UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2016

OR

FOR THE TRANSITION PERIOD FROM                    TO                   

Commission file number: 0-10815

UNIFIED GROCERS, INC.

(Exact name of registrant as specified in its charter)

 

5200 Sheila Street, Commerce, CA 90040

(Address of principal executive offices) (Zip Code)

(323) 264-5200

(Registrant's telephone number, including area code)

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  [  ]    No  [X]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  [  ]    No  [X]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  As of January 28, 2017, the number of shares outstanding was:

Class A: 121,450 shares; Class B: 403,367 shares; Class C: 15 shares; Class E: 103,132 shares

 

 

 

 

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Table of Contents

 

 

 

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PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS (UNAUDITED)

Unified Grocers, Inc. and Subsidiaries

Consolidated Condensed Balance Sheets – Unaudited

 

 

The accompanying notes are an integral part of these statements.

 

 

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Unified Grocers, Inc. and Subsidiaries

Consolidated Condensed Statements of Earnings (Loss) – Unaudited

 

 

The accompanying notes are an integral part of these statements.

 

 

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Unified Grocers, Inc. and Subsidiaries

Consolidated Condensed Statements of Comprehensive Earnings (Loss) – Unaudited

 

 

The accompanying notes are an integral part of these statements.

 

 

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Unified Grocers, Inc. and Subsidiaries

Consolidated Condensed Statements of Cash Flows – Unaudited

 

 

The accompanying notes are an integral part of these statements.

 

 

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Unified Grocers, Inc. and Subsidiaries

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS – UNAUDITED

 

The consolidated condensed financial statements include the accounts of Unified Grocers, Inc. and all its subsidiaries (the “Company” or “Unified”). Inter-company transactions and accounts with subsidiaries have been eliminated. The interim financial statements included herein have been prepared by the Company without audit, pursuant to the rules and regulations promulgated by the Securities and Exchange Commission (the “SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been omitted pursuant to SEC rules and regulations; nevertheless, management believes that the disclosures are adequate to make the information presented not misleading. These consolidated condensed financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K for the year ended October 1, 2016 filed with the SEC. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

The consolidated condensed financial statements reflect all adjustments that, in the opinion of management, are both of a normal and recurring nature and necessary for the fair presentation of the results for the interim periods presented. The preparation of the consolidated condensed financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated condensed financial statements and accompanying notes. As a result, actual results could differ from those estimates.

The Company’s banking arrangements allow the Company to fund outstanding checks when presented for payment to the financial institutions utilized by the Company for disbursements.  This cash management practice frequently results in total issued checks exceeding the available cash balance at a single financial institution. The Company’s policy is to record its cash disbursement accounts with a cash book overdraft in accounts payable.  At December 31, 2016 and October 1, 2016, the Company had book overdrafts of $76.3 million and $73.8 million, respectively, classified in accounts payable and included in cash provided by operating activities.

 

 

On October 7, 2015 (the “Closing Date”), the Company completed the sale of all of the outstanding shares of the Company’s wholly owned subsidiary, Unified Grocers Insurance Services (“UGIS”), to AmTrust Financial Services, Inc. (“AmTrust” or the “Buyer”) pursuant to the terms of a Stock Purchase Agreement (the “Stock Purchase Agreement”) by and between the Company and AmTrust dated as of April 16, 2015.  As of the Closing Date, UGIS owned all of the outstanding shares of the capital stock of Springfield Insurance Company (“SIC”) and Springfield Insurance Company Limited (Bermuda) (“SICL,” and collectively with UGIS and SIC, the “Acquired Companies”).  For additional information, see Note 2 to “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the year ended October 1, 2016. Prior to the sale of UGIS to AmTrust, the Acquired Companies were reported by the Company as a segment identified as the Insurance segment (“Insurance”).

