| MARSH SUPERMARKETS INC Item 1A Risk Factors The Company’s business faces many risks and uncertainties |
| These risks and uncertainties include, but are not limited to, the risks described below and elsewhere in this Annual Report on Form 10-K, particularly in “Cautionary Note Regarding Forward-Looking Statements” under Part II, Item 7 of this report |
| The following is not intended to be a complete discussion of all potential risks or uncertainties facing the Company, as there may be additional risks not presently known to the Company or risks that the Company currently deems immaterial or unlikely |
| If any of the events or circumstances described in the following risk factors occurs, the Company’s business, financial condition or results of operations could be materially adversely affected and could result in a decline in the trading price of the Company’s common stock |
| Risks Relating to the Business The Company faces a high level of competition which may have a negative impact on its revenues and profitability |
| The retail food industry is intensely competitive with respect to price, food quality and selection, customer service and location |
| The Company is in direct competition with numerous local outlets of regional and national supermarket and convenience store chains, independent grocery stores, specialty and gourmet markets, drug stores, dollar stores and food departments in mass merchandise and club stores |
| In the markets in which the Company operates, there are a number of well-established competitors that have substantially higher economies of scale and greater financial, marketing, personnel and other resources than the Company and, as a result, may be able to devote greater resources to new store development, store remodels, and sourcing, promoting and selling their products |
| Increased competition may have an adverse effect on profitability as the result of lower sales, lower gross profits, greater operating costs such as marketing, and the inability to reduce expenses at a rate equal to or higher than sales declines |
| The Company’s principal competitors are Wal-Mart Stores, Inc, The Kroger Company and Meijer, Inc |
| The Company’s ability to attract customers is dependent, in large part, upon a combination of price, quality, customer service, product mix, brand recognition, store location, in-store marketing and design and promotional strategies |
| In each of these areas, traditional and non-traditional competitors compete with the Company and may successfully attract its customers to their stores by aggressively matching or exceeding what the Company offers |
| In recent years, many of the Company’s competitors have increased their presence in the Company’s markets, and the Company frequently faces the opening of a new 8 _________________________________________________________________ or remodeled competitor’s store |
| The Company’s responses to competitive pressure, such as additional promotions and increased advertising, could adversely affect its profitability |
| Also, the Company cannot assure that its actions will succeed in gaining or maintaining market share |
| Additionally, the Company cannot predict how its customers will react to the entrance of non-traditional competitors into the grocery retailing business |
| The Company’s substantial indebtedness could adversely affect its financial health |
| The Company has a significant amount of indebtedness |
| As of April 1, 2006, the Company had long-term debt totaling dlra189dtta9 million, which included dlra34dtta5 million outstanding under its revolving credit facility, dlra25dtta0 million outstanding under its term loan and dlra102dtta8 million in the Company’s outstanding 8 7/8prca senior subordinated notes |
| As of April 1, 2006, the Company had unused borrowing capacity under its revolving credit facility of dlra49dtta3 million, net of dlra11dtta2 million of outstanding letters of credit |
| The Company is vulnerable to increases in interest rates because the debt under its revolving credit facility and term loan is at a variable interest rate |
| The Company’s revolving credit facility, term loan and the indenture governing its 8 7/8prca senior subordinated notes require the Company to comply with certain covenants |
| In particular, the Company’s revolving credit facility restricts the Company’s ability to incur other indebtedness, sell assets or close stores, incur liens and make certain payments, and also includes a debt to EBITDA maximum ratio covenant |
| The Company’s term loan contains similar restrictions, except that the term loan has a minimum consolidated adjusted EBITDA covenant rather than a debt to EBITDA maximum ratio covenant |
| Further, the indenture governing the Company’s 8 7/8prca senior subordinated notes contains a fixed charge coverage ratio, and as of January 7, 2006, the Company fell below the minimum ratio required under the indenture |
| As a result, the Company’s permitted indebtedness is currently limited to all debt existing at January 7, 2006, plus the full capacity under its revolving credit facility |
| The Company is also prohibited from purchasing its stock and is limited to quarterly dividend payments of dlra1 million |
| The Company expects it will continue to be below the minimum ratio required until the earlier of the end of the fourth quarter of fiscal 2007 or upon refinancing of the 8 7/8prca senior subordinated notes |
| In addition, at April 1, 2006, the Company had an event of default under the term loan for failure to maintain the required adjusted EBITDA However, on June 16, 2006, the lenders amended the EBITDA covenant in the term loan such that the Company was ultimately not in default |
| The Company cannot assure you that it will continue to meet the revised covenant going forward |
| If the Company violates any of the covenants contained in its debt instruments, such violation could cause an event of default under such instruments |
| If the Company defaults under its revolving credit facility, term loan or indenture governing its 8 7/8prca senior subordinated notes because of a covenant breach or otherwise, all outstanding amounts could become immediately due and payable |
| The Company cannot assure you that it would be able to obtain sufficient funds to repay all the outstanding amounts |
