SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2003
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                             to
Commission file number 0-9904

 

 

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 the filing requirements for at least the past 90 days.    Yes  ý   No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes  o   No  ý

 

The number of shares outstanding of the registrant’s classes of common stock as of September 27, 2003 was:

 

2,017,043 of Class A Common Stock

1,363,584 of Class B Common Stock

 

 

PART I.  FINANCIAL INFORMATION

 

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(In Thousands)		September 27, 2003			December 28, 2002
		(Unaudited)			(Restated)
Assets
Current assets:
Cash and cash equivalents		$	45,173		$	30,161
Investments		29,529			27,566
Accounts and notes receivable, net		5,172			5,544
Inventories		14,502			14,542
Other current assets		2,180			2,473
Total current assets		96,556			80,286
Property held for resale or sublease		51			51
Property, plant and equipment, net		50,918			52,454
Deferred income taxes		2,822			2,066
Other assets		2,440			4,114
Total assets		$	152,787		$	138,971
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable, trade		$	15,792		$	15,306
Other current liabilities		19,400			15,868
Current portion of long-term debt		239			220
Total current liabilities		35,431			31,394
Long-term debt		2,101			2,283
Deferred rent		4,305			3,782
Other liabilities		2,615			2,485
Total liabilities		44,452			39,944
Commitments and contingent liabilities
Stockholders’ equity:
Common Stock, Class A		844			839
Common Stock, Class B		341			341
Capital surplus		5,518			4,362
Unrealized gain on available-for-sale securities		434			232
Retained earnings		104,951			97,006
		112,088			102,780
Treasury stock, at cost		(3,753		)	(3,753		)
Total stockholders’ equity		108,335			99,027
Total liabilities and stockholders’ equity		$	152,787		$	138,971

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2

 

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(UNAUDITED)

 

(In Thousands, Except Share and Per Share Data)

 

		Thirteen Weeks Ended						Thirty-Nine Weeks Ended
		September 27, 2003			September 28, 2002			September 27, 2003			September 28, 2002
					(Restated)						(Restated)
Sales		$	101,898		$	98,207		$	303,505		$	297,477
Cost of sales		56,988			55,177			170,411			168,170
Gross profit		44,910			43,030			133,094			129,307
Delivery, selling, general and administrative expenses		40,239			37,971			119,665			112,717
Operating income		4,671			5,059			13,429			16,590
Interest and dividend income		419			333			1,185			1,314
Other income (expense), net		0			105			843			(239		)
Interest expense		(53		)	(65		)	(197		)	(248		)
Income before income taxes		5,037			5,432			15,260			17,417
Income tax provision		2,052			2,214			6,215			7,097
Net income		$	2,985		$	3,218		$	9,045		$	10,320
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) from available-for-sale securities:
Unrealized holding gains arising during the period		0			37			656			525
Reclassification adjustment for realized (gains) losses included in net income		0			(75		)	(454		)	220
Net unrealized gain (loss), net of income tax expense (benefit) of $0 and $140 for 2003 and ($26) and $513 for 2002, respectively		0			(38		)	202			745
Comprehensive income		$	2,985		$	3,180		$	9,247		$	11,065
Net income per common share:
Basic		$	.88		$	.96		$	2.68		$	3.08
Diluted		.88			.95			2.68			3.07
Weighted average common shares outstanding:
Basic		3,380,625			3,361,069			3,378,908			3,352,874
Diluted		3,382,016			3,371,691			3,380,255			3,364,192

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

(In Thousands)

 

		Thirty-Nine Weeks Ended
		September 27, 2003			September 28, 2002
					(Restated)
Cash flows from operating activities:
Cash received from customers		$	303,914		$	299,133
Cash paid to suppliers and employees		(279,400		)	(271,707		)
Interest and dividends received		981			1,139
Interest paid		(204		)	(273		)
Income taxes paid		(5,500		)	(5,317		)
Net cash provided by operating activities		19,791			22,975
Cash flows from investing activities:
Capital expenditures		(4,672		)	(2,396		)
Purchases of investments		(7,521		)	(15,078		)
Sales of investments		6,828			11,286
Proceeds from the sale of property, plant and equipment		99			47
Net cash provided by (used in) investing activities		(5,266		)	(6,141		)
Cash flows from financing activities:
Proceeds from exercise of stock options		946			540
Principal payments under capital lease obligations		(163		)	(198		)
Purchase and retirement of Company stock		(296		)
Loan payment received from officer/director					135
Net cash provided by financing activities		487			477
Net increase in cash and cash equivalents		15,012			17,311
Cash and cash equivalents at beginning of period		30,161			15,103
Cash and cash equivalents at end of period		$	45,173		$	32,414