At the Closing Date, AmTrust and the Company also entered into a Master Services Agreement for a term of five (5) years, pursuant to which, among other things, each party agreed to provide the other with certain transition services relating to the business of the Acquired Companies.  AmTrust also agreed to pay the Company an annual payment following each of the first five years (ended December 31) of the term of the Master Services Agreement (each, an “Earn-Out Payment”).  Each Earn-Out Payment will be equal to four and one-half percent (4.5%) of gross written premiums on or attributable to all insurance policies purchased through AmTrust during the applicable year by Unified and its Members (see Note 5) or customers. The Company has recorded a receivable of $0.8 million due in Earn-Out Payments through December 31, 2016.      

 

Under the terms of the Stock Purchase Agreement with AmTrust, if during the five-year period following the Closing Date of the sale, the insurance reserves in respect of any accident arising prior to the closing of the sale of UGIS and covered by an insurance policy written by an insurance subsidiary prior to January 1, 2015 increase as a result of adverse development, the Company must pay AmTrust for the amount of the insurance reserve increase on a dollar for dollar basis, up to a maximum of $1 million in the aggregate. In addition, to the extent the increase in insurance reserves as a result of adverse development exceeds $1 million, AmTrust is entitled to offset up to a maximum of an additional $2 million of that increase from future Earn-Out Payments due to the Company under the Stock Purchase Agreement. See Item 1.01, “Entry into a Material Definitive Agreement,” including Exhibit 99.1, “Stock Purchase Agreement by and between Unified Grocers, Inc. and AmTrust Financial Services, Inc. dated as of April 16, 2015” thereto, of our Current Report on Form 8-K, filed on April 22, 2015, and Item 2.01, “Completion of Acquisition or Disposition of Assets,” including

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Exhibit 99.2, “Master Services Agreement by and between Unified Grocers, Inc. and AmTrust Financial Services, Inc. dated as of October 7, 2015” thereto, of our Current Report on Form 8-K, filed on October 14, 2015, for additional information. The Company believes that these insurance reserves were adequate at the time of the sale of UGIS.  The Company’s potential exposure under the Stock Purchase Agreement as a result of adverse development as of December 31, 2016 was $1.8 million.

 

AmTrust performs its actuarial studies once a year as of December 31. The first reserve measurement that would be taken into account for purposes of determining the amount of any payment or offset pursuant to the Stock Purchase Agreement with respect to adverse development affecting these insurance reserves covered the period ended December 31, 2016.  In late January 2017, AmTrust provided the Company with its initial assessment of adverse development with respect to these insurance reserves.  AmTrust’s assessment is that the amount of adverse development as of December 31, 2016 exceeds $1.8 million, the full amount of the Company’s exposure as of December 31, 2016 described above.  Once the Company has received adequate information as contemplated in the Stock Purchase Agreement, management will evaluate AmTrust’s assessment and determine whether there is any material impact on the insurance reserves and the Earn-Out Payment earned by the Company.  

 

The Company’s historical financials have been revised to present the operating results of the Acquired Companies as discontinued operations.

Summarized results of the discontinued operations are as follows for the thirteen weeks ended December 31, 2016, and January 2, 2016:

 

 

The operating results of the Acquired Companies were historically reported as the results of operations included in the Insurance segment.

Assets Held for Sale

In July 2016, the Company ceased operating its Southern California Dairy Division manufacturing facility (see Part I, Item 1, “Business – Recent Developments – Dairy Divisions” of the Company’s Annual Report on Form 10-K for the year ended October 1, 2016 for additional information).  Due to the closure of this facility, land, building and property improvements totaling $5.4 million have been reclassified to assets held for sale – current on the accompanying consolidated condensed balance sheets at both December 31, 2016 and October 1, 2016.  Management believes the carrying amount of such assets will be recovered principally through a sale transaction rather than continuing use and the sale of the assets (or disposal group) is probable, and transfer of the assets (or disposal group) is expected to qualify for recognition as a completed sale within one year of the Company’s fiscal year ended October 1, 2016.  The Company evaluated these assets for impairment at December 31, 2016 and October 1, 2016 and concluded there was no impairment of these assets as the Company is actively marketing these assets and has received offers in excess of their carrying amount.  See Note 3 to “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.  

