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EX-31.1 - EXHIBIT 31.1 - NASH FINCH COc08478exv31w1.htm
EX-12.1 - EXHIBIT 12.1 - NASH FINCH COc08478exv12w1.htm
EX-32.1 - EXHIBIT 32.1 - NASH FINCH COc08478exv32w1.htm
EX-31.2 - EXHIBIT 31.2 - NASH FINCH COc08478exv31w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period (16 weeks) ended October 9, 2010
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 No. 0-785
NASH-FINCH COMPANY
(Exact Name of Registrant as Specified in its Charter)
     
DELAWARE   41-0431960
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)
     
7600 France Avenue South,    
P.O. Box 355    
Minneapolis, Minnesota   55440-0355
(Address of principal executive offices)   (Zip Code)
(952) 832-0534
(Registrant’s telephone number including area code)
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 such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the proceeding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 8, 2010, 12,167,555 shares of Common Stock of the Registrant were outstanding.
 
 

 

 


 

Index
         
    Page No.  
 
       
         
       
         
    2  
         
    3  
         
    4  
         
    5  
         
    17  
         
    26  
         
    26  
         
       
         
    27  
         
    27  
         
    27  
         
    27  
         
    27  
         
    27  
         
    28  
         
    29  
         
 Exhibit 12.1
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1

 


Table of Contents

PART I. — FINANCIAL INFORMATION
ITEM 1. Financial Statements
NASH-FINCH COMPANY AND SUBSIDIARIES
Consolidated Statements of Income (unaudited)
(In thousands, except per share amounts)
                                 
    16 Weeks Ended     40 Weeks Ended  
    October 9,     October 10,     October 9,     October 10,  
    2010     2009     2010     2009  
 
                               
Sales
  $ 1,510,881       1,633,304     $ 3,845,191       3,990,218  
Cost of sales
    1,388,926       1,504,350       3,537,079       3,667,116  
 
                       
Gross profit
    121,955       128,954       308,112       323,102  
 
                       
 
                               
Other costs and expenses:
                               
Selling, general and administrative
    81,119       84,716       208,601       222,055  
Gain on acquisition of a business
                      (6,682 )
Gain on litigation settlement
          (7,630 )           (7,630 )
Depreciation and amortization
    10,883       12,592       27,638       31,299  
Interest expense
    7,123       7,621       17,747       18,765  
 
                       
Total other costs and expenses
    99,125       97,299       253,986       257,807  
 
                       
 
                               
Earnings before income taxes
    22,830       31,655       54,126       65,295  
 
                               
Income tax expense
    7,484       9,728       20,125       19,410  
 
                               
 
                       
Net earnings
  $ 15,346       21,927     $ 34,001       45,885  
 
                       
 
                               
Net earnings per share:
                               
Basic
  $ 1.21       1.68     $ 2.64       3.53  
Diluted
  $ 1.18       1.64     $ 2.57       3.44  
 
                               
Declared dividends per common share
  $ 0.18       0.18     $ 0.54       0.54  
 
                               
Weighted average number of common shares outstanding and common equivalent shares outstanding:
                               
Basic
    12,656       13,021       12,870       12,998  
Diluted
    13,038       13,377       13,223       13,344  
See accompanying notes to consolidated financial statements.

 

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NASH-FINCH COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share amounts)
                 
    October 9,     January 2,  
    2010     2010  
    (unaudited)        
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 785       830  
Accounts and notes receivable, net
    271,489       250,767  
Inventories
    341,405       285,443  
Prepaid expenses and other
    13,188       11,410  
Deferred tax asset, net
    5,592       9,366  
 
           
Total current assets
    632,459       557,816  
 
               
Notes receivable, net
    21,498       23,343  
Property, plant and equipment:
               
Property, plant and equipment
    653,901       637,167  
Less accumulated depreciation and amortization
    (415,159 )     (422,529 )
 
           
Net property, plant and equipment
    238,742       214,638  
 
               
Goodwill
    166,545       166,545  
Customer contracts and relationships, net
    18,803       21,062  
Investment in direct financing leases
    3,003       3,185  
Other assets
    11,090       12,947  
 
           
Total assets
  $ 1,092,140       999,536  
 
           
 
               
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Current maturities of long-term debt and capitalized lease obligations
  $ 3,170       4,438  
Accounts and other payables
    281,570       240,483  
Accrued expenses
    58,995       60,524  
Income taxes payable
    1,424       3,064  
 
           
Total current liabilities
    345,159       308,509  
 
               
Long-term debt
    299,363       257,590  
Capitalized lease obligations
    19,408       21,442  
Deferred tax liability, net
    23,057       19,323  
Other liabilities
    41,470       42,113  
Commitments and contingencies
           
 
               
Stockholders’ equity:
               
Preferred stock — no par value. Authorized 500 shares; none issued
           
Common stock — $1.66 2/3 par value. Authorized 50,000 shares, issued 13,676 and 13,675 shares, respectively
    22,793       22,792  
Additional paid-in capital
    113,089       106,705  
Common stock held in trust
    (1,203 )     (2,342 )
Deferred compensation obligations
    1,203       2,342  
Accumulated other comprehensive loss
    (10,415 )     (10,756 )
Retained earnings
    288,893       261,821  
Common stock in treasury, 1,508 and 863 shares, respectively
    (50,677 )     (30,003 )
 
           
Total stockholders’ equity
    363,683       350,559  
 
           
Total liabilities and stockholders’ equity
  $ 1,092,140       999,536  
 
           
See accompanying notes to consolidated financial statements.

 

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NASH-FINCH COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
(In thousands)
                 
    40 Weeks Ended  
    October 9,     October 10,  
    2010     2009  
Operating activities:
               
Net earnings
  $ 34,001       45,885  
Adjustments to reconcile net earnings to net cash provided by operating activities:
               
Gain on acquisition of a business
          (6,682 )
Gain on litigation settlement
          (7,630 )
Depreciation and amortization
    27,638       31,299  
Amortization of deferred financing costs
    1,411       1,357  
Non-cash convertible debt interest
    4,058       3,753  
Amortization of rebateable loans
    3,074       3,133  
Provision for bad debts
    216       1,070  
Provision for lease reserves
    291       1,492  
Deferred income tax expense (benefit)
    7,510       (1,237 )
Gain on sale of real estate and other
    (423 )     (1 )
LIFO credit
    (76 )     (732 )
Asset impairments
    926       1,738  
Share-based compensation
    6,179       7,421  
Deferred compensation
    838       990  
Other
    (730 )     (129 )
Changes in operating assets and liabilities:
               
Accounts and notes receivable
    (22,593 )     (38,921 )
Inventories
    (55,886 )     (32,838 )
Prepaid expenses
    1,887       824  
Accounts and other payables
    14,407       23,294  
Accrued expenses
    (912 )     (14,529 )
Income taxes payable
    (5,305 )     946  
Other assets and liabilities
    (200 )     1,795  
 
           
Net cash provided by operating activities
    16,311       22,298  
 
           
Investing activities:
               
Disposal of property, plant and equipment
    575       507  
Additions to property, plant and equipment
    (39,853 )     (12,563 )
Business acquired, net of cash
          (78,056 )
Loans to customers
    (1,095 )     (2,225 )
Payments from customers on loans
    1,703       3,411  
Other
    (400 )     (154 )
 
           
Net cash used in investing activities
    (39,070 )     (89,080 )
 
           
Financing activities:
               
Proceeds of revolving debt
    38,000       80,500  
Dividends paid
    (6,739 )     (6,929 )
Repurchase of Common Stock
    (20,267 )      
Payments of long-term debt
    (264 )     (248 )
Payments of capitalized lease obligations
    (3,009 )     (2,649 )
Increase (decrease) in book overdraft
    14,993       (1,346 )
Payments of deferred financing costs
          (2,706 )
Other
          196  
 
           
Net cash provided by financing activities
    22,714       66,818  
 
           
Net increase (decrease) in cash and cash equivalents
    (45 )     36  
Cash and cash equivalents:
               
Beginning of year
    830       824  
 
           
End of period
  $ 785       860  
 
           
Supplemental schedule of non-cash investing and financing activities:
               
Capital expenditures funded by other payables
  $ 8,500        
 
           
See accompanying notes to consolidated financial statements.

 

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Nash-Finch Company and Subsidiaries
Notes to Consolidated Financial Statements
October 9, 2010
Note 1 — Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. For further information, refer to the consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the year ended January 2, 2010.
The accompanying unaudited consolidated financial statements include all adjustments which are, in the opinion of management, necessary to present fairly the financial position of Nash-Finch Company and our subsidiaries (“Nash Finch” or “the Company”) at October 9, 2010, and January 2, 2010, the results of operations for the 16 and 40 weeks ended October 9, 2010 (“third quarter 2010”), and October 10, 2009 (“third quarter 2009”), and changes in cash flows for the 40 weeks ended October 9, 2010, and October 10, 2009. Adjustments consist only of normal recurring items, except for any items discussed in the notes below. All material intercompany accounts and transactions have been eliminated in the unaudited consolidated financial statements. Results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Note 2 — Acquisition
On January 31, 2009, the Company completed the purchase from GSC Enterprises, Inc. (“GSC”), of substantially all of the assets relating to three military food distribution centers located in San Antonio, Texas, Pensacola, Florida, and Junction City, Kansas, serving military commissaries and exchanges (“Business”). The Company also assumed certain trade payables and accrued expenses associated with the assets being acquired. The aggregate purchase price paid was $78.1 million in cash.
The following table summarizes the fair values of the assets acquired and liabilities assumed of the Business assumed at the acquisition date:
         
As of January 31, 2009        
(in thousands)        
Cash and cash equivalents
  $ 47  
Accounts receivable
    61,285  
Inventories
    42,061  
Prepaid expenses and other
    210  
Property, plant and equipment
    30,294  
Other assets
    890  
 
     
 
       
Total identifiable assets acquired
    134,787  
 
       
Current liabilities
    43,114  
Accrued expenses
    1,162  
Deferred tax liability, net
    4,272  
Other long-term liabilities
    1,456  
 
     
Total liabilities assumed
    50,004  
 
     
 
       
Net assets acquired
  $ 84,783  
 
     

 

