SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

FOR THE QUARTERLY PERIOD ENDED JULY 16, 2016

OR

FOR THE TRANSITION PERIOD FROM ______ TO ______

COMMISSION FILE NUMBER 333-191029

 

TOPS HOLDING II CORPORATION
(Exact name of registrant as specified in its charter)

 

 

 

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  o    No  x

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 preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    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 (as defined in Rule 12b-2 of the Exchange Act).

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

As of August 11, 2016, 126,559 shares of common stock of the registrant were outstanding.

 

 

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TOPS HOLDING II CORPORATION

TABLE OF CONTENTS

 

 

 

 

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PART I – FINANCIAL INFORMATION (Unaudited)

TOPS HOLDING II CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share and per share amounts)

(Unaudited)

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

 

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TOPS HOLDING II CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Dollars in thousands)

(Unaudited)

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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TOPS HOLDING II CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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TOPS HOLDING II CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. THE COMPANY, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company

Tops Holding II Corporation (“Holding II,” or collectively with its subsidiaries, the “Company”), the parent of Tops Holding LLC (“Holding I”), formerly Tops Holding Corporation, was incorporated on May 7, 2013.  Holding I is the parent of Tops Markets, LLC (“Tops Markets”), a supermarket retailer with supermarkets in Upstate New York, Northern Pennsylvania and Vermont.  As of July 16, 2016, the Company operated 165 supermarkets; 164 under the Tops banner and one under the Orchard Fresh banner, with an additional five supermarkets operated by franchisees under the Tops banner.  Holding II has no business operations other than the ownership of Holding I and as the issuer of the 2018 Notes (see Note 5) and a guarantor of the 2022 Notes (see Note 5).

Holding II is the reporting entity for the 2018 Notes and 2022 Notes.  Tops MBO Corporation (“Tops MBO Co”), the parent company of Holding II, is neither a co-issuer nor guarantor of these notes.  Accordingly, the condensed consolidated financial statements have been prepared for Holding II and exclude the assets and results of operations of Tops MBO Co.  Tops MBO Co’s assets consist solely of its investment in Holding II.  Tops MBO Co has no operations other than as the equity owner of Holding II.

Accounting Policies

A summary of the Company’s significant accounting policies is included in Note 1 to the audited consolidated financial statements of Holding II for the fiscal year ended January 2, 2016, which appear in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 23, 2016.

Basis of Presentation and Principles of Consolidation

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  The condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries.  All intercompany transactions have been eliminated.

The Company operates on a 52/53 week fiscal year ending on the Saturday closest to December 30.  Fiscal years include 13 four-week reporting periods, with an additional week in the thirteenth reporting period for 53-week fiscal years.  The first quarter of each fiscal year includes four reporting periods, while the remaining quarters include three reporting periods.

The Company’s condensed consolidated financial statements for the 12-week and 28-week periods ended July 16, 2016 and July 11, 2015 are unaudited, and in the opinion of management, contain all adjustments that are of a normal and recurring nature necessary for a fair statement of financial position and results of operations for such periods.

Recently Issued Accounting Pronouncements – Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers” (“ASU No. 2014-09”), which provides guidance regarding revenue recognition.  ASU No. 2014-09’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In August 2015, the FASB issued ASU No 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date,” which deferred the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, with earlier application permitted as of annual reporting periods beginning after December 15, 2016.  The Company is currently assessing the potential impact of ASU No. 2014-09 on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases,” (“ASU No. 2016-02”), which stipulates that lessees recognize a right-of-use asset and a lease liability for substantially all leases.  ASU No. 2016-02 is effective on a modified retrospective basis for reporting periods beginning after December 15, 2018, with early adoption permitted.  The Company is currently in the process of evaluating the effect of adoption of ASU No. 2016-02 on its consolidated financial statements.

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In March 2016, the FASB issued ASU No. 2016-08, “Principal versus Agent Considerations” (Reporting Revenue Gross versus Net) (“ASU No. 2016-08”).  ASU No. 2016-08 does not change the core principle of the guidance stated in ASU No. 2014-09, instead, the amendments in this ASU are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations and whether an entity reports revenue on a gross or net basis.  ASU No. 2016-08 will have the same effective date and transition requirements as the new revenue standard issued in ASU No. 2014-09.  The Company is currently in the process of evaluating the effect of adoption of ASU No. 2016-08 on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU No. 2016-13”).  The standard changes the methodology for measuring credit losses on financial instruments and the timing of when such losses are recorded.  ASU No. 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019.  Early adoption is permitted for fiscal years, and interim periods within those years, beginning after December 15, 2018.  The Company does not expect that the adoption of this guidance will have a material impact on its consolidated financial statements.

Segments

The Company’s supermarkets offer grocery, produce, frozen, dairy, meat, floral, seafood, health and beauty care, general merchandise, deli and bakery goods.  The Company operates one supermarket format where each supermarket offers the same general mix of products with similar pricing to similar categories of customers.  As of July 16, 2016, 51 corporate supermarkets offered pharmacy services and 52 corporate fuel centers were in operation.  The Company’s retail operations, which represent substantially all of the Company’s consolidated sales, earnings and total assets, are its only operating segment and reportable segment.  The Company’s retail operations as a whole reflect the level at which the business is managed and how the Company’s Chief Executive Officer and the Company’s President, who act as the Company’s chief operating decision makers, assess performance internally.    

The following table presents sales revenue by type of similar product (dollars in thousands):

 

 

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and notes thereto.  The most significant estimates used by management are related to the accounting for vendor allowances, valuation of long-lived assets including goodwill and intangible assets, lease classification, self-insurance reserves, inventory valuation and income taxes.  Actual results could differ from these estimates.

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Fair Value of Financial Instruments

The provisions of FASB Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” establish a framework for measuring fair value and a hierarchy that categorizes and prioritizes the sources to be used to estimate fair value as follows:

Level 1 – observable inputs such as quoted prices in active markets;

Level 2 – inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs); and

Level 3 – unobservable inputs that reflect the Company’s determination of assumptions that market participants would use in pricing the asset or liability.  These inputs are developed based on the best information available, including the Company’s own data.

Financial instruments include cash and cash equivalents, accounts receivable, accounts payable and long-term debt.  The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short-term nature of these financial instruments.  At July 16, 2016 and January 2, 2016, the carrying value and the estimated fair value of the Company’s debt instruments were as follows (dollars in thousands):

 

 

The fair values of the 2018 Notes and 2022 Notes (see Note 5), which are included in long-term debt as of July 16, 2016 and January 2, 2016, were based on quoted market prices, a Level 2 source.

Fair value measurements of non-financial assets and non-financial liabilities are primarily used in the impairment analysis of long-lived assets, goodwill and intangible assets.  Long-lived assets and definite-lived intangible assets are measured at fair value on a nonrecurring basis using Level 3 inputs.  Goodwill and the Tops tradename are reviewed annually for impairment on December 1, or more frequently if impairment indicators arise.

