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RNDY > SEC Filings for RNDY > Form 10-K on 22-Mar-2013All Recent SEC Filings

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Form 10-K for ROUNDY'S, INC.


22-Mar-2013

Annual Report


ITEM 7-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with the information included in Item 6-Selected Financial Data and our consolidated financial statements and the notes to those statements included in Item 8-Financial Statements and Supplementary Data of this Annual Report on Form 10-K. The statements in this discussion regarding our expectations of future performance, liquidity and capital resources and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under Item 1A-Risk Factors and "Forward-Looking Statements." Our actual results may differ materially from those contained in or implied by any forward-looking statements.

Overview

We are a leading Midwest supermarket chain with a 141-year operating history. We have achieved leading market positions in our core markets and are the largest grocery retailer in the state of Wisconsin by net sales for fiscal 2011, based on comparative data that we obtained from Metro Market Studies, Grocery Distribution Analysis and Guide, 2012. As of December 29, 2012, we operated 161 grocery stores in Wisconsin, Minnesota and Illinois under the Pick 'n Save, Rainbow, Copps, Metro Market and Mariano's retail banners, which are served by our three strategically located distribution centers and our food processing and preparation commissary.

Our net sales have remained relatively stable over our last three completed fiscal years, despite economic challenges. During this period, we have pursued pricing and merchandising improvement initiatives, as well as our Chicago expansion strategy. We also completed our exit from third party wholesale distribution, begun in 2002, with wholesale distribution sales decreasing from $63 million in fiscal 2008 to $15 million in fiscal 2012. As of December 29, 2012, we continue to serve as the primary wholesaler for one independent Pick 'n Save retail store. In recent periods, our net sales have increased as compared to prior comparable periods due primarily to sales generated from stores opened or replaced during fiscal 2011 and 2012.

Since fiscal 2009, we have been able to maintain attractive and consistent operating margins and cash flows generated as a result of our value positioning, efficient operating structure and distinctive merchandising strategies, especially those involving own-brand and perishable goods. In addition, we implemented several cost reduction measures during this period to help support our operating margins and cash flow, including initiatives to reduce shrink and improve labor productivity throughout our operations. These initiatives, together with our efficient cost structure, have enabled us to continue to make targeted investments to lower our everyday retail prices in an effort to improve our competitive position within our markets.

Going forward, we plan to continue to maintain our market leadership and focus on growing same-store sales, opening new stores and increasing our cash flow. We intend to pursue same-store sales growth by continuing to focus on price competitiveness, improving our marketing efforts, selectively remodeling and relocating existing stores and enhancing and expanding our own-brand, perishable and prepared food offerings. In addition, we intend to continue our expansion into the Chicago market with plans to open four to five stores per year in the Chicago market over the next five years. As of December 29, 2012, we had eight stores open in the Chicago market. Given its favorable competitive dynamics and attractive demographics, including a large population and above average household income, we believe the Chicago market provides us with a compelling expansion opportunity. We also plan to continue to support our operating margins and cash flow generation by implementing cost reduction measures, including initiatives to reduce shrink and improve labor productivity throughout our operations and by focusing on higher margin products.


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Factors Affecting Our Operating Results

Various factors affect our operating results during each period, including:

General Economic Conditions and Changes in Consumer Behavior

The overall economic environment and related changes in consumer behavior have a significant impact on our business. In general, positive conditions in the broader economy promote customer spending in our stores, while economic weakness results in a reduction of customer spending. Macroeconomic factors that can affect customer spending patterns, and thereby our results of operations, include employment rates, business conditions, changes in the housing market, the availability of credit, interest rates, tax rates and fuel and energy costs.

We believe that the impact of the current economic slowdown on our recent operating results has at least been partially mitigated by increased consumer preferences for meals at home. The recent economic environment has also led consumers to become more price sensitive and, as a result, consumers are increasingly purchasing own-brand products that offer a better value than national brands. Because own-brand items have a lower price point than national brands, as our own-brand sales mix increases, our overall net sales are reduced but our gross profit and gross margin improve.