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The fair value of the net assets acquired of $84.8 million exceeded the purchase price of $78.1 million. Consequently, the Company reassessed the recognition and measurement of identifiable assets acquired and liabilities assumed and concluded that the valuation procedures and resulting measures were appropriate. As a result, the Company recognized a gain of $6.7 million (net of tax) in the first quarter 2009 associated with the acquisition of the Business. The gain is included in the line item “Gain on acquisition of a business” in the Consolidated Statement of Income.
A contingency of $0.3 million is included in the other long-term liabilities account in the table above related to a payment the Company would have been required to make in the event a purchase option was not exercised associated with the sublease of the Pensacola, FL facility prior to October 10, 2010. The Company determined the range of the potential loss was zero to $1.0 million and the acquisition date fair value of the contingency was $0.3 million based upon a probability-weighted discounted cash flow valuation technique. The Company exercised the purchase option during the third quarter 2010. The resulting gain recognized from the settlement of this contingency of $0.3 million is included on the Selling, general and administrative line on our Consolidated Statement of Income.
The Company recognized acquisition and integration costs of approximately $0.9 million during the third quarter 2009. Acquisition and integration costs were $0.7 million and $2.3 million during year-to-date 2010 and year-to-date 2009, respectively.
Sales of the Business included in the Consolidated Statement of Income for the third quarter 2010 and third quarter 2009 were $219.3 million and $229.2 million, respectively, and were $563.3 million and $508.4 million during year-to-date 2010 and 2009, respectively. Although the Company has made reasonable efforts to do so, synergies achieved through the integration of the Business into the Company’s military segment, unallocated interest expense and the allocation of shared overhead specific to the Business cannot be precisely determined. Accordingly, the Company has deemed it impracticable to calculate the precise impact the Business has had and will have on the Company’s net earnings. However, please refer to “Note 13-Segment Reporting” of this Form 10-Q for a comparison of military segment sales and profit for the third quarter and year-to-date periods of fiscal 2010 and 2009.
Supplemental pro forma financial information
The unaudited pro forma financial information in the table below combines the historical results for the Company and the historical results for the Business for the 40 weeks ended October 10, 2009. This pro forma financial information is provided for illustrative purposes only and does not purport to be indicative of the actual results that would have been achieved by the combined operations for the period presented or that will be achieved by the combined operations in the future.
         
    40 Weeks Ended  
(in thousands, except per share data)   October 10, 2009  
Total revenues
  $ 4,052,508  
Net earnings
    46,051  
Basic earnings per share
    3.54  
Diluted earnings per share
    3.45  
Note 3 — Inventories
We use the LIFO method for valuation of a substantial portion of inventories. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs. Because these estimates are subject to many factors beyond management’s control, interim results are subject to the final year-end LIFO inventory valuation. If the FIFO method had been used, inventories would have been approximately $73.0 million higher at October 9, 2010, and $73.1 million higher at January 2, 2010. We recorded a LIFO charge of $0.3 million during the third quarter 2010 as compared to a LIFO credit of $0.4 million during the third quarter 2009. During year-to-date 2010 and 2009 we recorded LIFO credits of $0.1 million and $0.7 million, respectively.

 

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Note 4 — Share-Based Compensation
We account for share-based compensation awards in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718 (“ASC 718”) which requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the awards ultimately expected to vest is recognized as expense over the requisite service period. We recognized share-based compensation expense as a component of selling, general and administrative expense in our Consolidated Statements of Income in the amount of $6.2 million during year-to-date 2010 versus $7.4 million during year-to-date 2009.
We have four equity compensation plans under which incentive stock options, non-qualified stock options and other forms of share-based compensation have been, or may be, granted primarily to key employees and non-employee members of the Board of Directors. These plans include the 2009 Incentive Award Plan (as Amended and Restated as of March 2, 2010,) (“2009 Plan”), the 2000 Stock Incentive Plan (“2000 Plan”), the Director Deferred Compensation Plan, and the 1997 Non-Employee Director Stock Compensation Plan. These plans are more fully described in Part II, Item 8 in our Annual Report on Form 10-K for the fiscal year ended January 2, 2010 under the caption “Footnote 11 — Share-based Compensation Plans” and in Exhibit 10.1 to our current report on Form 8-K/A dated March 5, 2010.
As of October 10, 2009, options to purchase 10,000 shares of common stock at a weighted average price of $35.36 per share were outstanding and exercisable under the 2000 Plan. As of October 9, 2010, no options are outstanding.
Since 2005, awards have taken the form of performance units (including share units pursuant to our Long-Term Incentive Plan (“LTIP”)), restricted stock units (“RSUs”) and Stock Appreciation Rights (“SARs”).
Performance units have been granted during each of fiscal years 2005 through 2010 pursuant to our LTIP. These units vest at the end of a three-year performance period. All units under the 2006 plan were settled in shares of our common stock during the second quarter 2009. 102,133 units outstanding under the 2007 plan vested on January 2, 2010 and were settled in the second quarter 2010 for approximately 171,000 shares of common stock, of which approximately 145,000 were deferred by recipients until termination of employment as provided in the plan.
During year-to-date 2010 and fiscal year 2009, 123,128 and 108,696 units, respectively, were granted pursuant to our 2010 and 2009 LTIP. Depending on a comparison of the Company’s cumulative three-year actual EBITDA results to the cumulative three-year strategic plan EBITDA targets and the Company’s ranking on absolute return on net assets and compound annual growth rate for return on net assets among the companies in the peer group, a participant could receive a number of shares ranging from zero to 200% of the number of performance units granted. Because these units can only be settled in stock, compensation expense (for shares expected to vest) is recorded over the three-year period for the grant date fair value.
During fiscal 2006 through 2010, RSUs were awarded to certain executives of the Company. Awards vest in increments over the term of the grant or cliff vest on the fifth anniversary of the grant date, as designated in the award documents. In addition to the time vesting criteria, awards granted in 2008 and 2009 to two of the Company’s executives include performance vesting conditions. The Company records expense for such awards over the service vesting period if the Company anticipates the performance vesting conditions will be satisfied.
On December 17, 2008, in connection with the Company’s announcement of its planned acquisition of certain military distribution assets of GSC, eight executives of the Company were granted a total of 267,345 SARs with a per share price of $38.44. The SARs are eligible to become vested during the 36 month period commencing on closing of the acquisition of the GSC assets which was January 31, 2009. The SARs will vest on the first business day during the vesting period that follows the date on which the closing prices on NASDAQ for a share of Nash Finch common stock for the previous 90 market days is at least $55.00 or termination of the executive’s employment due to death or disability. Upon exercise, the Company will award the executive a number of shares of restricted stock equal to (a) the product of (i) the number of shares with respect to which the SAR is exercised and (ii) the excess, if any, of (x) the fair market value per share of common stock on the date of exercise over (y) the base price per share relating to such SAR, divided by (b) the fair market value of a share of common stock on the date such SAR is exercised. The restricted stock shall vest on the first anniversary of the date of exercise so long as the executive remains continuously employed with the Company.

 

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The fair value of SARs is estimated on the date of grant using a modified binomial lattice model which factors in the market and service vesting conditions. The modified binomial lattice model used by the Company incorporates a risk-free interest rate based on the 5-year treasury rate on the date of the grant. The model uses an expected volatility calculated as the daily price variance over 60, 200 and 400 days prior to grant date using the Fair Market Value (average of daily high and low market price of Nash Finch common stock) on each day. Dividend yield utilized in the model is calculated by the Company as the average of the daily yield (as a percent of the Fair Market Value) over 60, 200 and 400 days prior to the grant date. The modified binomial lattice model calculated a fair value of $8.44 per SAR which will be recorded over a derived service period of 3.55 years.
The following assumptions were used to determine the fair value of SARs granted during fiscal 2008:
         
Assumptions — SARs Valuation   2008 Grants  
 
       
Weighted-average risk-free interest rate
    1.37 %
Expected dividend yield
    1.86 %
Expected volatility
    35 %
Exercise price
  $ 38.44  
Market vesting price (90 consecutive market days at or above this price)
  $ 55.00  
Contractual term
  5.1 years  
The following table summarizes activity in our share-based compensation plans during the year-to-date period 2010:
                                 
            Weighted             Weighted  
            Average     Performance     Average  
            Remaining     Based Grants     Remaining  
    Service Based     Restriction/     (LTIP &     Restriction/  
    Grants (Board     Vesting Period     Performance     Vesting Period  
(in thousands, except vesting periods)   Units and RSUs)     (Years)     RSUs)     (Years)  
 
Outstanding at January 2, 2010
    606.8       1.0       408.1       1.0  
Granted
    33.1               123.6          
Forfeited/cancelled
                  (8.3 )        
Restrictions lapsed/ units settled
    (35.6 )             (102.1 )        
Shares deferred upon vesting/settlement & dividend equivalents on deferred shares*
    39.8               150.0          
 
                           
Outstanding at October 9, 2010
    644.1       0.7       571.3       0.9  
 
                       
 
                               
Exercisable/unrestricted at January 2, 2010
    273.6               170.6          
 
                           
Exercisable/unrestricted at October 9, 2010
    313.4               218.5          
 
                           
     
*   “Shares deferred upon vesting/settlement” above are net of the performance adjustment factor applied to the “units settled” for the participants that deferred shares as provided in the plan.
                 
            Weighted  
    Stock     Average  
    Appreciation     Base/Exercise  
(in thousands, except per share amounts)   Rights     Price Per SAR  
 
               
Outstanding at January 2, 2010
    267.3     $ 38.44  
Granted
             
Exercised/restrictions lapsed
             
Forfeited/cancelled
             
 
             
Outstanding at October 9, 2010
    267.3       38.44  
 
           
 
               
Exercisable/unrestricted at January 2, 2010
             
 
             
Exercisable/unrestricted at October 9, 2010
             
 
             
The weighted-average grant-date fair value of time vesting equity units and performance vesting units granted during year-to-date 2010 was $35.78 and $35.75, respectively.

