We believe that cash flows generated from operations supplemented by our cash, the unused borrowing capacity under the Credit Agreement (as defined below) and the availability of capital lease financing will be sufficient to provide for our debt service requirements, working capital needs and capital expenditure program. However, in the event that cash flows from operations continue to decrease, we may decide to limit our future cash capital expenditure program and, subject to the Senior Leverage Ratio (as defined below), our ability to utilize the full amount available under the Working Capital Facility (as defined below), could be limited.
During fiscal 2004, we entered into a senior secured credit facility (the “Credit Agreement”) with a group of lenders led by Fleet Retail Group, a Bank of America company. The Credit Agreement expires on October 1, 2009 and consists of a $180 million working capital facility (the “Working Capital Facility”), including letters of credit, and a $70 million term loan (the “Term Loan”). The Credit Agreement contains certain covenants which, among other things, place limits on the incurrence of additional indebtedness, issuance of cash-pay preferred stock, repurchase of Company stock, incurrence of liens, sale-leaseback transactions, hedging activities, sale or discount of receivables, investments, loans, advances, guarantees with affiliates, asset sales, acquisitions, mergers and consolidations, changing lines of business, repayments of other indebtedness, amendments to organizational documents and other matters customarily restricted in such agreements. The Credit Agreement also contains provisions permitting us to increase the size of the Working Capital Facility by $25 million and to repay and subsequently reborrow any portion of the Term Loan, in each instance subject to certain conditions. The Credit Agreement further provides that we must maintain a minimum inventory level of $150 million, that the maximum annual cash capital expenditures in a fiscal year are limited to the lesser of $150 million or an amount equal to our Consolidated EBITDA (as defined in the Credit Agreement) for the immediately preceding fiscal year plus any unused cash capital expenditures in the immediately preceding fiscal year up to a maximum of $20 million, and that we shall not permit the ratio of Credit Extensions to Consolidated EBITDA (calculated on a trailing four-fiscal-quarter basis) at the end of any fiscal quarter to be more than 2.4:1.0 for each of the first three quarters of fiscal 2006 and 1.9:1.0 for each fiscal quarter thereafter (the “Senior Leverage Ratio”). As used in the Credit Agreement, Credit Extensions mean the sum of the principal balance of all outstanding borrowings thereunder ($70.0 million under the Term Loan and $19.9 million under the Working Capital Facility as of October 28, 2006) and the amount of outstanding letters of credit ($84.5 million as of October 28, 2006). Based on the Senior Leverage Ratio as of October 28, 2006, we have full availability under the Working Capital Facility after giving effect to Credit Extensions ($75.6 million). Also, the Credit Agreement prohibits the payment of cash dividends. The Credit Agreement contains customary events of default, including without limitation, payment defaults, material breaches of representations, warranties and covenants, certain events of bankruptcy and insolvency, and a change of control. We were in compliance with the Credit Agreement covenants as of October 28, 2006.
Borrowings under the Credit Agreement bear interest at floating rates equal to LIBOR plus a premium that ranges between 1.50% to 2.25%, depending on the average remaining availability under the Credit Agreement. Our interest rate on borrowings under the Credit Agreement is currently at LIBOR plus 1.75%. Under the Term Loan, we are required to make a balloon payment of $70 million on October 1, 2009. The Working Capital Facility also expires on October 1, 2009. The weighted-average interest rate in effect on all borrowings under the Term Loan was 6.9% during the 39 weeks ended October 28, 2006.
All of the obligations under the Credit Agreement are guaranteed by our 100% owned subsidiaries, except our non-guarantor subsidiaries, which are comprised of four 100% owned and consolidated single-purpose entities. Each of these single-purpose entities owns the real estate on which a supermarket leased to Pathmark is located. The obligations under the Credit Agreement and those of the subsidiaries guaranteeing the Credit Agreement are secured by substantially all of the Company’s tangible and intangible assets including, without limitation, intellectual property, real property, including leasehold interests, and the capital stock in each of these subsidiaries.
We have outstanding $350 million aggregate principal amount of Senior Subordinated Notes, including $150 million issued at a premium, which pay cash interest semi-annually on February 1 and August 1. The indenture relating to the Senior Subordinated Notes (the “Indenture”) contains a number of restrictive covenants, including a restriction on our ability to declare cash dividends on our Common Stock. We were in compliance with the Senior Subordinated Notes covenants as of October 28, 2006.
