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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended October 4, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to to
Commission file number 1-8140
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FLEMING COMPANIES, INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 48-0222760
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6301 WATERFORD BOULEVARD,
BOX 26647
OKLAHOMA CITY, OKLAHOMA 73126
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (405) 840-7200
(Former name, former address and former fiscal year, if changed since last
report.)
------------------------
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 _X_ No ____
The number of shares outstanding of each of the issuer's classes of common
stock, as of October 31, 1997 is as follows:
Class Shares Outstanding
Common stock, $2.50 par value 37,804,000
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INDEX
PAGE NUMBER
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PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Condensed Statements of Earnings--
12 Weeks Ended October 4, 1997, and October 5, 1996............................................... 3
Consolidated Condensed Statements of Earnings--
40 Weeks Ended October 4, 1997, and October 5, 1996............................................... 4
Consolidated Condensed Balance Sheets--
October 4, 1997, and December 28, 1996............................................................ 5
Consolidated Condensed Statements of Cash Flows--
40 Weeks Ended October 4, 1997, and October 5, 1996............................................... 6
Notes to Consolidated Condensed Financial Statements................................................ 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................................. 15
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings............................................................................ 27
Item 6. Exhibits and Reports on Form 8-K............................................................. 30
Signatures.............................................................................................. 31
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FLEMING COMPANIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
FOR THE 12 WEEKS ENDED OCTOBER 4, 1997, AND OCTOBER 5, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997 1996
------------ ------------
Net sales............................................................................. $ 3,453,261 $ 3,705,970
Costs and expenses:
Cost of sales....................................................................... 3,131,023 3,373,525
Selling and administrative.......................................................... 272,826 281,316
Interest expense.................................................................... 39,084 34,955
Interest income..................................................................... (11,116) (11,610)
Equity investment results........................................................... 3,710 5,708
Litigation charge................................................................... -- 20,000
------------ ------------
Total costs and expenses.......................................................... 3,435,527 3,703,894
------------ ------------
Earnings before taxes................................................................. 17,734 2,076
Taxes on income....................................................................... 10,286 1,061
------------ ------------
Net earnings.......................................................................... $ 7,448 $ 1,015
------------ ------------
------------ ------------
Net earnings per share................................................................ $ .20 $ .03
------------ ------------
------------ ------------
Dividends paid per share.............................................................. $ .02 $ .02
------------ ------------
------------ ------------
Weighted average shares outstanding................................................... 37,804 37,788
------------ ------------
------------ ------------
See notes to consolidated condensed financial statements.
3
FLEMING COMPANIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS
FOR THE 40 WEEKS ENDED OCTOBER 4, 1997, AND OCTOBER 5, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997 1996
------------- -------------
Net sales.......................................................................... $ 11,755,946 $ 12,616,535
Costs and expenses:
Cost of sales.................................................................... 10,670,361 11,482,148
Selling and administrative....................................................... 911,420 980,591
Interest expense................................................................. 124,129 125,045
Interest income.................................................................. (36,410) (38,335)
Equity investment results........................................................ 11,027 12,972
Litigation charge................................................................ 19,218 20,650
------------- -------------
Total costs and expenses....................................................... 11,699,745 12,583,071
------------- -------------
Earnings before taxes.............................................................. 56,201 33,464
Taxes on income.................................................................... 28,602 17,100
------------- -------------
Earnings before extraordinary charge............................................... 27,599 16,364
Extraordinary charge from early retirement of debt (net of taxes).................. 13,330 --
------------- -------------
Net earnings....................................................................... $ 14,269 $ 16,364
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------------- -------------
Net earnings per share:
Earnings before extraordinary charge............................................. $ .73 $ .43
Extraordinary charge............................................................. .35 --
------------- -------------
Net earnings..................................................................... $ .38 $ .43
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------------- -------------
Dividends paid per share........................................................... $ .06 $ .34
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------------- -------------
Weighted average shares outstanding................................................ 37,803 37,768
------------- -------------
------------- -------------
See notes to consolidated condensed financial statements.
4
FLEMING COMPANIES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
OCTOBER 4, DECEMBER 28,
1997 1996
------------ ------------
Current assets:
Cash and cash equivalents.......................................................... $ 27,019 $ 63,667
Receivables........................................................................ 309,813 329,505
Inventories........................................................................ 997,219 1,051,313
Other current assets............................................................... 95,140 119,123
------------ ------------
Total current assets............................................................. 1,429,191 1,563,608
Investments and notes receivable..................................................... 183,214 205,683
Investment in direct financing leases................................................ 202,358 212,202
Property and equipment............................................................... 1,595,454 1,562,382
Less accumulated depreciation and amortization..................................... (673,326) (603,241)
------------ ------------
Net property and equipment........................................................... 922,128 959,141
Other assets......................................................................... 162,142 118,096
Goodwill............................................................................. 970,602 996,446
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Total assets......................................................................... $ 3,869,635 $4,055,176
------------ ------------
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................... $ 814,933 $ 952,769
Current maturities of long-term debt............................................... 47,601 124,613
Current obligations under capital leases........................................... 20,916 19,715
Other current liabilities.......................................................... 234,288 245,774
------------ ------------
Total current liabilities........................................................ 1,117,738 1,342,871
Long-term debt....................................................................... 1,137,684 1,091,606
Long-term obligations under capital leases........................................... 359,162 361,685
Deferred income taxes................................................................ 28,626 37,729
Other liabilities.................................................................... 136,057 145,327
Commitments and contingencies
Shareholders' equity:
Common stock, $2.50 par value per share............................................ 94,510 94,494
Capital in excess of par value..................................................... 504,232 503,595
Reinvested earnings................................................................ 526,422 514,408
Cumulative currency translation adjustment......................................... (4,700) (4,700)
------------ ------------
1,120,464 1,107,797
Less ESOP note..................................................................... (5,199) (6,942)
Less additional minimum pension liability.......................................... (24,897) (24,897)
------------ ------------
Total shareholders' equity..................................................... 1,090,368 1,075,958
------------ ------------
Total liabilities and shareholders' equity........................................... $ 3,869,635 $4,055,176
------------ ------------
------------ ------------
See notes to consolidated condensed financial statements.
5
FLEMING COMPANIES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
FOR THE 40 WEEKS ENDED OCTOBER 4, 1997, AND OCTOBER 5, 1996
(IN THOUSANDS)
1997 1996
---------- ----------
Cash flows from operating activities:
Net earnings........................................................................... $ 14,269 $ 16,364
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization........................................................ 139,738 145,082
Credit losses........................................................................ 14,840 21,550
Deferred income taxes................................................................ (577) (7,574)
Equity investment results............................................................ 11,027 12,973
Gain on sale of businesses........................................................... (2,586) (3,666)
Litigation charge.................................................................... -- 20,650
Cost of early debt retirement........................................................ 22,227 --
Consolidation and restructuring reserve activity..................................... (1,987) (713)
Change in assets and liabilities, excluding effect of acquisitions:
Receivables........................................................................ 1,036 (22,698)
Inventories........................................................................ 52,762 120,411
Accounts payable................................................................... (133,626) (45,204)
Other assets and liabilities....................................................... (32,197) (34,061)
Other adjustments, net............................................................... (2,894) 77
---------- ----------
Net cash provided by operating activities.......................................... 82,032 223,191
---------- ----------
Cash flows from investing activities:
Collections on notes receivable........................................................ 47,829 45,480
Notes receivable funded................................................................ (29,725) (48,876)
Notes receivable sold.................................................................. -- 34,980
Purchase of property and equipment..................................................... (82,348) (100,602)
Proceeds from sale of property and equipment........................................... 11,859 12,283
Investments in customers............................................................... (1,963) (356)
Proceeds from sale of investment....................................................... 2,196 3,506
Businesses acquired.................................................................... (9,572) --
Proceeds from sale of businesses....................................................... 13,093 9,244
Other investing activities............................................................. 6,255 5,683
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Net cash used in investing activities.............................................. (42,376) (38,658)
---------- ----------
Cash flows from financing activities:
Proceeds from long-term borrowings..................................................... 896,950 128,000
Principal payments on long-term debt................................................... (927,616) (279,544)
Principal payments on capital lease obligations........................................ (15,362) (16,342)
Sale of common stock under incentive stock and stock ownership plans................... 491 2,002
Dividends paid......................................................................... (2,260) (12,700)
Other financing activities............................................................. (28,507) (5,229)
---------- ----------
Net cash used in financing activities.............................................. (76,304) (183,813)
---------- ----------
Net increase (decrease)in cash and cash equivalents...................................... (36,648) 720
Cash and cash equivalents, beginning of period........................................... 63,667 4,426
---------- ----------
Cash and cash equivalents, end of period................................................. $ 27,019 $ 5,146
---------- ----------
---------- ----------
Supplemental information:
Cash paid for interest................................................................. $ 119,529 $ 117,133
Cash paid for income taxes............................................................. $ 33,361 $ 32,118
---------- ----------
---------- ----------
See notes to consolidated condensed financial statements.
6
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. The consolidated condensed balance sheet as of October 4, 1997, and the
consolidated condensed statements of earnings and cash flows for the 12-week and
40-week periods ended October 4, 1997, and for the 12-week and 40-week periods
ended October 5, 1996, have been prepared by the company, without audit. In the
opinion of management, all adjustments necessary to present fairly the company's
financial position at October 4, 1997, and the results of operations and cash
flows for the periods presented have been made. All such adjustments are of a
normal, recurring nature except as disclosed. Earnings per share disclosures are
computed using weighted average shares outstanding. The impact of common stock
options on earnings per share is immaterial. Certain reclassifications have been
made to the prior year amounts to conform to the current year's classification.
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These consolidated condensed
financial statements should be read in conjunction with the consolidated
financial statements and related notes included in the company's 1996 annual
report on Form 10-K.
3. The LIFO method of inventory valuation is used for determining the cost
of most grocery and certain perishable inventories. The excess of current cost
of LIFO inventories over their stated value was $34 million at October 4, 1997,
and $29 million at December 28, 1996.