 

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Note 5 — Fair Value Measurements
ASC Topic 820 (“ASC 820”) defines fair value, establishes a framework for measuring fair value and expands disclosures about financial and non-financial assets and liabilities recorded at fair value. It also applies under other accounting pronouncements that require or permit fair value measurements.
The fair value hierarchy for disclosure of fair value measurements under ASC 820 is as follows:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Quoted prices, other than quoted prices included in Level 1, which are observable for the assets or liabilities, either directly or indirectly.
Level 3: Inputs that are unobservable for the assets or liabilities.
Our outstanding interest rate swap agreements are classified within level 2 of the valuation hierarchy as readily observable market parameters are available to use as the basis of the fair value measurement. As of October 9, 2010, we have recorded a fair value liability of $0.6 million in relation to our outstanding interest rate swap agreements as compared to $1.1 million as of January 2, 2010, which is included in accrued expenses on our Consolidated Balance Sheet.
Other Financial Assets and Liabilities
Financial assets with carrying values approximating fair value include cash and cash equivalents and accounts receivable. Financial liabilities with carrying values approximating fair value include accounts payable and outstanding checks. The carrying value of these financial assets and liabilities approximates fair value due to their short maturities.
The fair value of notes receivable approximates the carrying value at October 9, 2010 and January 2, 2010. Substantially all notes receivable are based on floating interest rates which adjust to changes in market rates.
Long-term debt, which includes the current maturities of long-term debt, at October 9, 2010, had a carrying value and fair value of $300.0 million and $296.9 million, respectively, and at January 2, 2010, had a carrying value and fair value of $258.2 million and $255.0 million, respectively. The fair value is based on interest rates that are currently available to us for issuance of debt with similar terms and remaining maturities.
We account for the impairment of long-lived assets in accordance with ASC Subtopic 360-10-35. During the third quarter 2010 we recognized asset impairments of $0.1 million as compared to asset impairment of $0.8 million during the third quarter 2009. For year-to-date 2010 and 2009 assets impairments were $0.9 million and $1.7 million, respectively. We utilize a discounted cash flow model that incorporates unobservable level 3 inputs to test for long-lived asset impairment.
Note 6 — Derivatives
We have market risk exposure to changing interest rates primarily as a result of our borrowing activities and commodity price risk associated with anticipated purchases of diesel fuel. Our objective in managing our exposure to changes in interest rates and commodity prices is to reduce fluctuations in earnings and cash flows. From time-to-time we use derivative instruments, primarily interest rate and commodity swap agreements, to manage risk exposures when appropriate, based on market conditions. We do not enter into derivative agreements for trading or other speculative purposes, nor are we a party to any leveraged derivative instrument.

 

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The interest rate swap agreements are designated as cash flow hedges and are reflected at fair value in our Consolidated Balance Sheet and the related gains or losses on these contracts are deferred in stockholders’ equity as a component of other comprehensive income. As of October 9, 2010, and January 2, 2010, we had recorded a fair value liability of $0.6 million and $1.1 million, respectively, which are included in accrued expenses in our Consolidated Balance Sheet. Deferred gains and losses are amortized as an adjustment to interest expense over the same period in which the related items being hedged are recognized in income. However, to the extent that any of these contracts are not considered to be effective in accordance with ASC Topic 815 (“ASC 815”) in offsetting the change in the value of the items being hedged, any changes in fair value relating to the ineffective portion of these contracts are immediately recognized in income. Our two outstanding interest rate swaps have been considered effective in accordance with ASC 815 since they began during fiscal 2008.
Our interest rate swap agreements resulted in net payments of approximately $0.3 million and $0.5 million during the third quarters of fiscal 2010 and 2009, respectively, and resulted in net payments of $0.9 million and $1.2 million during year-to-date 2010 and year-to-date 2009, respectively, which are included in interest expense on our Consolidated Statement of Income.
As of October 9, 2010, we had two outstanding interest rate swap agreements with notional amounts totaling $35.0 million as compared to $52.5 million as of October 10, 2009. The notional amounts of the two outstanding swaps are reduced as follows (amounts in thousands):
                                 
Notional     Effective Date     Termination Date     Fixed Rate  
 
    $30,000       10/15/2008       10/15/2009       3.49%  
 
    20,000       10/15/2009       10/15/2010       3.49%  
 
    10,000       10/15/2010       10/15/2011       3.49%  
                                 
Notional     Effective Date     Termination Date     Fixed Rate  
 
    $22,500       10/15/2008       10/15/2009       3.38%  
 
    15,000       10/15/2009       10/15/2010       3.38%  
 
    7,500       10/15/2010       10/15/2011       3.38%  
In addition to the previously discussed interest rate and commodity swap agreements, from time-to-time we enter into fixed price fuel supply agreements to support our food distribution segment. On January 1, 2009, we entered into an agreement which required us to purchase a total of 252,000 gallons of diesel fuel per month at prices ranging from $1.90 to $1.98 per gallon. The term of the agreement was for one year and expired on December 31, 2009. This fixed price fuel agreement qualified for the “normal purchase” exception under ASC 815, therefore the fuel purchases under the contract were expensed as incurred as an increase to cost of sales.
Note 7 — Other Comprehensive Income
Other comprehensive income consists of market value adjustments to reflect derivative instruments at fair value, pursuant to ASC 815. The components of comprehensive income are as follows:
                                 
    16 Weeks Ended     Year-to-date Ended  
    October 9,     October 10,     October 9,     October 10,  
(In thousands)   2010     2009     2010     2009  
 
                               
Net earnings
  $ 15,346       21,927       34,001       45,885  
Change in fair value of derivatives, net of tax
    154 (1)     23 (2)     341 (3)     302 (4)
 
                       
Comprehensive income
  $ 15,500       21,950       34,342       46,187  
 
                       
     
(1)   Net of tax of $99.
 
(2)   Net of tax of $15.
 
(3)   Net of tax of $218.
 
(4)   Net of tax of $193.
The gain reported in other comprehensive income during the third quarter and year-to-date periods of 2010 and 2009 reflect a change in fair value of our outstanding interest rate swap agreements during the respective periods. During the third quarter and year-to-date periods of 2010 and 2009, our outstanding interest rate swap agreements were designated as cash flow hedges. Please refer to “Note 6 — Derivatives” of this Form 10-Q for information related to our interest rate swap agreements.

 

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Note 8 — Long-term Debt and Bank Credit Facilities
Total debt outstanding was comprised of the following:
                 
    October 9,     January 2,  
(In thousands)   2010     2010  
 
               
Asset-backed credit agreement:
               
Revolving credit
  $ 162,100       124,100  
Senior subordinated convertible debt, 3.50% due in 2035
    135,422       131,364  
Industrial development bonds, 5.60% to 5.75% due in various installments through 2014
    2,170       2,365  
Notes payable and mortgage notes, 7.95% due in various installments through 2013
    319       388  
 
           
Total debt
    300,011       258,217  
Less current maturities
    (648 )     (627 )
 
           
Long-term debt
  $ 299,363       257,590  
 
           
Asset-backed Credit Agreement
Our credit agreement is an asset-backed loan consisting of a $340.0 million revolving credit facility, which includes a $50.0 million letter of credit sub-facility (the “Revolving Credit Facility”). Provided no default is then existing or would arise, the Company may from time-to-time, request that the Revolving Credit Facility be increased by an aggregate amount (for all such requests) not to exceed $110.0 million. The Revolving Credit Facility has a 5-year term and will be due and payable in full on April 11, 2013. The Company can elect, at the time of borrowing, for loans to bear interest at a rate equal to the base rate, as defined in the credit agreement, or LIBOR plus a margin. The LIBOR interest rate margin was 2.00% as of October 9, 2010, and can vary quarterly in 0.25% increments between three pricing levels ranging from 1.75% to 2.25% based on the excess availability, which is defined in the credit agreement as (a) the lesser of (i) the borrowing base; or (ii) the aggregate commitments; minus (b) the aggregate of the outstanding credit extensions. As of October 9, 2010, $157.6 million was available under the Revolving Credit Facility after giving effect to outstanding borrowings and to $20.3 million of outstanding letters of credit primarily supporting workers’ compensation obligations and real estate purchases.
The credit agreement contains no financial covenants unless and until (i) the continuance of an event of default under the credit agreement, or (ii) the failure of the Company to maintain excess availability (a) greater than 10% of the borrowing base for more than two (2) consecutive business days or (b) greater than 7.5% of the borrowing base at any time, in which event, the Company must comply with a trailing 12-month basis consolidated fixed charge covenant ratio of 1.0:1.0, which ratio shall continue to be tested each month thereafter until excess availability exceeds 10% of the borrowing base for 90 consecutive days.
The credit agreement contains standard covenants requiring the Company and its subsidiaries, among other things, to maintain collateral, comply with applicable laws, keep proper books and records, preserve the corporate existence, maintain insurance, and pay taxes in a timely manner. Events of default under the credit agreement are usual and customary for transactions of this type including, among other things: (a) any failure to pay principal there under when due or to pay interest or fees on the due date; (b) material misrepresentations; (c) default under other agreements governing material indebtedness of the Company; (d) default in the performance or observation of any covenants; (e) any event of insolvency or bankruptcy; (f) any final judgments or orders to pay more than $15.0 million that remain unsecured or unpaid; (g) change of control, as defined in the credit agreement; and (h) any failure of a collateral document, after delivery thereof, to create a valid mortgage or first-priority lien.
We are currently in compliance with all covenants contained within the credit agreement.
Senior Subordinated Convertible Debt
To finance a portion of the acquisition of distribution centers in 2005, we sold $150.1 million in aggregate issue price (or $322.0 million aggregate principal amount at maturity) of senior subordinated convertible notes due in 2035. The notes are our unsecured senior subordinated obligations and rank junior to our existing and future senior indebtedness, including borrowings under our Revolving Credit Facility. See our Annual Report on Form 10-K for the fiscal year ended January 2, 2010, for additional information regarding the notes.