| Any acceleration of amounts due under its revolving credit facility, term loan or the indenture governing its 8 7/8prca senior subordinated notes would have a material adverse effect on the Company |
| The Company may not be able to refinance its 8 7/8prca senior subordinated notes |
| As of April 1, 2006, the Company had dlra102dtta8 million principal balance of its 8 7/8prca senior subordinated notes outstanding |
| At maturity in August 2007, the entire outstanding principal amount of the 8 7/8prca senior subordinated notes becomes due and payable by the Company |
| The Company has not reserved funds nor does the Company expect to generate sufficient cash flow from operations to repay the 8 7/8prca senior subordinated notes when they mature |
| The Company expects that its ability to repay the 8 7/8prca senior subordinated notes at their scheduled maturity will be dependent in whole or in part on refinancing all or a portion of the 8 7/8prca senior subordinated notes before they mature |
| The Company cannot assure you that it will be able to arrange for additional financing on favorable terms, if at all, to pay the principal amount at maturity |
| Changes in the terms on which suppliers require the Company to pay for store merchandise could have an adverse effect on the Company’s business, financial condition and results of operations |
| The Company has negotiated delayed payments terms with many of its suppliers, which payment terms are subject to change at any time |
| If the Company’s suppliers change their payment terms for whatever reason and require faster payment by the Company, it could have a material adverse effect on the Company’s business, financial condition and results of operations |
| The Company is in a labor-intensive business, and increased labor costs or the Company’s inability to retain its employees could have a material adverse effect on the Company’s business and results of operations |
| 9 _________________________________________________________________ The Company’s business is labor intensive, and the Company’s operations tend to be more labor intensive than some of its competitors due to the additional customer service offered in its stores |
| Tight labor markets, government mandated increases in the minimum wage or other benefits and increased costs of health care and other benefits could result in an increase in labor costs, which could adversely affect the Company’s financial condition and results of operations |
| In addition, the Company’s success continues to be based, in part, on the customer service provided by its employees |
| The Company must continue to attract, retain and motivate its employees in order to operate effectively |
| The Company’s significant pension and post-retirement obligations could increase future expenses |
| The Company has a “frozen” qualified defined benefit pension plan, which provides for payment of retirement benefits on the basis of an employee’s length of service and earnings |
| Pension plan assets consist principally of listed stocks, corporate and government notes and bonds and investments in various funds |
| Currently, the pension plan is underfunded by dlra19dtta5 million, and future actions to fund the pension plan may adversely affect the Company’s financial condition |
| In addition, in December 2005, the Company terminated two unfunded supplemental executive retirement plans (the “SERPs”) |
| The Company funded dlra6dtta3 million in payments under the SERPs in January 2006, and the Company is obligated to fund the same amount in each of June 2006 and January 2007 |
| The Company also contributes to two multi-employer pension plans based on obligations arising under its collective bargaining agreements |
| These plans are not administered or in any way controlled by the Company, and the Company has relatively little control over the level of contributions it is required to make to these plans |
| Additionally, the benefit levels and related issues will continue to create collective bargaining agreement challenges |
| Under current law, an employer that withdraws or partially withdraws from a multi-employer pension plan may incur a withdrawal liability to the plan, which represents the portion of the plan’s underfunding that is allocable to the withdrawing employer under very complex actuarial and allocation rules |
| The amount of any increase or decrease in the Company’s required contribution to these multi-employer pension plans will depend upon the outcome of collective bargaining actions taken by trustees who manage the plans, government regulations, the actual return on assets held in the plans, and the potential payment of a withdrawal liability if the Company chooses to exit a market, among other factors |
| Various operating factors may affect the Company’s costs of operations and its profit margins |
| Profit margins in the grocery retail industry are very narrow |
| In order to increase or maintain its profit margins, the Company must continue to develop and implement strategies to reduce costs, such as productivity improvements, shrink reduction, distribution center efficiencies and other similar strategies |
| During fiscal year 2006, in an effort to reduce costs, the Company closed two supermarkets, six convenience stores and a restaurant; implemented a reduction in force of approximately 25 employees at its headquarters, including four officers; and took other cost-reduction measures |
| The Company’s failure to achieve forecasted cost reductions might have a material adverse effect on its business |
| In addition, changes in the Company’s product mix also may negatively affect certain financial measures |
| The Company’s business is sensitive to local and regional economic conditions, and economic downturns or uncertainty may have a material adverse effect on its financial condition and results of operations |
| The Company’s stores are concentrated in Indiana and western Ohio |
| Changes in economic and social conditions in the Company’s operating regions, including the rate of inflation, interest rates, energy costs, tax rates, population demographics and employment and job growth, affect consumer shopping habits |
| Economic downturns or uncertainty may not only adversely affect overall demand and intensify price competition, but may also cause consumers to purchase lower priced, and often lower margin, items and to make fewer purchases |
