Unified Grocers Inc. Form 10-Q

The document presents condensed consolidated financial statements for Unified Grocers, Inc., for the interim period ending July 2, 2011, and the fiscal year ending October 2, 2010. These statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP). However, certain information and note disclosures typically included have been omitted as allowed by SEC rules and regulations. Management asserts that the remaining disclosures are sufficient to prevent the presented information from being misleading. Readers are directed to consult the audited financial statements and accompanying notes within the company's Form 10-K filing for the year ended October 2, 2010, for complete information. It is explicitly stated that interim period results do not necessarily reflect full-year performance. This initial section sets the stage for the financial reporting, highlighting the reliance on U.S. GAAP and the use of SEC-permitted omissions, while emphasizing the need for cross-referencing with the complete 10-K report for a comprehensive understanding. The importance of understanding that the interim data is not necessarily representative of a full-year performance is emphasized.

A significant portion of the document details the impact of various recent Accounting Standards Updates (ASUs) on the company's financial reporting. The updates discussed include ASU No. 2010-26, focusing on accounting for costs associated with acquiring or renewing insurance contracts; ASU No. 2010-20, addressing disclosures about the credit quality of financing receivables and the allowance for credit losses; and ASU No. 2011-04, providing guidance on fair value measurement. The document outlines the effective dates for each ASU and explains the company's adoption plan, including prospective and retrospective application where applicable. The company is actively assessing the potential impact of these new standards on its consolidated financial statements and interim reporting disclosures, indicating an ongoing process of adaptation and compliance. Specific details are provided on the timeline for implementing the changes and the company's current assessment of the potential impact on their financial reports. The effective dates for each ASU's implementation are clearly stated.

The report addresses the SEC's Release No. 33-9002, mandating the submission of financial statement information in eXtensible Business Reporting Language (XBRL). Unified Grocers indicates its compliance with this requirement, beginning with periods ending on or after June 15, 2011, aligning with their Form 10-Q filing for the third fiscal quarter of 2011. The company confirms it provided the necessary XBRL exhibits concurrently with this 10-Q filing. The temporary limitation on liability for good-faith compliance attempts, as detailed in Section 232.406T of the release, is also mentioned. This section clarifies the company's adherence to the SEC's mandate for interactive data and its commitment to utilizing XBRL for increased transparency and investor accessibility. The specific date of compliance is highlighted and the cross-reference to Part II, Item 6 of the 10-Q for details on the filed exhibits is provided. The temporary safe harbor provision regarding good-faith compliance is also noted.

Unified Grocers held a significant investment in Western Family Holding Company common stock. As of both July 2, 2011, and October 2, 2010, this investment amounted to $9.4 million, representing approximately 20% ownership. Western Family, a private cooperative based in Oregon, is a key supplier of food and general merchandise products to Unified Grocers. The company's ownership percentage is partly tied to the volume of purchases made from Western Family. This investment is accounted for using the equity method of accounting. The consistent value of the investment across the two reporting dates is noted. The close relationship between Unified Grocers and Western Family, highlighted by the significant investment and the link between ownership percentage and purchasing volume, is a key aspect of this section. The consistent valuation across the reporting periods further emphasizes the stability of this investment.

Unified Grocers sponsors an Executive Salary Protection Plan (ESPP) to provide supplemental post-termination retirement income for its officers. The plan's assets are held in a rabbi trust and primarily consist of life insurance policies (reported at cash surrender value) and publicly traded mutual funds (reported at estimated fair value). The cash surrender value of the life insurance policies was $17.8 million on July 2, 2011, and $15.9 million on October 2, 2010. In accordance with ASC Topic 710 (Compensation – General), the rabbi trust's assets and liabilities are treated as assets and liabilities of the company itself, with all earnings and expenses reported in the consolidated statement of earnings. This section details the composition and valuation of the ESPP assets, highlighting the use of a rabbi trust and the specific accounting treatment of its assets and liabilities in accordance with ASC 710. The significant difference in the cash surrender value of the life insurance policies between the two reporting periods is also notable.

The company uses the cost or equity methods to account for equity securities lacking readily determinable fair values. As of July 2, 2011, the company assessed its equity securities for impairment and found none. This section underscores the company's approach to valuing its investments, specifying the accounting methods used for securities without readily available fair values. The absence of impairment in the equity securities as of July 2, 2011, is a key finding. The emphasis on the valuation methodologies and the specific date of the impairment assessment are key elements. The procedures followed for fair value measurement are highlighted, along with the outcome of the impairment assessment.