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

(In Thousands)

 

		Thirty-Nine Weeks Ended
		September 27, 2003			September 28, 2002
					(Restated)
Reconciliation of Net Income to Net Cash Provided by Operating Activities:
Net income		$	9,045		$	10,320
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		6,049			6,174
Provision for losses on accounts and notes receivable		(12		)	93
Net (gain) loss from the disposal of property, plant and equipment		60			(32		)
Realized (gain) loss on investments		(843		)	239
Tax benefit of stock option transactions		222
Change in assets and liabilities net of effects from investing and financing activities:
(Increase) decrease in assets:
Investments		(85		)	(130		)
Accounts and notes receivable		384			1,689
Inventories		40			1,157
Other current assets		293			1,639
Other assets		1,674			125
Deferred income taxes		(896		)	(115		)
(Decrease) increase in liabilities:
Accounts payable and accrued expenses		3,207			1,105
Deferred rent		523			543
Other liabilities		130			168
Net cash provided by operating activities		$	19,791		$	22,975

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5

 

ARDEN GROUP, INC. AND CONSOLIDATED SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

1.                    Basis of Presentation and Principles of Consolidation

 

The consolidated financial statements of Arden Group, Inc.  (the “Company”) include the accounts of the Company and its direct and indirect subsidiaries.  All intercompany accounts and transactions are eliminated in consolidation.  The Company operates 18 supermarkets in Southern California.

 

The accompanying consolidated financial statements for the thirteen and thirty-nine weeks ended September 27, 2003 and September 28, 2002 have been prepared in accordance with the instructions to Form 10-Q, Article 10 of Regulation S-X and generally accepted accounting principles (“GAAP”) for interim financial information.  These financial statements have not been audited by independent public accountants but include all adjustments which, in the opinion of management of the Company, are necessary for a fair statement of the financial position and the results of operations for the periods presented.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to SEC regulations.  Accordingly, the accompanying consolidated financial statements should be read in conjunction with the Company’s amended fiscal 2002 Annual Report on Form 10-K.  The results of operations for the nine months ended September 27, 2003 are not necessarily indicative of the results to be expected for the full year ending January 3, 2004.

 

2.                    Restatement

 

The accompanying financial statements for the thirteen and thirty-nine weeks ended September 28, 2002 and the balance sheet as of December 28, 2002 have been restated to reflect rental expense and income on a straight-line basis for leases having scheduled fixed rent increases and the related impact on incentive compensation.  The Company had previously recorded rental expense and income as incurred.  The restatement reflects all required adjustments for leases with scheduled fixed rent increases based on a comprehensive review of the Company’s leases.  This restatement resulted in a reduction of previously reported net income of $104,000 and $311,000 for the thirteen and thirty-nine weeks ended September 28, 2002, respectively.  Basic net income per share declined $.03 and $.09 for the thirteen and thirty-nine weeks ended September 28, 2002, respectively.  In addition, as a result of the cumulative effect of the restatement for the years 1994 through 2002, ending retained earnings for fiscal 2002 were reduced by $2,164,000.  The restatement did not impact the Company’s cash flow for any of the periods presented.  The Company has amended its Form 10-K for the year ended December 28, 2002 and its Form 10-Q for the thirteen weeks ended March 29, 2003 to reflect this restatement.

 

6

 

The following tables represent the impact of the restatement on balances as reported, adjusted and restated on prior periods.

