A&P posts Q3 loss, claims turnaround progress; touts impact of debt restructuring

By Paul Deckelman

New York, Jan. 6 - The Great Atlantic & Pacific Tea Co. Inc. is still running in the red - but company executives on Friday pronounced themselves pleased with the progress that the venerable Montvale, N.J.-based parent of A&P and other supermarket chains is making in re-inventing itself, with an eye towards a return to profitability next year.

One of the factors they said would help the company improve its financial position is its "strong balance sheet," which was enhanced by A&P's recent debt refinancing, as well as the company's sale last year of its profitable A&P Canada unit, with proceeds used to largely eliminate its bond obligations.

"Our revitalization is off to the best possible start," the company's chairman, Christian W.E. Haub, declared on a conference call with analysts following the release of the results for the 2005 fiscal third quarter ended Dec. 3. "I am delighted by our improvement so far - but not surprised by it."

Haub said that the company - which operates 427 stores, primarily across the Northeastern United States from Connecticut to Washington, D.C., as well as in Michigan, Louisiana and Mississippi, was making "good progress" in the quarter on its various initiatives, including trying to cut costs internally by "auctioning" contracts to fulfill its product needs in many items among several major manufacturers in each product instead of going through food brokers and other middlemen, closing underperforming stores and reducing headcount, and renovating existing stores and converting those operating under the A&P banner to the company's "Fresh Market" concept, which A&P envisions as a wave-of-the-future re-invention of the supermarket shopping experience. 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.

However, the company's recently appointed president and chief executive officer, Eric Claus - the former head of A&P's very successful Canadian unit before its sale last year- said that A&P was tweaking the concept, borrowing some of the features that worked in his Canadian stores and otherwise modifying "Fresh Market" to make the idea work better, for instance taking into account that most "Fresh Market" outlets will be existing stores that are renovated rather than stores built from scratch, as the initial "Fresh Market" prototype store in Mount Kisco, N.Y. was.

But Claus also declared that there was more to the turnaround than merely throwing renovation dollars - averaging between $2.5 million and $4.5 million per store - at the problem.

"If you don't have the right merchandising program, you can have the best architects and store designers and they'll give you the most beautiful store in the world - but if you don't know how to merchandise and operate it, you'll never get the returns [on capital spent].

Shaking high price image

He said that A&P's various stores - including the eponymous parent chain, Waldbaum's, Super Fresh, Sav-a-Center and Food Basics - would move to aggressively promote themselves, and to try to shake the high-priced image the stores have, which hurts them when they are in competition with such larger, lower-price operators as Wal-Mart Stores' Super Centers and such national chains as Albertson's Inc. and The Kroger Co., as well as rival Northeastern regional operators as Stop & Shop, a unit of the Dutch supermarket giant Koninklijke Ahold NV, and Pathmark Stores Corp.

In some cases, though, Claus said, the stores would cut back on ridiculously extravagant and costly promotional giveaways that temporarily attract buyers but that "we don't get any credit for" in terms of building real shopper loyalty, citing as an example a holiday-season promotion a year or two ago in which shoppers accumulating a certain amount of sales would get as much as 60% off a subsequent order; "You'd get people coming in and doing a grocery order for $64 and paying $3."

Claus added "we're very aggressive" at offering bargains, "but we're not being aggressive stupid. Any fool can take a 5-liter bottle of Tide [laundry detergent] and sell it for $1.50 under cost and give everything away."

Sees possible consolidation

Haub, noting recent trends in the supermarket industry, said that "the possible consolidation of our industry in the U.S. remains an issue," even despite Albertson's decision late last year to not attempt to sell itself whole to a buyout group making what the Boise, Ida.-based national grocery store chain operator considered to be an inadequate offer.

"We continue to believe that there will be situations in our core markets that present opportunities in the months and the years to come," the chairman said. "Should an opportunity materialize that our executive management and our board consider being in the best strategic interest for the future of A&P, we will pursue it."

He said that "our strong balance sheet clearly provides us the opportunity to grow by participating in the industry's restructuring and ultimate consolidation."

