired six Harris Teeter store locations in western North Carolina. The majority of the stores acquired were temporarily closed for remodeling, stocking and training of employees. Six of the acquired stores were re-opened during the fourth quarter of fiscal 2012. Subsequent to the end of fiscal 2012, two of the acquired stores were re-opened under a new format and banner - "201central." The 201central format features a worldwide variety of wine, beer, specialty foods and other selected merchandise.

The Company continued with its planned new store development program and during fiscal 2012, has opened thirteen new stores (which includes six of the stores acquired from Lowes Foods and one replacement) and closed eight stores (comprised of the six stores sold to Lowes Foods, one replacement that opened in fiscal 2012 and one replacement that is expected to open in fiscal 2013) for a net addition of five stores. In addition, one store located in the Washington D.C. market was closed due to flooding that occurred in the third quarter of fiscal 2012. The Company is in the process of repairing damage and expects to re-open the store during fiscal 2013. During fiscal 2011, the Company opened seven new stores and closed two stores for a net addition of five stores, and during fiscal 2010, the Company opened 13 new stores and closed three stores for a net addition of 10 stores. Much of the Company's new store growth is focused on expanding its Washington, D.C. metro market area which incorporates northern Virginia, the District of Columbia, southern Maryland and coastal Delaware. During fiscal 2011, the


Company acquired 350,000 square feet of additional distribution capacity that is contiguous to its existing distribution facility in Greensboro, North Carolina. This represented an approximate 22% increase in the square footage of the Company's existing distribution facilities and was acquired to meet our continued growth. There were 208 stores in operations at the end of fiscal 2012, as compared to 204 at the end of fiscal 2011 and 199 at the end of fiscal 2010.

Results of Operations

The following table sets forth the components of consolidated net earnings for the Company for the 52 weeks ended October 2, 2012 (fiscal 2012) and October 2, 2011 (fiscal 2011) and the 53 weeks ended October 3, 2010 (fiscal 2010), respectively. The table also sets forth the percentage increase or decrease of such components over the prior year (in thousands):

                       Fiscal 2012              Fiscal 2011              Fiscal 2010             % Inc. (Dec.)
                                  % to                     % to                     % to      2012 vs     2011 vs
                                 Sales                    Sales                    Sales       2011        2010
  Net Sales      $ 4,535,414     100.00   $ 4,285,565     100.00   $ 4,099,353     100.00         5.8         4.5
  Cost of
  Sales            3,176,914      70.05     3,015,517      70.36     2,871,907      70.06         5.4         5.0
  Gross Profit     1,358,500      29.95     1,270,048      29.64     1,227,446      29.94         7.0         3.5

  SG&A
  Expenses:
  Harris
  Teeter
  without
  Lowes Foods
  Incremental
  Transaction
  Costs            1,150,501      25.36     1,078,978      25.18     1,045,860      25.51         6.6         3.2
  Lowes Foods
  Incremental
  Transaction
  Costs               29,810       0.66             -       0.00             -       0.00        n.m.        n.m.
  Corporate            7,211       0.16        10,364       0.24         4,730       0.12       (30.4 )     119.1
  Total            1,187,522      26.18     1,089,342      25.42     1,050,590      25.63         9.0         3.7
  Operating
  Profit             170,978       3.77       180,706       4.22       176,856       4.31        (5.4 )       2.2

  Interest
  Expense, net        16,411       0.36        18,983       0.44        19,521       0.47       (13.5 )      (2.8 )
  Net
  Investment
  Gains                    -       0.00        19,392       0.45           310       0.01        n.m.        n.m.
  Earnings
  From
  Continuing
  Operations
  Before
  Income Taxes       154,567       3.41       181,115       4.23       157,645       3.85       (14.7 )      14.9
  Income Tax
  Expense             54,640       1.21        69,657       1.63        58,993       1.44       (21.6 )      18.1
  Earnings
  From
  Continuing
  Operations          99,927       2.20       111,458       2.60        98,652       2.41       (10.3 )      13.0
  (Loss)
  Earnings
  From
  Discontinued
  Operations,
  Net of
  Income Taxes       (17,415 )                (20,211 )                 13,389
  Net Earnings   $    82,512              $    91,247              $   112,041