 

 

2. GOODWILL AND INTANGIBLE ASSETS, NET

The following table summarizes the change in the Company’s goodwill balance during the 28-week period ended July 16, 2016 (dollars in thousands):

 

 

Goodwill is reviewed annually for impairment on December 1, or more frequently upon the occurrence of trigger events.  Based on the Company’s assessment, no goodwill impairment was recorded during the 12-week and 28-week periods ended July 16, 2016 and July 11, 2015.

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Intangible assets, net of accumulated amortization, consist of the following (dollars in thousands):

 

 

 

The Tops tradename is reviewed annually for impairment on December 1, or more frequently if impairment indicators arise.  Based on the Company’s assessment, no impairment was recorded during the 12-week and 28-week periods ended July 16, 2016 and July 11, 2015.

During the 12-week periods ended July 16, 2016 and July 11, 2015, amortization expense related to intangible assets was $1.9 million and $2.7 million, respectively.  During the 28-week periods ended July 16, 2016 and July 11, 2015, amortization expense related to intangible assets was $5.2 million and $6.2 million, respectively.  This amortization is included in depreciation and amortization in the condensed consolidated statements of comprehensive loss.

Depreciation and amortization in the condensed consolidated statements of comprehensive loss during each of the 12-week periods ended July 16, 2016 and July 11, 2015 includes $0.1 million of contra-expense related to the amortization of unfavorable lease rights, which are classified in other long-term liabilities in the condensed consolidated balance sheets.  During each of the 28-week periods ended July 16, 2016 and July 11, 2015, depreciation and amortization in the condensed consolidated statements of comprehensive loss includes $0.2 million of contra-expense related to the amortization of unfavorable lease rights.  Expected future amortization of these unfavorable lease rights is contra-expense of $0.1 million in the remaining period of Fiscal 2016, $0.3 million in Fiscal 2017, $0.3 million in Fiscal 2018, $0.3 million in Fiscal 2019, $0.3 million in Fiscal 2020 and $0.7 million thereafter.

As of July 16, 2016, expected future amortization of intangible assets is as follows (dollars in thousands):

 

 

 

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3. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following (dollars in thousands):

 

 

 

4. CAPITAL LEASE OBLIGATIONS

The Company has a number of capital leases in effect for supermarket properties and equipment.  The initial lease terms generally range up to twenty-five years and will expire at various times through 2036, with options to renew for additional periods.  The majority of the supermarket leases provide for base rental, plus real estate taxes, insurance, common area maintenance and other operating expenses applicable to the leased premises.  Some leases contain escalation clauses for future rents and contingent rents based on sales volume.

As of July 16, 2016, future minimum lease rental payments applicable to non-cancelable capital lease obligations were as follows (dollars in thousands):

 

 

The Company entered into build-to-suit and sale-leaseback transactions in various years involving certain properties that did not qualify for sale-leaseback accounting as the lease agreements included various forms of continuing involvement.  As a result, the transactions have been classified as financing transactions in accordance with ASC Topic 840, “Leases,” due to the existence of continuing involvement within the lease agreements.

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Under the financing method, the assets remain on the consolidated balance sheet and proceeds received by the Company from these transactions are recorded as capital lease obligations, allocated between land, as applicable, and building.  Payments under these leases are applied as payments of imputed interest and deemed principal on the underlying building obligations, with no underlying cash payments deemed attributable to the land obligations and the estimated net book value of the buildings at the conclusion of the lease terms.  The related land assets are not depreciated, and at the end of the lease terms, the remaining capital lease obligations will equal the combined net book values of the land and buildings.  At the expiration of the lease terms, which range from 2017 to 2036, or when the Company’s continuing involvement under the lease agreements ends, the related land, buildings and capital lease obligations will be removed from the consolidated balance sheet, with no underlying cash payments.  These capital lease obligations are reflected as non-cash obligations in the preceding table.

 

5. DEBT

Long-term debt is comprised of the following (dollars in thousands):

 

 

On June 10, 2015, Holding I and Tops Markets II Corporation (collectively, the “Issuers”) issued $560.0 million in aggregate principal amount of senior secured notes due in 2022, bearing annual interest at a rate of 8.00% (the “2022 Notes”).  The proceeds from the 2022 Notes were used to fund a tender offer for, and redeem the balance of, the previously outstanding $460.0 million of senior secured notes issued by Holding I, Tops Markets and Tops Markets II Corporation (the “2017 Notes”) and to fund a partial tender offer for $60.0 million of the $150.0 million outstanding 8.75%/9.50% senior unsecured notes issued by Holding II (the “2018 Notes”), including tender and redemption premiums of $23.0 million and $1.2 million, respectively, which have been recorded within loss on debt extinguishment in the condensed consolidated statements of comprehensive loss during the 12-week and 28-week periods ended July 11, 2015.  The proceeds were also used to pay accrued and unpaid interest related to the tendered and redeemed notes and fees and expenses related to the issuance of the 2022 Notes.  The 2022 Notes mature on June 15, 2022 and require semi-annual interest payments on June 15 and December 15.  The 2022 Notes are redeemable, in whole or in part, at any time on or after June 15, 2018 at specified redemption prices.  Prior to June 15, 2018, the Company may redeem the 2022 Notes, in whole or in part, at a specified “make-whole” premium.

The 2022 Notes are collateralized by (i) first priority security interests, subject to certain exceptions and permitted liens, in the stock held by the Issuers and the guarantor subsidiaries, Tops Markets, Tops PT, LLC, Tops Gift Card Company, LLC and Erie Logistics LLC (collectively, the “Guarantors”), the Company’s warehouse and distribution facility in Lancaster, New York, the Company’s retail facility located in Fayetteville, New York and certain owned real property acquired by the Issuers and the Guarantors following the issue date of the 2022 Notes, equipment, intellectual property, and substantially all other assets of the Issuers and the Guarantors, other than those assets securing the Company’s asset-based revolving credit facility (the “2017 ABL Facility”) on a first priority basis (collectively, the “2022 Notes Priority Collateral”), and (ii) second priority security interests, subject to certain exceptions and permitted liens, in the assets of Holding II, the Issuers and the Guarantors that secure the 2017 ABL Facility on a first priority basis, including present and future receivables, deposit accounts, inventory, prescription lists, and certain rights and proceeds relating thereto (collectively, the “ABL Priority Collateral”).

The 2022 Notes are guaranteed on a senior secured basis, jointly and severally, by each of the Guarantors and will in the future be guaranteed by certain of Holding I’s future domestic subsidiaries.  The 2022 Notes are also guaranteed on a senior unsecured basis by Holding II.