Unified Grocers' insurance subsidiaries employ a strategy of investing a substantial portion of received premiums into fixed maturity securities and equity securities to fund loss reserves. This investment strategy, while necessary for operational functionality, exposes the subsidiaries to both credit risk and interest rate risk. To mitigate credit risk, the company has established internal guidelines and practices that focus on limiting non-investment-grade securities. The company actively assesses whether any unrealized losses are considered other-than-temporary, indicating a proactive approach to risk management. The document highlights this inherent tension between the need for investment and the associated risks, demonstrating the company's awareness of potential financial vulnerabilities. A further commitment to the evaluation of unrealized losses is evidenced, suggesting a systematic approach to risk assessment and management.

The cost of sales within the insurance segment is primarily composed of claims loss and loss adjustment expenses, underwriting expenses, commissions, premium taxes, and regulatory fees. The cost of insurance and the accuracy of loss reserves are heavily influenced by actuarial estimates, which are meticulously derived from a comprehensive analysis of healthcare cost trends, claims history, demographic data, and industry benchmarks. This reliance on actuarial modeling emphasizes the inherent uncertainty in projecting future expenses and loss reserves, particularly given the dynamic nature of healthcare costs and potential regulatory changes. The substantial impact of these variables on loss reserves and future expenses is explicitly acknowledged, showcasing the need for ongoing monitoring and adjustment of these figures. A clear indication that changes in these factors can lead to significant fluctuations in the calculated amounts is highlighted.

The document details fluctuations in insurance expenses (excluding workers' compensation) and the cost of sales within the insurance segment. In the 2011 period, a net decrease in insurance expense of $1.4 million (0.1% of Wholesale Distribution net sales) is reported, primarily attributed to improved cash surrender value of life insurance policy assets held in a rabbi trust. This improvement is linked to changes in the fair value of underlying securities, which are heavily weighted towards U.S. equity markets and priced based on readily observable market values. Regarding cost of sales, a $2.4 million decrease from $3.7 million in 2010 to $1.3 million in 2011 is reported, due to a combination of increased reserves for a significant customer fire loss claim in 2010 and decreased premium revenue in 2011. The interplay between market conditions, actuarial estimations, and significant claims in shaping the insurance segment's financial performance is a central theme in this discussion. Specific monetary figures for expense and revenue changes are included for clarity.

The report details fluctuations in interest expense and weighted average borrowings. Interest expense increased by $0.3 million in the 2011 period compared to the 2010 period, primarily due to higher outstanding debt. Conversely, in another instance, interest expense decreased by $0.1 million from the 2010 period, resulting from a lower effective borrowing rate. The effective borrowing rate for the combined primary debt (revolving lines of credit and senior secured notes) was 4.3% in 2011 and 4.5% in 2010. This change is attributed to a shift in the proportion of debt instruments, with a lower percentage of senior secured notes offset by a higher effective rate on a new revolving line of credit. Weighted average borrowings increased significantly, by $27.5 million in one instance and $11.7 million in another, mainly due to increased inventory levels. The variations in interest expense, attributed to changes in the debt structure and borrowing rates, are clearly documented, as are the changes in weighted average borrowings directly linked to inventory levels. The specifics of the interest rates and the reasons for changes in borrowings are presented with clear numerical data.

On October 8, 2010, Unified Grocers established a new revolving credit agreement with Wells Fargo Bank, National Association. This agreement provides for a revolving credit facility with total commitments of $275 million. This commitment can be increased to a maximum of $400 million, either through existing lenders increasing their commitments or by adding new lenders. Although unanimous lender consent is not required for such increases, no individual lender is obligated to increase their individual commitment. The agreement has an expiration date of October 8, 2015, and is intended to refinance existing debt, finance capital expenditures and working capital, and facilitate acquisitions and general corporate purposes. This section provides key terms of the new credit agreement, including commitment amounts, potential for expansion, and intended uses of the credit facility. The expiration date and the flexibility offered by the agreement in terms of increasing commitments are highlighted, emphasizing its financial implications.

The revolving credit agreement includes financial covenants that the company must maintain. These covenants include requirements regarding minimum tangible net worth, fixed charge coverage ratio, and total funded debt relative to earnings before interest, taxes, depreciation, amortization, and patronage dividends (EBITDAP). The company reports current compliance with all covenants and expresses its expectation to remain compliant. However, the report acknowledges that this does not guarantee future compliance. This section emphasizes the significance of meeting these financial covenants for maintaining the credit facility, implying that non-compliance could create significant financial challenges for the company. The specific covenants mentioned and the company's current status concerning these metrics are clearly stated, emphasizing the importance of maintaining these ratios.