Net debt down to $146 million

A&P took a pair of major steps last year to strengthen its balance sheet. Around mid-year, it announced that it was selling its lucrative Canadian operations to Metro Inc., Canada's third-biggest grocer, for $1.475 billion in cash and stock. A&P used part of the approximately $982 million cash portion of the proceeds to redeem almost all of its then-outstanding $199 million of 7¾% notes due 2007 and $217 million of 9 1/8% notes due 2011.

According to data provided by the company in conjunction with its conference call presentation, as of the end of the fiscal third quarter on Dec. 3, A&P had just $32 million of the 73/4s still outstanding and only $13 million of the 9 1/8s, following the successful tender offer last year that took out most of each issue.

The company's total debt and other obligations stood at $559 million, including those remaining portions of the two series of bonds, $200 million of 9 3/8% preferred securities due 2039, $35 million of capital leases, $277 million real estate liabilities and $2 million of other assorted obligations.

The company reported $413 million in short-term investments, marketable securities and restricted cash, the latter amounting to $147 million. Net debt - the total of debt and lease obligations less the short term investments, securities and cash, stood at $146 million at the end of the quarter. Excluding the $147 million of restricted cash from consideration, net debt was $292 million.

Although this represented a $117 million increase in net debt over where it had stood at the end of the previous quarter in early September, $29 million, it was still far below the $945 million of net debt that the company was carrying at the end of the fiscal first quarter in June.

Chief financial officer Brenda Galgano told the conference call that the increase in net debt over the quarter was due to $13 million of negative operating cash flow, $23 million of cash related to non-recurring transactions, including a $13 million cash payment related to the Canadian transaction, and a working capital increase of some $80 million, which she said was "mostly temporary," primarily due to the transfer of the company's distribution network last year to C&S Wholesale Grocers Inc. and the transition involved, as well as a buildup of inventories for the just-ended holiday sales period.

Galgano said that the company's net investment position - its short-term investments, marketable securities and restricted cash, plus the $492 million value of its 15.9% stake in Metro Inc., derived from the A&P Canada sale, stood at $759 million, valued at $18.50 per diluted A&P common share.

Besides the use of the Canadian unit's sale proceeds to take out most of its bond debt, the other major balance sheet development last year was the restructuring of its credit facilities.

In mid-October, the company terminated its previous $335 million revolving credit facility, and obtained a new one-year $200 million cash collateralized letter-of-credit facility via Bank of America NA. It followed that up a month later with a new $150 million five-year revolving credit facility via a banking syndicate led by B of A and including JPMorgan Chase Bank NA and Wachovia Bank NA. The variable interest rate on the new facility is Libor plus 100 basis points if average daily usage is 33.33% or less, Libor plus 125 basis points if usage is above 33.33% but less than 66.68% and Libor plus 150 basis points for usage of 66.68% or more.

Galgano said that the new credit facilities are "significantly less costly than the prior arrangement.

The CFO added that while the new letters-of-credit agreement entered into in October is cash collateralized, with the related cash classified as restricted cash on the balance sheet, A&P has the option to instead issue those letters of credit under the new revolver, "although at a slightly higher cost," thus affording "additional liquidity and operational flexibility."

The company recorded $3 million in costs connected to the early extinguishment of debt and the write-off of deferred financing fees during the quarter, due to the replacement of the previous credit facility, and $29 million of such costs in the second quarter, arising from the takeout of most of its bond debt.

A&P said that U.S. sales for the quarter were $1.58 billion, compared with $1.67 billion in the third quarter of fiscal 2004. Fiscal 2004 third quarter total sales of $2.52 billion included $850 million related to the now-divested A&P Canada unit. U.S. total comparable store sales increased 1.8% in the quarter versus year-ago. Excluding New Orleans - where a number of company owned stores closed for a time due to Hurricane Katrina, with the five weakest performers still closed - U.S. comparable store sales decreased 0.3% vs. year-ago. Net loss for the quarter was $71 million or $1.74 per diluted share this year, versus a loss of $75 million or $1.96 per diluted share last year.

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