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On May 15, 2013, Holding II issued $150.0 million of 2018 Notes.  As discussed above, on June 10, 2015, Holding II successfully tendered for and repurchased $60.0 million of 2018 Notes.  On January 20, 2016 and December 18, 2015, $1.2 million and $3.3 million, respectively, of 2018 Notes were repurchased in “open market” transactions, resulting in a remaining outstanding principal amount of $85.5 million as of July 16, 2016.  If certain conditions are met, Holding II may be entitled to pay interest on the 2018 Notes by increasing the principal of the notes or by issuing new notes as pay-in-kind interest.  This payment in kind interest would accrue at an annual rate of 9.50%.  The 2018 Notes mature on June 15, 2018 and require semi-annual interest payments on June 15 and December 15.  To the extent permitted by the indenture governing the 2022 Notes and the 2017 ABL Facility (see below), Holding I may make dividend payments to Holding II to fund additional repurchases and the semi-annual interest payments for the 2018 Notes.  The 2018 Notes are redeemable, in whole or in part, at specified redemption prices.  

On December 14, 2012, Tops Markets entered into the 2017 ABL Facility with Bank of America, N.A. as collateral agent and administrative agent.  The 2017 ABL Facility allows a maximum borrowing capacity of $125.0 million, subject to a borrowing base calculation, with an option for up to $50.0 million of additional borrowing capacity if the required conditions are met.  The borrowing base includes inventory, pharmacy prescription files and certain receivables.  The 2017 ABL Facility matures on December 14, 2017.

Costs associated with the 2022 Notes and 2018 Notes of $10.7 million and $2.7 million, respectively, were capitalized and are being amortized over the respective terms of the 2022 Notes and 2018 Notes using the effective interest method.  Costs associated with the 2017 ABL Facility of $1.1 million were capitalized and are being amortized on a straight-line basis over the term of the 2017 ABL Facility.  

During the 12-week periods ended July 16, 2016 and July 11, 2015, amortization expense related to the deferred financing costs was $0.5 million and $0.8 million, respectively.  During the 28-week periods ended July 16, 2016 and July 11, 2015, amortization expense related to the deferred financing costs was $1.2 million and $2.1 million, respectively.  This amortization expense is included in interest expense in the condensed consolidated statements of comprehensive loss.  At July 16, 2016, long-term debt included deferred financing costs, net of accumulated amortization of $3.0 million, totaling $11.4 million.  At January 2, 2016, long-term debt included deferred financing costs, net of accumulated amortization of $1.8 million, totaling $12.7 million. 

As of July 16, 2016, the unused availability under the 2017 ABL Facility was $46.5 million, after giving effect to the borrowing base calculation, $22.8 million of letters of credit outstanding and $47.7 million of borrowings outstanding.  As of January 2, 2016, $23.8 million of letters of credit were outstanding under the 2017 ABL Facility.  Revolving loans under the 2017 ABL Facility, at the Company’s option, bear interest at either LIBOR plus a margin of 150 to 200 basis points, determined based on levels of borrowing availability, or the prime rate plus a margin of 50 to 100 basis points, determined based on levels of borrowing availability.  As of July 16, 2016 and January 2, 2016, the weighted average interest rates on borrowings under the 2017 ABL Facility were 2.56% and 3.20%, respectively.  The 2017 ABL Facility is collateralized primarily by (i) first priority interests, subject to certain exceptions and permitted liens, in the ABL Priority Collateral, and (ii) second priority interests, subject to certain exceptions and permitted liens, in the 2022 Notes Priority Collateral.

The instruments governing the 2022 Notes, 2018 Notes and the 2017 ABL Facility impose customary affirmative and negative covenants on the Company, including restrictions on indebtedness, liens, type of business, acquisitions, investments, sale or transfer of assets, payment of dividends, transactions involving affiliates, and obligations on a change in control.  Failure to meet any of these covenants would be an event of default.  On August 19, 2014, the 2017 ABL Facility was amended to reduce specified restrictions on the Company’s ability to make certain restricted payments, including dividends.  As of July 16, 2016, the Company was in compliance with its covenants under these agreements.

 

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6. INCOME TAXES

Income tax expense was as follows (dollars in thousands):

 

 

Based on an assessment of positive and negative evidence regarding the realization of the Company’s deferred tax assets, the Company continues to maintain a full valuation allowance against total net deferred tax assets, and consequently, the Company recognized no income tax benefit during the 12-week and 28-week periods ended July 16, 2016 and July 11, 2015.

 

The income tax expense recognized for the 12-week and 28-week periods ended July 16, 2016 solely reflects the recognition of additional valuation allowance associated with the tax amortization of the Company’s indefinite-lived tradename and goodwill deferred tax liabilities.  The effective tax rates would have been 38.9% and 39.0%, respectively, without the establishment of valuation allowance.

The income tax expense recognized for the 12-week and 28-week periods ended July 11, 2015 solely reflects the recognition of additional valuation allowance associated with the tax amortization of the Company’s indefinite-lived tradename and goodwill deferred tax liabilities.  The effective tax rate would have been 39.1% during each of the periods without the establishment of valuation allowance.

As of the beginning of fiscal year 2016, the Company had U.S. federal and state net operating loss carryforwards of $70.9 million and $71.5 million, respectively, which expire beginning in 2029.  In addition, the Company had federal tax credits of $5.4 million, which expire beginning in 2027.

 

 

7. GAIN ON SALE OF ASSETS

During January 2015, the Company sold pharmacy scripts and inventory related to 27 of its in-store pharmacy locations for cash proceeds of $14.9 million.  These pharmacies were then closed.  A resulting gain on sale of assets of $11.0 million, net of the carrying value of sold inventory of $3.2 million and direct selling expenses of $0.7 million, was recognized in the condensed consolidated statement of comprehensive loss for the 28-week period ended July 11, 2015.

 

 

8. DIVIDENDS PAID

On January 14, 2016, the Company paid a dividend to Tops MBO Co totaling $2.0 million.

On January 8, 2015, the Company paid a dividend of $0.8 million to Tops MBO Co to repurchase outstanding shares of common stock of Tops MBO Co from a former Company executive.  In addition, one outstanding share of common stock of Holding II was repurchased.

 

 

9. COMMITMENTS AND CONTINGENCIES

Multiemployer Pension Plans

On December 22, 2013, Tops Markets acquired all of the membership interests of Erie Logistics, LLC (“Erie Logistics”) and certain other assets from C&S Wholesale Grocers, Inc. (“C&S”).  Erie Logistics operates the Company’s warehouse and distribution facilities located in Lancaster and Cheektowaga, New York and employs the warehouse and driver personnel at these facilities, all of whom are represented by Teamsters Local 264.  Under its supply agreement with Tops Markets, C&S, through Erie Logistics, had operated these facilities since 2002.