_______________

n.m. - not meaningful

Sales

Net sales increased 5.8% in fiscal 2012 and 4.5% in fiscal 2011 when compared to the respective prior years. The increase in sales in fiscal 2012 and fiscal 2011 was attributable to increases in comparable store sales (see definition below) and sales from new stores that were partially offset by store closings. The fiscal 2011 sales increase over fiscal 2010 was impacted by the fact that fiscal 2010 was a 53-week year. On a comparable week basis (reducing fiscal 2010 sales for the first week of the annual period), sales increased by 6.4% from fiscal 2010 to fiscal 2011. Comparable store sales for fiscal 2012 increased 3.97% ($165.5 million), as compared to an increase of 3.27% ($129.4 million) in fiscal 2011 and a decrease of 1.10% ($42.0 million) in fiscal 2010 (adjusted to 52 weeks). Comparable store sales have been negatively impacted, to some extent, by the cannibalization created by strategically opening stores in key major markets that have a close proximity to existing stores. Management believes that the Company's strategy of opening additional stores within close proximity to existing stores, and any similar new additions in the foreseeable future, have a strategic benefit of enabling the Company to capture sales and expand market share as the markets it serves continue to grow. During fiscal 2012, the Company increased the number of stores in operation by five, as compared to a net increase of five stores during fiscal 2011 and a net increase of 10 stores during fiscal 2010. The increase in sales from new stores exceeded the loss of sales from closed stores by $82.4 million in fiscal 2012, $122.0 million in fiscal 2011 and $238.2 million in fiscal 2010.


The Company has responded to its customers' changing buying habits with increased promotional activity designed to increase the overall value to the customers. During fiscal 2012, on a comparable basis, customer visits, average basket size and the average number of items sold increased. In addition, Harris Teeter experienced average increases in active households per comparable store (based on VIC data) of 1.61%, evidencing a continued growing customer base in those stores. Store brand penetration has also increased on a year over year basis. Store brand penetration based on units sold increased 31 basis points to 24.26% in fiscal 2012 from 23.95% in fiscal 2011. Store brand penetration based on sales dollars increased by 58 basis points to 25.15% in fiscal 2012 from 24.57% in fiscal 2011.

The Company considers its reporting of comparable store sales growth to be effective in determining core sales growth during periods of fluctuation in the number of stores in operation, their locations and their sizes. While there is no standard industry definition of "comparable store sales," the Company has been consistently applying the following definition. Comparable store sales are computed using corresponding calendar weeks to account for the occasional extra week included in a fiscal year. A new store must be in operation for 14 months before it enters into the calculation of comparable store sales. A closed store is removed from the calculation in the month in which its closure is announced. A new store opening within an approximate two-mile radius of an existing store that is to be closed as a result of the new store opening is included as a replacement store in the comparable store sales measurement as if it were the same store. Sales increases resulting from existing comparable stores that are expanded in size are included in the calculations of comparable store sales, if the store remains open during the construction period. If the location is closed during the construction period, the sales during the reporting period are removed from the calculation. If the location is completely rebuilt, it is reported as a replacement store and included in the same store sales calculation for the weeks actually open. Comparable store sales for fiscal 2011 was computed on a 52-week basis by reducing fiscal 2010 sales for the first week of the annual period.

Gross Profit

Gross profit as a percent to sales increased 31 basis points from fiscal 2011 to fiscal 2012 and declined 30 basis points from fiscal 2010 to fiscal 2011. The increase in the gross profit margin from fiscal 2011 to fiscal 2012 was driven by a decrease in the annual LIFO charge between the respective years and an improvement of 10 basis points in the retail gross profit margin resulting from our effective promotional activity. The decrease in the gross profit margin from fiscal 2010 to fiscal 2011 was driven by an increase in the annual LIFO charge between the respective years and the Company's efforts to drive sales through its promotional activity, which includes lowering the sales price on selected items (price investment) that resulted in a reduction in the retail gross profit margin by 2 basis points during fiscal 2011. The annual LIFO adjustment reduced gross profit by $3.0 million (0.07% to sales) in fiscal 2012, reduced gross profit by $11.1 million (0.26% to sales) in fiscal 2011 and increased gross profit by $1.6 million (0.04% to sales) in fiscal 2010.