 

Consolidated Balance Sheets

(In Thousands)

 

		As of December 28, 2002
		As Reported			Adjustments			Restated
Accounts and notes receivable, net		$	5,412		$	132		$	5,544
Total current assets		80,154			132			80,286
Deferred income taxes		580			1,486			2,066
Total assets		$	137,353		$	1,618		$	138,971
Deferred rent		$			$	3,782		$	3,782
Total liabilities		36,162			3,782			39,944
Retained earnings		99,170			(2,164		)	97,006
Total stockholders’ equity		101,191			(2,164		)	99,027
Total liabilities and stockholders’ equity		$	137,353		$	1,618		$	138,971

 

Consolidated Statements of Operations and Comprehensive Income

(In Thousands, Except Per Share Data)

 

		Thirteen Weeks Ended September 28, 2002
		As Reported			Adjustments			Restated
Delivery, selling, general and administrative expenses		$	37,796		$	175		$	37,971
Operating income		5,234			(175		)	5,059
Income before income taxes		5,607			(175		)	5,432
Income tax provision		2,285			(71		)	2,214
Net income		$	3,322		$	(104	)	$	3,218
Comprehensive income		$	3,284		$	(104	)	$	3,180
Net income per common share:
Basic		.99			$	(.03	)	.96
Diluted		.99			(.04		)	.95

 

		Thirty-Nine Weeks Ended September 28, 2002
		As Reported			Adjustments			Restated
Delivery, selling, general and administrative expenses		$	112,193		$	524		$	112,717
Operating income		17,114			(524		)	16,590
Income before income taxes		17,941			(524		)	17,417
Income tax provision		7,310			(213		)	7,097
Net income		$	10,631		$	(311	)	$	10,320
Comprehensive income		$	11,376		$	(311	)	$	11,065
Net income per common share:
Basic		$	3.17		$	(.09	)	$	3.08
Diluted		3.16			(.09		)	3.07

 

The Consolidated Statement of Operations and Comprehensive Income for the thirty-nine weeks ended September 27, 2003 includes restated balances for the thirteen weeks ended March 29, 2003.  The restatement of the Company’s Consolidated Statement of Operations and Comprehensive Income for the thirteen weeks ended March 29, 2003 reflects adjustments in amounts comparable to the thirteen weeks ended September 28, 2002 shown above.

 

7

 

3.                    Common Stock and Net Income Per Common Share

 

Basic net income per share is computed by dividing the net income attributable to common stockholders by the weighted average number of common shares outstanding during the period.  Diluted net income per share is calculated by adjusting outstanding shares to include all potentially dilutive stock options.

 

During the third quarter of 2003, the Company purchased 4,005 shares of its Class A Common Stock for an aggregate purchase price of approximately $246,000.  In July 2003, stock options for 4,125 shares of Class A Common Stock were exercised at an average exercise price of $29.06 per share.

 

On August 18, 2003, the Company announced it had established a regular quarterly dividend of 25 cents per share of Class A Common Stock and 22.5 cents per share of Class B Common Stock.  The first quarterly dividend aggregating $811,000 was paid on October 15, 2003 to stockholders of record as of the close of business on September 22, 2003.  As of September 27, 2003 there were 2,017,043 Class A shares and 1,363,584 Class B shares outstanding.

 

4.                    Recent Accounting Standards

 

Effective the first quarter of 2003, the Company adopted Emerging Issues Task Force Issue No. (“EITF”) 02-16, “Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor.”  EITF 02-16 addresses how a retailer should account for vendor credits and cash consideration received from a vendor.  Adoption of the provisions of EITF 02-16 did not have a significant impact on the Company’s consolidated financial statements.

 

In April 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. (“SFAS”) 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities.”  This statement is effective for contracts entered into or modified after June 30, 2003.  The adoption of this Statement is not expected to have any impact on the Company’s consolidated financial statements as the Company has not entered into hedging or derivative contracts.

 

In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  The adoption of this standard did not have an impact on the Company’s consolidated financial statements.

 

5.                    Stock Options and Stock Appreciation Rights

 

As allowed by SFAS 123, as amended by SFAS 148, the Company follows the disclosure requirements of SFAS 123, but continues to account for its employee stock option plans in accordance with Accounting Principles Board Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees,” which results in no charge to earnings when options are issued at fair market value.