4. During the first and second quarters of 1997, the company undertook
various activities and received a series of commitments which culminated in the
implementation of an $850 million senior secured credit facility and the sale of
$500 million of senior subordinated notes on July 25, 1997. Proceeds from the
senior subordinated notes plus initial borrowings under the senior secured
credit facility were used to repay all outstanding bank debt (which totaled
approximately $550 million) and the balance, together with additional revolver
borrowings, was used to redeem the company's $200 million of floating rate
senior notes.
The recapitalization program resulted in an extraordinary charge of $13.3
million, after income tax benefits of $8.9 million, or $.35 per share, in the
company's second quarter ended July 12, 1997. Almost all of the charge
represented a non-cash write-off of unamortized financing costs related to the
debt which was prepaid.
The new $850 million senior secured credit facility consists of a $600
million revolving credit facility with a maturity date of July 25, 2003, and a
$250 million amortizing term loan with a maturity date of July 25, 2004. The new
credit facility is secured by the inventory and accounts receivable of the
company and its subsidiaries and is guaranteed by substantially all of the
company's subsidiaries. See Note 6. The stated interest rate on borrowings under
the new credit agreement is equal to the London interbank offered interest rate
("LIBOR") plus a margin. The level of the margin is dependent on credit ratings
on the company's senior secured bank debt.
The $500 million of senior subordinated notes ("Notes") consists of two
issues: $250 million of 10 1/2% Notes due December 1, 2004 and $250 million of
10 5/8% Notes due July 31, 2007. The Notes are general unsecured obligations of
the company, subordinated in right of payment to all existing and future senior
indebtedness of the company, and senior to or of equal rank with all future
subordinated indebtedness of the company (the company currently has no other
subordinated indebtedness outstanding). The payment
7
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
of principal, interest and premium, if any, payable on the Notes is guaranteed
by substantially all of the company's subsidiaries. See Note 6.
The new credit facility currently contains the following more significant
financial covenants: maintenance of a fixed charge coverage ratio of at least
1.7 to 1, based on earnings before interest, taxes, depreciation and
amortization and net rent expense; maintenance of a ratio of
inventory-plus-accounts receivable to funded-bank-debt (including letters of
credit) of at least 1.4 to 1; and a limitation on restricted payments, including
dividends.
5. In accordance with applicable accounting standards, the company records
a charge reflecting contingent liabilities (including those associated with
litigation matters) when management determines that a material loss is
"probable" and either "quantifiable" or "reasonably estimable". Additionally,
the company discloses material loss contingencies when the likelihood of a
material loss is deemed to be greater than "remote" but less than "probable".
Set forth below is information regarding certain material loss contingencies:
PREMIUM
The company and several other defendants were named in two suits filed in
U.S. District Court in Miami, Florida in 1993. The suits involved an allegedly
fraudulent scheme conducted by a failed grocery diverter--Premium Sales
Corporation ("Premium")--and others in which large losses occurred to the
detriment of a class of investors which brought one of the suits. The other suit
was brought by the receiver/ trustee of the estates of Premium and certain of
its affiliated entities. Plaintiffs sought actual damages of approximately $300
million, treble damages, punitive damages, attorneys' fees, costs, expenses and
other appropriate relief.
The company denied plaintiffs' accusations; however, to avoid future expense
and eliminate uncertainty, the company entered into a settlement agreement in
December 1996. The company recorded a charge of $20 million during the third
quarter of 1996 in anticipation of the settlement and deposited that amount into
an escrow account in December 1996 pending finalization of the settlement. On
September 23, 1997, the deposited funds were released from escrow and on October
17, 1997, the claimants dismissed their actions against the company with
prejudice.
DAVID'S
The company and certain of its affiliates were named in a lawsuit filed by
David's Supermarkets, Inc. ("David's") in the District Court of Johnson County,
Texas in 1993 alleging product overcharges during a three year period. In April
1996, judgment in excess of $210 million was entered against the company and the
company recorded a $7.1 million liability. During the second quarter of 1996,
the judgment was vacated, a new trial granted and the accrual was reduced to
$650,000.
The company denied the plaintiff's allegations; however, to eliminate the
uncertainty and expense of protracted litigation, the company paid $19.9 million
to the plaintiff in April 1997 in exchange for dismissal, with prejudice, of all
plaintiff's claims against the company, resulting in a charge to first quarter
earnings of $19.2 million.
FURR'S
Furr's Supermarkets, Inc. ("Furr's"), which purchased approximately $545
million of products from the company in 1996 under a supply contract expiring in
2001, filed a lawsuit in the District Court of Bernalillo County, New Mexico, in
February 1997 naming as defendants the company, certain company
8
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
officers and a company employee. Furr's claimed it was overcharged for products
under the supply contract and alleged various causes of action including breach
of contract, misrepresentation, fraud and violation of certain of New Mexico's
trade practices statutes. Furr's sought an award of unspecified monetary damages
including actual, consequential, incidental, punitive and treble damages
together with interest, attorneys' fees and court costs.
Fleming denied each of Furr's allegations and filed suit against Furr's
seeking to enforce an indemnification agreement entered into by Furr's in 1993.
Fleming also filed a shareholder derivative suit alleging malfeasance against
certain of Furr's officers and directors.
Prior to filing the lawsuit, Furr's sought to exercise the supply contract's
competitiveness clause and sought to audit the company's pricing. Furr's
submitted what it asserted was a "qualified competitive bid" as defined in the
contract. Fleming rejected the bid as not qualifying under the contract and
invoked the arbitration clause of the supply contract.
On October 23, 1997, Fleming and Furr's Supermarkets, Inc. ("Furr's")
reached an agreement of their business dispute.
Pursuant to the terms of the agreement, neither Furr's nor Fleming admitted
liability or wrongdoing. Until the end of April 1998, Furr's will be offered for
sale (including Fleming's equity investment of approximately 30%). Offerees will
have the opportunity to buy Furr's either with or without Fleming's El Paso
product supply center, together with the related equipment and inventory. If the
product supply center is not sold, Furr's (or Furr's purchaser) is obligated to
pay certain liquidation costs to Fleming and Fleming will liquidate the
inventory in the ordinary course. If Furr's is not sold, Furr's will have 30
days during which to elect to purchase the El Paso product supply center (and
close within 120 days) or to pay Fleming liquidation costs (after a nine month
transition period). Under the agreement, Fleming's supply contract with Furr's
will terminate in nineteen months, or earlier, and Fleming will pay Furr's
$800,000 per month until the contract terminates. Other Fleming customers
currently being served by the El Paso product supply center will continue to be
served by other Fleming units.
As the result of the agreement, Furr's dismissed its lawsuit against Fleming
and certain members of its management and Fleming dismissed its lawsuits against
Furr's and certain of its officers and directors, each with prejudice. The
arbitration proceedings were also dismissed. Furr's has agreed that Fleming's
past pricing practices were consistent with its supply contract and has agreed
that Fleming's FlexPro-SM- marketing plan will be applicable until the supply
contract terminates.
While Fleming will cooperate in the sale of Furr's, the ultimate outcome of
these efforts cannot be predicted. However, Fleming believes that by June 1999,
or earlier, Fleming will cease to supply Furr's, Fleming's distribution assets
serving Furr's will be liquidated and Fleming's substantial equity investment in
Furr's may be sold. The settlement does not cause an impairment in value of any
recorded asset balances. While the loss of Furr's business will be significant
in the near term, Fleming believes that the reinvestment of its employed capital
in other profitable operations will offset the lost business.
MEGAFOODS
In August 1994, a former customer, Megafoods Stores, Inc. ("Megafoods" or
the "debtor"), and certain of its affiliates filed chapter 11 bankruptcy
proceedings in Arizona. The company filed claims, including a claim for
indebtedness for goods sold on open account, equipment leases and secured loans,
totaling approximately $28 million (including claims for future payments and
other non-recorded assets). Additionally, the debtor was liable or contingently
liable to the company under store subleases and lease guarantees extended by the
company for the debtor's benefit. The debtor objected to the company's claims
9
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
and filed an adversary proceeding against the company seeking subordination of
the company's claims, return of an approximate $12 million deposit and
affirmative relief for damages which was subsequently amended to include
allegations of overcharges for products.
In August 1996, the court approved a settlement of both the debtor's
adversary proceeding against the company and the company's disputed claims in
the bankruptcy. The settlement, which has been approved by the creditors but
awaits confirmation by the court of a plan of liquidation, provides that the
company will retain the $12 million deposit, relinquish its secured and
unsecured claims in exchange for the right to receive 10% of distributions, if
any, made to the unsecured creditors and pay the debtor $2.5 million in exchange
for the furniture, fixtures and equipment from 17 stores and two storage
facilities. The company agreed to lease the furniture, fixtures and equipment in
14 of the stores to the reorganized debtor for nine years (or until, in each
case, the expiration of the store lease) at an annual rental of $18,000 per
store.
During the fourth quarter of 1996, the debtor sold its Phoenix stores. In
January 1997, the debtor filed a joint liquidating plan which incorporates the
settlement agreement. During the second quarter of 1997, the debtor sold its
Texas assets and the purchaser agreed to assume the debtor's obligation to lease
furniture, fixtures and equipment from the company. The consummation of this
sale resulted in the disposition of substantially all of the debtor's remaining
physical assets. The company did not receive any distribution from the sale of
the debtor's assets. The hearing for confirmation of the debtor's plan of
liquidation is scheduled for November 20, 1997.
The company recorded charges relating to Megafoods of approximately $6.5
million in 1994, $3.5 million in 1995 and $5.8 million in 1996. Approximately $3
million of recorded net assets relating to Megafoods (consisting of equipment)
remain on the company's books.