Expenses

Selling, general & administrative ("SG&A") expenses for fiscal 2012 and its percent to sales increased from fiscal 2011 by $98.2 million and 76 basis points, respectively. The increase was driven by incremental store growth and its impact on associated operational costs such as labor, credit and debit card fees, rent and other occupancy costs, and $29.8 million (or 66 basis points on a percent to sales basis) of Lowes Foods Transaction incremental costs (as described below). The increase in SG&A expenses (excluding advertising and support department costs) from fiscal 2011 to fiscal 2012 for stores opened during fiscal 2011 and fiscal 2012 accounted for $42.4 million of the $98.2 million increase in total SG&A expenses. Store labor and benefit costs increased from fiscal 2011 to fiscal 2012 by $33.2 million and represented a 6 basis point increase on a percent to sales basis. Increased costs of $12.0 million in advertising and support departments between fiscal 2011 and fiscal 2012 represented a 13 basis point increase on a percent to sales basis.

SG&A expenses for fiscal 2011 increased from fiscal 2010 by $38.8 million as a result of incremental store growth. However, SG&A expenses as a percent to sales decreased 21 basis points from fiscal 2010 to 2011, as a result of the leverage created through sales gains that apply against fixed costs, along with improved labor management and other cost control initiatives. The increase in SG&A expenses (excluding advertising and support department costs) over the previous year for stores opened in fiscal 2010 and fiscal 2011 amounted to $40.2 million, exceeding the $38.8 million increase in total SG&A expenses from fiscal 2010 to fiscal 2011. Even though store labor and associated benefit costs increased between fiscal 2010 and fiscal 2011, as a result of Harris Teeter's new store growth, there was a 29 basis point reduction in these costs as a percent to sales. Advertising and support department costs as a percent to sales also declined between fiscal 2010 and fiscal 2011, representing a 5 basis point reduction.

The Company continues to focus on its cost control programs in an effort to offset increased fringe benefit costs associated with incentive bonus plans and pension expense, as well as increased remodeling expenses resulting from the Company's store remodeling program. Pre-opening costs are included with SG&A expenses and consist of rent, labor and associated fringe benefits, and recruiting and relocation costs incurred prior to a new store opening and amounted to $5.8 million (0.13% of sales)


for fiscal 2012 (excluding stores acquired from Lowes Foods), as compared to $7.0 million (0.16% of sales) for fiscal 2011 and $8.4 million (0.20% of sales) in fiscal 2010. Pre-opening costs fluctuate between reporting periods depending on the new store opening schedule and market location.

The Lowes Foods Transaction incremental costs of $29.8 million consist of $3.9 million in non-cash impairment charges related to the write-off of a portion of the goodwill that related to stores not integrated into the operations. The costs also include an increase in the Company's closed store reserves of $15.5 million, incremental pre-opening costs associated with the stores acquired and other fair market adjustments to fixed assets and intangibles.

Corporate SG&A expenses include a portion of compensation and benefits of holding company employees and certain other costs that have not historically been fully allocated to the Company's operating subsidiaries. Corporate SG&A expenses for fiscal 2012 were offset by $3.1 million of gains recorded in connection with proceeds received on company-owned life insurance policies. Corporate SG&A expenses in fiscal 2010 were reduced by $3.9 million as a result of gains realized in connection with the exchange of the Company's corporate aircraft.