 

Sale of Los Angeles Bakery Facility

On December 31, 2016, the Company completed the sale of its Bakery operations.  The buyer will continue to offer the Company’s Members a private label offering for bread and an expanded product offering for the Company’s Southern California Members.  The buyer paid the Company $3.0 million for the Company’s Bakery facility, related equipment, inventory, and customer list.  In addition, the buyer intends to retain substantially all union and non-union Bakery associates and assume the related union contract and union pension obligations. The Company recorded a $1.4 million loss on the sale of the Bakery operations.

 

 

The Company evaluates the fair value of its assets and liabilities in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) and ASC Topic 825, “Financial Instruments.”

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Management has evaluated its assets and liabilities valued at fair value as follows:

The Company records marketable securities at fair value in accordance with ASC Topic 320, “Investments – Debt and Equity Securities.”  The Company’s Wholesale Distribution segment holds insurance contracts and mutual funds valued at fair value in support of certain employee benefits.  See Note 4 for further discussion on investments.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value (these values represent an approximation of possible value and may never actually be realized):

Cash and cash equivalents.    The carrying amount approximates fair value due to the short maturity of these instruments.

Accounts receivable and notes receivable.    The carrying amount of accounts receivable approximates its fair value due to its short-term maturity.  Except as discussed below, the carrying amount of notes receivable approximates its fair value based principally on the underlying interest rates and terms, maturities, collateral and credit status of the receivables and after consideration of recorded allowances.

Concentration of credit risk.    The Company’s largest customer, Cash & Carry Stores, LLC, a wholly-owned subsidiary of Smart & Final, Inc., a Non-Member customer, and the ten largest Member and Non-Member customers (including Cash & Carry Stores, LLC) constituted approximately 16% and 52%, respectively, of total net sales for the thirteen week period ended December 31, 2016.  The Company’s ten customers with the largest accounts receivable balances accounted for approximately 43% and 41% of total accounts receivable at December 31, 2016 and at October 1, 2016, respectively.  Management believes that receivables are well diversified and that the allowances for doubtful accounts are sufficient to absorb estimated losses.

Investments.    Generally, the fair values for investments are readily determinable based on actively traded securities in the marketplace.  Investments that are not actively traded are valued based upon inputs including quoted prices for identical or similar assets.  Equity securities that do not have readily determinable fair values are accounted for using the cost or equity methods of accounting. The Company regularly evaluates securities carried at cost to determine whether there has been any diminution in value that is deemed to be other than temporary and adjusts the value accordingly.

The following table represents the Company’s financial instruments recorded at fair value and the hierarchy of those assets as of December 31, 2016:

 

 

The following table represents the Company’s financial instruments recorded at fair value and the hierarchy of those assets as of October 1, 2016:

 

 

Mutual funds are valued by the Company based on information received from a third party.  These assets are valued based on quoted prices in active markets (Level 1 inputs).  As of December 31, 2016 and October 1, 2016, respectively, $10.4 million and $10.6 million of mutual funds, held in rabbi trusts to provide for employee benefit obligations, are included in other assets in the Company’s consolidated condensed balance sheets.  For assets traded in active markets,

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the assets are valued at quoted bond market prices (Level 1 inputs).  The Company determines the classification of financial asset groups within the fair value hierarchy based on the lowest level of input into each group’s asset valuation.

The Company did not have any significant transfers into or out of Levels 1 and 2 during the thirteen week period ended December 31, 2016.

Notes payable.    The fair values of borrowings under the Company’s credit facilities are estimated to approximate their carrying amounts due to the short maturities of those obligations.  The fair values for other notes payable are based primarily on rates currently available to the Company for debt with similar terms and remaining maturities.

The fair value of notes payable was $276.2 million and $253.6 million compared to their carrying value of $277.8 million and $254.2 million at December 31, 2016 and October 1, 2016, respectively.  These fair values were based on estimates of market conditions, estimates using present value and risks existing at that time (Level 2 inputs).