RANDALL'S
On July 30, 1997, Randall's Food Markets, Inc. ("Randall's"), initiated
arbitration proceedings against Fleming before the American Arbitration
Association in Dallas, Texas. Randall's alleges that Fleming conspired with a
group of manufacturers and vendors to defraud Randall's by cooperating to
inflate prices charged to Randall's. Randall's also alleges that Fleming
impermissably modified the pricing mechanism of the supply contract. Randall's
alleges breach of contract, fraud and RICO violations, and seeks actual damages,
punitive damages, treble damages under RICO, termination of its supply contract
and attorneys' fees and court costs. Randall's alleges it suffered substantial
but unquantified damages. The contract on which Randall's bases its claim
prohibits either party from recovering any amount other than actual damages;
recovery of consequential damages, punitive damages and all similar forms of
damages are expressly prohibited. Randall's asserts that such provision is
contrary to public policy and therefore not binding on it.
Randall's has been a Fleming customer for over 30 years. In 1996 Randall's
purchased approximately $485 million of products from Fleming under an eight
year supply contract entered into in 1993 in connection with Fleming's purchase
of certain distribution assets from Randall's. Prior to initiating the
arbitration proceeding and making allegations against Fleming for overcharges,
Randall's had sought unsuccessfully to terminate the supply contract.
The company believes it has complied with its obligations to Randall's in
good faith and that punitive and consequential damages are not recoverable under
the supply contract. The company will vigorously defend its interests in the
arbitration. While management is unable to predict the potential range of
monetary exposure to Randall's, if any, the effect of an unfavorable outcome or
the loss of Randall's business could have a material adverse effect on the
company.
10
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
CLASS ACTION SUITS
In 1996, the company and certain of its present and former officers and
directors, including the chief executive officer, were named as defendants in
nine purported class action lawsuits filed by certain stockholders and one
purported class action lawsuit filed by a noteholder. In April 1997, the court
consolidated the nine stockholder cases as City of Philadelphia, et al. v.
Fleming Companies, Inc., et al.; the noteholder case was also consolidated, but
only for pre-trial purposes. A complaint has been filed in the consolidated
cases alleging liability for the company's failure to properly account for and
disclose the contingent liability created by the David's litigation and by the
company's alleged "deceptive business practices." The plaintiffs claim that
these alleged failures and practices led to the David's litigation and to other
material contingent liabilities, caused the company to change its manner of
doing business at great cost and loss of profit, and materially inflated the
trading price of the company's common stock. The company denies each of these
allegations.
On November 12, 1997, the company won a declaratory judgment action against
certain of its insurance carriers regarding a directors and officers ("D&O")
insurance policy issued to Fleming for the benefit of its officers and
directors. On motion for summary judgment, the U.S. District Court for the
Western District of Oklahoma ruled that the company's exposure, if any, under
the class action suits is covered by the D&O policies (aggregating $60 million)
written by the insurance carriers, and that the "larger settlement rule" will be
applicable to the case. According to the trial court, under the larger
settlement rule, a D&O insurer would be liable for the entire amount of coverage
available under a policy even if there were some overlap in the liability
created by the insured individuals and the uninsured corporation. If a
corporation's liability were increased by uninsured parties beyond that of the
insured individuals, then that portion of the liability would be the sole
obligation of that corporation. The court also held that allocation was not
available to the insurance carriers as an affirmative defense. The insurance
carriers have 30 days within which to appeal.
The plaintiffs seek undetermined but significant damages and management is
unable to predict the ultimate outcome of these cases. However, while management
believes that the cases could have a material adverse impact on interim or
annual results of operations, based upon the ruling of the court described
above, the cases will not have a material adverse effect on the company's
liquidity or consolidated financial position.
CENTURY
Century Shopping Center Fund I ("Century Fund I") commenced an action in
November 1988 in the Milwaukee County Circuit Court, State of Wisconsin, seeking
injunctive relief and monetary damages of an unspecified amount against a
subsidiary which was subsequently merged into the company. The plaintiff
originally obtained a temporary restraining order preventing the subsidiary from
closing a store at the Howell Plaza Shopping Center, for which the plaintiff was
the landlord, and from opening a new store at a competing shopping center
located nearby. Shortly thereafter, the order was dissolved by the court and the
stores opened and closed as scheduled. Following the closure of the store, a
number of shopping center tenants and the center itself experienced financial
difficulty ultimately resulting in bankruptcy.
In November 1993, the court granted Century Fund I leave to amend its
complaint to allege breach of contract, tortious interference with contract,
tortious interference to business, defamation, attempted monopolization,
conspiracy to monopolize, conspiracy to restrain trade, and monopolization.
Plaintiff claims that defendant and defendant's new landlord conspired to force
the Howell Plaza Shopping Center out of business.
11
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
In June 1993, three former tenants of the Howell Plaza Shopping Center filed
another case in the same court and in September 1993, the trustee in bankruptcy
for Howell Plaza, Inc. (the predecessor to Century Fund I and its successor as
defendant's landlord) filed a third case. The allegations of these cases are
very similar to the allegations made in the Century Fund I case.
In June 1994, the trial court granted defendant's motion to dismiss all
three cases. That decision was reversed in August 1995 by the Wisconsin Court of
Appeals. The matter was remanded to the trial court. The cases have been
consolidated but are not currently set for trial.
Plaintiffs seek actual damages, consequential damages, treble damages,
punitive damages, attorneys' fees, court costs and other appropriate relief. In
March 1997, plaintiffs supplied the company with an analysis of damages; alleged
actual damages, after trebling but excluding any estimated punitive damages,
amounted to approximately $18 million.
In July 1997, the trial court granted plaintiffs' motion for summary
judgment with respect to their breach of contract claim against Fleming (as to
liability only, not as to damages). The company has petitioned the Wisconsin
Court of Appeals for a certification of an interlocutory appeal of that
decision. Plaintiffs have alleged $1.7 million of actual damages resulted from
the breach of contract. Management is unable to predict the ultimate outcome of
this matter. However, an unfavorable outcome in the litigation could have a
material adverse effect on the company.
OTHER
The company supplies goods and services to some of its customers
(particularly to its large customers) pursuant to supply contracts containing a
"competitiveness" clause. Under this clause, a customer may submit a "qualified
bid" from a third-party supplier to provide the customer with a range of goods
and services comparable to those goods and services offered by Fleming. If the
prices to be charged under the qualifying bid are lower than those charged by
the company by more than an agreed percentage, the company may lower its prices
to come within the agreed percentage or, if the company chooses not to lower its
prices, the customer may accept the competitor's bid. The competitiveness clause
is not exercised frequently and disputes regarding the clause must generally be
submitted to binding arbitration. Additionally, the company believes that most
of its supply contracts prohibit recovery of both punitive and consequential
damages if any dispute ever arises.
From time to time, customers may seek to renegotiate the terms of their
supply contracts, or exercise the competitiveness clause of such agreements or
otherwise alter the terms of their contractual obligations to the company to
obtain financial concessions. Based on its historical experience, the company
does not believe such efforts have had a material adverse effect on its
operations or financial condition to date.
The company utilizes numerous computer systems which were developed
employing six digit date structures (i.e., two digits each for the month, day
and year). Where date logic requires the year 2000 or beyond, such date
structures may produce inaccurate results. Management has implemented a program
to comply with year 2000 requirements on a system-by-system basis. Program costs
are being expensed as incurred, but to compensate for the dilutive effect on
results of operations, the company has delayed other non-critical development
and support initiatives. Fleming's plan includes extensive systems testing and
is expected to be completed by the first quarter of 1999. The solution for each
system is potentially unique and may be dependent on third-party software
providers and developers. A failure on the part of the company to ensure that
its computer systems are year 2000 compliant could have a material adverse
effect on the company's operations. Additionally, failure of the company's
suppliers or, more importantly, its
12
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
customers, to become year 2000 compliant might have a material adverse impact on
the company's operations.
The company's facilities and operations are subject to various laws,
regulations and judicial and administrative orders concerning protection of the
environment and human health, including provisions regarding the transportation,
storage, distribution, disposal or discharge of materials. In conformity with
these provisions, the company has a comprehensive program for testing and
removal, replacement or repair of its underground fuel storage tanks and for
site remediation where necessary. The company has established reserves that it
believes will be sufficient to satisfy anticipated costs of all known
remediation requirements. In addition, the company is addressing several other
environmental cleanup matters involving its properties, all of which the company
believes are immaterial.
The company and others have been designated by the U.S. Environmental
Protection Agency ("EPA") and by similar state agencies as potentially
responsible parties under the Comprehensive Environmental Response, Compensation
and Liability Act ("CERCLA") or similar state laws, as applicable, with respect
to EPA-designated Superfund sites. While liability under CERCLA for remediation
at such sites is generally joint and several with other responsible parties, the
company believes that, to the extent it is ultimately determined to be liable
for the expense of remediation at any site, such liability will not result in a
material adverse effect on its consolidated financial position or results of
operations. The company is committed to maintaining the environment and
protecting natural resources and human health and to achieving full compliance
with all applicable laws, regulations and orders.
The company is a party to various other litigation and contingent loss
situations arising in the ordinary course of its business including: disputes
with customers and former customers; disputes with owners and former owners of
financially troubled or failed customers; disputes with employees regarding
wages, workers' compensation and alleged discriminatory practices; tax
assessments and other matters. The ultimate effect of such actions, some of
which are for substantial amounts, cannot be predicted with certainty. Although
the resolution of any of these matters could have a material adverse impact on
interim or annual results of operations, the company expects that the outcome of
these matters will not have a material adverse effect on the company's liquidity
or consolidated financial position.
6. Certain company indebtedness is guaranteed by all direct and indirect
subsidiaries of the company (except for certain inconsequential subsidiaries),
all of which are wholly owned. The guarantees are joint and several, full,
complete and unconditional. There are no restrictions on the ability of the
subsidiary guarantors to transfer funds to the company in the form of cash
dividends, loans or advances. Full financial statements for the subsidiary
guarantors are not presented herein because management does not believe such
information would be material.
13
FLEMING COMPANIES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The following summarized financial information, which includes allocations
of material corporate-related expenses, for the combined subsidiary guarantors
may not necessarily be indicative of the results of operations or financial
position had the subsidiary guarantors been operated as independent entities.