Net interest expense (interest expense less interest income) for fiscal 2012 decreased by $2.6 million from the prior year period. Net interest expense for fiscal 2012 included a reversal of accrued interest amounting to $1.3 million that was associated with a reduction of the Company's unrecognized tax positions and approximately $0.3 million of additional interest income associated with income tax refunds. Net interest expense has also been reduced as a result of lower interest on debt borrowings due to lower average outstanding borrowings.

Net investment gains for fiscal 2011 include a pre-tax gain of $19.5 million the Company realized upon the sale of the Company's foreign investment.

The effective consolidated income tax rate on continuing operations for fiscal 2012 was 35.4% as compared to 38.5% for fiscal 2011 and 37.4% for fiscal 2010. Income tax expense for fiscal 2012 was favorably impacted by the non-taxable gains on insurance proceeds received in the third quarter of fiscal 2012 and income tax expense for fiscal 2011 included additional foreign taxes paid in connection with the gain realized on the sale of the Company's foreign investment.

Continuing Operations

As a result of the items discussed above, earnings from continuing operations after tax were $99.9 million, or $2.04 per diluted share, in fiscal 2012, as compared to $111.5 million, or $2.28 per diluted share, in fiscal 2011 and $98.7 million, or $2.03 per diluted share, in fiscal 2010 (a 53-week year). In fiscal 2012, the Lowes Foods Transaction incremental costs reduced earnings from continuing operations after tax by $18.1 million, or $0.37 per diluted share, the life insurance gains increased earnings from continuing operations after tax by $3.1 million, or $0.06 per diluted share, and the interest expense reversal increased earnings from continuing operations after tax by $0.8 million, or $0.02 per diluted share. The after-tax gain on the sale of the Company's foreign investment company increased fiscal 2011 earnings from continuing operations by $10.3 million, or $0.21 per diluted share.

Discontinued Operations

The following table sets forth the components of discontinued operations for the
52 weeks ended October 2, 2012 (fiscal 2012) and October 2, 2011 (fiscal 2011)
and the 53 weeks ended October 3, 2010 (fiscal 2010), respectively (in
thousands):


                                             Fiscal 2012     Fiscal 2011     Fiscal 2010
  Net Sales                                $      30,313   $     320,876   $     301,097
  Cost of Sales                                   23,205         241,539         228,685
  Gross Profit                                     7,108          79,337          72,412
  SG&A Expenses                                   22,824          52,351          51,297
  Operating Profit (Loss)                        (15,716 )        26,986          21,115
  Interest Expense                                    19             380             421
  Interest Income                                    (17 )          (170 )           (66 )
  Less Net Earnings Attributable to                   37             698           1,067
  Noncontrolling Interest
  Loss on Disposition of Discontinued              3,717          48,750               -
  Operations
  (Loss) Earnings on Discontinued                (19,472 )       (22,672 )        19,693
  Operations
  Income Tax (benefit) Expense                    (2,057 )        (2.461 )         6,304
  (Loss) Earnings From Discontinued        $     (17,415 ) $     (20,211 ) $      13,389
  Operations, Net of Taxes


Income tax expense from discontinued operations for fiscal 2012 includes deferred tax expense of $3.5 million relating to a valuation allowance for additional capital losses recognized in connection with the sale of A&E.

Outlook

The Company's operating performance and strong financial position provide the flexibility to continue with its store development program for new and replacement stores along with the remodeling and expansion of existing stores. During fiscal 2013, the Company plans to open twelve new stores (which includes two replacements and the two store locations acquired from Lowes Foods that were converted to our 201central format) and complete major remodels on nine stores (three of which will be expanded in size). The fiscal 2013 new store openings are currently scheduled for three in the first quarter, two in the third quarter and seven in the fourth quarter. The 2013 store development program is expected to result in a 5.4% increase in retail square footage as compared to a 4.5% increase realized in fiscal 2012. The Company routinely evaluates its existing store operations in regards to its overall business strategy and from time to time will close or divest older or underperforming stores.

The new store program anticipates the continued expansion of Harris Teeter's existing markets, including the Washington, D.C. metro market area which incorporates northern Virginia, the District of Columbia, southern Maryland and coastal Delaware. Real estate development by its nature is both unpredictable and subject to external factors including weather, construction schedules and costs. Any change in the amount and timing of new store development can impact the expected capital expenditures, sales and operating results.