 

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Note 9 — Guarantees
We have guaranteed debt and lease obligations of certain food distribution customers. In the event these retailers are unable to meet their debt service payments or otherwise experience an event of default, we would be unconditionally liable for the outstanding balance of their debt and lease obligations ($10.4 million as of October 9, 2010, as compared to $13.5 million as of January 2, 2010), which would be due in accordance with the underlying agreements.
We have entered into debt and lease guarantees on behalf of certain food distribution customers that are accounted for under ASC Topic 460 (“ASC 460”). ASC 460 provides that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value of the obligation it assumes under that guarantee. The maximum undiscounted payments we would be required to make in the event of default under the guarantees is $7.6 million, which is included in the $10.4 million total referenced above. These guarantees are secured by certain business assets and personal guarantees of the respective customers. We believe these customers will be able to perform under their respective agreements and that no payments will be required and no loss will be incurred under the guarantees. As required by ASC 460, a liability representing the fair value of the obligations assumed under the guarantees of $1.0 million is included in the accompanying consolidated financial statements for the guarantees accounted for under ASC 460. All of the other guarantees were issued prior to December 31, 2002 and therefore not subject to the recognition and measurement provisions of ASC 460.
We have also assigned various leases to other entities. If the assignees were to become unable to continue making payments under the assigned leases, we estimate our maximum potential obligation with respect to the assigned leases to be $9.5 million as of October 9, 2010 as compared to $8.0 million as of January 2, 2010.
Note 10 — Income Taxes
For the third quarter 2010 and 2009 our tax expense was $7.5 million and $9.7 million, respectively. Year-to-date 2010 and 2009 tax expense was $20.1 million and $19.4 million, respectively.
The provision for income taxes reflects the Company’s estimate of the effective rate expected to be applicable for the full fiscal year, adjusted for any discrete events, which are reported in the period that they occur. This estimate is re-evaluated each quarter based on the Company’s estimated tax expense for the full fiscal year. The third quarter 2010 effective tax rate was impacted by the reversal of previously unrecognized tax benefits primarily due to statute of limitations expirations. For the third quarter 2009, the effective tax rate was reflective of the effects from the settlement of 2009 uncertain tax positions including the release of certain income tax contingency reserves related to these discrete events. Additionally, the third quarter 2009 reflects the one time tax effect on the gain from the settlement of the legal litigation with Roundy’s. For the third quarter 2010 and 2009, the effective tax rate was 32.8% and 30.7%, respectively.
The total amount of unrecognized tax benefits as of end of the third quarter 2010 was $11.6 million. The net decrease in unrecognized tax benefits of $1.7 million since June 19, 2010 was due to a $2.4 million decrease in the unrecognized tax benefits relating to expiration of the statute of limitations. This was offset by a $0.7 million increase in unrecognized tax benefits as a result of tax positions taken in prior periods. The total amount of tax benefits that if recognized would impact the effective tax rate was $3.9 million at the end of the third quarter 2010. We recognize interest and penalties accrued related to unrecognized tax benefits in income tax expense. At the end of the third quarter 2010, we had approximately $1.7 million for the payment of interest and penalties accrued.
During the next 12 months, the Company anticipates the federal and various state and local statutes of limitation to expire. Due to the uncertain response of the taxing authorities, an estimate of the range of possible outcomes cannot be reasonably estimated at this time. Audit outcomes and the timing of audit settlements are subject to significant uncertainty.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state and local jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for years 2006 and prior. We are currently under audit by the Internal Revenue Service for our fiscal year 2008.

 

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Note 11 — Pension and Other Postretirement Benefits
The following tables present the components of our pension and postretirement net periodic benefit cost:
16 Weeks Ended October 9, 2010, and October 10, 2009:
                                 
    Pension Benefits     Other Benefits  
(In thousands)   2010     2009     2010     2009  
 
                               
Interest cost
  $ 680       716       12       15  
Expected return on plan assets
    (570 )     (551 )            
Amortization of prior service cost
                (9 )     (25 )
Recognized actuarial loss (gain)
    431       422       (2 )     (2 )
 
                       
Net periodic benefit cost
  $ 541       587       1       (12 )
 
                       
40 Weeks Ended October 9, 2010, and October 10, 2009:
                                 
    Pension Benefits     Other Benefits  
(In thousands)   2010     2009     2010     2009  
 
                               
Interest cost
  $ 1,701       1,790       30       37  
Expected return on plan assets
    (1,427 )     (1,377 )            
Amortization of prior service cost
                (23 )     (63 )
Recognized actuarial loss (gain)
    1,078       1,054       (5 )     (4 )
 
                       
Net periodic benefit cost
  $ 1,352       1,467       2       (30 )
 
                       
Weighted-average assumptions used to determine net periodic benefit cost for the first three quarters of 2010 and first three quarter of 2009 were as follows:
                                 
    Pension Benefits     Other Benefits  
    2010     2009     2010     2009  
Weighted-average assumptions:
                               
Discount rate
    5.60 %     6.30 %     5.60 %     6.30 %
Expected return on plan assets
    6.50 %     7.00 %     N/A       N/A  
Rate of compensation increase
    N/A       N/A       N/A       N/A  
Total contributions to our pension plan in fiscal 2010 are expected to be $0.9 million.
Multi-employer pension plan
Certain of our unionized employees are covered by the Central States Southeast and Southwest Areas Pension Funds (“the Plan”), a multi-employer pension plan. Contributions are determined in accordance with the provisions of negotiated union contracts and are generally based on the number of hours worked. In fiscal 2009, the Company contributed $3.5 million to the Plan. Based on the most recent information available we believe the present value of actuarial accrued liabilities of the Plan substantially exceeds the value of the assets held in trust to pay benefits. The underfunding is not a direct obligation or liability of the Company. Moreover, if the Company were to exit certain markets or otherwise cease making contributions to the Plan, the Company could trigger a substantial withdrawal liability. However, the amount of any increase in contributions will depend upon several factors, including the number of employers contributing to the Plan, results of the Company’s collective bargaining efforts, investment returns on assets held by the Plan, actions taken by the trustees of the Plan, and actions that the Federal government may take. We are currently unable to reasonably estimate a liability. Any adjustment for withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably estimated.

 

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Note 12— Earnings Per Share
The following table reflects the calculation of basic and diluted earnings per share:
                                 
    Third Quarter Ended     Year-to-Date Ended  
    October 9,     October 10,     October 9,     October 10,  
(In thousands, except per share amounts)   2010     2009     2010     2009  
 
                               
Net earnings
  $ 15,346       21,927       34,001       45,885  
 
                       
 
                               
Net earnings per share-basic:
                               
Weighted-average shares outstanding
    12,656       13,021       12,870       12,998  
 
                               
Net earnings per share-basic
  $ 1.21       1.68       2.64       3.53  
 
                       
 
                               
Net earnings per share-diluted:
                               
Weighted-average shares outstanding
    12,656       13,021       12,870       12,998  
Dilutive impact of options
                      1  
Shares contingently issuable
    382       356       353       345  
 
                       
Weighted-average shares and potential dilutive shares outstanding
    13,038       13,377       13,223       13,344  
 
                       
 
                               
Net earnings per share-diluted
  $ 1.18       1.64       2.57       3.44  
 
                       
 
Anti-dilutive options excluded from calculation (weighted-average amount for period)
          10             5  
Certain options and SARs were excluded from the calculation of diluted net earnings per share because the exercise price was greater than the market price of the stock and would have been anti-dilutive under the treasury stock method.
The senior subordinated convertible notes due 2035 will be convertible at the option of the holder, only upon the occurrence of certain events, at an adjusted conversion rate of 9.5222 shares (initially 9.3120) of our common stock per $1,000 principal amount at maturity of notes (equal to an adjusted conversion price of approximately $48.95 per share). Upon conversion, we will pay the holder the conversion value in cash up to the accreted principal amount of the note and the excess conversion value, if any, in cash, stock or both, at our option. The notes are only dilutive above their accreted value and for all periods presented the weighted average market price of the Company’s stock did not exceed the accreted value. Therefore, the notes are not dilutive to earnings per share for any of the periods presented.
During the second quarter 2010 and 2009, performance units granted under the 2007 LTIP Plan and 2006 LTIP Plan, respectively, were settled in shares of common stock, some of which were deferred by executives as required by the plans. Vested shares deferred by executives are included in the calculation of basic earnings per share. Other performance units and RSUs granted during 2007, 2008, 2009 and 2010 pursuant to the 2000 Plan and 2009 Plan will be settled in shares of Nash Finch common stock. Unvested RSUs are not included in basic earnings per share until vested. All shares of time-restricted stock are included in diluted earnings per share using the treasury stock method, if dilutive. Performance units granted for the LTIP are only issuable if certain performance criteria are met, making these shares contingently issuable under ASC Topic 260. Therefore, the performance units are included in diluted earnings per share at the payout percentage based on performance criteria results as of the end of the respective reporting period and then accounted for using the treasury stock method, if dilutive. For the third quarter 2010, approximately 170,000 shares related to the LTIP and 212,000 shares related to RSUs were included under “shares contingently issuable” in the calculation of diluted EPS as compared to 201,000 shares related to the LTIP and 155,000 shares related to RSUs during the third quarter 2009. For year-to-date 2010, approximately 142,000 shares related to the LTIP and 211,000 shares related to RSUs were included under “shares contingently issuable” in the calculation of diluted EPS as compared to 190,000 shares related to the LTIP and 155,000 shares related to RSUs during year-to-date 2009.

 

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Note 13 — Segment Reporting
We sell and distribute products that are typically found in supermarkets and operate three reportable operating segments. Our food distribution segment consists of 14 distribution centers that sell to independently operated retail food stores, our corporate owned stores and other customers. During the third quarter 2010, we closed our food distribution center in Bridgeport, Michigan. The military segment consists primarily of six distribution centers that distribute products exclusively to military commissaries and exchanges. During the third quarter 2010, our military distribution center in Columbus, Georgia, which is now included in the six distribution centers noted above, became operational. Excluded from the military distribution center totals are three military distribution centers we purchased during the third quarter 2010 in Bloomington, Indiana and Oklahoma City, Oklahoma. The Bloomington, Indiana facility is scheduled to become operational during the fourth fiscal quarter of 2010 while Oklahoma City, Oklahoma, which consists of two adjacent properties, is scheduled to become operational during fiscal 2012. The retail segment consists of 53 corporate-owned stores that sell directly to the consumer. We closed one retail store during the third quarter 2010.
In fiscal 2010, the Company revised its calculation of segment profit and unallocated corporate overhead to present segment profitability on a fully-allocated basis, with the exception of costs associated with corporate debt and other discrete items as shown in the “as adjusted” columns below. In addition, LIFO expenses or credits are now allocated to the business segments. Management believes the revised calculation of segment profit more accurately represents the operating profitability of the reporting segments, on a pre-tax basis. The revision had no impact on the Company’s consolidated financial statements in any period presented. Previously, interest expense was included in unallocated corporate overhead. Certain prior year amounts shown below have been revised to conform to the current year presentation. Amounts related to fiscal 2009 periods after the third quarter will be revised as shown the next time those periods are presented.
                                 