OCTOBER 4, OCTOBER 5,
1997 1996
------------- -------------
(IN MILLIONS)
Current assets........................................................ $ 23 $ 22
Noncurrent assets..................................................... $ 53 $ 49
Current liabilities................................................... $ 16 $ 10
Noncurrent liabilities................................................ $ 7 $ 9
40 WEEKS ENDED
----------------------------
OCTOBER 4, OCTOBER 5,
1997 1996
------------- -------------
(IN MILLIONS)
Net sales............................................................. $ 256 $ 265
Costs and expenses.................................................... $ 256 $ 269
Net earnings (loss)................................................... -- $ (2)
During the last three years, a significant number of subsidiary guarantors
have been merged into the parent company, resulting in a substantial reduction
in the amounts appearing in the summarized financial information.
7. The accompanying earnings statements include the following:
40 WEEKS 12 WEEKS
---------------------- --------------------
1997 1996 1997 1996
---------- ---------- --------- ---------
(IN THOUSANDS)
Depreciation and amortization (includes amortized costs
in interest expense)................................... $ 139,738 $ 145,082 $ 41,113 $ 47,401
Amortized costs in interest expense...................... $ 7,165 $ 9,967 $ 1,668 $ 3,040
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Several events have shaped Fleming's results of operations and capital and
liquidity position during each of the past three fiscal years and the first
three quarters of 1997. Since 1993, changes in the food marketing and
distribution industry have reduced sales and increased competitive pressures for
the company and many of its customers. In January 1994, the company announced a
strategic plan to transform its operations to better serve its customers and
achieve higher profitability. As part of this plan, the company consolidated
food distribution facilities, reorganized its management group and reengineered
the way it prices and sells grocery, frozen and dairy products and retail
services. In July 1994, the company acquired Scrivner Inc. ("Scrivner"), adding
$6 billion in annual food distribution sales and more than 175 retail stores.
The company also dealt with business and litigation challenges during this
period: the bankruptcy of a major customer in 1994, the addition by foreclosure
in early 1996 of a 71-store customer in Arizona and several litigation
developments in 1996 and 1997. Each of these events is discussed in more detail
below.
CHANGING INDUSTRY ENVIRONMENT. The food marketing and distribution
industry is undergoing accelerated change as producers, manufacturers,
distributors and retailers seek to lower costs and increase services in
an increasingly competitive environment of relatively static overall
demand. Alternative format food stores (such as warehouse stores and
supercenters) have gained retail food market share at the expense of
traditional supermarket operators, including independent grocers, many of
whom are Fleming customers. Vendors, seeking to ensure that more of their
promotional fees and allowances are used by retailers to increase sales
volume, increasingly direct promotional dollars to large
self-distributing chains, alternative formats and other channels of
distribution. The company believes that these changes have led to reduced
sales, reduced margins and lower profitability among many of its
customers and at the company itself.
CONSOLIDATIONS, REORGANIZATION AND REENGINEERING. Throughout 1994 and
1995, the company consolidated 13 food distribution centers, including
nine centers acquired in the Scrivner acquisition, into other operations.
Smaller, less efficiently located facilities were closed and their
operations transferred to larger facilities seeking economies of scale in
operations. These consolidations were costly and resulted in loss of
sales because of the reluctance of certain customers to change and
because of increased distances from new centers.
In 1994, the company eliminated its regional food distribution
organization, centralizing these staff functions and several others. It
also established the Retail Food Segment following the acquisition of
Scrivner and its significant retail food operations.
The design of reengineering, which includes several programs, began in
1994 and implementation commenced in 1995. The most significant of these
programs was the introduction of an innovative marketing plan which
altered the way food products and distribution services are marketed to
customers. Activity-based pricing analyses and marketing research are
used to establish prices of grocery, frozen and dairy products and
charges for handling, storage and delivery services. Other significant
reengineering programs include the development and implementation of
VISIONET-TM-, a proprietary interactive electronic communication network
for retail customers, transportation outsourcing and the installation of
FOODS, a standard food distribution computer operating system.
Some of the costs of the plan have not been charged to the results of
operations but to reserves established at the end of 1993. The recorded
reserves cover severance, facility consolidation expenses and asset
impairment adjustments. All other costs of the plan not covered by
recorded reserves are included in the results of operations. However, the
costs of the plan cannot be
15
separately quantified because actions implementing the plan often are not
unique to consolidation, reorganization and reengineering. Normal,
on-going business development activities are usually performed at the
same time and by the same associates which makes isolating costs related
to the plan impractical. Although the consolidation and reorganization
are complete, and many of the reengineering initiatives have been
completed, more initiatives are in-process or planned but completion
dates are not yet known because of the dependency on customer acceptance,
labor relations and the need to balance benefits and costs.
SCRIVNER. In July 1994, Fleming purchased Scrivner for approximately $390
million in cash and the assumption of $670 million of indebtedness while
refinancing approximately $340 million of its own debt. To finance the
transaction, the company entered into a $2.2 billion bank credit
agreement, $500 million of which was refinanced with fixed and floating
rate senior notes prior to the end of 1994. On July 25, 1997, as part of
the recapitalization program, the company replaced its former bank credit
agreement with the new credit agreement in the aggregate principal amount
of $850 million and called for redemption of all $200 million of the
floating rate senior notes placed in 1994. The floating rate senior notes
were redeemed on September 15, 1997.
Because the company quickly integrated Scrivner's operations, it is
difficult to estimate the impact Scrivner had on sales, gross margins or
earnings. However, Scrivner's significant retail food presence
substantially increased Fleming's corporate-owned retail stores from 139
before the acquisition to approximately 345 (including 283 supermarkets)
immediately following the acquisition. This substantial increase in
retail food operations not only added to total sales, but also raised
both gross margin and selling and administrative expenses as retail food
operations typically operate at higher levels in these areas than do food
distribution operations. Interest expense increased as a result of
increased borrowing levels due to the acquisition and to higher interest
rates attributable in substantial part to lower credit ratings for the
company's long-term debt. Interest expense rose from $78 million in 1993
to $120 million in 1994 and $175 million in 1995 before falling to $163
million in 1996. Goodwill amortization was $23.1 million in 1994, $30.1
million in 1995 and $32.0 million in 1996; the increase from 1994 was
principally due to Scrivner.
MEGAFOODS. In August 1994, Megafoods, Inc. and certain of its affiliates
("Megafoods" or the "debtor"), filed Chapter 11 bankruptcy proceedings in
Phoenix, Arizona. The company estimates that prior to bankruptcy,
annualized sales to Megafoods approximated $335 million. By 1995, sales
to Megafoods were approximately $87 million and by 1996, there were no
sales. The company filed claims for indebtedness for goods sold on open
account, equipment leases and secured loans totaling approximately $28
million and for substantial contingent claims for store subleases and
lease guarantees extended by the company for the debtor's benefit.
Megafoods brought an adversary proceeding seeking, among other things,
damages against the company. The company recorded losses resulting from
deteriorating collateral values of $6.5 million in 1994 and $3.5 million
in 1995, and in 1996 recorded $5.8 million to reflect continuing
deterioration and the effects of a proposed settlement of the company's
claim and the debtor's allegations.
ABCO. At year-end 1994, the company was the largest single shareholder
(approximately 48% of stock outstanding), the major supplier and the
second largest creditor of ABCO Markets, Inc. ("ABCO"), a supermarket
chain located in Arizona. By the fall of 1995, the company's investments
in, and loans to, ABCO totaled approximately $39 million. In September
1995, ABCO defaulted on both its bank debt and its debt to the company.
The company exercised a warrant to gain an additional 3% of ABCO's
capital stock and purchased the bank's preferred position for $21
million. In January 1996, the company foreclosed and acquired all of
ABCO's assets consisting of approximately 71 stores at the time of
foreclosure. Certain of ABCO's minority shareholders have challenged this
action and are seeking rescission and/or damages.
16
LITIGATION. In March 1996, a jury in central Texas returned verdicts in
David's Supermarkets, Inc. v. Fleming ("David's") which resulted in a
judgment of $211 million against Fleming. In response, the company
established a reserve of $7.1 million and amended its former bank credit
agreement to facilitate posting a partially collateralized supersedeas
bond. Pursuant to the amendment, pricing for borrowing under the former
credit agreement was increased. The judgment was vacated in June 1996,
and the company's reserve was reduced to $650,000. During the first
quarter of 1997, Fleming entered into court-sanctioned mediation and, as
a result of a settlement reached with the plaintiff, paid $19.9 million
to settle the litigation.
During the third quarter of 1996, the company recorded a charge of $20
million to reflect an announced settlement agreement reached in lawsuits
involving a failed grocery diverter, Premium Sales Corporation. In
February 1997, the company's largest customer filed suit against it
alleging product overcharges and in July 1997, another large customer
commenced arbitration proceedings against the company also alleging
product overcharges. See Note 5 to the company's financial statements and
Part II, Item 1--Legal Proceedings for a further discussion of certain
litigation and contingent liability issues.
CREDIT POLICIES. In 1995, Fleming began imposing stricter credit policies
and applying cost/benefit analyses to loans to and investments made in
its distribution customers. Traditionally, food distributors have used
availability of financial assistance as a competitive tool. Fleming
believes that its stricter credit policies have resulted in decreased
sales.
Management believes that the combination of these events has negatively
affected the company's financial performance during the past three years and the
first three quarters of 1997. Additionally, the continuing commitments under the
recent Furr's agreement may negatively impact earnings through May 1999 and
lower sales and operating losses in certain company-owned retail stores are
likely to continue to negatively impact results for the near term. See
"--Litigation and Other Contingencies--Furr's."
However, management also believes that the company's ultimate success will
depend on its ability to continue to cut costs while expanding profitable
operations. The company has revised its marketing plans and is taking other
steps to reverse sales declines. The recapitalization program will provide the
company with greater financial flexibility to redeploy assets and seek to
increase the more profitable facets of both its Food Distribution and Retail
Food Segments. These initiatives include increased marketing emphasis and
expanded offerings of Fleming Retail Services, streamlining and expanding
Fleming Brands, developing and marketing additional foodservice products and
growing retail food operations through remodels, new store development and
selective acquisitions. While the company believes considerable progress has
been made to date, no assurance can be given that the company will be successful
in continuing to cut costs, in reversing sales declines or in increasing higher
margin activities.