| A general reduction in the level of consumer spending or the Company’s inability to respond to shifting consumer attitudes regarding products, store location and other factors could adversely affect its growth and profitability |
| 10 _________________________________________________________________ Severe weather and natural disasters can adversely impact the areas in which the Company conducts its business |
| Severe weather conditions such as tornadoes, as well as other natural disasters, in the Company’s operating regions could damage the Company’s properties, adversely impact the areas in which the Company conducts its business or the suppliers from whom the Company obtains products or otherwise cause disruptions to operations |
| In the event of a business interruption or the inability to source product, the Company’s business, financial condition and results of operations could be adversely affected |
| Unfavorable changes in government regulations may affect the Company’s business and results of operations |
| Like other companies that sell food, tobacco, beer, wine, liquor and prescription drugs, the Company’s stores are subject to various federal, state and local laws, regulations and administrative practices affecting its business |
| The Company must comply with numerous provisions regulating health and sanitation standards, food labeling, equal employment opportunity, minimum wages and licensing for the sale of food, tobacco, prescription drugs and alcoholic beverages |
| The Company cannot predict the nature of future laws, regulations, interpretations or applications, or determine what effect either additional government regulations or administrative orders, when and if promulgated, or disparate federal, state and local regulatory schemes would have on its future business |
| The Company could, however, require the reformulation of certain products to meet new standards, the recall or discontinuance of certain products not able to be reformulated, additional record keeping, expanded documentation of the properties of certain products and expanded or different labeling |
| Any or all of such requirements could have an adverse effect on the Company’s results of operations and financial condition |
| The Company, particularly its Village Pantry division, is subject to state and federal environmental regulations and faces the risk of being held liable for environmental damages that may occur |
| Under various federal, state and local laws, ordinances and regulations, the Company may, as the owner or operator of its locations, be liable for the costs of removal or remediation of contamination at these or its former locations, whether or not the Company knew of, or was responsible for, the presence of such contamination |
| The failure to properly remediate such contamination may subject the Company to liability to third parties and may adversely affect its ability to sell or rent such property or to borrow money using such property as collateral |
| Additionally, persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of such substances at sites where they are located, whether or not such site is owned or operated by such person |
| Although the Company does not typically arrange for the treatment or disposal of hazardous substances, it may be deemed to have arranged for the disposal or treatment of hazardous or toxic substances and, therefore, may be liable for removal or remediation costs, as well as other related costs, including governmental fines, and injuries to persons, property and natural resources |
| In addition, compliance with existing and future environmental laws regulating underground storage tanks may require significant capital expenditures and increased operating and maintenance costs |
| The remediation costs and other costs required to clean up or treat contaminated sites could be substantial |
| The Company is currently aware of the existence of petroleum contamination at 21 Village Pantry locations, all located in Indiana, and is in the process of remediation at each of these sites |
| An Indiana excess liability fund has reimbursed the Company for more than 95prca of remediation costs incurred over the past three years, and it is expected that the fund will continue to reimburse the Company for future costs, but there can be no assurance that this will occur |
| In the future, the Company may incur substantial expenditures for remediation of contamination that has not been discovered at existing or previously owned or operated locations |
| The Company cannot assure you that it has identified all environmental liabilities at all of its current and former locations; that material environmental conditions not known to the Company do not exist; that future laws, ordinances or regulations will not impose material environmental liability on the Company; or that a material environmental condition does not otherwise exist as to any one or more of its locations |
| In addition, failure to comply with any environmental laws, ordinances or regulations or an increase in regulations could adversely affect the Company’s operating results and financial condition |
| The Company depends on one principal supplier for the gasoline sold at its Village Pantry stores |
| In June 2005, the Company signed a new branded product supply and trademark license agreement with Marathon^® |
| Marathon supplies all of the Village Pantry division’s gasoline purchases |
| The contract with Marathon expires in July 2008, but the Company may not be able to renew the contract upon expiration |
| A change of suppliers, a disruption in supply or a significant change in the Village Pantry division’s relationship with Marathon could have a material adverse effect on the 11 _________________________________________________________________ division’s business, financial condition and results of operations |
| In addition, the supply of gasoline and the Village Pantry division’s wholesale purchase costs could be adversely impacted in the event of shortage, which could result from, among other things, lack of capacity at United States oil refineries or severe weather conditions including hurricanes |
| These factors could materially impact the Village Pantry division’s gasoline gallon volume, gasoline gross profit and overall customer traffic, which in turn would impact its merchandise sales |