    3rd Quarter 2009     4th Quarter 2009  
    Segment profit     Segment profit  
    As     As     As     As  
(In thousands)   adjusted     reported     adjusted     reported  
 
                               
Food Distribution
  $ 15,181       27,302       11,495       20,611  
Military
    13,448       15,183       10,146       11,400  
Retail
    1,937       5,882       (1,449 )     2,381  
 
                       
Total segment profit
    30,566       48,367       20,192       34,392  
 
                               
Adjustment of inventory to LIFO
          445             2,301  
Gain on acquisition of a business
                       
Gain on litigation settlement
    7,630       7,630              
Goodwill impairment
                (50,927 )     (50,927 )
Special charge
                (6,020 )     (6,020 )
Interest
    (6,541 )           (4,790 )      
Unallocated corporate overhead
          (24,787 )           (21,291 )
 
                       
Earnings before income taxes
  $ 31,655       31,655       (41,545 )     (41,545 )
 
                       

 

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    3rd Quarter 2009        
    Year-to-date     Fiscal 2009  
    Segment profit     Segment profit  
    As     As     As     As  
(In thousands)   adjusted     reported     adjusted     reported  
 
Food Distribution
  $ 31,671       67,505       43,166       88,116  
Military
    32,774       38,317       42,920       49,717  
Retail
    2,676       13,507       1,227       15,888  
 
                       
Total segment profit
    67,121       119,329       87,313       153,721  
 
                               
Adjustment of inventory to LIFO
          732             3,033  
Gain on acquisition of a business
    6,682       6,682       6,682       6,682  
Gain on litigation settlement
    7,630       7,630       7,630       7,630  
Goodwill impairment
                (50,927 )     (50,927 )
Special charge
                (6,020 )     (6,020 )
Interest
    (16,138 )           (20,928 )      
Unallocated corporate overhead
          (69,078 )           (90,369 )
 
                       
Earnings before income taxes
  $ 65,295       65,295       23,750       23,750  
 
                       
A summary of the major segments of the business is as follows:
                                                 
    Third Quarter Ended  
    October 9, 2010     October 10, 2009  
    Sales from     Inter-             Sales from     Inter-        
    external     segment     Segment     external     segment     Segment  
(In thousands)   customers     sales     profit     customers     sales     profit  
 
                                               
Food Distribution
  $ 731,503       78,439       12,848       818,202       90,231       15,181  
Military
    620,822             12,822       637,056             13,448  
Retail
    158,556             2,824       178,046             1,937  
Eliminations
          (78,439 )                 (90,231 )      
 
                                   
Total
  $ 1,510,881             28,494       1,633,304             30,566  
 
                                   
                                                 
    Year-to-Date Ended  
    October 9, 2010     October 10, 2009  
    Sales from     Inter-             Sales from     Inter-        
    external     segment     Segment     external     segment     Segment  
(In thousands)   customers     sales     profit     customers     sales     profit  
 
                                               
Food Distribution
  $ 1,889,511       198,092       27,228       2,040,013       224,000       31,671  
Military
    1,555,407             36,157       1,508,312             32,774  
Retail
    400,273             5,440       441,893             2,676  
Eliminations
          (198,092 )                 (224,000 )      
 
                                   
Total
  $ 3,845,191             68,825       3,990,218             67,121  
 
                                   

 

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Reconciliation to Consolidated Statements of Income:
                                 
    Third Quarter Ended     Year-to-Date Ended  
    October 9,     October 10,     October 9,     October 10,  
(In thousands)   2010     2009     2010     2009  
 
                               
Total segment profit
  $ 28,494       30,566       68,825       67,121  
Unallocated amounts:
                               
Gain on acquisition of a business
                      6,682  
Gain on litigation settlement
          7,630             7,630  
Interest
    (5,664 )     (6,541 )     (14,699 )     (16,138 )
 
                       
Earnings before income taxes
  $ 22,830       31,655       54,126       65,295  
 
                       
Note 14 — Share Repurchase
On November 10, 2009, our Board of Directors approved a share repurchase program authorizing the Company to spend up to $25.0 million to purchase shares of the Company’s common stock. The program took effect on November 16, 2009, and will continue until the earlier to occur of (i) the date that the aggregate purchases under the program reach $25.0 million, or (ii) December 31, 2010. During the third quarter 2010, we repurchased a total of 141,023 shares for $5.0 million, at an average price per share of $35.11 and during year-to-date 2010, we have repurchased 582,735 shares for $20.3 million, at an average price per share of $34.78. Since the program’s inception, we have repurchased a total of 613,455 shares for $21.3 million, at an average price per share of $34.70. The average prices per share referenced above include commissions.
Note 15 — Military Real Estate Purchases
During the third quarter 2010, we purchased three properties for the expansion of our military food distribution business in Bloomington, Indiana and Oklahoma City, Oklahoma. The Bloomington, Indiana facility is approximately 303,000 square feet and Oklahoma City, Oklahoma consists of two adjacent properties with 538,000 combined square feet. In addition, we exercised an option to purchase the real estate of our existing military food distribution facility in Pensacola, Florida for $9.5 million, which had previously been leased.
We utilized our Revolving Credit Facility to finance the purchase of the facilities in Bloomington, Indiana and Oklahoma City, Oklahoma for a combined total of $16.0 million. We made a $1.0 million earnest money payment to the sellers of the Pensacola, Florida facility at the time we exercised the purchase option with the remaining $8.5 million included on the accounts and other payables line on our Consolidated Balance Sheet.
Note 16 — Legal Proceedings
We are engaged from time-to-time in routine legal proceedings incidental to our business. We do not believe that these routine legal proceedings, taken as a whole, will have a material impact on our business or financial condition.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Information and Cautionary Factors
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements relate to trends and events that may affect our future financial position and operating results. Any statement contained in this report that is not statements of historical fact may be deemed forward-looking statements. For example, words such as “may,” “will,” “should,” “likely,” “expect,” “anticipate,” “estimate,” “believe,” “intend, “ “potential” or “plan,” or comparable terminology, are intended to identify forward-looking statements. Such statements are based upon current expectations, estimates and assumptions, and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Important factors known to us that could cause or contribute to material differences include, but are not limited to the following:
  the effect of competition on our food distribution, military and retail businesses;
  general sensitivity to economic conditions, including the uncertainty related to the current state of the economy in the U.S. and worldwide economic slowdown; continued disruptions to the credit and financial markets in the U.S. and worldwide; changes in market interest rates; continued volatility in energy prices and food commodities;
  macroeconomic and geopolitical events affecting commerce generally;
  changes in consumer buying and spending patterns;
  our ability to identify and execute plans to expand our food distribution, military and retail operations;
  possible changes in the military commissary system, including those stemming from the redeployment of forces, congressional action and funding levels;
  our ability to identify and execute plans to improve the competitive position of our retail operations;
  the success or failure of strategic plans, new business ventures or initiatives;
  our ability to successfully integrate and manage current or future businesses we acquire, including the ability to manage credit risks and retain the customers of those operations;
  changes in credit risk from financial accommodations extended to new or existing customers;
  significant changes in the nature of vendor promotional programs and the allocation of funds among the programs;
  limitations on financial and operating flexibility due to debt levels and debt instrument covenants;
  legal, governmental, legislative or administrative proceedings, disputes, or actions that result in adverse outcomes;
  failure of our internal control over financial reporting;
 
  changes in accounting standards;
 
  technology failures that may have a material adverse effect on our business;
 
  severe weather and natural disasters that may impact our supply chain;
 
  unionization of a significant portion of our workforce;
  costs related to a multi-employer pension plan which has liabilities in excess of plan assets;
  changes in health care, pension and wage costs and labor relations issues;
  product liability claims, including claims concerning food and prepared food products;
  threats or potential threats to security; and
  unanticipated problems with product procurement.
A more detailed discussion of many of these factors, as well as other factors, that could affect the Company’s results is contained in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ended January 2, 2010. You should carefully consider each of these factors and all of the other information in this report. We believe that all forward-looking statements are based upon reasonable assumptions when made. However, we caution that it is impossible to predict actual results or outcomes and that accordingly you should not place undue reliance on these statements. Forward-looking statements speak only as of the date when made and we undertake no obligation to revise or update these statements in light of subsequent events or developments. Actual results and outcomes may differ materially from anticipated results or outcomes discussed in forward-looking statements. You are advised, however, to consult any future disclosures we make on related subjects in future reports to the Securities and Exchange Commission (“SEC”).

 

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Overview
In terms of revenue, we are the second largest publicly traded wholesale food distributor in the United States serving the retail grocery industry and the military commissary and exchange systems. Our business consists of three primary operating segments: food distribution, military food distribution and retail.
In November 2006, we announced the launch of a strategic plan, Operation Fresh Start, designed to sharpen our focus and provide a strong platform to support growth initiatives. Our strategic plan is built upon extensive knowledge of current industry, consumer and market trends, and formulated to differentiate the Company. The strategic plan includes long-term initiatives to increase revenues and earnings, improve productivity and cost efficiencies of our Food Distribution, Retail, and Military business segments, and leverage our corporate support services. The Company has strategic initiatives to improve working capital, manage debt, and increase shareholder value through capital expenditures with acceptable returns on investment. Several important elements of the strategic plan include:
    Supply chain services focused on supporting our businesses with warehouse management, inbound and outbound transportation management and customized solutions for each business;
    Growing the Military business segment through acquisition and expansion of products and services, as well as creating warehousing and transportation cost efficiencies with a long-term distribution center strategic plan;
    Providing our independent retail customers with high level of order fulfillment, broad product selection including leveraging the Our Family brand, support services emphasizing best-in-class offerings in marketing, advertising, merchandising, store design and construction, market research, retail store support, retail pricing and license agreement opportunities; and
    Retail formats designed to appeal to the needs of today’s consumers.
In addition to the strategic initiatives already in progress, our 2010 initiatives consist of the following:
    Implement our military distribution center network expansion including opening a new distribution center, completing the integration of three distribution facilities acquired from GSC Enterprises, and identifying alternative locations for future expansion;
    Complete supply chain and center store initiatives within our food distribution segment;
    Implement new cost reduction and profit improvement initiatives; and
    Identify acquisitions that support our strategic plan.
Our food distribution segment sells and distributes a wide variety of nationally branded and private label grocery products and perishable food products from 14 distribution centers to approximately 1,700 independent retail locations located in 28 states across the United States. Several of our distribution centers also distribute products to military commissaries and exchanges located in their respective geographic areas. During the third quarter of fiscal 2010 we closed our Bridgeport, Michigan food distribution center.
Our military segment contracts with manufacturers and food brokers to distribute a wide variety of grocery products to military commissaries and exchanges located in the United States and the District of Columbia, and in Europe, Puerto Rico, Cuba, the Azores and Egypt. We have over 30 years of experience acting as a distributor to U.S. military commissaries and exchanges. On January 31, 2009, we completed the purchase from GSC Enterprises, Inc., of substantially all of the assets relating to three wholesale food distribution centers located in San Antonio, Texas, Pensacola, Florida, and Junction City, Kansas, including all inventory and customer contracts related to the purchased facilities (“GSC acquisition”). On December 1, 2009, we announced our purchase of a facility in Columbus, Georgia, which began servicing military commissaries and exchanges in the third fiscal quarter of 2010. During the third quarter of fiscal 2010, we three purchased facilities in Bloomington, Indiana and Oklahoma City, Oklahoma. We anticipate the Bloomington, Indiana facility will begin servicing military commissaries and exchanges during the fourth fiscal quarter of 2010 and the two adjacent facilities in Oklahoma City, Oklahoma will become operational in fiscal 2012.