 

8

 

The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested stock option awards in each period presented:

 

				39 Weeks Ended
				September 27, 2003			September 28, 2002
							(Restated)
Net earnings as reported				$	9,045		$	10,320
Add:	Stock-based compensation expense determined under APB 25, net of related tax effects			53
Deduct:		Stock-based employee compensation expense determined under fair value based method, net of related tax effects		(16		)	(63		)
Pro forma net income				$	9,082		$	10,257
Earnings per share:
Basic – as reported				$	2.68		$	3.08
Basic – pro forma				2.69			3.06
Diluted – as reported				2.68			3.07
Diluted – pro forma				2.69			3.05

 

Stock options and SARs transactions during 2003 have been as follows:

 

						SARs
		Stock Options				Officers				Non-Employee Directors
		Options		Weighted Average Price ($)		SARs		Weighted Average Price ($)		SARs		Weighted Average Price ($)
Outstanding as of December 28, 2002		26,750		35.81		7,500		30.89		32,500		34.89
Granted		—		—		20,000		60.50		10,000		54.25
Exercised		(23,250	)	36.82		(2,500	)	34.53		(5,000	)	29.06
Forfeitures		(875	)	29.06		—		—		—		—
Outstanding as of September 27, 2003		2,625		29.06		25,000		54.21		37,500		40.83
Exercisable as of September 27, 2003		625				2,500				15,000

 

The following table summarizes information about the Company’s Stock Options and SARs outstanding at September 27, 2003:

 

		Options Outstanding						Options Exercisable
Range of Exercise Price		Number Outstanding		Weighted Average Remaining Contractual Life		Weighted Average Exercise Price ($)		Number Exercisable		Weighted Average Exercise Price ($)
Stock Options
$29.06		2,625		1.5 years		29.06		625		29.06
SARs – Non-Employee
Directors
$29.06		17,500		1.5 years		29.06		10,000		29.06
$48.00		10,000		2.7 years		48.00		5,000		48.00
$54.25		10,000		4.5 years		54.25		—		54.25
SARs – Officers
$29.06		5,000		1.5 years		29.06		2,500		29.06
$60.50		20,000		4.9 years		40.00		—		60.50

 

9

 

During the third quarter 2003, the Company recorded $75,000 in compensation expense relating to stock appreciation rights.  In the third quarter of 2002, the Company recognized income of $47,000 related to SARs.  The Company reported $157,000 of compensation expense in the first nine months of 2003 related to SARs compared to $271,000 in the same period of the prior year.

 

6.                    Commitments and Contingent Liabilities

 

The Company and its subsidiaries are subject to a myriad of environmental laws, regulations and lease covenants with its landlords regarding air, water and land use, products for sale, and the use, storage and disposal of hazardous materials. The Company believes it substantially complies, and has in the past substantially complied, with federal, state and local environmental laws and regulations and private covenants.  The Company cannot, at this time, estimate the expense it ultimately may incur in connection with any current or future violations; however, it believes any such claims will not have a material adverse impact on either the Company’s consolidated financial position, results of operations or cash flows.

 

The Company or its subsidiaries are defendants in a number of cases currently in litigation, being vigorously defended, in which the complainants seek monetary damages.  As of the date hereof, no estimate of potential liability, if any, is possible. Based upon current information, management, after consultation with legal counsel defending the Company’s interests in the cases, believes the ultimate disposition thereof will have no material effect upon either the Company’s consolidated financial position, results of operations or cash flows.

 

7.                    Subsequent Events

 

The multi-employer union labor contract covering the majority of the Company’s employees, as well as other participating employers in Southern California, expired October 5, 2003.  The Company initially signed a 30-day extension of the expired agreement with the UFCW Union Locals that has subsequently reverted to a “day by day” contract extension subject to seventy-two hours written notice of cancellation by either party.  Employees for three major grocery retailers covered by the expired union labor contracts have been on strike or lock-out since the evening of October 11, 2003 after the bargaining employers and unions failed to reach an agreement.  The resulting terms of any new labor agreement could have an impact on future operating results.

 

10

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

 

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements made by or on behalf of the Company.  Certain statements contained in Management’s Discussion and Analysis, in other parts of this report and in other Company filings, are forward-looking statements.  These statements discuss, among other things, future sales growth, operating results and financial condition.  Forward-looking statements reflect the Company’s current plans and expectations regarding important risk factors and are based on information currently known to the Company.