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In late January 2014, the Company received notice that the New York State Teamsters Conference Pension and Retirement Fund (the “Fund”) had suspended Erie Logistics as a participating employer in the Fund pending the Fund’s investigation into the acquisition of Erie Logistics from C&S.  This suspension was retroactive to the effective date of the acquisition.  During this “suspension” and thereafter through the date of this Quarterly Report on Form 10-Q, Erie Logistics has elected to continue to make contributions to the Fund in accordance with the terms set forth in the collective bargaining agreements with Teamsters Local 264.  The Fund has rejected and returned these contributions.  During the 12-week periods ended July 16, 2016 and July 11, 2015, these rejected contributions totaled $1.2 million and $0.8 million, respectively.  During the 28-week periods ended July 16, 2016 and July 11, 2015, these rejected contributions totaled $2.9 million and $2.4 million, respectively.  On May 27, 2014, the Fund provided Erie Logistics and C&S with notice of its determination that Erie Logistics incurred employer withdrawal liability as a result of the acquisition.  The notice provides that Erie Logistics owes withdrawal liability of $183.7 million, payable in a lump sum or in monthly installments, calculated to give effect to a limit on total withdrawal liability imposed by the Employee Retirement Income Security Act (“ERISA”), of $641,514 for 240 months.

The Company believes that the Fund’s determination of a withdrawal violates ERISA, the existing participation agreements between Erie Logistics and the Fund, and the fiduciary duties of the trustees of the Fund.  The Company is vigorously contesting this determination through mandatory arbitration under ERISA.

The Company has not recorded any reserve for this matter as a loss is not considered probable.  If it were ultimately determined that Erie Logistics has incurred a withdrawal liability to the Fund, the Company would bear financial responsibility for this liability.  Under the terms of the purchase agreement for the acquisition of Erie Logistics from C&S, and as a continuation of its prior contractual obligations, the Company retains the obligation to indemnify C&S in the event withdrawal liability is imposed on Erie Logistics, the Company or C&S.  During the pendency of the proceeding to contest the withdrawal determination, ERISA requires that conditional monthly payments of withdrawal liability be made, which began July 28, 2014.  During each of the 28-week periods ended July 16, 2016 and July 11, 2015, the monthly conditional payments of withdrawal liability totaled $3.8 million.  These monthly conditional payments are in addition to pension contributions the Company has elected to make for the benefit of Erie Logistics’ associates under the collective bargaining agreements with Teamsters Local 264 which, as noted, the Fund has refused to accept.  The aggregate conditional monthly payments of withdrawal liability, totaling $15.4 million as of July 16, 2016, have been recorded in other assets, while the aggregate rejected contributions that the Company has elected to make, totaling $11.8 million as of July 16, 2016, have been recorded in other long-term liabilities and cash within its condensed consolidated balance sheet.

On July 28, 2014, Teamsters Local 264 filed a grievance charging a violation of its collective bargaining agreements by reason of the Company’s failing to participate in the Fund.  On July 4, 2016, the arbitrator denied this grievance.  The Company is in active discussions with Teamsters Local 264 regarding certain aspects of the grievance and the arbitrator’s decision.  

Purchase Commitments

Effective December 22, 2013, in connection with its purchase of all the membership interests of Erie Logistics and certain other assets from C&S, the Company modified its existing agreement with C&S whereby the Company resumed warehousing and transportation functions for the WNY warehouses, while C&S continues to provide procurement and purchasing services in support of the majority of the Company’s supply chain.  This modified agreement sets out the parties' respective responsibilities for the procurement and purchase of merchandise intended for use or resale in a majority of the Company’s supermarkets.  In consideration for the services it provides under this agreement, C&S is paid a fee based on all merchandise purchased by the Company from C&S through the WNY warehouses with C&S also having incentive income opportunities under the agreement.  As of April 1, 2015, the Company and C&S agreed in principle to amend certain operating terms of this agreement and extend the term through April 1, 2020.

On September 24, 2012, the Company entered into a separate agreement with C&S to provide warehousing, transportation, procurement and purchasing services in support of the 21 supermarkets acquired from GU Markets in October 2012.  This agreement expires on September 23, 2022.

Effective May 1, 2013, Tops Markets entered into a member participation agreement with Topco, a procurement cooperative for food retailers and wholesalers, for the supply of substantially all of the Company’s prescription drugs.  Tops Markets must purchase 95% of its branded prescription drugs and 95% of its generic pharmaceutical products through Topco.  This agreement expires February 28, 2017.

Effective March 1, 2016, the Company extended its existing IT outsourcing agreement with HP Enterprise Services, LLC (“HPE”) through February 29, 2024.  Under this agreement, HPE provides data center operations, mainframe processing, business applications and systems development, which are expected to enhance the Company’s customer service and efficiency.  The amounts payable to HP under this agreement are based upon the services requested by the Company at predetermined rates.

The costs of these purchase commitments are not reflected in the Company’s consolidated balance sheets.

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Environmental Liabilities

The Company is contingently liable for potential environmental issues related to some of its properties.  As the Company is unaware of environmental issues that are expected to materially impact the Company’s consolidated financial statements as a whole, no amounts were accrued as of July 16, 2016 or January 2, 2016.

Collective Bargaining Agreements

The Company employs approximately 15,000 associates.  Approximately 83% of these associates are members of United Food and Commercial Workers, or UFCW, District Union Local One, or Local One, or two other UFCW unions.  Approximately 4% of these associates are members of Teamsters Local 264, who work in the Company’s WNY warehouse and distribution facilities.  All other associates are non-union.  The Company is a party to five collective bargaining agreements with Local One expiring between April 2017 and October 2018.  The Company has one non-Local One UFCW collective bargaining agreement that expired in April 2016.  The Company is currently operating under a memorandum of agreement to extend that expired collective bargaining agreement.  The Company also is a party to one other non-Local One UFCW collective bargaining agreement that expires in February 2018.  The Company is a party to three collective bargaining agreements with Teamsters Local 264 that expire in August 2019.

Legal Proceedings

Except as otherwise disclosed in this note, the Company is unaware of any legal proceedings that are expected to materially impact the Company’s consolidated financial statements as a whole.  No amounts related to contingent liabilities due to legal proceedings were accrued as of July 16, 2016 or January 2, 2016.

 

 

10. BUSINESS ACQUISITION

On July 13, 2016, the Company announced an agreement to acquire four supermarkets from The Stop & Shop Supermarket Company LLC, which currently operates these stores under the Stop & Shop banner, and two supermarkets from Hannaford Bros. Co., LLC and Martin’s Foods of South Burlington, LLC, which currently operate these stores under the Hannaford banner, in eastern New York and Massachusetts. These transactions are expected to close beginning August 21, 2016 and are subject to customary closing conditions. The aggregate purchase price for this combined acquisition of $12.0 million, plus an estimated purchase price for inventory of $5.9 million, is expected to be funded using cash on hand and available borrowings under the Company’s 2017 ABL Facility.  

The Company believes the acquisition creates significant strategic value due to the expansion it provides to the Company’s supermarket base as well as the minimal incremental general and administrative expenses expected to be incurred.