 

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Our retail segment operated 53 corporate-owned stores primarily in the Upper Midwest as of October 9, 2010. Primarily due to highly competitive conditions in which supercenters and other alternative formats compete for price conscious customers, we closed one retail store in 2010 and four retail stores in 2009. We are implementing initiatives of varying scope and duration with a view toward improving our response to and performance under these highly competitive conditions. These initiatives include designing and reformatting some of our retail stores into alternative formats to increase overall retail sales performance. As we continue to assess the impact of performance improvement initiatives and the operating results of individual stores, we may need to recognize additional impairments of long-lived assets and goodwill associated with our retail segment, and may incur restructuring or other charges in connection with closure or sales activities. The retail segment yields a higher gross profit percent of sales and higher selling, general and administrative (“SG&A”) expenses as a percent of sales compared to our food distribution and military segments. Thus, changes in sales of the retail segment can have a disproportionate impact on consolidated gross profit and SG&A as compared to similar changes in sales in our food distribution and military segments.
Results of Operations
Sales
The following tables summarize our sales activity for the 16 weeks ended October 9, 2010 (“third quarter 2010”), compared to the 16 weeks ended October 10, 2009 (“third quarter 2009”), and the 40 weeks ended October 9, 2010 (“year-to-date 2010”), compared to the 40 weeks ended October 10, 2009 (“year-to-date 2009”):
                                                 
    Third quarter 2010     Third quarter 2009        
            Percent of             Percent of     Increase/(Decrease)  
(In thousands)   Sales     Sales     Sales     Sales     $     %  
Segment Sales:
                                               
Food Distribution
  $ 731,503       48.4 %     818,202       50.1 %     (86,699 )     (10.6 %)
Military
    620,822       41.1 %     637,056       39.0 %     (16,234 )     (2.5 %)
Retail
    158,556       10.5 %     178,046       10.9 %     (19,490 )     (10.9 %)
 
                                     
Total Sales
  $ 1,510,881       100.0 %     1,633,304       100.0 %     (122,423 )     (7.5 %)
 
                                     
                                                 
    Year-to-date 2010     Year-to-date 2009        
            Percent of             Percent of     Increase/(Decrease)  
(In thousands)   Sales     Sales     Sales     Sales     $     %  
Segment Sales:
                                               
Food Distribution
  $ 1,889,511       49.1 %     2,040,013       51.1 %     (150,502 )     (7.4 %)
Military
    1,555,407       40.5 %     1,508,312       37.8 %     47,095       3.1 %
Retail
    400,273       10.4 %     441,893       11.1 %     (41,620 )     (9.4 %)
 
                                     
Total Sales
  $ 3,845,191       100.0 %     3,990,218       100.0 %     (145,027 )     (3.6 %)
 
                                     
Total Company sales declined 7.5% during the third quarter 2010 as compared to the comparable prior year period. Excluding the previously announced transition of a portion of a food distribution customer buying group to another supplier during the second quarter 2010, total Company sales declined 4.9% during the third quarter 2010.
Total Company sales declined 3.6% during year-to-date 2010 as compared to the comparable prior year period. However, excluding the additional sales of $59.4 million attributable to acquired military locations during the first quarter 2010 and the previously announced transition of a portion of a food distribution customer buying group to another supplier during the second quarter 2010, total Company sales declined 3.7% during year-to-date 2010.
The decrease in food distribution sales for the third quarter 2010 of 10.6% is primarily attributable to the previously announced transition of a portion of a food distribution customer buying group to another supplier during the second quarter 2010 which accounted for $44.6 million in sales during the third quarter 2009 and a decline in comparable sales to existing customers. Excluding the impact of the customer transition, food distribution sales declined 5.4%. The decrease in comparable sales to existing customers was partially attributable to deflation in certain product categories.

 

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Food distribution sales declined 7.4% during year-to-date 2010 which is primarily attributable to a decrease in comparable sales to existing customers and the previously announced transition of a portion of a food distribution customer buying group to another supplier during the second quarter 2010 which accounted for $60.8 million during year-to-date 2009. Excluding the impact of this customer, food distribution sales declined 4.5%. The decrease in comparable sales to existing customers during year-to-date 2010 was partially attributable to deflation in certain product categories.
Military segment sales were down 2.5% during the third quarter 2010 as compared to the prior year, primarily due to timing differences between the quarters relating to export shipments and to a lesser extent from a reduction in domestic sales promotions. Domestic sales declined 1.6% decline while overseas sales declined 6.3% as compared to the comparable prior year quarter.
Year-to-date military sales increased 3.1% in comparison to the prior year. However, excluding the additional sales attributable to the acquired locations during the first quarter 2010 of $59.4 million, year-to-date comparable military segment sales decreased by 0.8% in comparison to the prior year. The comparable decrease in year-to-date military segment sales is due to a 1.3% decrease in domestic sales which was partially offset by a 1.3% increase in sales overseas.
Domestic and overseas sales represented the following percentages of military segment sales. Note that the business acquired through the GSC acquisition services domestic military bases only.
                                 
    Third Quarter     Year-to-date  
    2010     2009     2010     2009  
Domestic
    81.2 %     80.4 %     81.0 %     80.6 %
Overseas
    18.8 %     19.6 %     19.0 %     19.4 %
Retail sales were down 10.9% and 9.4% during the third quarter and year-to-date 2010, respectively, as compared to the comparable prior year periods. Same store sales were down 6.3% and 4.9% during the third quarter and year-to-date 2010, respectively. Same store sales compare retail sales for stores which were in operation for the same number of weeks in the comparative periods. In addition, we have closed four retail stores since the beginning of the third quarter 2009.
During the third quarters of 2010 and 2009, our corporate store count changed as follows:
                 
    Third quarter     Third quarter  
    2010     2009  
Number of stores at beginning of period
    54       57  
Closed stores
    (1 )      
 
           
Number of stores at end of period
    53       57  
 
           
During year-to-date 2010 and 2009, our corporate store count changed as follows:
                 
    Year-to-date     Year-to-date  
    2010     2009  
Number of stores at beginning of period
    54       57  
New stores
          1  
Closed stores
    (1 )     (1 )
 
           
Number of stores at end of period
    53       57  
 
           

 

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Consolidated Gross Profit
Consolidated gross profit was 8.1% of sales for the third quarter 2010 compared to 7.9% of sales for the third quarter 2009. Our gross profit margin improved by 0.3% of sales during the third quarter, which was driven primarily by higher gross margin performance in our food distribution and military segments. However, our overall gross profit margin was negatively affected by 0.1% of sales in the third quarter 2010 due to a sales mix shift between our business segments between the years. This was due to a higher percentage of 2010 sales occurring in the military segment which have a lower gross profit margin than the retail and food distribution segments.
Consolidated gross profit was 8.0% of sales for year-to-date 2010 compared to 8.1% of sales for the year-to-date 2009. Our overall gross profit margin was negatively affected by 0.2% of sales during year-to-date 2010 due to a sales mix shift between our business segments between the years. This was due to a higher percentage of 2010 sales occurring in the military segment, due primarily to the GSC acquisition, which have a lower gross profit margin than the retail and food distribution segments. However, the impact of the sales mix shift was partially offset by higher gross margin performance in our food distribution and military segments.
Consolidated Selling, General and Administrative Expenses
Consolidated SG&A for the third quarter 2010 was 5.4% of sales as compared to 5.2% of sales during the third quarter 2009. Our SG&A was negatively impacted by year-over-year increases in non-cash stock compensation of $1.0 million, employee insurance costs of $0.7 million and $0.7 million in workers compensation claim costs, or in total 0.2% of sales. However, our SG&A benefited by 0.1% of sales during the third quarter 2010 due to the sales mix shift between our business segments due to the higher level of military sales relative to the other business segments in 2009.
Consolidated SG&A for year-to-date 2010 was 5.4% of sales as compared to 5.6% of sales during year-to-date 2009. Our SG&A margin benefited by 0.2% of sales during year-to-date 2010 due to the sales mix shift between our business segments due to the higher level of military sales relative to the other business segments in 2009.
Gain on Acquisition of a Business
A gain on the acquisition of a business of $6.7 million (net of tax) was recognized during the first quarter 2009 related to the GSC acquisition. The fair value of the identifiable assets acquired and liabilities assumed of $84.8 million exceeded the fair value of the purchase price of the business of $78.1 million. Consequently, we reassessed the recognition and measurement of identifiable assets acquired and liabilities assumed and concluded that the valuation procedures and resulting measures were appropriate.
Gain on Litigation Settlement
A gain of $7.6 million was recognized in the third quarter 2009 related to the settlement of litigation in connection with our 2005 acquisition of certain distribution centers and other assets from Roundy’s Supermarkets, Inc. A more detailed discussion of this litigation settlement is contained in Part I, Item 3, “Legal Proceedings,” of our Annual Report on Form 10-K for the fiscal year ended January 2, 2010.
Depreciation and Amortization Expense
Depreciation and amortization expense was $10.9 million for the third quarter 2010 as compared to $12.6 million during the comparable prior year period. Depreciation and amortization expense was $27.6 million during year-to-date 2010 as compared to $31.3 million during year-to-date 2009. The decrease during the current year periods as compared to the prior year is attributable to lower depreciation and amortization expense in our food distribution and retail segments.
Interest Expense
Interest expense was $7.1 million for the third quarter 2010 compared to $7.6 million for the comparable prior year period. Average borrowing levels decreased from $357.9 million during the third quarter 2009 to $323.4 million during the third quarter 2010. The effective interest rate was 4.6% for the third quarter 2010 as compared to 4.7% for the third quarter 2009. Interest expense was $17.7 million for year-to-date 2010 compared to $18.8 million for the comparable prior year period. Average borrowing levels decreased from $361.9 million during year-to-date 2009 to $324.5 million during year-to-date 2010. The effective interest rate was 4.6% for both year-to-date 2010 and 2009. Certain components of our interest expense are excluded from the calculation of our effective interest rate as the costs are not directly attributable to our long-term borrowing rates.