 

The Company cautions readers that any forward-looking statements contained in this report or made by the management of the Company involve risks and uncertainties, and are subject to change based on various important factors.  The following factors, among others, could affect the Company’s financial results and could cause the Company’s financial performance to differ materially from the expectations expressed in any forward-looking statement made by or on behalf of the Company:

 

•                  the strength of the U.S. economy, in particular, the economic conditions in Southern California;

•                  the effects of and changes in fiscal policies and laws, as well as, changes in accounting policies and practices;

•                  inflation or deflation;

•                  potential business disruptions from acts of terrorism or national emergencies;

•                  the impact of fluctuations in the Company’s stock price on compensation expense;

•                  the ability of vendors, including Unified Western Grocers, Inc., to continue providing products and services in a timely manner;

•                  consolidations in the supermarket industry and competition from other supermarkets and food retailers, some of which are non-union;

•                  the ability to renew current leases on favorable terms;

•                  the ability of the Company to materially increase sales at its Pasadena store;

•                  whether and when the landlord of the Century City Shopping Center implements a major construction project, the details of such project as and if implemented, and the effects of such project on the Gelson’s store;

•                  the amount of future premiums incurred by the Company in order to maintain adequate insurance coverage;

•                  the financial impact of the Company’s termination of its guaranteed cost workers’ compensation policy and the resulting change to self-insurance with stop-loss coverage for workers’ compensation claims;

•                  the impact of the Company’s workers’ compensation safety records and claims experience and any changes to the insurance industry’s rating process and premium schedules on workers’ compensation stop-loss coverage;

•                  the adequacy of self-insurance reserves for reported claims and incurred but not reported claims;

•                  the impact of uninsured losses;

•                  the impact of any violation of environmental laws, regulations or lease provisions;

•                  the retirement of existing senior management;

 

11

 

•                  the term of any future suspension and subsequent reinstatement of multi-employer union pension contributions, the number of hours worked by the applicable union employees, the required rate of contribution and the future rate of return received by the union pension plans on their investments;

•                  the continuation of the current strike and lock-out at three major Southern California grocery retailers;

•                  the renegotiation of expiring union labor contracts and the resulting financial impact of the new contract terms;

•                  the rate of increase in health care costs;

•                  any changes in assumptions or market conditions that could affect management’s estimate of future cash flows when evaluating assets for impairment.

 

Restatement

 

The accompanying financial statements and related Management’s Discussion and Analysis for the thirteen and thirty-nine weeks ended September 28, 2002 and the balance sheet as of December 28, 2002 have been restated to reflect rental expense and income on a straight-line basis for leases having scheduled fixed rent increases and the related impact on incentive compensation.  The Company had previously recorded rental expense and income as incurred.  The restatement reflects all required adjustments for leases with scheduled fixed rent increases based on a comprehensive review of the Company’s leases.  The restatement resulted in a reduction of previously reported net income of $104,000 and $311,000 for the thirteen and thirty-nine weeks ended September 28, 2002, respectively.  Basic net income per share declined $.03 and $.09 for the thirteen and thirty-nine weeks ended September 28, 2002, respectively.  Net income for fiscal 2000, 2001 and 2002 was reduced approximately $375,000, $436,000 and $414,000, respectively, as a result of this restatement.  In addition, as a result of the cumulative effect of the restatement for the years 1994 through 2002, ending retained earnings for fiscal 2002 were reduced by $2,164,000.  The restatement did not impact the Company’s cash flow for any of the periods presented.  The Company has also amended its Form 10-K for the year ended December 28, 2002 and its Form 10-Q for the thirteen weeks ended March 29, 2003 to reflect this restatement.

 

With respect to existing leases:  Rent expense recognized by the Company will exceed actual cash rental payments through the 2005 fiscal year in order to recognize rent expense on a straight-line basis for these particular leases.  Commencing in 2006, cash rental payments will exceed rent expense as the Company reduces the Deferred Rent balance in order to recognize straight-line rent expense.

 

Third Quarter Analysis

 

Net income in the third quarter of 2003 decreased 7.2% to $2,985,000 compared to $3,218,000 during the third quarter of 2002.  Operating income decreased 7.7% to $4,671,000 in the third quarter of 2003 compared to $5,059,000 in the prior year.

 

Sales from the Company’s 18 supermarkets (all of which are located in Southern California) were $101,898,000 in the third quarter of 2003 representing an increase of 3.8% compared to same store sales for the third quarter of 2002.

 

The Company’s gross profit as a percent of sales was 44.1% in the third quarter of 2003 compared to 43.8% in the same period of 2002.  Product pricing decisions contributed to the increase in margins.