Based upon a preliminary expected allocation of the aggregate purchase price, the assets to be acquired will be recorded at their respective estimated fair values as of the acquisition dates.  Due to the timing of the closings for the acquisition, the preliminary expected allocation of the aggregate purchase price is based on management’s best estimates of fair values as of the expected acquisition dates using information available as of the date of this 10-Q and is subject to adjustments.  The valuations are expected to be finalized within 12 months of the closing of the acquisition.  As the valuations are finalized, any changes to the preliminary expected valuation of assets acquired may result in material adjustments to the fair value of inventory, equipment and identifiable intangible assets acquired and will be adjusted retrospectively.  

The following table summarizes the expected preliminary allocation of the purchase price to the assets acquired as of the expected transaction dates (dollars in thousands):  

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The following table summarizes the Company’s unaudited pro forma operating results for the 12-week and 28-week periods ended July 16, 2016 and July 11, 2015, giving effect to the acquisition as if it occurred as of the beginning of fiscal year 2015 (dollars in thousands):

 

 

The pro forma financial information above reflects the $0.2 million of transaction costs incurred by the Company during the 12-week and 28-week periods ended July 16, 2016 within the operating results for the 28-week period ended July 11, 2015.  Additionally, the pro forma information includes estimated depreciation and amortization of $0.5 million during each of the 12-week periods ended July 16, 2016 and July 11, 2015, and estimated depreciation and amortization of $1.2 million during each of the 28-week periods ended July 16, 2016 and July 11, 2015.  This pro forma financial information is not intended to represent or be indicative of what would have occurred if the acquisition had taken place as of the beginning of the periods presented and should not be taken as representative of the Company’s future consolidated results of operations.

 

 

11. IMPAIRMENT

During August 2016, the Company determined that the expected future cash flows associated with one supermarket location were insufficient to recover that location’s aggregate net book value of long-lived assets.  As a result, the net book values of leasehold improvements and equipment assets were written down to their estimated fair values, a Level 3 fair value source.  A corresponding non-cash impairment of $2.1 million was recognized in the condensed consolidated statements of comprehensive loss for the 12-week and 28-week periods ended July 16, 2016.

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

The following discussion should be read in conjunction with our condensed consolidated financial statements and related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q (the “10-Q”).

We are a leading supermarket retailer in Upstate New York, Northern Pennsylvania and Vermont.  Introduced in 1962, our Tops brand is widely recognized as a strong retail supermarket brand name in our market area, supported by strong customer loyalty and attractive supermarket locations.  As of July 16, 2016, we operated 165 full-service supermarkets, 164 under the Tops banner and one under the Orchard Fresh banner, with an additional five supermarkets operated by franchisees under the Tops banner.

Forward-Looking Statements

This 10-Q includes forward‑looking statements, which are generally statements about future events, plans, objectives and performance.  Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will” and similar expressions identify forward‑looking statements.  Forward‑looking statements reflect our current expectations, based on currently available information, and are not guarantees.  Although we believe that the expectations reflected in such forward‑looking statements are reasonable, these expectations could prove inaccurate as such statements involve risks and uncertainties, many of which are beyond our ability to control or predict.  Should one or more of these risks or uncertainties, or other risks or uncertainties not currently known to us or that we currently deem to be immaterial, materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected.  Important factors relating to these risks and uncertainties include, but are not limited to, the following:

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We caution that investors should not place undue reliance on forward‑looking statements, which speak only as of the date on which they are made.  We disclaim any intention, obligation or duty to update or revise any forward‑looking statements, whether as a result of new information, future events or otherwise, except as required by law.

BASIS OF PRESENTATION

We operate on a 52/53 week fiscal year ending on the Saturday closest to December 30.  Our fiscal years include 13 four-week reporting periods, with an additional week in the thirteenth reporting period for 53-week fiscal years.  Our first quarter of each fiscal year includes four reporting periods, while the remaining quarters include three reporting periods.

Our condensed consolidated financial statements for the 12-week and 28-week periods ended July 16, 2016 and July 11, 2015 are unaudited, and, in the opinion of our management, contain all adjustments that are of a normal and recurring nature necessary for a fair statement of financial position and results of operations for such periods.

RECENT EVENTS AFFECTING OUR RESULTS OF OPERATIONS AND THE COMPARABILITY OF REPORTED RESULTS OF OPERATIONS

June 2015 Refinancing

On June 10, 2015, Holding I and Tops Markets II Corporation issued $560.0 million in aggregate principal amount of 2022 Notes, bearing annual interest at a rate of 8.00%. The proceeds from the 2022 Notes were used to fund a tender offer for, and redeem the balance of, the previously outstanding $460.0 million of 2017 Notes and to fund a partial tender offer for $60.0 million of the $150.0 million outstanding 2018 Notes, including tender and redemption premiums of $23.0 million and $1.2 million, respectively.  The proceeds were also used to pay accrued and unpaid interest related to the tendered and redeemed notes and fees and expenses related to the issuance of the 2022 Notes.

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2015 Sale of Pharmacy Assets

During January 2015, we sold pharmacy scripts and inventory related to 27 of our in-store pharmacy locations, which resulted in a gain on sale of assets of $11.0 million in the condensed consolidated statement of comprehensive loss for the 28-week period ended July 11, 2015.

RESULTS OF OPERATIONS

12-Week Period Ended July 16, 2016 Compared with the 12-Week Period Ended July 11, 2015

Summary

The results of operations during the 12-week period ended July 16, 2016 were impacted by the $12.8 million incremental inside sales contribution from seven acquired and new supermarkets opened since May 2015 and a same store sales decrease of 1.1%, primarily resulting from food cost deflation.  Relatively lower margin fuel sales decreased $6.7 million during the 12-week period ended July 16, 2016, primarily as a result of a decrease in fuel retail prices.  This decrease in lower margin fuel sales, combined with a $1.9 million decrease in distribution costs, which occurred largely due to lower self-insured workers’ compensation claims expense, drove an 80 basis points increase in gross profit margin.  

Net Sales

The following table includes the components of our net sales for the 12-week periods ended July 16, 2016 and July 11, 2015.

(Dollars in thousands)

 

 

Inside sales increased due to the $12.8 million incremental contribution from seven acquired and new supermarkets opened since May 2015.  Same store sales decreased 1.1%, primarily due to food cost deflation in certain categories, including meat and dairy, and competitive pressure to lower food prices in response.  Same store sales is inside sales, excluding franchise revenue, for “same stores,” which are supermarkets that have been operating for at least 13 full four-week periods.  To calculate the same store sales change, we used the 12-week period ended July 18, 2015, as this represents the most comparable period to the 12-week period ended July 16, 2016.

 

The decrease in fuel sales was due to a 15.6% decrease in the average retail price per gallon, net of applicable discounts, and a 0.9% net decrease in gallons sold.

