A&P posts wider quarterly loss; anticipates being net debt free with Canada sale proceeds

By Paul Deckelman

New York, July 22 - The Great Atlantic & Pacific Tea Co. Inc. on Friday posted a wider loss for the fiscal first quarter than it reported a year ago - but executives of the venerable Montvale, N.J.-based supermarket operator known to millions as simply "A&P" attributed the wider loss to special charges connected with the company's ongoing strategic restructuring and pronounced themselves pleased with its operational performance, which showed improvements in both the U.S. and the Canadian divisions. They also continued to bask in the warm afterglow of the company's announcement earlier in the week that it would sell that valuable Canadian subsidiary for close to a billion-and-a-half dollars, and will use at least some of those proceeds to seriously de-leverage the company.

A&P's chairman and chief executive officer, Christian W.E. Haub, said that the improved performance was a continuation of a trend that had been seen over the past two years.

"Both our U.S. and Canadian operations made significant progress and, as a company, we achieved our highest quarterly EBITDA in three years," he declared.

Loss widens - but EBITDA improves

For the 2005 fiscal first-quarter ended June 16, the company showed a loss of $89.2 million ($2.28 per share), more than double the year-earlier red ink of $42.8 million ($1.11 per share). On a continuing operations basis, the loss in the latest quarter was $89 million ($2.27 per share), versus a loss of $41 million ($1.08 per share) in last year's first quarter.

However, Haub and chief financial officer Mitchell P. Goldstein pointed out that the latest-quarter results include charges totaling $68 million, including $50 million in restructuring costs, primarily related to the sale of the company's U.S. distribution operations to C&S Wholesale Grocers Inc., $15 million related to exist costs in the Midwest, where it has closed some of its Farmer Jack stores and is trying to sell the remainder of the unit, and $3 million related to a Canadian dollar hedge. Last year's results included a $1 million restructuring charge.

Excluding these items, EBITDA in the latest quarter was $101 million, up from $81 million for the same period of fiscal 2004. Adjusted EBITDA - leaving out the effects of an accounting change - was $97 million, a 33% gain over the comparable year-earlier total of $73 million, the fourth consecutive quarter in which earnings, measured by EBITDA, improved year-over-year.

"Our U.S. business turnaround progressed in the first quarter," Haub said, "with a solid sales trend and improved EBITDA driven mainly by lower SG&A [sales, general and administrative expenses]."

Haub said that A&P's efforts to lower its overhead costs and improve productivity "more than offset" the decline in gross margin arising from the money the company spent continuing to roll out its "Fresh Market," concept, which A&P envisions as a re-invention of the supermarket shopping experience.

At the same time, "the already strong performance of A&P Canada improved further in the first quarter," Haub said. Noting that the first-quarter results would most likely be the last time that full A&P Canada results would be reported as part of the parent's total, "they are certainly going out with a bang," he exclaimed.

On Tuesday, A&P announced that it would sell the Canadian unit to Metro Inc., Canada's third-biggest grocer, for $1.475 billion. The deal involves the transfer to the Montreal-based company of 236 A&P, Dominion and Food Basics stores in Ontario, Canada's most populous province. A&P will receive $982 million of the purchase price in cash and $409 million in stock and certain debt to be assumed by the buyer, with A&P getting 8.1 million shares, equivalent to a 16% stake in the Canadian company. A&P will also appoint two directors to the Metro board.

A&P relying on new "Fresh Market" concept

A&P plans to use some of the proceeds to refurbish and renovate many of its stores as it switches them over to the "Fresh Market" format, which the company introduced last fall in suburban Mt. Kisco, N.Y., and touts as its key strategy for regaining market share.

A&P - founded in 1859 and which, at its peak in the 1930s at one point had almost 16,000 stores coast-to-coast, making it the largest supermarket operator of its time - has in recent years lost market share to other national supermarket chains such as Safeway Inc., Albertson's Inc., The Kroger Co., as well as regional operators like Northeastern powerhouse Stop & Shop, a unit of the Dutch supermarket giant Koninklijke Ahold NV.