After taking into consideration one-time adjustments (recapitalization
charge in 1997, litigation charges in 1996 and 1997, a facilities consolidation
and restructuring adjustment in 1995 and $3 million in other charges in 1996 due
primarily to divested stores), adjusted earnings per share and adjusted EBITDA
(in millions) for the past eleven quarters were as follows:
1995 ADJUSTED 1996 ADJUSTED 1997 ADJUSTED
---------------------- ---------------------- ----------------------
EPS EBITDA EPS EBITDA EPS EBITDA
--------- ----------- --------- ----------- --------- -----------
First quarter........................ $ 0.40 $ 146 $ 0.25 $ 126 $ 0.39 $ 137
Second quarter....................... 0.39 113 0.30 104 0.35 106
Third quarter........................ 0.10 92 0.19 100 0.23 100
Fourth quarter....................... 0.11 97 0.27 105
--------- ----- --------- -----
$ 1.00 $ 448 $ 1.01 $ 435
--------- ----- --------- -----
--------- ----- --------- -----
17
RESULTS OF OPERATIONS
Set forth in the following table is information for the third interim and
year-to-date periods of 1997 and 1996 regarding components of the company's
earnings expressed as a percentage of net sales.
THIRD INTERIM PERIOD 1997 1996
---------- ----------
Net sales............................................... 100.00% 100.00%
Gross margin............................................ 9.33 8.97
Less:
Selling and administrative............................ 7.90 7.59
Interest expense...................................... 1.13 .94
Interest income....................................... (.32) (.31)
Equity investment results............................. .11 .15
Litigation charge..................................... -- .54
---------- ----------
Total expenses...................................... 8.82 8.91
---------- ----------
Earnings before taxes................................... .51 .06
Taxes on income......................................... .30 .03
---------- ----------
Net earnings............................................ .22% .03%
---------- ----------
---------- ----------
YEAR TO DATE 1997 1996
---------- ----------
Net sales............................................... 100.00% 100.00%
Gross margin............................................ 9.23 8.99
Less:
Selling and administrative............................ 7.75 7.77
Interest expense...................................... 1.06 .99
Interest income....................................... (.31) (.30)
Equity investment results............................. .09 .10
Litigation charge..................................... .16 .16
---------- ----------
Total expenses...................................... 8.76 8.73
Earnings before taxes................................... .48 .27
Taxes on income......................................... .24 .14
---------- ----------
Earnings before extraordinary charge.................... .23 .13
Extraordinary charge from early retirement of debt...... .11 --
---------- ----------
Net earnings............................................ .12% .13%
---------- ----------
---------- ----------
NET SALES
Sales for the third quarter (12 weeks) of 1997 decreased by $.3 billion, or
7%, to $3.5 billion from $3.7 billion for the same period in 1996. Year to date,
sales decreased by $.9 billion, or 7%, to $11.8 billion from $12.6 billion in
1996. Several trends and events adversely impacted sales as described in the
General section above. Additionally, the closing or sale of certain
company-owned retail stores negatively impacted sales.
Retail sales generated by the same stores for the third quarter and
year-to-date periods in 1997 compared to the same periods in 1996 decreased 5.2%
and 3.2%, respectively. The decrease was attributable, in part, to new stores
opened by competitors in some markets and aggressive marketing initiatives by
certain competitors.
Fleming measures inflation using data derived from the average cost of a ton
of product sold by the company. Food price inflation year-to-date 1997 was 1.4%
compared to 2.3% for the same period in 1996.
18
GROSS MARGIN
Gross margin for the third quarter of 1997 decreased by $10 million, or 3%,
to $322 million from $332 million for the same period of 1996, but increased as
a percentage of net sales to 9.33% from 8.97% for the same period in 1996. Year
to date, gross margin decreased by $49 million, or 4%, to just under $1.1
billion from just over $1.1 billion, but also increased as a percentage of net
sales to 9.23% from 8.99% for the same period in 1996. The increase in gross
margin percentage was primarily due to improved gross margins at company-owned
retail stores. Food price inflation resulted in a LIFO charge in 1997 of $.5
million for the third quarter and $4.6 million year to date compared to charges
of $.5 million for the quarter and $2.0 million year to date in 1996.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses for the third quarter of 1997 decreased
by $8 million, or 3%, to $273 million from $281 million for the same period in
1996 and increased as a percentage of net sales to 7.90% for 1997 from 7.59% in
1996. Year to date, selling and administrative expenses decreased by $69
million, or 7%, to $911 million from $981 million for the same period in 1996
and decreased as a percentage of net sales to 7.75% for 1997 from 7.77% in 1996.
The year-to-date percentage decrease was principally due to improvements in
operating efficiencies for company-owned retail stores. The increase in the
third quarter was due primarily to increased corporate expenses in 1997 in the
information technology area and the absence in 1997 of a favorable retail
divestiture accrual adjustment.
As more fully described in the 1996 Annual Report on Form 10-K, the company
has a significant amount of credit extended to its customers through various
methods. These methods include customary and extended credit terms for inventory
purchases, secured loans with terms generally up to ten years, and equity
investments in and secured and unsecured loans to certain customers.
Credit loss expense is included in selling and administrative expenses and
for the third quarter of 1997 decreased by $3 million to $4 million from $7
million for the comparable period in 1996. Year to date, credit loss expense was
$15 million in 1997 compared to $22 million in 1996 for a decrease of $7
million. Since 1994, tighter credit practices and reduced emphasis on credit
extensions to and investments in customers have resulted in less exposure and a
decrease in credit loss expense. Further material reductions are not expected.
INTEREST EXPENSE
Interest expense for the third quarter of 1997 increased to $39 million from
$35 million for the same period in 1996. Year to date, interest expense
decreased to $124 million from $125 million in 1996. Lower average debt levels
in 1997 compared to 1996 primarily accounted for the year-to-date improvement.
Interest expense increased in the third quarter of 1997 compared to the same
period in 1996 primarily because the interest rates on the new senior
subordinated notes are higher than the rates on debt which was repaid. See Note
4 to the company's financial statements.
The stated interest rate on the company's floating rate indebtedness is
equal to the London interbank offered interest rate ("LIBOR") plus a margin. The
company employs interest rate swaps and caps from time to time to manage
exposure to changing interest rates and interest expense. In the third quarter
of 1997, interest rate swaps covering $250 million aggregate principal amount of
floating rate indebtedness were employed. Interest rate hedge agreements
contributed $1.4 million of net interest expense in the 1997 third quarter
compared to $2.1 million of net interest expense for the same period of 1996.
Year to date, interest rate hedge agreements contributed $5.9 million of net
interest expense in 1997 compared to $7.0 million in 1996.
19
INTEREST INCOME
Interest income for the third quarter of 1997 decreased to $11 million from
$12 million in the same period in 1996. Year to date, interest income decreased
to $36 million in 1997 from $38 million in 1996. The decrease is primarily due
to the company's sale in the third quarter of 1996 of $35 million of notes
receivable with limited recourse. The decrease is partly offset by new notes
funded since the note sale.
EQUITY INVESTMENT RESULTS
The company's portion of operating losses from equity investments for the
third quarter of 1997 decreased to $4 million from $6 million for the same
period in 1996. Year to date, operating losses from equity investments decreased
to $11 million from $13 million in 1996. The reduction in losses is due to
improved results of operations in certain of the underlying equity investments.
LITIGATION CHARGE
In the first quarter of 1997, the company paid $19.9 million in complete
settlement of the David's litigation. In the first quarter of 1996, the company
accrued $7.1 million as the result of a jury verdict regarding the case. In the
second quarter of 1996, the accrual was reversed following the vacation of the
judgment resulting from the jury verdict, and a new accrual for $650,000 was
established. In the third quarter of 1996, the company accrued $20 million
related to an agreement reached to settle the Premium lawsuits. See Note 5 to
the company's financial statements and Part II, Item 1--Legal Proceedings.
TAXES ON INCOME
The effective tax rate for 1997 is presently estimated at 58.0%. The 58.0%
rate was used in calculating both the third quarter and year-to-date income tax
amounts. The presentation of the year-to-date tax is split by reflecting a tax
benefit at the statutory rate of 40% for the extraordinary charge and reflecting
the balance of the tax amount on the taxes on income line. The rate used for the
third quarter and year to date for 1996 was 51.1%. The increase is primarily due
to lower earnings in 1997 compared to 1996 (primarily due to the litigation
charge and write-off of costs associated with the early retirement of debt) with
basically no change in the blended statutory rate or nondeductible dollar
amounts (permanent differences) from 1996.
OTHER
Several factors negatively affecting earnings in the third quarter of 1997
are likely to continue for the near term. Management believes that these factors
include lower sales and operating losses in certain company-owned retail stores.
Additionally, the continuing commitments under the recent Furr's agreement may
negatively impact earnings through May 1999. See "--Litigation and Other
Contingencies-- Furr's."
20
SEGMENT INFORMATION
Sales and operating earnings for the company's food distribution and retail
food segments are presented below.
40 WEEKS 12 WEEKS
-------------------- --------------------
1997 1996 1997 1996
--------- --------- --------- ---------
(IN MILLIONS)
Sales:
Food distribution........................................... $ 9,127 $ 9,780 $ 2,678 $ 2,907
Retail food................................................. 2,629 2,837 775 799
--------- --------- --------- ---------
Total sales................................................... $ 11,756 $ 12,617 $ 3,453 $ 3,706
--------- --------- --------- ---------
--------- --------- --------- ---------
Operating earnings:
Food distribution........................................... $ 212 $ 226 $ 63 $ 64
Retail food................................................. 58 35 11 15
Corporate expense........................................... (96) (107) (25) (28)
--------- --------- --------- ---------
Total operating earnings...................................... $ 174 $ 154 $ 49 $ 51
--------- --------- --------- ---------
--------- --------- --------- ---------
Operating earnings for industry segments consist of net sales less related
operating expenses. Operating expenses exclude interest expense, interest
income, equity investment results, litigation charge and taxes on income.