 

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Gross Profit

The following table includes a comparison of cost of goods sold, distribution costs and gross profit for the 12-week periods ended July 16, 2016 and July 11, 2015.

(Dollars in thousands)

 

 

As a percentage of net sales, the decrease in cost of goods sold was due to a shift in product mix given the smaller proportion of relatively lower margin fuel sales.  Non-cash LIFO inventory valuation adjustments changed from expense of $0.2 million during the 12-week period ended July 11, 2015 to income of $0.1 million during the 12-week period ended July 16, 2016.  Excluding the impact of LIFO adjustments, cost of goods sold as a percentage of inside sales was 67.4% during each of the 12-week periods ended July 16, 2016 and July 11, 2015.

The decrease in distribution costs was largely due to a $1.7 million decrease in self-insured workers’ compensation claims expense.

Operating Expenses

The following table includes a comparison of operating expenses for the 12-week periods ended July 16, 2016 and July 11, 2015.

(Dollars in thousands)

 

 

Wages, Salaries and Benefits

The increase in wages, salaries and benefits as a percentage of net sales was due to the smaller proportion of fuel sales as a percentage of net sales, which require relatively modest labor investments.  As a percentage of inside sales, wages, salaries and benefits was a consistent 15.2%.

Selling and General Expenses

Selling and general expenses remained relatively consistent as a percentage of net sales.

Administrative Expenses

The increase in administrative expenses was largely due to a $0.4 million increase in bonus expense based upon performance against budget metrics and $0.2 million of incremental legal and professional fees incurred during the 12-week period ended July 16, 2016 related to the ongoing dispute and associated arbitration proceeding with the New York State Teamsters Conference Pension and Retirement Fund discussed in Note 9 to our condensed consolidated financial statements contained in Item 1 of this Form 10-Q.  

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Rent Expense, Net

Rent expense reflects our rental expense for our supermarkets under operating leases, net of income we receive from various entities that rent space in our supermarkets under subleases.  The increase in rent expense was due to new supermarket openings since May 2015.

Depreciation and Amortization

The increase in depreciation and amortization was due to incremental depreciation related to capital expenditures since mid-2015.

Advertising

Advertising remained relatively consistent as a percentage of net sales.

Impairment

During the 12-week period ended July 16, 2016, we determined that the expected future cash flows associated with one supermarket location were insufficient to recover the location’s aggregate net book value of long-lived assets.  As a result, the net book values of leasehold improvements and equipment assets were written down to their estimated fair values.  A corresponding non-cash impairment of $2.1 million was recognized in the condensed consolidated statement of comprehensive loss.  

Loss on debt extinguishment

During June 2015, we satisfied and discharged our obligations under our 2017 Notes and redeemed $60.0 million of our 2018 Notes.  In connection with these financing activities, we recorded a $34.5 million loss on debt extinguishment during the 12-week period ended July 11, 2015.  See Note 5 to our condensed consolidated financial statements in Item 1 of this 10-Q for further details.

Interest Expense, Net

Interest expense decreased $0.5 million due to a lower average borrowing rate on long-term debt as a result of our June 2015 refinancing activities.  

Income Tax Expense

Based on an assessment of positive and negative evidence regarding the realization of our deferred tax assets, we continue to maintain a full valuation allowance against total net deferred tax assets, and consequently, we recognized no income tax benefit during the 12-week periods ended July 16, 2016 and July 11, 2015.  

The income tax expense recognized for the 12-week periods ended July 16, 2016 and July 11, 2015 solely reflects the recognition of additional valuation allowance associated with the tax amortization of our indefinite-lived tradename and goodwill deferred tax liabilities.  The effective tax rates would have been 38.9% and 39.1%, respectively, without the establishment of valuation allowance.

Net Loss

Our net loss decreased $34.6 million for the reasons described above.

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28-Week Period Ended July 16, 2016 Compared with the 28-Week Period Ended July 11, 2015

Summary

The results of operations during the 28-week period ended July 16, 2016 compared with the 28-week period ended July 11, 2015 were impacted by the $29.5 million incremental inside sales contribution from seven acquired and new supermarkets opened since May 2015 and a same store sales decrease of 1.3%, primarily resulting from food cost deflation.  Fuel sales decreased $17.3 million during the 28-week period ended July 16, 2016, primarily as a result of a decrease in fuel retail prices.  Due to market changes in fuel retail prices and costs, fuel profit was unusually high during the 28-week period ended July 11, 2015 and returned to normal levels in 2016, which was the primary driver of the fuel gross profit decrease of $2.5 million.  Offsetting this decrease were incremental savings of $2.4 million associated with the amendment of certain operating terms in our agreement with C&S, which became effective April 1, 2015.  Our operating expenses were impacted by $2.2 million of incremental legal and professional fees during the 28-week period ended July 16, 2016 related to the ongoing dispute and associated arbitration proceeding with the New York State Teamsters Conference Pension and Retirement Fund.  

Net Sales

The following table includes the components of our net sales for the 28-week periods ended July 16, 2016 and July 11, 2015.

(Dollars in thousands)

 

Inside sales increased due to the $29.5 million incremental contribution from seven acquired and new supermarkets opened since May 2015.  This increase was partially offset by a $2.4 million reduction in pharmacy sales attributable to the closure of 27 in-store pharmacies during January 2015.  Same store sales decreased 1.3%, primarily due to food cost deflation in certain categories, including meat and dairy, and competitive pressure to lower food prices in response.  Same store sales is inside sales, excluding franchise revenue, for “same stores,” which are supermarkets that have been operating for at least 13 full four-week periods.  Sales related to the 27 closed in-store pharmacies have been excluded for purposes of calculating same store sales.  To calculate the same store sales change, we used the 28-week period ended July 18, 2015, as this represents the most comparable period to the 28-week period ended July 16, 2016.

 

The decrease in fuel sales was due to a 19.0% decrease in the average retail price per gallon, net of applicable discounts, and a 1.0% net decrease in gallons sold.

 

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Gross Profit

The following table includes a comparison of cost of goods sold, distribution costs and gross profit for the 28-week periods ended July 16, 2016 and July 11, 2015.

(Dollars in thousands)

As a percentage of net sales, the decrease in cost of goods sold was due to a shift in product mix given the smaller proportion of relatively lower margin fuel sales.  Non-cash LIFO inventory valuation expense decreased $0.1 million from $0.4 million during the 28-week period ended July 11, 2015 to $0.3 million during the 28-week period ended July 16, 2016.  Excluding the impact of LIFO adjustments, cost of goods sold as a percentage of inside sales was 67.3% during each of the 28-week periods ended July 16, 2016 and July 11, 2015.  

The decrease in distribution costs was due to $1.9 million of incremental savings associated with the amendment of certain operating terms of our agreement with C&S, which became effective April 1, 2015.  This amount recorded in distribution costs is in addition to $0.5 million of savings classified in cost of goods sold related to the amended terms.  In addition, there was a $1.7 million decrease in self-insured workers’ compensation claims expense.