 

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The calculation of our effective interest rate excludes non-cash interest required to be recognized on our senior subordinated convertible notes under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 470-20 (“ASC 470-20”). Non-cash interest expense recognized under ASC 470-20 was $1.6 million and $1.5 million during the third quarter 2010 and 2009, respectively, and was $4.1 and $3.8 million for year-to-date 2010 and 2009, respectively. Additionally, the calculation of our average borrowing levels includes the unamortized equity component of our senior subordinated convertible notes that is required to be recognized under ASC 470-20. The inclusion of the unamortized equity component brings the basis in our senior subordinated convertible notes to $150.1 million for purposes of calculating our average borrowing levels, or their aggregate issue price, which we are required to pay semi-annual cash interest on at a rate of 3.50% until March 15, 2013.
Income Taxes
Income tax expense is provided on an interim basis using management’s estimate of the annual effective rate. Our effective tax rate for the full fiscal year is subject to change and may be impacted by changes to nondeductible items and tax reserve requirements in relation to our forecasts of operations, sales mix by taxing jurisdictions, or to changes in tax laws and regulations. The effective income tax rate was 32.8% and 30.7% for the third quarter 2010 and third quarter 2009, respectively. The effective income tax rate was 37.2% and 29.7% for year-to-date 2010 and 2009, respectively.
During the third quarter of 2010, various federal, state and local statutes of limitations expired. During the third quarter 2009, the Company filed claims with and received refunds from various tax authorities. Accordingly, the Company reported the effect of these discrete events in the third quarters 2010 and 2009, respectively. The lower effective tax rate for the third quarter 2010 and 2009 are reflective of the results from the reversal, refunds and the settlement of uncertain tax positions. The effective rate for the third quarters differed from statutory rates due to the amount of permanent book tax differences relative to the Company’s pre-tax book income. We estimate the full year effective tax rate for 2010 will be approximately 38.2% which excludes the potential impact of discrete events.
Net Earnings
Net earnings for the third quarter 2010 were $15.3 million, or $1.18 per diluted share, as compared to net earnings of $21.9 million, or $1.64 per diluted share, in the third quarter 2009. Net earnings for year-to-date 2010 were $34.0 million, or $2.57 per diluted share, as compared to net earnings of $45.9 million, or $3.44 per diluted share, during year-to-date 2009. Net earnings in the periods presented in this report were affected by a number of events included in the discussion above that affected the comparability of results.
Liquidity and Capital Resources
The following table summarizes our cash flow activity and should be read in conjunction with the Consolidated Statements of Cash Flows:
                         
    40 Weeks Ended        
    October 9,     October 10,     Increase/  
(In thousands)   2010     2009     (Decrease)  
 
                       
Net cash provided by operating activities
  $ 16,311       22,298       (5,987 )
Net cash used in investing activities
    (39,070 )     (89,080 )     50,010  
Net cash provided by financing activities
    22,714       66,818       (44,104 )
 
                 
Net change in cash and cash equivalents
  $ (45 )     36       (81 )
 
                 
Cash provided by operating activities decreased $6.0 million during year-to-date 2010 as compared to year-to-date 2009. A year-over-year increase in our investment in inventories of $23.0 million, a year-over-year decrease in accounts payable of $8.9 million and a year-over-year decrease in income taxes payable of $6.3 million were the primary factor contributions to the decline in cash provided by operating activities as compared to the prior year. However, these items were partially offset by a year-over-year decrease in accounts receivable of $16.3 million and a year-over-year increase in accrued expenses of $13.6 million. The year-over-year increase in our investment in inventories is primarily attributable to our new military food distribution in Columbus, Georgia becoming operational during the third quarter 2010. The year-over-year decrease in accounts receivable was due primarily to a temporary timing difference related to our military accounts receivable billing cycle that has accelerated collections during year-to-date 2010 as compared to the comparable prior year period. The year-over-year increase in accrued expense was primarily attributable to higher bonus and profit sharing payments made during year-to-date 2009 as compared to year-to-date 2010.

 

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Net cash used in investing activities decreased by $50.0 million during year-to-date 2010 as compared to the year-to-date 2009. Net cash used in investing activities for year-to-date 2010 consisted primarily of additions to property, plant and equipment of $39.9 million. The additions to property, plant and equipment during year-to-date 2010 consisted primarily of expansion activities associated with our military distribution business, including the purchase of new facilities in Bloomington, Indiana and Oklahoma City, Oklahoma during the third quarter 2010 and the addition of fixtures and equipment and conversion activities associated with our Columbus, Georgia facility, which was purchased in December 2009 and became operational during the third quarter 2010. During the year-to-date 2009, net cash used in investing activities consisted primarily of the GSC acquisition of $78.1 million and additions to property, plant and equipment of $12.6 million.
Cash provided by financing activities decreased by $44.1 million during year-to-date 2010 as compared to year-to-date 2009. During year-to-date 2010, cash provided by financing activities consisted primarily of proceeds of revolving debt of $38.0 million and an increase in outstanding checks of $15.0 million, which were partially offset by share repurchases of $20.3 million and dividend payments of $6.7 million. Cash provided by financing activities during year-to-date 2009 included net borrowings of revolving debt of $80.5 million, primarily due to the GSC acquisition, which was partially offset by dividend payments of $6.9 million and payments of deferred financing costs of $2.7 million.
During the remainder of fiscal 2010, we expect that cash flows from operations will be sufficient to meet our working capital needs and enable us to reduce our debt, with temporary draws on our credit facility during the year to build inventories for certain holidays. Longer term, we believe that cash flows from operations, short-term bank borrowing, various types of long-term debt and lease and equity financing will be adequate to meet our working capital needs, planned capital expenditures and debt service obligations.
Asset-backed Credit Agreement
Our credit agreement is an asset-backed loan consisting of a $340.0 million revolving credit facility, which includes a $50.0 million letter of credit sub-facility (the “Revolving Credit Facility”). Provided no default is then existing or would arise, we may from time-to-time, request that the Revolving Credit Facility be increased by an aggregate amount (for all such requests) not to exceed $110.0 million.
The Revolving Credit Facility has a 5-year term and will be due and payable in full on April 11, 2013. We can elect, at the time of borrowing, for loans to bear interest at a rate equal to the base rate, as defined in the credit agreement, or LIBOR plus a margin. The LIBOR interest rate margin was 2.00% as of October 9, 2010, and can vary quarterly in 0.25% increments between three pricing levels ranging from 1.75% to 2.25% based on the excess availability, which is defined in the credit agreement as (a) the lesser of (i) the borrowing base; or (ii) the aggregate commitments; minus (b) the aggregate of the outstanding credit extensions.
The credit agreement contains no financial covenants unless and until (i) the continuance of an event of default under the credit agreement, or (ii) the failure of us to maintain excess availability (a) greater than 10% of the borrowing base for more than two (2) consecutive business days or (b) greater than 7.5% of the borrowing base at any time, in which event, we must comply with a trailing 12-month basis consolidated fixed charge covenant ratio of 1.0:1.0, which ratio shall continue to be tested each month thereafter until excess availability exceeds 10% of the borrowing base for 90 consecutive days.
The credit agreement contains standard covenants requiring us, among other things, to maintain collateral, comply with applicable laws, keep proper books and records, preserve the corporate existence, maintain insurance, and pay taxes in a timely manner. Events of default under the credit agreement are usual and customary for transactions of this type including, among other things: (a) any failure to pay principal thereunder when due or to pay interest or fees on the due date; (b) material misrepresentations; (c) default under other agreements governing material indebtedness of the Company; (d) default in the performance or observation of any covenants; (e) any event of insolvency or bankruptcy; (f) any final judgments or orders to pay more than $15.0 million that remain unsecured or unpaid; (g) change of control, as defined in the credit agreement; and (h) any failure of a collateral document, after delivery thereof, to create a valid mortgage or first-priority lien.

 

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At October 9, 2010, $157.6 million was available under the Revolving Credit Facility after giving effect to outstanding borrowings and to $20.3 million of outstanding letters of credit primarily supporting workers’ compensation obligations and real estate purchases. We are currently in compliance with all covenants contained within the credit agreement.
Our Revolving Credit Facility represents one of our primary sources of liquidity, both short-term and long-term, and the continued availability of credit under that agreement is of material importance to our ability to fund our capital and working capital needs.
Senior Subordinated Convertible Debt
We also have outstanding $150.1 million in aggregate issue price (or $322.0 million in aggregate principal amount at maturity) of senior subordinated convertible notes due in 2035. The notes are unsecured senior subordinated obligations and rank junior to our existing and future senior indebtedness, including borrowings under our Revolving Credit Facility. Cash interest at the rate of 3.50% per year is payable semi-annually on the issue price of the notes until March 15, 2013. After that date, cash interest will not be payable, unless contingent cash interest becomes payable, and original issue discount for non-tax purposes will accrue on the notes daily at a rate of 3.50% per year until the maturity date of the notes. See our Annual Report on Form 10-K for the fiscal year ended January 2, 2010, for additional information.
Consolidated EBITDA (Non-GAAP Measurement)
The following is a reconciliation of EBITDA and Consolidated EBITDA to net earnings for the third quarters and year-to-date periods of 2010 and 2009 (amounts in thousands):
                                 
    2010     2009     2010     2009  
    Qtr 3     Qtr 3     Year-to-Date     Year-to-Date  
Net earnings
  $ 15,346       21,927     $ 34,001       45,885  
Income tax expense
    7,484       9,728       20,125       19,410  
Interest expense
    7,123       7,621       17,747       18,765  
Depreciation and amortization
    10,883       12,592       27,638       31,299  
 
                       
EBITDA
    40,836       51,868       99,511       115,359  
LIFO charge (credit)
    285       (445 )     (76 )     (732 )
Lease reserves
    725       425       291       1,491  
Asset impairments
    108       840       926       1,738  
Gains on sale of real estate
          (54 )           (54 )
Share-based compensation
    2,717       1,706       6,179       7,421  
Subsequent cash payments on non-cash charges
    (578 )     (712 )     (2,287 )     (2,043 )
Gain on acquisition of a business
                      (6,682 )
Gain on litigation settlement
          (7,630 )           (7,630 )
Settlement of pre-acquisition contingency
    (310 )           (310 )      
 
                       
Consolidated EBITDA
  $ 43,783       45,998     $ 104,234       108,868  
 
                       
EBITDA and Consolidated EBITDA are measures used by management to measure operating performance. EBITDA is defined as net earnings before interest, taxes, depreciation, and amortization. Consolidated EBITDA excludes certain non-cash charges and other items that management does not utilize in assessing operating performance and is a metric used to determine payout of performance units pursuant to our Short-Term and Long-Term Incentive Plans. The above table reconciles net earnings to EBITDA and Consolidated EBITDA. Not all companies utilize identical calculations; therefore, the presentation of EBITDA and Consolidated EBITDA may not be comparable to other identically titled measures of other companies. Neither EBITDA or Consolidated EBITDA are recognized terms under GAAP and do not purport to be an alternative to net earnings as an indicator of operating performance or any other GAAP measure. In addition, EBITDA and Consolidated EBITDA are not intended to be measures of free cash flow for management’s discretionary use since they do not consider certain cash requirements, such as interest payments, tax payments and capital expenditures.