Our core markets also feature relatively stable local economies with diversified employer bases and stable to modestly growing populations. Although our markets have been impacted by the economic downturn, unemployment rates in Wisconsin and Minneapolis are lower than the national average.

Inflation and Deflation Trends

Inflation and deflation can impact our financial performance. During inflationary periods, our financial results can be positively impacted in the short term as we sell lower-priced inventory in a higher price environment if we are able to successfully pass those higher prices on to our customers. Over the longer term, the impact of inflation is largely dependent on our ability to pass through inventory price increases to our customers, which is subject to competitive market conditions. In recent inflationary periods, we have generally been able to pass through most cost increases. For example, our operating results in fiscal 2008 were positively impacted by the inflationary environment, largely driven by higher commodity prices. Conversely, during deflationary periods our operating results are generally adversely affected. In fiscal 2009, for example, the food retail sector began experiencing deflation, as input costs declined and price competition among retailers intensified, pressuring sales across the industry. In fiscal 2010, food deflation moderated and, beginning in early fiscal 2011, we began to experience inflation in some commodity driven categories, which has had a slight negative impact on our gross margins as price competition has partially limited our ability to immediately pass through higher prices on certain products. In fiscal 2012, we again experienced deflationary trends, some of which were related to pricing and promotional activity, in several key product categories that negatively affected our same-store sales and margins.

Cost Management Initiatives

Our recent operating results reflect the impact of our ongoing initiatives to lower our operating costs to support our margins. For example, we have improved our labor productivity over the last several years through various initiatives. In particular, we have reduced unproductive labor hours through implementation of lean initiatives, including a focus on improving organizational efficiency, work processes and store layouts. We have also refined our labor standards and have also centralized certain perishable and prepared foods production in our commissary operation.

We have also undertaken a number of initiatives to improve our supply chain costs. For example, we have outsourced our inbound transportation to a third party transportation services organization. We have also reduced our mileage for outbound loads through a lean initiative that improved our cube sizing and allowed maximum space utilization of our fleet. In our warehouse operation, we have reduced our warehouse labor costs by refining our labor standards. We have also improved our product procurement costs with a third party driven initiative to


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develop a collaborative process with suppliers to take excess costs out of the supply chain through vendor consolidation, SKU rationalization, direct sourcing and reverse engineering of product costs.

Targeted Investments in Everyday Low Prices

Our recent operating results have been impacted by our price cutback initiative that we began to implement in fiscal 2007 in order to improve our pricing compared to conventional supermarket and supercenter competitors. Through this initiative we have lowered our everyday prices on approximately 5,500 to 6,000 key value items in highly competitive and price sensitive markets. A substantial portion of our existing store network has absorbed the impact of the price cutback initiative, and we expect to expand it to other stores depending on local competitive conditions. In addition, we recently adjusted our pricing in certain markets for select key product categories to better compete against supercenter pricing. In those markets and categories, we are going to market with a lower everyday price and fewer deep promotional offers. This is more efficient and ultimately helps our overall price image.

Store Openings and Store Closings

Our operating results in any particular period are impacted by the timing of new store openings and store closings. For example, we typically incur higher than normal employee costs at the time of a new store opening associated with set-up and other opening costs. During the first several weeks following a new store opening, operating margins are also affected by promotional discounts and other marketing costs and strategies associated with new store openings, as well as higher shrink and costs related to hiring and training new employees. A new store in our core markets can take a year or more to achieve a level of operating profitability comparable to our company-wide average for existing stores, with a somewhat longer time horizon anticipated with respect to our new Chicago stores.

In addition, many of our new store openings in existing markets have had a near term negative impact on our same-store sales as a result of cannibalization from existing stores in close proximity. Over the longer term, we believe that any such cannibalization will be more than offset by future net sales growth and expanded market share. When we close underperforming stores, we expense the present value of any remaining future lease liabilities, net of expected sublease income, which negatively impacts our operating results during the period of the closure.