There are no credit agency ratings-related triggers in either the Credit Agreement or in the Indenture that would adversely impact the cost of borrowings, annual amortization of principal or related debt maturities.
During the second quarter of fiscal 2006, we formed a new subsidiary to handle all sales and maintain our liability related to Gift Cards. The new subsidiary is a guarantor of our Credit Agreement and our Senior Subordinated Notes. Financial information related to the new subsidiary is included in the guarantor subsidiaries column in our consolidating financial information in the notes to the consolidated financial statements.
CapitalExpenditures. Capital expenditures in the third quarter of fiscal 2006 were $25.1 million compared to $28.3 million in the third quarter of fiscal 2005. Capital expenditures in the first nine months of fiscal 2006 were $59.8 million compared to $43.8 million in the first nine months of fiscal 2005. Capital expenditures for fiscal 2006 are expected to be approximately $70 million. We completed 13 store renovations during the first nine months of fiscal 2006 and expect to complete one store renovation during the fourth quarter.
Critical Accounting Policies
Our discussion of results of operations and financial condition relies on our consolidated financial statements that are prepared based on certain critical accounting policies that require management to make judgments and estimates that are subject to varying degrees of uncertainty. We believe that investors need to be aware of these policies and how they impact our financial statements as a whole, as well as our related discussion and analysis presented herein. While we believe that these accounting policies are based on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these estimates or forecasts. The accounting policies and related risk described in our Annual Report on Form 10-K for the year ended January 28, 2006 are those that depend most heavily on these judgments and estimates. As of October 28, 2006, there have been no material changes to any of the critical accounting policies contained therein.
New Accounting Pronouncements
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and SFAS No. 3". This statement changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition through a cumulative adjustment within net income in the period of the change. This statement requires retrospective application to prior periods’ financial statements unless it is impracticable to determine the period-specific effects or the cumulative effect of the change and is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material impact on our consolidated financial statements.
In October 2005, the FASB issued FASB Staff Position (“FSP”) No. FAS 13-1 “Accounting for Rental Costs Incurred during a Construction Period,” which concluded that rental costs incurred during and after a construction period are for the right to control the use of a leased asset and must be recognized as rental expense. Such costs were previously capitalizable as construction costs if the company had a policy to do so. This FSP is effective for reporting periods beginning after December 15, 2005. The adoption of FSP No. FAS 13-1 did not have a material impact on our consolidated financial position or results of operations.
19
In June 2006, FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of SFAS No. 109” was issued. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”, and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Additionally, this interpretation provides guidance on subsequent derecognition of tax positions, financial statement classification, recognition of interest and penalties, accounting in interim periods, and disclosure and transition requirements. FIN No. 48 is effective for our fiscal year beginning February 4, 2007, with early adoption permitted. We are in the process of evaluating this interpretation, but do not expect that the implementation of FIN No. 48 will have a material impact on our consolidated financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under this statement, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for our fiscal year beginning February 3, 2008, with early adoption permitted. We are in the process of evaluating this statement, but do not expect that the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of SFAS No. 87, 88, 106 and 132 (R).” This statement requires an employer to recognize the funded status of a defined benefit postretirement plan as an asset or liability in the statement of financial position. Changes in the funded status should be recognized through comprehensive income in the year in which the changes occur. Additionally, an employer will be required to disclose information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of gains or losses, prior service costs or credits, and transition assets or obligations. SFAS No. 158 is effective for our fiscal year ending February 3, 2007. This statement also requires an employer to measure the funded status of a plan as of the date of its fiscal year-end statement of financial position. As we have always used the calendar year for measurement, this will result in a change in our financial statements. We are not required to adopt this change until our fiscal year ending February 1, 2009. We cannot estimate the impact of SFAS No. 158 on our stockholders’ equity in advance of the measurement date. Had the new standard been in effect for our fiscal year ended January 28, 2006, we estimate that our stockholders’ equity would have been reduced by approximately $49 million. The impact of adoption could differ materially from this estimate as it will reflect negotiated plan changes, asset performance through the end of the calendar year as well as interest rates and other factors that will be applicable as of December 31, 2006. These factors cannot be known in advance.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”. This bulletin provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative facts are considered, is material. SAB No. 108 is effective for our fiscal year ending February 3, 2007, with early application encouraged. We are in the process of evaluating this bulletin, but do not expect that the adoption of SAB No. 108 will have a material impact on our consolidated financial statements.