Unified Grocers' patronage dividends totaled $10.9 million for the 2011 period, a notable increase from the $8.6 million reported in 2010. These dividends are derived from the company's three patronage earnings divisions: the California Dairy Division, the Pacific Northwest Dairy Division, and the Cooperative Division. The 2011 earnings for the California Dairy Division were $8.2 million, compared to $8.9 million in 2010, reflecting a decrease in sales volume. The Pacific Northwest Dairy Division showed consistent earnings of $1.1 million and $1.2 million in 2011 and 2010, respectively. The Cooperative Division experienced a significant turnaround, reporting $1.6 million in patronage earnings in 2011 after recording losses of $1.5 million in 2010. This improvement is largely due to a settlement (C&K Settlement) and reduced distribution, selling, and administrative expenses, somewhat offset by lower sales. Dividends from the Cooperative Division are distributed annually (historically in cash, Class B, and Class E shares), while those from the dairy divisions are paid quarterly (historically in cash). This section provides detailed figures for patronage dividends across the different divisions, highlighting the significant increase in total dividends from 2010 to 2011. The reasons behind these changes, especially the impact of the C&K Settlement on Cooperative Division earnings, are thoroughly explained.

Unified Grocers exchanges its Class A and Class B shares with its members at a price determined by a formula approved by the board, known as the Exchange Value Per Share. Before September 30, 2006, this value was calculated by dividing Book Value by the number of outstanding shares. Book Value included the year-end balances of Class A and Class B shares, retained earnings, and accumulated other comprehensive earnings (loss). However, the calculation was revised on September 30, 2006, to exclude accumulated other comprehensive earnings (loss). Further modifications, approved at the February 23, 2010, shareholder meeting, authorized the board to retain a portion of annual earnings from non-patronage business, excluding these retained earnings from the Exchange Value Per Share computation. The calculation was further refined to exclude non-allocated retained earnings, the redemption value of unredeemed shares, and the number of shares tendered for redemption. This detailed explanation of the Exchange Value Per Share calculation and its evolution over time is critical for understanding the equity structure of Unified Grocers and the value proposition for its members. Key dates for the changes and the specific components added and removed from the calculation are outlined.

Unified Grocers faces significant risks stemming from economic and competitive factors. The company's profitability is sensitive to inflationary and deflationary pressures, affecting sales, cost of sales, employee compensation, and energy costs. Price volatility in commodities, ingredients, and packaged goods presents challenges in passing cost changes onto customers in a timely manner. Furthermore, increased competition from larger, fully integrated grocery chains and supercenters, which benefit from economies of scale, threatens to erode market share and reduce sales volume. This reduction in volume could negatively impact patronage dividends and the Exchange Value Per Share, thus affecting the value of members' Class A and Class B shares. The company's vulnerability to broader economic conditions and the competitive landscape is a recurring theme, emphasizing the dynamic and challenging environment in which it operates. Specific examples of economic factors impacting operations, such as fluctuating commodity costs and competition from large chains, are outlined.

Unified Grocers faces credit and liquidity risks, primarily relating to its members' financial health and the overall economic climate. Loans to members, trade receivables, and lease guarantees could be jeopardized by a sustained economic downturn. The company maintains reserves for these potential defaults, but acknowledges the risk that actual losses could exceed these reserves and negatively impact its operating results. The company's exposure to these risks, tied to the financial stability of its customers and the overall economic environment, is emphasized. The company's proactive establishment of reserves to cover these potential losses is described, but it is also acknowledged that unforeseen events may still lead to significant financial issues. The company's reliance on its established reserves and the potential for future challenges due to economic shifts are highlighted.

The company faces risks relating to its operations and regulatory compliance. These include potential product liability claims, product recalls, and negative publicity resulting from food contamination. Unified Grocers maintains stringent quality standards and pursues contractual indemnification and insurance coverage to mitigate these risks. However, the potential for product liability claims exceeding insurance coverage or negative publicity is acknowledged as a major concern. In addition, the company operates under increasingly stringent environmental laws and regulations. Potential costs associated with environmental remediation and compliance with new legislation (such as emission reduction mandates) are highlighted as possible impediments to future profitability. The company's vulnerability to both product-related incidents and environmental regulations, along with its efforts to mitigate these risks, are thoroughly detailed. The possibility of significant, unforeseen expenses related to each issue is stressed.

Several additional risk factors are identified. These include the potential for inadequate resources to fund operations, despite the company's reliance on cash flow and member investments. Maintaining compliance with financial covenants within its credit facility is crucial. The company also acknowledges the inherent uncertainties in actuarial assumptions used for benefit plan valuations, which may impact the reported values of assets and liabilities. Further considerations include the possibility of a loss of cooperative tax status, potentially increasing tax liability, and the risks associated with disruptions from severe weather, natural disasters, and adverse climate changes. The company notes that while it has implemented business resumption plans and carries insurance, there is a possibility of significant disruptions and potentially high deductibles for insurance claims. This section details a wide range of risks affecting the company's financial health, emphasizing the potential for unforeseen events and the complexities of operating in a volatile environment. These factors cover areas such as funding, tax compliance, weather-related events, and the stability of the company’s own internal controls.