We also look for opportunities to relocate existing stores to improve location, lease terms or store layout. Relocated stores typically achieve a level of operating profitability comparable to our company-wide average for existing stores more quickly than new stores.

Changes in our store base during the periods presented are summarized below:

                                                    Fiscal Year Ended
                                      1/1/2011        12/31/2011        12/29/2012
      Stores at beginning of period         154               155               158
      New stores opened                       1                 3                 4
      Relocated stores opened                 5                 4                 2
      Stores closed but relocated            (5 )              (4 )              (3 )

      Stores at end of period               155               158               161

Expanded Own-brand Offering

Delivering high quality own-brand products is a key component of our pricing and merchandising strategy, as we believe it builds and deepens customer loyalty, enhances our value proposition, generates higher gross margins relative to national brands and improves the breadth and selection of our product offering. A strong own-brand offering has become an increasingly important competitive advantage in the retail food industry, given consumers' growing focus on value and greater willingness to purchase own-brand products over national brands.


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Our portfolio of own-brand items has increased from approximately 1,600 items at the end of fiscal 2005 to approximately 5,700 as of December 29, 2012, with the percentage of sales from own-brand items increasing from 8.4% to 21.2% during this same period. Because own-brand items have a lower price point than national brands, as our own-brand sales mix increases, our overall net sales are reduced but our gross profit and gross margin improve.

Developments in Competitive Landscape

The U.S. food retail industry is highly competitive. Our competitors include national, regional and local conventional supermarkets, national and regional supercenters, membership warehouse clubs, and alternative food retailers, such as natural foods stores, smaller specialty stores and farmers' markets. In any particular financial period, our results of operations may be impacted by changes to the competitive landscape in one or more of our markets, including as a result of existing competitors expanding their presence or new competitors entering our markets. For example, in recent years we have faced increased competition from the continued expansion of supercenters, such as Wal-Mart throughout our Wisconsin markets and SuperTarget in the Minneapolis/St. Paul area. In certain cases, the impact of these competitive supercenter openings has caused our net sales to decline in the near term. However, the longer term impact of supercenter openings on our overall net sales and market share is more difficult to predict and is dependent on a number of factors in a particular market, including strength of competition, the competitive response by us and other food retailers, and consumer shopping preferences. In some cases, smaller regional and independent grocers are displaced by supercenter openings, creating an opportunity for us to gain market share.

Our competitors will often implement significant promotional activities in an effort to gain market share, in particular in connection with new store openings. In order to remain competitive and maintain our market share, we sometimes elect to implement competing promotional activities, which may result in near term pressure on our operating margins unless we are able to implement corresponding cost saving initiatives. Changes in the competitive landscape in our markets may also impact our level of capital expenditures in the event we decide to remodel or relocate an existing store to improve our competitive position.

Interest Expense and Loss on Debt Extinguishment

Our interest expense in any particular period is impacted by our overall level of indebtedness during that period and changes in the interest rates payable on such indebtedness. In April 2010, we borrowed $150 million under a second lien credit facility in order to pay a $150 million dividend to our shareholders, and entered into an additional amendment to a first lien credit facility that modified our interest rate structure. In February 2012, we used all of the net proceeds that we received from our initial public offering ("IPO"), together with our indebtedness from our new senior credit facility, to repay all of our outstanding borrowings and other amounts owed under our old credit facilities. In connection with such repayment, we recorded a charge of approximately $8.0 million, net of tax, to write off all of our unamortized deferred financing costs and the unamortized original issue discount as well as prepayment penalties associated with such indebtedness and to reflect the related prepayment premiums. Going forward, our interest expense will include the amortization of the financing costs associated with our new debt financing arrangements.