Forward-Looking Information
This report contains both historical and “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements appear in a number of places in this report and include statements regarding our intent, belief and current expectations with respect to, among other things, capital expenditures and technology initiatives, the ability to borrow funds under our credit facility, the ability to successfully implement our operating strategies, including trends affecting our business, financial condition and results of operations. The words “anticipate”, “believe”, “expect”, “forecast”, “guidance”, “intend”, “may”, “ongoing”, “plan”, “project”, “will” and other similar expressions generally identify forward-looking
20
statements. While these forward-looking statements and the related assumptions are made in good faith and reflect our current judgment regarding the direction of our business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. These statements are based upon a number of assumptions and estimates which are inherently subject to significant uncertainties and contingencies, many of which are beyond our control and reflect future business decisions which are subject to change. Some of these assumptions inevitably will not materialize, and unanticipated events will occur which will affect our results. Some important factors (but not necessarily all factors) that could negatively affect our revenues, growth strategies, future profitability and operating results, or that otherwise could cause actual results to differ materially from those expressed in or implied by any forward-looking statement, include the following:- changes in business and economic conditions and other adverse conditions in our markets;
- unanticipated environmental damages;
- increased competition;
- increased labor and labor-related costs (e.g., medical and pension) and/or labor disruptions;
- reliance on third-party suppliers;
- our ability to successfully implement our marketing, operating, renovation and expansion strategies and cost reduction initiatives; and
- natural disasters.
For a discussion of these factors, see Item 1 – Business – Factors Affecting Our Business and Prospects in our Annual Report on Form 10-K for the year ended January 28, 2006, subsequent Quarterly Reports on Form 10-Q and subsequent Current Reports on Form 8-K. These reports are not intended to be a discussion of all potential risks or uncertainties as it is not possible to predict or identify all risk factors. We undertake no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaim any obligation to do so.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
There have been no material changes regarding our market risk position from the position reflected in the information provided under Part II, Item 7A, “Quantitative or Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended January 28, 2006.
Item 4. Controls and Procedures.
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act as of October 28, 2006. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of October 28, 2006, the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in the Company’s Exchange Act reports.
There have been no changes during the Company’s fiscal quarter ended October 28, 2006 in the Company’s internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financing reporting.
21
Part II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Repurchases of Equity Securities. The table below is a listing of repurchases of Common Stock during the third quarter of fiscal 2006.
| (a)
Total Number of
Shares Purchased
| | (b)
Average Price
Paid Per Share
| | (c)
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
| | (d)
Maximum
Number of Shares
That May Yet Be
Purchased Under
the Plans or
Programs
|
|---|
| |
| July 30 to August 26, 2006 (1) | | | | 761 | | $ | 8.62 | | | — | | | — | |
| | | | | | | | |
| August 27 to September 30, 2006 (1) | | | | 17,827 | | $ | 9.64 | | | — | | | — | |
| | | | | | | | |
| October 1 to October 28, 2006 (1) | | | | 6,022 | | $ | 10.03 | | | — | | | — | |
| | | | | | | | |
| (1) | | Represents shares withheld, at the election of certain holders of restricted stock and restricted stock units, by the Company from the vested portion of restricted stock and restricted stock unit awards with a market value approximating the amount of withholding taxes due. |
Item 6. Exhibits.
| 10.1 | | Deferred Compensation Plan, effective as of August 25, 2005 (incorporated by reference from the Company's Current Report on Form 8-K as filed with SEC on September 27, 2006). |
| 10.2 | | Amendment to John T. Standley's Employment Agreement, dated October 11, 2006, filed herewith. |
| 31.1 | | Form of CEO Certification, filed herewith. |
| 31.2 | | Form of CFO Certification, filed herewith. |
| 32.1 | | Certification of John T. Standley, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
| 32.2 | | Certification of Frank G. Vitrano, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. |
22
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.
| Pathmark Stores, Inc. |
| |
| |
| By: | /s/ Frank G. Vitrano |
| | | | |
| | | | |
| | Frank G. Vitrano |
| | President and Chief Financial Officer |
| | |
| | |
| By: | /s/ Kevin Darrington |
| | | | |
| | | | |
| | Kevin Darrington |
| | Senior Vice President, Controller and Chief Accounting Officer |
| | |
Date: December 7, 2006
23