 

12

 

Delivery, selling, general and administrative (“DSG&A”) expense as a percent of sales was 39.5% in the third quarter of 2003 compared to 38.7% in the third quarter of 2002.  Increases in workers’ compensation premiums and union health and welfare benefit payments resulted in approximately $1,100,000 incremental DSG&A expenses in the third quarter of 2003.  During the third quarter 2003, the Company recorded $75,000 in compensation expense relating to stock appreciation rights (“SARs”).  In the third quarter of 2002, the Company recognized income of $47,000 related to SARs.

 

The Company contributes to several multi-employer union pension plans.  Contributions to the multi-employer union pension plan, covering a majority of the Company’s employees (the “Plan”), have been periodically suspended and reinstated in recent years.  Most recently, contributions were suspended in November 2002 and reinstated in March 2003.  The Company recorded thirteen weeks pension expense in the third quarters of 2003 and 2002.

 

In June 2003, in an effort to control the substantially increasing workers’ compensation rates, the Company terminated its guaranteed cost workers’ compensation insurance policy and purchased a high deductible workers’ compensation policy.  The Company has stop-loss coverage to limit its loss exposure on a per claim basis and is insured for covered costs in excess of per claim limits.  No assurance can be given that this change will result in a reduction in workers’ compensation expense or limit future increases.  The Company devotes substantial time and commitment to maintaining a safe work environment.  The ultimate cost of workers’ compensation is highly dependent upon legal and legislative trends, the inflation rates of health care costs and the Company’s ability to manage claims.  Self-insurance accruals for losses up to the purchased stop-loss coverage are based on reported claims and an estimate of claims incurred but not reported.

 

Stock-based compensation under the SARs program is subject to variable accounting in accordance with FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”  As a result, the SARs compensation charge may vary each quarter depending on the market price of the Company’s Class A Common Stock.  Assuming the Company’s stock price remains at the September 27, 2003 closing price of $62.00, the Company anticipates SARs compensation expense of approximately $118,000 on an after tax basis for the year ended January 3, 2004.  For the fiscal year ended December 28, 2002, SARs compensation expense was $481,000.  Compensation expense related to SARs will be adjusted by approximately $23,000 after tax for each increase or decrease of one dollar in the Company’s stock price.  The above estimates are based on the number of outstanding SARs as of September 27, 2003.  The exercise of these SARs or the grant of additional SARs could cause the estimates to vary.  On August 6, 2003, the Company granted SARs covering 20,000 shares at a base price of $60.50 per share, the fair market value of the Class A Common Stock on that date.

 

The Company procures approximately 21% of its product costs through Unified Western Grocers, Inc. (“Unified”), a grocery cooperative.  As a member-patron, the Company is required to provide Unified with certain minimum deposits in order to purchase product from the cooperative.  As of September 27, 2003, the Company had approximately $1,339,000 on deposit with Unified.  The minimum deposit requirement is satisfied through a combination of cash, credit and ownership of equity shares in Unified.  In September 2002, Unified’s Board of Directors authorized a quasi-reorganization that eliminated its accumulated deficit in retained earnings and restated assets and liabilities to their fair values.  Unified’s Board of Directors adopted an equity enhancement plan for its 2002 fiscal year.  Under the equity enhancement plan, member-patrons will receive five-year low interest bearing subordinated patronage dividend certificates in lieu of amounts previously paid in cash and Class B shares.  In 2002, the Company earned approximately $149,000 in subordinated patronage dividend certificates.  In the event Unified continues to incur reductions in earned surplus, the Company may face impairment issues relating to the

 

13

 

deposits provided to Unified.  In view of the above, the Company has elected not to recognize the 2002 patronage dividend as income until the certificates are redeemed.  The Company will evaluate this policy on an annual basis, based on facts and circumstances as they exist in the future.

 

Interest and dividend income was $419,000 in the third quarter of 2003 compared to $333,000 for the same period in 2002 primarily due to higher average levels of interest bearing investments in 2003.

 

Other income (expense) includes net gains (losses) realized on investments of $105,000 in 2002.

 

SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that unrealized holding gains and losses for available-for-sale securities be included as a component of stockholders’ equity.  There were no unrealized gains (losses) on available-for-sale securities compared to unrealized losses of $38,000 (net of income tax benefits of $26,000) in the third quarter of 2002.