General corporate expenses are not allocated to food distribution and retail
food segments. The transfer pricing between segments is at cost. 1996 corporate
expense has been restated to exclude litigation charge which is a separate line
on the earnings statements.
LIQUIDITY AND CAPITAL RESOURCES
Set forth below is certain information regarding the company's capital
structure at the end of the third quarter of 1997 and at the end of fiscal 1996:
CAPITAL STRUCTURE OCTOBER 4, 1997 DECEMBER 28, 1996
--------------------- ---------------------
(IN MILLIONS)
Long-term debt.................................... $ 1,185 44.6% $ 1,216 45.5%
Capital lease obligations......................... 380 14.3 381 14.2
--------- ----- --------- -----
Total debt........................................ 1,565 58.9 1,597 59.7
Shareholders' equity.............................. 1,090 41.1 1,076 40.3
--------- ----- --------- -----
Total capital................................... $ 2,655 100.0% $ 2,673 100.0%
--------- ----- --------- -----
--------- ----- --------- -----
- ------------------------
Note: The above table includes current maturities of long-term debt and current
obligations under capital leases.
During the 40 weeks ended October 4, 1997, total debt was reduced by $32
million primarily because net cash provided by operating activities exceeded net
cash used in investing activities by $40 million.
Operating activities generated positive net cash flows of $82 million for
the 40 weeks ended October 4, 1997 compared to positive net cash flows of $223
million for the same period in 1996. The variance is explained primarily by a
higher decrease in accounts payable, a lower reduction in inventories and lower
cash earnings, offset in part by a reduction in accounts receivable in 1997
versus an increase in 1996. Working capital was $311 million at the end of the
third quarter of 1997, an increase from $221 million at year-end 1996. The
current ratio increased to 1.28 to 1 at the end of the third quarter 1997 from
1.16 to 1 at year-end 1996.
21
Capital expenditures were $82 million for the 40 weeks ended October 4, 1997
compared to $101 million for the same period in 1996. Management budgeted total
capital expenditures for 1997, excluding acquisitions, of approximately $155
million compared to $129 million actual expenditures in 1996. Completion of the
company's recapitalization program permits the company to increase its total
investment spending for capital expenditures and acquisitions. The company
intends to increase its retail segment operations by increasing investments in
new and remodeled stores in the company's existing retail chains and by making
selective acquisitions of supermarket chains or groups as opportunities arise.
Total capital expenditures for 1998 are expected to be $231 million.
The debt-to-capital ratio at the end of the third quarter of 1997 was 58.9%,
down from 59.7% at year-end 1996. The company's long-term target ratio is
between 50% and 55%.
On October 20, 1997, the board of directors approved a quarterly cash
dividend of $.02 per share for the fourth quarter of 1997 payable December 10,
1997. For the previous six fiscal quarters the board of directors has approved a
$.02 per share quarterly dividend.
The company's principal sources of liquidity and capital have been cash
flows from operating activities, borrowings under its credit facility with banks
and other lenders and the public and private debt capital markets.
On July 25, 1997, the company entered into a new $850 million senior secured
credit facility and sold $500 million of senior subordinated notes. Proceeds
from the initial borrowings under the new credit facility and the sale of the
senior subordinated notes were used to repay all outstanding bank debt under the
previous credit facility and the balance, together with additional revolver
borrowings, were used to redeem the company's $200 million floating rate senior
notes due 2001. The recapitalization program provides the company with increased
flexibility to redeploy assets and pursue increased business investment, such as
the expansion of the company's retail food operations, strengthens Fleming's
capital structure by reducing senior secured bank loans and repaying the
floating rate senior notes, extends the average life of total debt outstanding,
and reduces annual scheduled debt maturities.
The new $850 million senior secured credit facility consists of a $600
million revolving credit facility, with a final maturity of July 25, 2003, and a
$250 million amortizing term loan, with a maturity of July 25, 2004. Up to $300
million of the revolver may be used for issuing letters of credit. Borrowings
and letters of credit issued under the new credit facility may be used for
general corporate purposes and are secured by a first priority security interest
in the accounts receivable and inventories of the company and its subsidiaries
and in the capital stock or other equity interests owned by the company in its
subsidiaries. In addition, the new credit facility is guaranteed by
substantially all company subsidiaries (see Note 6 to the company's financial
statements). The stated interest rate on borrowings under the new credit
agreement is equal to the London interbank offered interest rate ("LIBOR") plus
a margin. The level of the margin is dependent on credit ratings on the
company's senior secured bank debt.
At the end of the third quarter of 1997, borrowings under the credit
facility totaled $250 million in term loans and $40 million of revolver
borrowings, and $85 million of letters of credit had been issued.
The $500 million of senior subordinated notes ("Notes") consists of two
issues: $250 million of 10 1/2% Notes due December 1, 2004 and $250 million of
10 5/8% Notes due July 31, 2007. The Notes are general unsecured obligations of
the company, subordinated in right of payment to all existing and future senior
indebtedness of the company, and senior to or of equal rank with all future
subordinated indebtedness of the company (the company currently has no other
subordinated indebtedness outstanding).
The composite average interest rate for total debt before the effect of
interest rate hedges was 9.5% at October 4, 1997, versus 8.9% at October 5,
1996. Including the effect of the interest rate hedges, the composite average
interest rate was 9.9% and 9.5% at the respective quarter ends.
22
The credit agreement and the indentures under which other company debt
instruments were issued contain customary covenants associated with similar
facilities. The credit agreement currently contains the following more
significant financial covenants: maintenance of a fixed charge coverage ratio of
at least 1.7 to 1, based on earnings before interest, taxes, depreciation and
amortization and net rent expense; maintenance of a ratio of
inventory-plus-accounts receivable to funded-bank-debt (including letters of
credit) of at least 1.4 to 1; and a limitation on restricted payments, including
dividends. Covenants contained in the company's indentures under which other
company debt instruments were issued are generally less restrictive than those
of the credit agreement.
In addition, the credit facility may be terminated in the event of a defined
change of control. Under the company's indentures, noteholders may require the
company to repurchase notes in the event of a defined change of control coupled
with a defined decline in credit ratings.
At the end of the third quarter of 1997, the company would have been allowed
to borrow an additional $475 million under the revolving credit facility
contained in the credit agreement based on the actual borrowings and letters of
credit outstanding. Under the company's most restrictive borrowing covenant,
which is the fixed charges coverage ratio contained in the credit agreement, $43
million of additional fixed charges could have been incurred. The company is in
compliance with all financial covenants under the new credit agreement and its
indentures.
On June 27, 1997, Moody's Investors Service (Moody's) announced it had
revised its credit ratings for Fleming. Moody's downgraded its rating for the
company's senior secured credit facility with banks and other lenders to Ba3
from Ba2, senior unsecured notes to B1 from Ba3, and counterparty ratings to B1
from Ba3. Moody's assigned a Ba3 rating to the company's new $850 million credit
agreement, and a B3 rating for the new $500 million of senior subordinated
notes.
On June 30, 1997, Standard & Poor's Rating Group (S&P) announced it had
revised its outlook on Fleming to stable from negative and had affirmed the
company's BB corporate credit rating. Additionally, S&P raised its rating on the
company's senior unsecured notes to BB- from B+. It also assigned a B+ rating to
the company's new $500 million senior subordinated notes. On July 2, 1997, S&P
announced it had assigned a BB+ rating to the company's new $850 million credit
facility.
At the end of the third quarter of 1997, the company had a total of $85
million of contingent obligations outstanding under undrawn letters of credit,
primarily related to insurance reserves associated with the company's normal
risk management activities. To the extent that any of these letters of credit
would be drawn, payments would be financed by borrowings under the credit
agreement.
During the third quarter of 1997, the company employed interest rate swaps
covering a total of $250 million of floating rate indebtedness with three
counterparty banks possessing investment grade credit ratings (see "--Results of
Operations-Interest expense"). The swaps have an average fixed interest rate of
7.2% and an average remaining term of 2.5 years. Net interest payments made or
received under interest rate swaps are included in interest expense.
Cash flows from operating activities and the company's ability to borrow
under its credit agreement are expected to be the company's principal sources of
liquidity and capital for the foreseeable future. In addition, lease financing
may be employed for new stores. Management believes these sources will be
adequate to meet working capital needs, capital expenditures (including
expenditures for acquisitions, if any) and other capital needs for the next
twelve months.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128--Earnings Per
Share, which is effective for the company's fiscal year ending December 27,
1997. The statement establishes standards for computing and presenting
23
earnings per share. Adoption of SFAS No. 128 is not expected to have a material
impact on earnings per share.
Also in February 1997, the FASB issued SFAS No. 129--Disclosure of
Information about Capital Structure, which is effective for the company's fiscal
year ending December 27, 1997. The statement establishes standards for
disclosing information about a reporting company's capital structure. Adoption
of SFAS No. 129 relates to disclosure within the financial statements and will
not have a material effect on the company's financial statements.
In June 1997, the FASB issued SFAS No. 130--Reporting Comprehensive Income
which is effective for the company's fiscal year ending December 26, 1998. The
statement addresses the reporting and displaying of comprehensive income and its
components. Earnings per share will only be reported for net income and not for
comprehensive income. The company presently believes that comprehensive income
will not be significantly different from reported net income.
Also in June 1997, the FASB issued SFAS No. 131--Disclosures about Segments
of an Enterprise and Related Information. SFAS No. 131 modifies current segment
reporting requirements and establishes, for public companies, criteria for
reporting disclosures about a company's products and services, geographic areas
and major customers in annual and interim financial statements. The company will
adopt SFAS No. 131 for the fiscal year ending December 26, 1998 and does not
expect any change in defined segments.