Operating Expenses

The following table includes a comparison of operating expenses for the 28-week periods ended July 16, 2016 and July 11, 2015.

(Dollars in thousands)

 

Wages, Salaries and Benefits

Wages, salaries and benefits remained relatively consistent as a percentage of net sales.

Selling and General Expenses

The decrease in selling and general expenses was primarily due to a $1.4 million decrease in utility costs attributable to lower commodity costs and usage due to the milder weather during early 2016.

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Administrative Expenses

The increase in administrative expenses was largely due to $2.2 million of incremental legal and professional fees incurred during the 28-week period ended July 16, 2016 related to the ongoing dispute and associated arbitration proceeding with the New York State Teamsters Conference Pension and Retirement Fund discussed in Note 9 to our condensed consolidated financial statements contained in Item 1 of this Form 10-Q.  The increase also reflects normal wage adjustments and increased corporate associate healthcare costs.  

Rent Expense, Net

Rent expense reflects our rental expense for supermarkets under operating leases, net of income we receive from various entities that rent space in our supermarkets under subleases.  The increase in rent expense was due to new supermarket openings since May 2015.

Depreciation and Amortization

The increase in depreciation and amortization was due to incremental depreciation related to capital expenditures since early 2015.

Advertising

Advertising remained relatively consistent as a percentage of net sales.

Impairment

During the 28-week period ended July 16, 2016, we determined that the expected future cash flows associated with one supermarket location were insufficient to recover the location’s aggregate net book value of long-lived assets.  As a result, the net book values of leasehold improvements and equipment assets were written down to their estimated fair values.  A corresponding non-cash impairment of $2.1 million was recognized in the condensed consolidated statement of comprehensive loss.  

Gain on Sale of Assets

During January 2015, we sold pharmacy scripts and inventory related to 27 of our in-store pharmacy locations for cash proceeds of $14.9 million.  These pharmacies were then closed.  A resulting gain on sale of assets of $11.0 million, net of the carrying value of sold inventory of $3.2 million and direct selling expenses of $0.7 million, was recognized in the condensed consolidated statement of comprehensive loss for the 28-week period ended July 11, 2015.

Loss on debt extinguishment

During June 2015, we satisfied and discharged our obligations under our 2017 Notes and redeemed $60.0 million of our 2018 Notes.  In connection with these financing activities, we recorded a $34.5 million loss on debt extinguishment during the 28-week period ended July 11, 2015.  See Note 5 to our condensed consolidated financial statements in Item 1 of this 10-Q for further details.

Interest Expense, Net

Interest expense decreased $1.3 million due primarily to a lower average borrowing rate on long-term debt as a result of our June 2015 refinancing activities.

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Income Tax Expense

Based on an assessment of positive and negative evidence regarding the realization of our deferred tax assets, we continue to maintain a full valuation allowance against total net deferred tax assets, and consequently, we recognized no income tax benefit during the 28-week periods ended July 16, 2016 and July 11, 2015.  

The income tax expense recognized for the 28-week periods ended July 16, 2016 and July 11, 2015 solely reflects the recognition of additional valuation allowance associated with the tax amortization of our indefinite-lived tradename and goodwill deferred tax liabilities.  The effective tax rates would have been 39.0% and 39.1%, respectively, without the establishment of valuation allowance.

Net Loss

Our net loss decreased $23.7 million for the reasons described above.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of cash are cash flows generated from our operations and borrowings under our 2017 ABL Facility.  Our 2017 ABL Facility allows a maximum borrowing capacity of $125.0 million, subject to a borrowing base calculation, with an option for future upsizing with up to $50.0 million of incremental commitments if the required conditions are met.  As of July 16, 2016, the unused availability under our 2017 ABL Facility was $46.5 million, after giving effect to the borrowing base calculation, $22.8 million of letters of credit outstanding and $47.7 million of borrowings outstanding.  We expect that cash generated from operations and availability under our 2017 ABL Facility will permit us to fund our debt service requirements, investments in working capital, capital expenditures, acquisitions and other cash requirements for at least the next twelve months.  We do not expect to make dividends of significant size in the near future; however, we may pay dividends to our stockholders from time to time.  Our financial flexibility will depend upon our future operating performance, which will be affected by prevailing economic conditions in the grocery industry and financial, business, and other factors, some of which are beyond our control.  Although unforeseen, if faced with the need to increase liquidity, we could readily respond through the control of variable operating expenses (for example, by adjusting employment levels) and through the reduction of planned capital expenditure and acquisition activities.

On June 10, 2015, Holding I and Tops Markets II Corporation issued $560.0 million in aggregate principal amount of 2022 Notes, bearing annual interest of 8.00%.  The proceeds from the 2022 Notes were used to fund a tender offer for, and redeem the balance of, the previously outstanding $460.0 million of 2017 Notes and to fund a partial tender offer for $60.0 million of the $150.0 million outstanding 2018 Notes, including tender and redemption premiums of $23.0 million and $1.2 million, respectively.  The proceeds were also used to pay accrued and unpaid interest related to the tendered and redeemed 2017 Notes and 2018 Notes and fees and expenses related to the issuance of the 2022 Notes.  See Note 5 to our condensed consolidated financial statements of Item 1 in this 10-Q.

During January 2015, we sold pharmacy scripts and inventory related to 27 of our in-store pharmacies for cash proceeds of $14.9 million.  These pharmacies were then closed.

On December 15, 2016, semi-annual cash interest payments totaling $26.1 million are payable related to our 2022 Notes and 2018 Notes.  We expect these payments will be primarily funded through cash from operations.  No principal amounts are payable related to these notes until their respective maturities on June 15, 2022 and June 15, 2018.

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Cash Flows Information

The following is a summary of cash provided by or used in each of the indicated types of activities:

(Dollars in thousands)

 

 

Cash provided by operating activities during the 28-week period ended July 16, 2016 decreased $22.5 million compared with the 28-week period ended July 11, 2015.  Changes in operating assets and liabilities represented a use of cash of $7.6 million during the 28-week period ended July 16, 2016 compared with a source of cash of $17.6 million during the 28-week period ended July 11, 2015.  This year-over-year change was primarily attributable to a larger decrease in accrued expenses and an increase in inventory during the 28-week period ended July 16, 2016.  The larger decrease in accrued expenses was due to an $8.9 million increase in bonus payments due to better performance against budget metrics in 2015 versus 2014.  Inventory decreased during the 28-week period ended July 11, 2015, in part due to the sale of pharmacy inventory related to the closure of 27 of our in-store pharmacies.  Inventory increased during the 28-week period ended July 16, 2016 due to the replenishment of lower than normal inventory levels at 2015 year-end, which was caused in part by the 2015 fiscal year ending after the New Year's Day holiday.    