 

In September 2001, the Company opened a Gelson’s Market in a mixed use shopping center/apartment project in Pasadena, California, which is currently performing significantly below management’s expectations.  Improvement in sales at the Pasadena store is dependent upon, among other things, the acceptance and use of the center’s underground parking by potential Gelson’s customers.  However, the acceptance and use of the center’s underground parking does not guarantee that sales at the Pasadena store will increase to originally estimated levels.  In 2002, enhancements were made  to the interior of the store, as well as to traffic flow in the garage and signage.  These changes have resulted in an increase in sales at the Pasadena store, however, additional sales increases are necessary or the Company’s fixed assets at that store could become impaired.  The Company has the right, under certain circumstances, to terminate its lease in the Spring of 2005 which would result in a significant write-off of fixed assets and other costs.

 

A major road improvement project commenced in early 2003 along Santa Monica Boulevard in West Los Angeles, California, which is estimated to last approximately three years.  At some times during the construction schedule, construction will occur in the immediate proximity of the Century City Shopping Center where Gelson’s has a store.  The Company expects that sales at this store will be negatively impacted during the construction period.  In addition, the landlord of the Century City Shopping Center has tentative plans for a major construction project which would result in the relocation of the movie theaters and other tenants to newly constructed areas immediately adjacent to the Gelson’s store.  Those plans also include the expansion of the Gelson’s store.  The Company does not know if or when this project might begin or how long it could take.  The project is in the planning stage.  The Company, however, expects that the sales of the Century City store will be negatively impacted during this construction.  The Company also expects that the parking for Gelson’s customers will be adversely affected by the addition of other tenants and the relocation of the theaters and food court to the immediate vicinity of the Gelson’s store.

 

The multi-employer union labor contract covering the majority of the Company’s employees, as well as other participating employers in Southern California, expired October 5, 2003.  The Company initially signed a 30-day extension of the expired agreement with the UFCW Union Locals that has subsequently reverted to a “day by day” contract extension subject to seventy-two hours written notice of cancellation by either party.  Employees for three major grocery retailers covered by the expired union labor contracts have been on strike or lock-out since the evening of October 11, 2003 after the bargaining employers and unions failed to reach an agreement.  The resulting terms of any new labor agreement could have an impact on future operating results.  The Company’s sales at all stores have, on a temporary basis, increased substantially as a result of the strike and lock-out at the three major retailers.

 

14

 

Year-To-Date Analysis

 

Net income in the first nine months of 2003 decreased 12.4% to $9,045,000 compared to $10,320,000 during the first nine months of 2002.  Operating income decreased 19.1% to $13,429,000 for the first nine months of 2003 compared to $16,590,000 in the same period of the prior year.

 

Sales from the Company’s 18 supermarkets (all of which are located in Southern California) were $303,505,000 in the first nine months of 2003.  This represents an increase of 2.0% over the first nine months of 2002 when same store sales were $297,477,000.  During the first quarter of 2003, the Silverlake/Los Feliz Mayfair store was converted to the Gelson’s name and format as part of a major remodel.  Sales at the store were adversely impacted by a ten-day closure and reduced customer traffic during the construction phase of the remodel which was completed in late March 2003.

 

The Company’s gross profit as a percent of sales was 43.9% in the first nine months of 2003 compared to 43.5% in the same period of 2002.  Product pricing decisions contributed to the increase in margins.

 

DSG&A expense as a percent of sales was 39.4% in the first nine months of 2003 compared to 37.9% in the same period of 2002.  The increase in costs is primarily due to the multi-employer union pension reinstatement, higher workers’ compensation premiums and increases in union health and welfare benefit payments.  During the first nine months of 2003, these costs increased approximately $4,300,000 over the prior year.  The Company reported $157,000 of compensation expense in the first nine months of 2003 related to SARs compared to $271,000 in the same period of the prior year.

 

Interest and dividend income was $1,185,000 in the first nine months of 2003 compared to $1,314,000 for the same period in 2002 primarily due to lower overall interest rates partially offset by higher average levels of interest bearing investments in 2003.

 

Interest expense decreased to $197,000 in the first nine months of 2003 compared to $248,000 in the first nine months of 2002 due to the termination of a capital lease in June 2002.

 

Other income (expense) includes net gains (losses) realized on investments of $843,000 and ($239,000) in 2003 and 2002, respectively.

 

SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that unrealized holding gains and losses for available-for-sale securities be included as a component of stockholders’ equity.  Unrealized gains on available-for-sale securities were $202,000 (net of income tax expense of $140,000) in the first nine months of 2003 compared to unrealized gains of $745,000 (net of income tax expense of $513,000) in the same period of 2002.