Stock Compensation

In connection with the completion of our IPO, we granted an aggregate of 819,286 shares of restricted stock to certain of our directors, executive officers and non-executive officers. During fiscal 2012, we cancelled 62,348 shares of restricted stock that were granted to executives that are no longer with the Company, and granted an additional 73,110 shares to new directors and executive officers. The restricted stock for executive officers and non-executive officers associated with these grants will vest over five years and the restricted stock for our directors will vest over one year. We recorded total stock-based compensation expense of $0.8 million, net of tax, in fiscal 2012. We estimate that we will record compensation expense associated with these grants of


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approximately $0.8 million for fiscal 2013 through fiscal 2016, and approximately $0.1 million for fiscal 2017, in each case net of tax, and based on the initial public offering price of $8.50 per share for those shares granted in connection with the IPO or the share price on the day of each grant that occurred subsequent to the IPO.-

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of performance and financial measures. These key measures include net sales and same-store sales, gross profit, operating and administrative expenses and Adjusted EBITDA.

Net Sales and Same-Store Sales

We evaluate net sales because it helps us measure the impact of economic trends and inflation or deflation, the effectiveness of our marketing, promotional and merchandising activities, the impact of new store openings and store closings, and the effect of competition over a given period. Net sales represent product sales less returns and allowances and sales promotions. We derive our net sales primarily from the operation of retail grocery stores and to a much lesser extent from the independent distribution of food and non-food products to an independently-owned store. We recognize retail sales at the point of sale. We do not record sales taxes as a component of retail revenues as we consider ourselves a pass-through conduit for collecting and remitting sales taxes.

We also consider same-store sales to be a key indicator in evaluating our performance. Same-store sales controls for the effects of new store openings, making it a useful measure for period-to-period comparisons. Our practice is to include sales from a store in same-store sales beginning 53 weeks following the store's opening. When a store that is included in same-store sales is remodeled or relocated, we continue to include sales from that store in same-store sales. This practice may differ from the methods that our competitors use to calculate same-store or "comparable" sales. As a result, data in this Annual Report on Form 10-K regarding our same-store sales may not be comparable to similar data made available by our competitors.

Various factors may affect our net sales and same-store sales, including:

overall economic trends and conditions;

consumer preferences and buying trends;

our competition, including competitor store openings or closings near our stores;

the pricing of our products, including the effects of inflation or deflation;

the number of customer transactions in our stores;

our ability to provide product offerings that generate new and repeat visits to our stores;

the level of customer service that we provide in our stores;

our in-store merchandising-related activities;

our ability to source products efficiently; and

the number of stores we open, remodel or relocate in any period.

Gross Profit

We use gross profit to measure the effectiveness of our pricing and procurement strategies as well as initiatives to increase sales of higher margin items and to reduce shrink. We calculate gross profit as net sales less cost of sales. Cost of sales includes product costs, inbound freight, warehousing costs, receiving and inspection costs, distribution costs, and depreciation and amortization expenses associated with our supply chain operations. The


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components of our cost of sales may not be identical to those of our competitors. As a result, data in this Annual Report on Form 10-K regarding our gross profit may not be comparable to similar data made available by our competitors.

Our cost of sales is directly correlated with our overall level of sales. Gross profit as a percentage of net sales is affected by:

relative mix of products sold;

shrink resulting from product waste, damage, theft or obsolescence;

promotional activity; and

inflationary and deflationary trends.

Operating and Administrative Expenses

We evaluate our operating and administrative expenses in order to identify areas where we can create savings, such as labor process improvements. Operating and administrative expenses consist primarily of personnel costs, sales and marketing expenses, depreciation and amortization expenses as well as other expenses associated with facilities unrelated to our supply chain network, internal management expenses and expenses for accounting, information systems, legal, business development, human resources, purchasing and other administrative departments.