Cash used in investing activities increased $7.2 million during the 28-week period ended July 16, 2016 compared with the 28-week period ended July 11, 2015 due to net cash proceeds of $11.3 million from the sale of pharmacy scripts during January 2015, partially offset by a decrease in normal capital expenditure payments.  We expect to invest $40 million to $45 million in capital expenditures during fiscal year 2016, primarily related to new supermarket locations, including the six supermarkets to be acquired in late August, remodels and maintenance activities.  We expect to fund these capital expenditures primarily with cash from operations.

Cash used in financing activities decreased $15.1 million during the 28-week period ended July 16, 2016 compared with the 28-week period ended July 11, 2015.  The decrease reflects a change in net borrowings and repayments on our 2017 ABL Facility of $25.5 million, from net repayments of $24.5 million during the 28-week period ended July 11, 2015 to net borrowings of $1.0 million during the 28-week period ended July 16, 2016.  Partially offsetting this impact were cash flows related to the June 2015 refinancing activities, including the proceeds from the 2022 Notes of $560.0 million, the tender offer for, and redemption of the balance of, the previously outstanding 2017 Notes and partial tender offer for the 2018 Notes, and fees and expenses incurred related to the 2022 Notes issuance.  We paid a dividend of $2.0 million to Tops MBO Co and repurchased $1.2 million of our 2018 Notes during the 28-week period ended July 16, 2016.

Multiemployer Pension Plans

We contribute to the Local One plan, a defined benefit multiemployer pension plan, under our collective bargaining agreements with Local One.  The Local One plan generally provides retirement benefits to participants based on their service to contributing employers.  We are contingently liable for withdrawal liability in the event that we withdraw from the Local One plan.  The actuary for the Local One plan has estimated that, as of December 31, 2014, our withdrawal liability would have been $349.2 million in the event of our complete withdrawal from the Local One plan during 2015.  In accordance with applicable accounting rules, our contingent withdrawal liability is not included in our consolidated financial statements.  We have no intention to withdraw from the Local One plan.  During the 28-week periods ended July 16, 2016 and July 11, 2015, we made contributions of $7.8 million and $6.6 million, respectively, to this plan.  We are required to increase our annual contributions to the Local One plan pursuant to our current collective bargaining agreements and the Local One plan’s current rehabilitation plan.

As a result of our acquisition of Erie Logistics from C&S in December 2013, we believe we assumed the obligation to participate in and contribute to the Fund.  During the 28-week periods ended July 16, 2016 and July 11, 2015, we made contributions to the Fund of $2.9 million and $2.7 million, respectively.

We are contingently liable for withdrawal liability in the event of a withdrawal from the Fund, which includes any withdrawal liability imposed on Erie Logistics for which C&S is liable.  In late January 2014, we received notice that the Fund had suspended Erie Logistics as a participating employer in the Fund pending the Fund’s investigation into the acquisition and on May 27, 2014, the Fund provided notice (“Notice”) to Erie Logistics and C&S of its determination that Erie Logistics incurred employer withdrawal liability as a result of the acquisition.

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Though no longer contractually required to do so given the suspension and Notice, we have elected to continue to tender contributions to the Fund for the Erie Logistics associates in accordance with the terms set forth in the collective bargaining agreements with Teamsters Local 264.  The Fund has rejected and returned these contributions to date.  As a result, to date, we have chosen to establish a separate interest bearing account to hold these rejected contributions, although we may decide, in our sole discretion, to discontinue this practice in the future.

The Notice provides that Erie Logistics owes withdrawal liability of $183.7 million, payable in a lump sum or in monthly installments, calculated to give effect to a limit on total withdrawal liability imposed by ERISA, of $641,514 for 240 months.  If it were ultimately determined that Erie Logistics incurred a withdrawal liability to the Fund, the Company would bear financial responsibility for this liability.  Under the terms of the purchase agreement for the acquisition of Erie Logistics from C&S, and as a continuation of our prior contractual obligations, the Company retains the obligation to indemnify C&S in the event withdrawal liability is imposed on Erie Logistics, the Company or C&S.  Although we are vigorously contesting the withdrawal determination, during the pendency of the proceeding to contest such determination, ERISA requires that conditional monthly payments of withdrawal liability be made, which began July 28, 2014.  During each of the 28-week periods ended July 16, 2016 and July 11, 2015, the monthly conditional payments of withdrawal liability totaled $3.8 million.  These monthly conditional payments are in addition to pension contributions the Company has tendered which the Fund has rejected and returned, as discussed above and in Note 9 to our condensed consolidated financial statements included in Item 1 of this 10-Q.

Off-Balance Sheet Arrangements

Our off-balance sheet arrangements at July 16, 2016 consisted of operating leases and any potential withdrawal liability obligations under our multi-employer pension plans.  We are not a party to any other off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, net sales, expenses, results of operations, liquidity, capital expenditures or capital resources.

Inflation

Product cost inflation could vary from our estimates due to general economic conditions, weather, availability of raw materials and ingredients in the products that we sell and their packaging, and other factors beyond our control.

CRITICAL ACCOUNTING POLICIES

Our condensed consolidated financial statements are prepared in accordance with GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reported periods.

Refer to Holding II’s audited consolidated financial statements as of January 2, 2016 included in our Annual Report on Form 10-K for a description of certain critical accounting policies, including those related to vendor allowances, inventory valuation, valuation of tradename, valuation of long-lived assets, acquisition accounting, leases, self-insurance programs and income taxes.

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The table below provides information about our outstanding debt as of July 16, 2016.  The amounts shown for each year represent the contractual maturities of long-term debt, excluding capital lease obligations.  Interest rates reflect the weighted average rates for the outstanding instruments.  The Fair Value column includes the fair value of our debt instruments as of July 16, 2016.  Refer to Note 1 of our condensed consolidated financial statements in Item 1 of this 10-Q for information about our accounting policy for financial instruments.

(Dollars in thousands)

 

 

COMMODITY PRICE RISK

We purchase products that are impacted by commodity prices and are therefore subject to price volatility caused by weather, market conditions and other factors, which are not considered predictable or within our control.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of July 16, 2016, the Chief Executive Officer and the Chief Financial Officer, together with designated members of the finance and accounting organization, evaluated the Company’s disclosure controls and procedures.  Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures were effective as of July 16, 2016.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There was no change in the Company’s internal control over financial reporting during the 12-week period ended July 16, 2016 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

The disclosure contained under the heading “Multiemployer Pension Plans” in Note 9 to the condensed consolidated financial statements contained in Item 1 of this 10-Q is hereby incorporated by reference.

The Company is subject to various claims and legal proceedings which arise in the ordinary course of business.  While the outcome of these claims and proceedings cannot be predicted with certainty, management does not believe that the outcome of any of these claims and proceedings will have a material effect on our results of operations, financial position or cash flows.

There are no material changes from risk factors for the Company disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2016.

 

 

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SIGNATURE

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

 

 

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