It has drastically scaled back its operations and now has 637 stores in 10 U.S. states, the District of Columbia and Canada. Pro forma for the sale of the Canadian operations, it will have about 400 stores, most of them in the Northeastern U.S. When the company completes its divestiture of the remaining Farmer Jack outlets in Ohio and Michigan, it is expected to have about 325 stores, according to published reports, stretching between Hartford, Conn., and Washington, D.C., with a heavy concentration of A&P, Waldbaum's and Food Emporium stores in the New York metropolitan area and Super Fresh outlets in the Middle-Atlantic states.

Since introducing its "Fresh Market" idea last year as the wave of the company's future - the heavily renovated stores feature fresh and organic foods, and expanded customer service departments, as well as other amenities such as, in some cases, a Starbucks coffee kiosk within a store, expanded offerings of complete meals, and dining tables - A&P has converted 42 stores to "Fresh Markets" so far, all of them flagship A&P-branded outlets in New York or New Jersey, including 19 during the just-ended quarter.

On the conference call, Haub - asked by an analyst whether A&P will now speed up the pace of store conversions - replied "we have quite a bit more planning to do, now that we've had a change of circumstances from the [fiscal] fourth quarter," which ended in mid-March, when the original conversion schedule was drawn up.

Haub also said that with sales at the converted stores having risen in the mid-single-digit percentage range for smaller conversions, where only a section of the store was renovated, but having shot up "in the high teens" percentage-wise for the larger conversions where the whole store gets a makeover, A&P now intends to go solely to the full-scale conversions, even though they will cost more - upwards of $1.5 million apiece.

Buyback of near-term bonds expected

Much of the rest of the money will go to cleaning up the company's balance sheet, which showed $171 million of cash and short-term investments as of June 18, as well as $689 million of debt and capital leases, including approximately $199 million of 7¾% notes due 2007 and $217 million of 9 1/8% notes due 2011. Counting total long-term real estate liabilities and deducting the value of $74 million of temporary investments, A&P had net debt of $945 million, up a bit from the $921 million it had as of Feb. 26, the end of the previous quarter, due to the performance of the business and normal seasonal factors, according to Goldstein. Including $129 million in letters of credit supported through the company's revolving credit agreement, A&P closed the quarter with $1.074 billion of funded net debt, and had $204 million of remaining revolver availability, the CFO said. That $204 million, plus the $74 million of short-term investments gives the company total availability of $278 million.

With $945 million of net debt and ongoing operating EBITDA, adjusted for non-operating matters, of $281 million, the company had a leverage ratio of debt to last 12-month trailing EBITDA of 3.4 times as of the quarter end, "down significantly" from 4.2 times a year earlier, Goldstein said.

With the announced agreement to sell the Canadian operations to Metro, "we'll have 'negative net debt', with almost $1 billion of cash on hand," Goldstein declared. A&P said in its quarterly 10-Q filing Friday with the Securities and Exchange Commission that planned use of the proceeds from the Canadian sale includes open market purchases and/or a tender for the 2007 notes - which under the terms of its credit revolver must be refinanced six months prior to their maturity this coming April - as well as the purchase, either via a tender offer or on the open market, of the 2011 notes.

"Even with the repurchase of our close-in notes, our investable cash will be well over $500 million," Goldstein projected.

CEO sees return to "sustainable profitability"

"We are very enthusiastic about where A&P is now," Goldstein concluded. "We have fixed the balance sheet. We have a strong management team in place," with the elevation of Eric Claus, heretofore the president of A&P Canada, to president and chief executive officer of the overall company; Haub relinquishes the CEO post to become executive chairman, and current president Brian C. Piwek, who is also chief operating officer, will retire. "And we are beginning to get traction in turning the U.S. business around."

Haub said that he was "quite confident" that the actions the company has already taken - the beginning of the "Fresh Market" conversions, the sale of the Canadian unit, the closure of some non-core Midwestern stores and the divestment of the distribution operation to C&S - as well as the steps the company is planning, including the rollout of more "Fresh Market" stores after full-scale conversions, the ultimate sale of the remaining core Farmer Jack operations in Ohio and Michigan, further measures to reduce overhead and the expected debt paydown, "will add over $75 million in additional EBITDA to the new A&P over time."

He said the company should be able to achieve its target of "sustainable profitability" in the latter part of fiscal 2006.

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