LITIGATION AND OTHER CONTINGENCIES
From time to time the company faces litigation or other contingent loss
situations resulting from owning and operating its assets, conducting its
business or complying (or allegedly failing to comply) with federal, state and
local laws, rules and regulations which may subject the company to material
contingent liabilities. In accordance with applicable accounting standards, the
company records as a liability amounts reflecting such exposure when a material
loss is deemed by management to be both "probable" and "quantifiable" or
"reasonably estimable." Certain losses associated with litigation matters
(excluding legal fees and other costs) were recorded as follows (see Note 5 to
the company's financial statements and Part II, Item 1--Legal Proceedings):
PREMIUM. In the third quarter of 1996, an agreement was reached to
settle two related lawsuits pending against the company, and others, in the
U.S. District Court in Miami related to a failed grocery diverter, Premium
Sales Corporation. The company recorded a charge of $20 million during the
third quarter of 1996 in anticipation of the settlement. On October 17,
1997, all claims were dismissed in exchange for a payment of $19.5 million
plus $500,000 for costs and expenses.
DAVID'S. Based on the vacation of the judgment entered against the
company in the David's litigation, the charge recorded during the first
quarter of 1996 of approximately $7 million was reduced during the second
quarter of 1996 to $650,000. During the third and fourth quarters, an
additional $14,000 per quarter was recorded as additional interest. On March
21, 1997, the company reached a settlement with the plaintiff and paid $19.9
million in April 1997 in exchange for dismissal of all claims against the
company, with prejudice, resulting in a charge to earnings of $19.2 million.
Since the announcement of the initial judgment in the David's
litigation, other customers involved in disputes with the company have made
allegations of overcharges purporting to be similar to those made in the
David's case and such allegations may be made by others in the future.
Management is unable to predict the potential range of monetary exposure to
the company from such allegations, if any. However, if the plaintiff in any
such cases were to be successful in these assertions, the outcome could have
a material adverse effect on the company.
MEGAFOODS. In August 1996, the court approved a settlement of both the
debtor's adversary proceeding against the company and the company's disputed
claims in the bankruptcy proceedings of
24
a former customer and certain of its affiliates ("Megafoods"). The
settlement has been approved by the creditors and is subject to court
approval of a plan of liquidation. Under the terms of the settlement, the
company will retain a $12 million working capital deposit, relinquish its
secured and unsecured claims in exchange for the right to receive 10% of
distributions, if any, made to the unsecured creditors and pay the debtor
$2.5 million in exchange for the furniture, fixtures and equipment from 17
of its stores (located primarily in Texas) and two Texas storage facilities.
The company agreed to lease the furniture, fixtures and equipment in 14 of
the stores for nine years (or until, in each case, the expiration of the
store lease) to the reorganized debtor at an annual rental of $18,000 per
store.
During the fourth quarter of 1996, the debtor sold its Phoenix stores;
no distributions were made to the unsecured creditors. In January 1997, the
debtor filed a joint liquidating plan which incorporated the settlement
agreement. During the second quarter of 1997, the debtor sold its Texas
assets and the purchaser agreed to assume the debtor's obligation to lease
furniture, fixtures and equipment from the company. The debtor has now
disposed of substantially all of its physical assets. The company has not
received any distribution from the debtor's estate. The hearing on
confirmation of the debtor's plan is scheduled for November 20, 1997.
The company recorded charges of $6.5 million in 1994, $3.5 million in
1995 and $5.8 million in 1996. If the settlement is consummated, the company
will make an additional payment of $2.5 million to the debtor's estate. Net
assets recorded related to Megafoods (consisting of equipment) approximate
$3 million.
FURR'S On October 23, 1997, Fleming and Furr's Supermarkets, Inc.
("Furr's") reached an agreement of their business dispute.
Pursuant to the terms of the agreement, neither Furr's nor Fleming
admitted liability or wrongdoing. Until the end of April 1998, Furr's will
be offered for sale (including Fleming's equity investment of approximately
30%). Offerees will have the opportunity to buy Furr's either with or
without Fleming's El Paso product supply center, together with the related
equipment and inventory. If the product supply center is not sold, Furr's
(or Furr's purchaser) is obligated to pay certain liquidation costs to
Fleming and Fleming will liquidate the inventory in the ordinary course. If
Furr's is not sold, Furr's will have 30 days during which to elect to
purchase the El Paso product supply center (and close within 120 days) or to
pay Fleming liquidation costs (after a nine month transition period). Under
the agreement, Fleming's supply contract with Furr's will terminate in
nineteen months, or earlier, and Fleming will pay Furr's $800,000 per month
until the contract terminates. Other Fleming customers currently being
served by the El Paso product supply center will continue to be served by
other Fleming units.
As the result of the agreement, Furr's dismissed its lawsuit against
Fleming and certain members of its management and Fleming dismissed its
lawsuits against Furr's and certain of its officers and directors, each with
prejudice. The arbitration proceedings were also dismissed. Furr's has
agreed that Fleming's past pricing practices were consistent with its supply
contract and has agreed that Fleming's FlexPro-SM- marketing plans will be
applicable until the supply contract terminates.
While Fleming will cooperate in the sale of Furr's, the ultimate outcome
of these efforts cannot be predicted. However, Fleming believes that by June
1999, or earlier, Fleming will cease to supply Furr's, Fleming's
distribution assets serving Furr's will be liquidated and Fleming's
substantial equity investment in Furr's may be sold. The settlement does not
cause an impairment in value of any recorded asset balances. While the loss
of Furr's business will be significant in the near term, Fleming believes
that the reinvestment of its employed capital in other profitable operations
will offset the lost business.
25
In addition, the company discloses material loss contingencies in the notes
to its financial statements when the likelihood of a material loss has been
determined to be greater than "remote" but less than "probable." These and other
such contingent matters are discussed in Note 5 to the company's financial
statements, which appear elsewhere herein. Also see Part II, Item 1 -- Legal
Proceedings. An adverse outcome experienced in one or more of such matters, or
an increase in the likelihood of such an outcome, could have a material adverse
effect on the company's business, results of operations, cash flow, capital,
access to capital or financial condition.
Fleming has numerous computer systems which were developed employing six
digit date structures (i.e., two digits each for month, day and year). Where
date logic requires the year 2000 or beyond, such date structures may produce
inaccurate results. Management has implemented a program to comply with year
2000 requirements on a system-by-system basis. Program costs are being expensed
as incurred but to compensate for the dilutive effect on results of operations,
the company has delayed other non-critical development and support initiatives.
Fleming's plan includes extensive systems testing and is expected to be
completed by the first quarter of 1999. The solution for each system is
potentially unique and may be dependent on third-party software providers and
developers. Failure to ensure that the company's computer systems are year
2000-compliant could have a material adverse effect on the company's operations.
Additionally, failure of the company's suppliers or, more importantly, its
customers, to become year 2000 compliant might have a material adverse impact on
the company's operations.
FORWARD-LOOKING INFORMATION
This report contains forward-looking statements of expected future
developments. The company wishes to ensure that such statements are accompanied
by meaningful cautionary statements pursuant to the safe harbor established in
the Private Securities Litigation Reform Act of 1995. The forward-looking
statements herein refer to, among other matters, the company's ability to
implement measures to reverse sales declines, cut costs and improve earnings;
the company's assessment of the probability and materiality of losses associated
with litigation and other contingent liabilities; the company's and its
customers' ability to develop and implement year-2000 systems solutions; the
company's ability to expand portions of its business or enter new facets of its
business; the company's expectations regarding the adequacy of capital and
liquidity; and the receptiveness of the company's customers to its alternative
marketing plans. These forward-looking statements reflect management's
expectations and are based upon currently available data; however, actual
results are subject to future events and uncertainties which could materially
impact actual performance.
The company's future performance also involves a number of risks and
uncertainties which may cause actual performance to differ materially. Among
these factors are: the continuation of changes in the food distribution industry
which have increased competitive pressures and reduced operating margins in both
food distribution and retail food operations; the potential negative effects of
the company's substantial indebtedness; limitations on management's discretion
with respect to certain business matters imposed by restrictive covenants
contained in the company's credit facility and indentured debt instruments;
failure of the company to successfully implement its alternative marketing
plans; an inability to achieve cost savings due to unexpected developments or
changed plans regarding capital expenditures; potential adverse developments
with respect to litigation and other contingency matters; general economic
conditions and the impact of such conditions, or any of the factors listed
above, on consumer spending.
26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The following describes developments in various pending legal proceedings to
which Fleming is subject. For additional information, see "Management's
Discussion and Analysis--Litigation and Other Contingencies" and Note 5 to the
company's financial statements appearing elsewhere herein. See also the
company's Form 10-Q for the periods ended April 19, 1997 and July 12, 1997.
PREMIUM. Fleming entered into a settlement agreement with respect to the
Premium cases in December 1996. The company recorded a charge of $20 million
during the third quarter of 1996 in anticipation of the settlement and
deposited that amount into an escrow account in December pending
finalization. On September 23, 1997, the deposited funds were released from
escrow and on October 17, 1997 the claimants dismissed their actions against
the company with prejudice.
FURR'S. Furr's Supermarkets, Inc. ("Furr's") filed suit in February 1997 in
the Second Judicial District Court of Bernalillo County, New Mexico naming
as defendants the company, certain company officers and an employee. On
October 23, 1997, Fleming and Furr's reached an agreement of their business
dispute.
Pursuant to the terms of the agreement, neither Furr's nor Fleming admitted
liability or wrongdoing. Until the end of April 1998, Furr's will be offered
for sale (including Fleming's equity investment of approximately 30%).
Offerees will have the opportunity to buy Furr's either with or without
Fleming's El Paso product supply center, together with the related equipment
and inventory. If the product supply center is not sold, Furr's (or Furr's
purchaser) is obligated to pay certain liquidation costs to Fleming and
Fleming will liquidate the inventory in the ordinary course. If Furr's is
not sold, Furr's will have 30 days during which to elect to purchase the El
Paso product supply center (and close within 120 days) or to pay Fleming
liquidation costs (after a nine month transition period). Under the
agreement, Fleming's supply contract with Furr's will terminate in nineteen
months, or earlier, and Fleming will pay Furr's $800,000 per month until the
contract terminates. Other Fleming customers currently being served by the
El Paso product supply center will continue to be served by other Fleming
units.