 

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Derivative Instruments
We have market risk exposure to changing interest rates primarily as a result of our borrowing activities and commodity price risk associated with anticipated purchases of diesel fuel. Our objective in managing our exposure to changes in interest rates and commodity prices is to reduce fluctuations in earnings and cash flows. From time-to-time we use derivative instruments, primarily interest rate and commodity swap agreements, to manage risk exposures when appropriate, based on market conditions. We do not enter into derivative agreements for trading or other speculative purposes, nor are we a party to any leveraged derivative instrument.
The interest rate swap agreements are designated as cash flow hedges and are reflected at fair value in our Consolidated Balance Sheet and the related gains or losses on these contracts are deferred in stockholders’ equity as a component of other comprehensive income. As of October 9, 2010, and January 2, 2010, we had recorded a fair value liability of $0.6 million and $1.1 million, respectively, which was included in accrued expenses in our Consolidated Balance Sheet. Deferred gains and losses are amortized as an adjustment to interest expense over the same period in which the related items being hedged are recognized in income. However, to the extent that any of these contracts are not considered to be effective in accordance with ASC Topic 815 (“ASC 815”) in offsetting the change in the value of the items being hedged, any changes in fair value relating to the ineffective portion of these contracts are immediately recognized in income. Our two outstanding interest rate swaps have been considered effective in accordance with ASC 815 since they began during fiscal 2008.
Our interest rate swap agreements resulted in net payments of approximately $0.3 million and $0.5 million during the third quarters of fiscal 2010 and 2009, respectively, and resulted in net payments of approximately $0.9 million and $1.2 million during year-to-date 2010 and year-to-date 2009, respectively, which are included in interest expense on our Consolidated Statement of Income.
As of October 9, 2010, we had two outstanding interest rate swap agreements with notional amounts totaling $35.0 million as compared to $52.5 million as of October 10, 2009. The notional amounts of the two outstanding swaps are reduced as follows (amounts in thousands):
                                 
Notional     Effective Date     Termination Date     Fixed Rate  
 
    $30,000       10/15/2008       10/15/2009       3.49%  
 
    20,000       10/15/2009       10/15/2010       3.49%  
 
    10,000       10/15/2010       10/15/2011       3.49%  
                                 
Notional     Effective Date     Termination Date     Fixed Rate  
 
    $22,500       10/15/2008       10/15/2009       3.38%  
 
    15,000       10/15/2009       10/15/2010       3.38%  
 
    7,500       10/15/2010       10/15/2011       3.38%  
In addition to the previously discussed interest rate and commodity swap agreements, from time-to-time we enter into fixed price fuel supply agreements to support our food distribution segment. On January 1, 2009, we entered into an agreement which required us to purchase a total of 252,000 gallons of diesel fuel per month at prices ranging from $1.90 to $1.98 per gallon. The term of the agreement was for one year and expired on December 31, 2009. This fixed price fuel agreement qualified for the “normal purchase” exception under ASC 815, therefore the fuel purchases under the contract were expensed as incurred as an increase to cost of sales.
Off-Balance Sheet Arrangements
As of the date of this report, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, often referred to as structured finance or special purpose entities, which are generally established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

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Recoverability of Goodwill
Our most recent annual impairment test of goodwill was completed during the fourth quarter of fiscal 2009 based on conditions as of the end of our third quarter of fiscal 2009 and determined that no indication of impairment existed in our food distribution and military segments. The fair value of the food distribution segment was approximately 24% higher than its carrying value, while the military segment’s fair value exceeded its carrying value by over 100%. We determined that an indication of impairment existed in our retail reporting unit in the first step of the fiscal 2009 impairment analysis which required us to calculate our retail segment’s implied fair value in the second step of the impairment analysis. Based on retail’s implied fair value we were required to write-off $50.9 million of goodwill in fiscal 2009.
The fair value for each reporting unit is determined based on an income approach which incorporates a discounted cash flow analysis which uses significant unobservable inputs, or level 3 inputs, as defined by the fair value hierarchy, and a market approach that utilizes current earnings multiples of comparable publicly-traded companies. The Company has weighted the valuation of its reporting units at 70% based on the income approach and 30% based on the market approach. The Company believes that this weighting is appropriate since it is often difficult to find other comparable publicly-traded companies that are similar to our reporting units and it is our view that future discounted cash flows are more reflective of the value of the reporting units.
Critical Accounting Policies and Estimates
Our critical accounting policies are discussed in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 2, 2010, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Critical Accounting Policies.” There have been no material changes to these policies or the estimates used in connection therewith during the 40 weeks ended October 9, 2010.
Recently Adopted and Proposed Accounting Standards
In June 2009, the FASB issued amendments to ASC Topic 810 (“ASC 810”), which addresses the elimination of the concept of a qualifying special purpose entity. The amended guidance also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, the amended guidance provides more timely and useful information about an enterprise’s involvement with a variable interest entity. Effective January 3, 2010, we adopted the amended provisions of ASC 810 which had no impact on our consolidated financial statements.
On December 15, 2009, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Disclosures Topic 820 “Improving Disclosures about Fair Value Measurements”. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in ASC Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. The Company adopted the provision of ASU 2010-06 effective January 3, 2010. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
Our exposure in the financial markets consists of changes in interest rates relative to our investment in notes receivable, the balance of our debt obligations outstanding and derivatives employed from time-to-time to manage our exposure to changes in interest rates and diesel fuel prices. (See Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 2, 2010 and Part I, Item 2 of this report under the caption “Liquidity and Capital Resources”).
ITEM 4. Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
There were changes, as noted below, in our internal control over financial reporting that occurred during the period covered by this quarterly report that materially affected our internal control over financial reporting.

 

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On January 31, 2009, the Company completed the purchase from GSC Enterprises, Inc., of substantially all of the assets relating to three military food distribution centers located in San Antonio, Texas, Pensacola, Florida and Junction City, Kansas serving military commissaries and exchanges (“Business”). The acquisition of the Business represents a material change in the Company’s internal control over financial reporting since management’s last assessment. We have integrated policies, processes, people, technology and operations in relation to the Business. Management will continue to evaluate our internal control over financial reporting and will include the Business as a part of management’s next assessment of the Company’s internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings
We are engaged from time-to-time in routine legal proceedings incidental to our business. We do not believe that these routine legal proceedings, taken as a whole, will have a material impact on our business or financial condition.
ITEM 1A. Risk Factors
There have been no material changes to our risk factors contained in Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the fiscal year ended January 2, 2010.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about shares of common stock the Company acquired during the third quarter of fiscal 2010:
                                 
                    (c) Total number     (d) Maximum  
                    of shares     amount  
    (a) Total             purchased as part     remaining that  
    number of     (b) Average     of publicly     may be spent  
    shares     price paid per     announced plans     under plans or  
Period   purchased (1)     share (1)     or programs (1)     programs (1)  
Period 7 (June 20, 2010 to July 17, 2010)
    141,023     $ 35.11       141,023     $ 3,715,744  
     
(1)   On November 10, 2009, our Board of Directors approved a share repurchase program to spend up to $25.0 million to purchase shares of the Company’s common stock. The program took effect on November 16, 2009 and will continue until the earlier to occur of (i) the date that the aggregate purchases under the program reach $25.0 million, or (ii) December 31, 2010. Since the program’s inception, we have repurchased a total of 613,455 shares for $21.3 million, at an average price per share of $34.70.
ITEM 3. Defaults upon Senior Securities
None
ITEM 4. (Removed and Reserved).
ITEM 5. Other Information
None

 

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ITEM 6. Exhibits
Exhibits filed or furnished with this Form 10-Q:
         
Exhibit No.   Description
       
 
  12.1    
Calculation of Ratio of Earnings to Fixed Charges
       
 
  31.1    
Rule 13a-14(a) Certification of the Chief Executive Officer
       
 
  31.2    
Rule 13a-14(a) Certification of the Chief Financial Officer
       
 
  32.1    
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

 

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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.
         
  NASH-FINCH COMPANY
Registrant
 
 
Date: November 16, 2010  by:   /s/ Alec C. Covington    
    Alec C. Covington   
    President and Chief Executive Officer   
 
Date: November 16, 2010  by:   /s/ Robert B. Dimond    
    Robert B. Dimond   
    Executive Vice President and Chief Financial Officer   

 

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NASH FINCH COMPANY
EXHIBIT INDEX TO QUARTERLY REPORT
ON FORM 10-Q
For the Quarter Ended October 9, 2010
             
Exhibit       Method of
No.   Item   Filing
       
 
   
  12.1    
Calculation of Ratio of Earnings to Fixed Charges
  Filed herewith
       
 
   
  31.1    
Rule 13a-14(a) Certification of the Chief Executive Officer
  Filed herewith
       
 
   
  31.2    
Rule 13a-14(a) Certification of the Chief Financial Officer
  Filed herewith
       
 
   
  32.1    
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
  Filed herewith

 

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