 

CAPITAL EXPENDITURES/LIQUIDITY

 

The Company generated cash from operating activities of approximately $19,791,000 for the thirty-nine weeks ended September 27, 2003.  Cash flows from operating activities resulted primarily from net income plus non-cash expenses and changes in operating working capital.

 

The Company plans to utilize cash-on-hand (including investments) and cash flow from operations to fund capital expenditures in 2003 and thereafter.  Capital expenditures of approximately $4,672,000 have

 

15

 

been incurred during the thirty-nine weeks ended September 27, 2003.  The Company anticipates declining capital expenditures in the balance of the fiscal year.

 

The Company also has two revolving lines of credit totaling $13,000,000 available for standby letters of credit, funding operations and expansion.  The Company maintains three standby letters of credit aggregating $5,744,000 pursuant to the Company’s general liability and workers’ compensation self-insurance programs.  The standby letters of credit reduce the available borrowings under its revolving lines.  There were no outstanding borrowings against either of the revolving lines as of September 27, 2003.

 

The following table sets forth the Company’s contractual cash obligations and commercial commitments as of September 27, 2003:

 

		Contractual Cash Obligations (In Thousands)
		Total			Less Than 1 Year			1-3 Years			4-5 Years			After 5 Years
7% Subordinated Income Debentures Due September 2014 Including Interest		$	2,174		$	86		$	172		$	172		$	1,744
Capital Lease Obligations Including Interest		1,375			348			695			332			0
Operating Leases		101,795			7,691			14,978			13,799			65,327
Total Contractual Cash Obligations		$	105,344		$	8,125		$	15,845		$	14,303		$	67,071

 

Other Commercial Commitments (In Thousands)

Total

Less Than 1 Year

1-3 Years

4-5 Years

After 5 Years

Standby Letters of Credit

$

5,744

$

5,744

 

In April 2003, the Company announced a stock repurchase program, authorized by the Board of Directors, to purchase from time to time up to 100,000 shares of its Class A Common Stock in the open market or in private transactions.  The timing, volume and price of purchases are at the discretion of the management of the Company.  During the thirty-nine week period ending September 27, 2003, the Company purchased and retired 4,942 shares of its Class A Common Stock for an aggregate purchase price of approximately $296,000.

 

On August 18, 2003, the Company announced it had established a regular quarterly dividend of 25 cents per share of Class A Common Stock and 22.5 cents per share of Class B Common Stock.  The first quarterly dividend aggregating $811,000 was paid on October 15, 2003 to stockholders of record as of the close of business on September 22, 2003.  As of September 27, 2003 there were 2,017,043 Class A shares and 1,363,584 Class B shares outstanding.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company currently has no bank debt or fixture financing.  If the Company should obtain financing or draw on its existing lines of credit, which bear interest at the bank’s reference rate or the bank’s adjusted

 

16

 

LIBOR rate plus an index up to 1.2%, the Company could then be exposed to market risk related to interest fluctuations.

 

A change in market prices exposes the Company to market risk related to its investments which totaled $29,529,000 as of September 27, 2003.  A hypothetical 10% drop in the market value of these investments would result in a $2,953,000 unrealized loss and a corresponding decrease in the fair value of these instruments.  This hypothetical drop would not affect cash flow and would not have an impact on earnings until the Company sold the investments.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

An evaluation was carried out by the Company’s Chief Executive Officer and Chief Financial Officer of the effectiveness of the Company’s disclosure controls and procedures as of September 27, 2003 (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934).  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures were effective.  During the period covered by this report, there have been no changes in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

17

 

PART II.  OTHER INFORMATION

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)	Exhibits:
	31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.
	31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.
(b)	Reports on Form 8-K:
	On August 18, 2003, the Company filed a Form 8-K furnishing under Item 7 for Item 12 its second quarter earnings press release.
	On August 18, 2003, the Company filed a Form 8-K furnishing under Item 7 a press release announcing that its Board of Directors has established a regular quarterly dividend.

 

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

			ARDEN GROUP, INC.
			Registrant
Date	November 11, 2003			/s/DAVID M. OLIVER
				David M. Oliver
				Chief Financial Officer
				(Authorized Signatory)

 

18