| Volatility of wholesale petroleum costs and retail prices could impact the Company’s operating results |
| Over the past three fiscal years, the Company’s gasoline revenue accounted for approximately 9prca of total revenues and its gasoline gross profit accounted for approximately 2prca of total gross profit |
| Crude oil and domestic wholesale petroleum markets are marked by significant volatility |
| General political conditions, acts of war or terrorism, and instability in oil producing regions, particularly in the Middle East and South America, could significantly impact crude oil supplies and wholesale petroleum costs |
| Significant increases and volatility in wholesale petroleum costs could result in significant increases in the retail price of petroleum products and in lower gasoline gross margin per gallon |
| Increases in the retail price of petroleum products could impact consumer demand for gasoline |
| This volatility makes it extremely difficult to predict the impact future wholesale cost fluctuations will have on the Company’s operating results and financial condition |
| The Company’s self-insurance arrangements could materially impact its results of operations |
| The Company uses a combination of insurance and self-insurance to provide for potential liabilities for workers’ compensation, automobile and general liability, property insurance, director and officers’ liability insurance, and employee health care benefits |
| The Company estimates the liabilities associated with the risks that it retains, in part, by considering historical claims experience, demographic and severity factors and other actuarial assumptions which, by their nature, are subject to a high degree of variability |
| Any actuarial projection of losses concerning workers’ compensation and general liability is subject to a high degree of variability |
| Among the causes of this variability are unpredictable external factors affecting future inflation rates, discount rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns |
| Although not currently anticipated by management, the Company’s results could be materially impacted by claims and other expenses related to the Company’s self-insurance program if future occurrences and claims differ from these assumptions and historical trends |
| The Company may record significant charges for impairment of goodwill and long-lived assets, which could adversely affect its results of operations |
| Goodwill is tested annually for impairment as of end of the third quarter of the Company’s fiscal year |
| The Company also tests goodwill for impairment when an event occurs or circumstances change that could more likely than not reduce the fair value of a reporting unit below its carrying amount |
| The Company’s long-lived assets, primarily stores, also are subject to periodic testing for impairment |
| Failure to achieve sufficient levels of cash flow at specific stores could result in impairment charges on goodwill and/or long-lived assets |
| During fiscal year 2006, the Company incurred dlra15dtta0 million in impairment charges on its long-lived assets and recorded impairment charges of dlra13dtta1 million on its goodwill largely as a result of store closings and the merger agreement with MSH Supermarkets |
| Future impairment charges recorded by the Company could adversely affect its financial condition |
| Risks Relating to the Merger with MSH Supermarkets The merger of the Company with MSH Supermarkets is subject to certain closing conditions that, if not satisfied or waived, will result in the merger not being completed, which may cause the market price of the Company’s common stock to decline |
| The pending merger of the Company with MSH Supermarkets is subject to customary conditions to closing, including the receipt of the required approval of the shareholders of the Company and consents from third parties |
| Many of the conditions to the closing of the merger are outside of the control of the Company |
| If any condition to the closing of the merger is not satisfied or, if permissible, waived, the merger will not be completed |
| If the Company does not complete the merger, the market price of the Company’s common stock may decline to the extent that the current market price reflects a market assumption that the merger or another transaction will be completed |
| If the merger is not approved by the Company’s shareholders, the Company will be obligated to reimburse MSH Supermarkets for up to dlra5 million in expenses |
| The Company will also pay legal fees and other expenses in connection with the merger, whether or not the merger is completed |
| In addition, the Company has expended, and will continue to expend, significant 12 _________________________________________________________________ management resources in an effort to complete the merger |
| If the merger is not completed, the Company will have incurred significant costs, including the diversion of management resources, for which it will have received little or no benefit |
| Further, the Company may be required to pay to MSH Supermarkets a breakup fee of dlra10 million under certain specified circumstances |
| Whether or not the merger with MSH Supermarkets is completed, the announcement and pendency of the merger may continue to cause disruptions in the Company’s business, which could have an adverse effect on its business and results of operations |
| We believe the announcement and pendency of the merger has caused and will continue to cause disruptions in the Company’s business |
| Specifically, employees may experience uncertainty about their future roles with the Company, which might adversely affect the Company’s ability to retain key managers and other employees, the attention of management toward the execution of business plans may be distracted by the potential merger, customers uncertain as to the future form of or existence of the Company may change shopping patterns, habits or destinations, and competitors may try to take advantage of the uncertainty by attracting both employees and customers |
| The Company, its directors and its former President are involved in pending litigation with respect to the merger with MSH Supermarkets, the result of which is uncertain |