As the result of the agreement, Furr's dismissed its lawsuit against Fleming
and certain members of its management and Fleming dismissed its lawsuits
against Furr's and certain of its officers and directors, each with
prejudice. The arbitration proceedings were also dismissed. Furr's has
agreed that Fleming's past pricing practices were consistent with its supply
contract and has agreed that Fleming's FlexPro-SM- marketing plans will be
applicable until the supply contract terminates.
While Fleming will cooperate in the sale of Furr's, the ultimate outcome of
these efforts cannot be predicted. However, Fleming believes that by June
1999, or earlier, Fleming will cease to supply Furr's, Fleming's
distribution assets serving Furr's will be liquidated and Fleming's
substantial equity investment in Furr's may be sold. The settlement does not
cause an impairment in value of any recorded asset balances. While the loss
of Furr's business will be significant in the near term, Fleming believes
that the reinvestment of its employed capital in other profitable operations
will offset the lost business.
The company is a party to various other litigation and contingent loss
situations arising in the ordinary course of its business including: disputes
with customers and former customers; disputes with owners and former owners of
financially troubled or failed customers; disputes with employees regarding
wages, workers' compensation and alleged discriminatory practices; tax
assessments and other matters, some of which are for substantial amounts. The
ultimate effects of such actions, including the matters described below, cannot
be predicted with certainty. Although the resolution of any of the matters
discussed below may have a material adverse impact on interim or annual results
of operations, based on plaintiffs'
27
allegations and the company's defenses, the company expects that the outcome of
these matters will not result in a material adverse effect on liquidity or
consolidated financial position.
CLASS ACTION SUITS. In 1996, the company and certain of its present and
former officers and directors, including the chief executive officer, were
named as defendants in nine purported class action lawsuits filed by certain
stockholders and one purported class action lawsuit filed by a noteholder.
In April 1997, the court consolidated the nine stockholder cases as City of
Philadelphia, et al. v. Fleming Companies, Inc., et al.; the noteholder case
was also consolidated, but only for pre-trial purposes. A complaint has been
filed in the consolidated cases alleging liability for the company's failure
to properly account for and disclose the contingent liability created by the
David's litigation and by the company's alleged "deceptive business
practices." The plaintiffs claim that these alleged failures and practices
led to the David's litigation and to other material contingent liabilities,
caused the company to change its manner of doing business at great cost and
loss of profit, and materially inflated the trading price of the company's
common stock. The plaintiffs seek undetermined but significant damages. The
company denies each of these allegations.
On November 12, 1997, the company won a declaratory judgment action against
certain of its insurance carriers regarding a directors and officers ("D&O")
insurance policy issued to Fleming for the benefit of its officers and
directors. On motion for summary judgment, the U.S. District Court for the
Western District of Oklahoma ruled that the company's exposure, if any,
under the class action suits is covered by D&O policies (aggregating $60
million) written by the insurance carriers and that the "larger settlement
rule" will be applicable to the case. According to the trial court, under
the larger settlement rule, a D&O insurer would be liable for the entire
amount of coverage available under a policy even if there were some overlap
in the liability created by the insured individuals and the uninsured
corporation. If a corporation's liability were increased by uninsured
parties beyond that of the insured individuals, then that portion of the
liability would be the sole obligation of that corporation. The court also
held that allocation was not available to the insurance carriers as an
affirmative defense. The insurance carriers have 30 days within which to
appeal.
TOBACCO CASES. In August 1996, Richard E. Ieyoub, the Attorney General of
the State of Louisiana, brought an action in the 14th Judicial District
Court of Louisiana against numerous defendants including the company. Since
then fourteen individual plaintiffs (Joseph Aezen; Najiyya El-Haddi;
Victoria Lynn Katz; Robert R. Applebaum; Carla Boyce; Robert J. Ruiz;
Rosalind K. Orr; Florence Ferguson; Ella Daly; Janet Anes; Kym Glasser;
Welton Lee Upshur; George Thompson; and Ronald Folkman) have commenced
litigation against the company (or one of its predecessors) in the Court of
Common Pleas, Philadelphia County, Pennsylvania; one individual (Doyle
Smith) and his spouse commenced an action in the Court of Common Pleas,
Dauphin County, Pennsylvania; and one individual (Olanda Carter) has
commenced action against the company in Circuit Court for Shelby County,
Tennessee. Each of these cases involves substantial alleged monetary
liability on the part of the company for the company's part in the
distribution of tobacco products.
In January 1997, a purported class action was brought in the 10th Judicial
District Court of Louisiana against numerous defendants (Morgan v. U.S.
Tobacco Co., et al.), including the company. Fleming was dismissed from this
case in September 1997.
The company is being indemnified and defended by substantial co-defendants
with respect to the remaining tobacco cases. Such indemnification is
unconditional and unlimited, as understood by the company. Additionally, the
United States Congress is currently working toward a global settlement of
tobacco related issues which could include a complete bar to future
litigation against intermediate distributors such as the company. No
assurance, however, can be given that such a global settlement will be
successfully achieved.
28
In addition, the company is involved in the following litigation matters
which, while significant, do not expose the company to any material monetary
liability:
DERIVATIVE SUITS. In October 1996, certain of the company's present and
former officers and directors, including the chief executive officer, were
named as defendants in a purported shareholder's derivative suit in the U.S.
District Court for the Western District of Oklahoma. Plaintiff's complaint
contains allegations that the defendants breached their respective fiduciary
duties to the company and were variably responsible for causing the company
to (i) become "involved with" Premium Sales and its illegal course of
business resulting in the Premium litigation and the $20 million settlement
agreement discussed above; (ii) "systematically" misrepresent and overstate
the cost of company products sold to its customers in violation of its sale
agreements, resulting in the David's litigation and ultimately leading to
the class action suits discussed above; and (iii) fail to meet its
disclosure obligations under the Securities Exchange Act of 1934, as
amended, resulting in the class action lawsuits discussed above and
increased borrowing costs, loss of customers and loss of market value.
Plaintiff sought damages from the defendants on behalf of the company in
excess of $50,000, forfeiture by the defendants of their salaries and other
compensation for the period in which they breached their fiduciary duties,
retention of all monies held by the company as deferred compensation or
otherwise on behalf of the defendants as a constructive trust for the
benefit of the company, and attorney's fees and costs.
In another purported shareholder derivative action filed in October 1996 in
the U.S. District Court for the Western District of Oklahoma, the plaintiff
sued the same and additional officers and directors. In this case, the
plaintiff alleged the defendants caused the company to (i) violate certain
sale agreements with David's Supermarkets resulting in the David's
litigation, (ii) fail to disclose to the investing public the risks
associated with the David's litigation, (iii) violate certain sale
agreements with Megafoods in a manner similar to that alleged by David's in
the David's litigation, and (iv) defraud persons who invested in the
Premium-related entities resulting in the Premium litigation.
On September 30, 1997, both derivative suits were dismissed, without
prejudice, for failure to make demand on the company's Board of Directors
prior to instigating the litigation.
POISON PILL BYLAW AMENDMENT. Oral arguments in the company's appeal were
heard in the 10th Circuit Court of Appeals on September 9, 1997. The
appelate court certified certain questions of law to the Oklahoma Supreme
Court to determine the underlying issues of Oklahoma corporate law.
The company supplies goods and services to some of its customers
(particularly to its large customers) pursuant to supply contracts containing a
"competitiveness" clause. Under this clause, the customer may submit to the
company a qualified bid from another supplier to provide a comparable range of
goods and services at prices lower than those charged by the company by more
than an agreed percentage. The company has the right to lower its prices to come
within the agreed percentage; if it chooses not to, the customer may accept the
competitor's bid. In many contracts, the customer has the right to examine
Fleming's billing practices under its contract and customers sometimes avail
themselves of this right. The competitiveness clause is not exercised frequently
and disputes regarding the clause must generally be submitted to binding
arbitration. Additionally, the company believes that most supply contracts
prohibit recovery of both punitive and consequential damages if any litigation
ever arises. From time to time, customers of the company may seek to renegotiate
the terms of their supply contracts, or exercise the competitiveness clause of
such agreements or otherwise alter the terms of their contractual obligations to
the company to obtain financial concessions. Based on its historical experience
the company does not believe such efforts have had a material adverse effect on
its operations or financial condition.
The company's facilities are subject to various laws and regulations
regarding the discharge of materials into the environment. In conformity with
these provisions, the company has a comprehensive program for testing and
removal, replacement or repair of its underground fuel storage tanks and for
site
29
remediation where necessary. The company has established reserves that it
believes will be sufficient to satisfy anticipated costs of all known
remediation requirements. In addition, the company is addressing several other
environmental cleanup matters involving its properties, all of which the company
believes are immaterial.
The company has been designated by the U.S. Environmental Protection Agency
("EPA") as a potentially responsible party under the Comprehensive Environmental
Response, Compensation and Liability Act ("CERCLA") with others, with respect to
certain EPA-designated Superfund sites. While liability under CERCLA for
remediation at such sites is joint and several with other responsible parties,
the company believes that, to the extent it is ultimately determined to be
liable for remediation at any site, such liability will not result in a material
adverse effect on its consolidated financial position or results of operations.
The company is committed to maintaining the environment and protecting natural
resources and to achieving full compliance with all applicable laws regulations
and orders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
PAGE
EXHIBIT NUMBER NUMBER
- ----------------- -------------
10.25 Agreement of Settlement and Release by and between Furr's Supermarkets, Inc. and
Fleming Companies, Inc.
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
(b) Reports on Form 8-K:
None
30
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.
FLEMING COMPANIES, INC.
(Registrant)
/s/ KEVIN J. TWOMEY
--------------------------------------
Kevin J. Twomey
VICE PRESIDENT--CONTROLLER
(PRINCIPAL ACCOUNTING OFFICER)
Date: November 17, 1997
31