Store-level labor costs are generally the largest component of our operating and administrative expenses. Store-level expenses, including labor, rent, utilities and maintenance, generally decrease as a percentage of net sales as our net sales increase. Accordingly, higher sales volumes allow us to leverage our store-level fixed costs to improve our operating margin.

The components of our operating and administrative expenses may not be identical to those of our competitors. As a result, data in this Annual Report on Form 10-K regarding our operating and administrative expenses may not be comparable to similar data made available by our competitors. Our operating and administrative expenses have increased due to additional legal, accounting, insurance and other expenses incurred as a result of being a public company.

Adjusted EBITDA

We believe that Adjusted EBITDA is a useful performance measure and we use it to facilitate a comparison of our operating performance on a consistent basis from period-to-period and to provide for a more complete understanding of factors and trends affecting our business. We also use Adjusted EBITDA as one of the primary methods for planning and forecasting overall expected performance and for evaluating on a quarterly and annual basis actual results against such expectations, and as a performance evaluation metric in determining achievement of certain compensation programs and plans for employees, including our senior executives.

We define Adjusted EBITDA as earnings before interest expense, interest expense associated with preferred stock, provision for income taxes, depreciation and amortization, LIFO charges, amortization of deferred financing costs, non-cash compensation expenses arising from the issuance of stock, costs incurred in connection with our IPO (or subsequent offerings of Roundy's common stock), loss on debt extinguishment, certain non-recurring or unusual employee and pension related costs and goodwill impairment charges. All of the omitted items are either (i) non-cash items or (ii) items that we do not consider in assessing our on-going operating performance. Because it omits non-cash items, we believe that Adjusted EBITDA is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges and more reflective of other factors that affect our operating performance. Because it omits the other items, we believe Adjusted EBITDA is also more reflective of our on-going operating performance.


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We determine the amount of the LIFO charges that we exclude in calculating Adjusted EBITDA by determining the base year values of beginning and ending inventories that we account for on a LIFO basis using cumulative price indexes as published by the Bureau of Labor Statistics and subtracting the current year difference between inventories calculated on a LIFO basis and the current cost of inventories valued on a FIFO basis.

Basis of Presentation

Our fiscal year is the 52 or 53 week period ending on the Saturday nearest to December 31. For the last three completed calendar years, our fiscal year ended on January 1, 2011, December 31, 2011 and December 29, 2012. For ease of reference, we identify our fiscal years in this Annual Report on Form 10-K by reference to the calendar year ending nearest to such date. For example, "fiscal 2012" refers to our fiscal year ended December 29, 2012. Our fiscal years include 12 reporting periods, with an additional week in the eleventh reporting period for 53 week fiscal years. All fiscal years presented included 52 weeks.

Results of Operations

Our results of operations in any particular period are affected by the number of stores we have in operation during that period. The following table summarizes our store network as of the end of each of our last three fiscal years.

                                                  Fiscal Year Ended
                                      1/1/2011       12/31/2011       12/29/2012
        Pick 'n Save                         94               93               93
        Rainbow                              32               32               32
        Copps                                26               26               25
        Metro Market                          2                3                3
        Mariano's                             1                4                8

        Total Company-owned stores          155              158              161

        Number of same-stores               154              155              156

The following table sets forth various components of our consolidated statements of income for fiscal 2010, 2011 and 2012 from the audited consolidated financial statements included in Item 8-Financial Statements and Supplementary Data in this Annual Report on Form 10-K, expressed both in dollars and as a percentage of net sales for the period indicated.

                                                                    Fiscal Year
                                          2010                         2011                          2012
Net Sales                        $ 3,766,988       100.0 %    $ 3,841,984       100.0 %    $ 3,890,537        100.0 %

Costs and Expenses:
Cost of sales                      2,748,919        73.0        2,804,709        73.0        2,855,385         73.4
Operating and administrative         868,972        23.1          886,862        23.1          908,300         23.3
Goodwill impairment charge                 -           -                -           -          120,800          3.1
Interest expense, current and
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