Startup costs associated with opening new stores can negatively impact operating margins and net income. In the current competitive environment, promotional costs to maintain market share could also negatively impact operating margins and net income in future periods. The continued execution of productivity initiatives implemented throughout all stores, maintaining controls over waste, implementation of operating efficiencies and effective merchandising strategies will dictate the pace at which the Company's operating results could improve, if at all.

The Company's management remains cautious in its expectations for fiscal 2013 due to the current economic environment and its impact on the Company's customers. The Company will continue to refine its merchandising strategies to respond to the changing shopping demands. The retail grocery market remains intensely competitive, including the possibility of new competitors coming into the Company's existing markets. Any operating improvement will be dependent on the Company's ability to increase market share, control costs and to effectively execute the Company's strategic expansion plans.

Capital Resources and Liquidity

The Company's principal source of liquidity has been cash generated from operating activities of Harris Teeter and borrowings available under the Company's credit facility. During fiscal 2012, the net cash provided by operating activities was $207.3 million, compared to $272.2 million in fiscal 2011 and $243.7 million in fiscal 2010. The decrease from fiscal 2011 to fiscal 2012 was driven by lower earnings and the timing of accruals and related payments associated with normal operations. Investing activities in fiscal 2012 required net cash of $45.1 million and included among other items approximately $170 million in cash proceeds from the sale of A&E and $26.3 million of cash paid for the Lowes Foods Transaction. Fiscal 2011 investing activities were $109.0 million and included Harris Teeter's sale of its ownership position in five investment properties along with one owned property which generated $22.6 million of cash and the Company's sale of a foreign investment which generated $21.6 million of cash. Historically, capital spending has been financed by cash provided by operating activities and supplemented with borrowings under the Company's credit facility. Financing activities in fiscal 2012 utilized $114.5 million of cash and included $80.0 million for the repayment of the term loan under the Company's prior credit facility. Financing activity also included $27.1 million for the payment of dividends in fiscal 2012, compared to $25.6 million in fiscal 2011 and $29.3 million in fiscal 2010 (consisting of five quarterly payments).

Fiscal 2012 capital expenditures totaled $199.9 million, as compared to $148.0 million in fiscal 2011 and $128.2 million in fiscal 2010. Fiscal 2010 capital expenditures included $21.5 million for the exchange of the corporate aircraft, which was partially offset by $14.4 million of proceeds from the sale of the old aircraft. Capital expenditures for fiscal 2013 are expected to total approximately $235 million. The Company anticipates that its capital investment for new store growth and store remodels will be concentrated in its existing markets for fiscal 2013, as well as in the foreseeable future. The Company has sufficient resources through internally generated funds, proceeds from the sale of A&E and borrowings available under the Company's credit facility to complete the planned capital investment. Management believes that the Company's revolving line of credit provides sufficient liquidity for what management expects the Company will require through the expiration of the line of credit in January 30, 2017.

On January 30, 2012, the Company amended and restated its then-existing credit agreement that provided financing under a $100.0 million term loan and a $350.0 million revolving line of credit. The prior credit agreement was due to expire in


December of 2012 and the Company had previously repaid $20.0 million of the term loan prior to the closing of the amended credit facility. The amended credit facility contains a revolving line of credit that provides for financing up to $350.0 million through its termination date on January 30, 2017. In connection with the closing of the amended credit agreement, the Company repaid the remaining $80.0 million term loan under the prior credit facility utilizing $40.0 million of cash and $40.0 million of borrowings under the new revolver. The amended credit agreement provides for an optional increase of the revolving credit facility by an additional amount of up to $100.0 million (if the existing or new lenders agree to assume the additional commitments) and two one-year maturity extension options, both of which require consent of certain of the lenders. Outstanding borrowings under the amended credit agreement bear interest at a variable rate, at the Company's option at: (a) an alternate base rate, . . .
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