 

 

 

The amortized cost and fair value of investments are as follows:

 

 

 

During the interim period ended December 31, 2016 and the fiscal year ended October 1, 2016, the Company did not hold any trading or held-to-maturity securities.

Net investment income, which is included in net sales, is summarized as follows:

 

 

Equity investments held by the Company that do not have readily determinable fair values are accounted for using the cost or equity methods of accounting.  The Company evaluated its equity investments for impairment as of December 31, 2016, and the Company did not consider any of these equity investments to be impaired.

The Company held investments in Western Family Holding Company (“Western Family”) common stock of $8.4 million and $8.6 million at December 31, 2016 and October 1, 2016, respectively.  Western Family is a privately held company located in Oregon that provides procurement, quality assurance, packaging and other services exclusively for its member-owners from which the Company purchases food and general merchandise products. The investment represents approximately a 20.3% and 17.2% ownership interest at December 31, 2016 and October 1, 2016, respectively.  The Company’s ownership percentage in Western Family is based, in part, on the volume of purchases transacted with Western Family.  The investment is accounted for using the equity method of accounting.

In June 2016, Western Family reached an agreement with Topco Associates, LLC (“Topco”), a cooperative, authorizing Topco to procure, manage and market Western Family’s private label brands, including the Western Family and Natural Directions national brand equivalent corporate brands that are sold through the Company.  Western Family will continue to own its private label brands and Unified will continue its ownership in Western Family.  Western Family announced that the transition of procurement and marketing to Topco will take several months, with all orders and invoices continuing through Western Family until that time.  When the transition of the products is complete, Western Family’s headquarters in

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Oregon will close and Western Family will lay off the majority of its workforce.  In conjunction with its agreement with Topco, Western Family provided its investors an estimate of the anticipated costs for the closure of its headquarters, and the Company accordingly reduced its investment in Western Family by its proportionate share of such costs in the amount of $0.4 million in fiscal 2016.  In addition, Western Family provided its investors updated financial information as of November 30, 2016, and the Company further reduced its investment by its proportionate ownership share in the amount of $0.2 million as of December 31, 2016.

As discussed in Part I, Item 1, “Business – Products – Corporate Brands” of our Annual Report on Form 10-K for the year ended October 1, 2016, the Company currently sells products under national brand equivalent and value-oriented corporate brands.  During fiscal 2016, the Company joined Topco concurrent with an investment of $60 thousand in Topco’s capital stock.  Topco is a privately held company headquartered in Illinois that provides procurement, quality assurance, packaging and other services exclusively for its member-owners, which include supermarket retailers, food wholesalers and foodservice companies.  Commencing in the fourth quarter of fiscal 2016, the Company began transitioning to Topco as its primary supplier for the Company’s Springfield national brand equivalent corporate brand and its value-oriented Special Value corporate brand products.  In addition, Topco serves as the Company’s sole-source supplier for general merchandise and health and beauty care products under its TopCare label. The investment is accounted for using the cost method of accounting.

The Company’s wholly-owned finance subsidiary, Grocers Capital Company (“GCC”), has an investment in National Consumer Cooperative Bank (“NCB”), which operates as a cooperative, and therefore, its participants are required to own its Class B common stock.  The investment in the Class B common stock of NCB, accounted for using the cost method of accounting, aggregated $4.1 million at both December 31, 2016 and October 1, 2016.  The Company recognized zero and $6 thousand of dividend income from NCB for the thirteen weeks ended December 31, 2016 and January 2, 2016, respectively.

 

 

Unified is a retailer-owned, grocery wholesale cooperative serving supermarket, specialty and convenience store operators located primarily in the western United States and the Pacific Rim. The Company’s customers range in size from single store operators to regional supermarket chains.  The Company sells a wide variety of products typically found in supermarkets.  The Company’s customers are comprised of its owners (“Members”) and non-owners (“Non-Members”).  Our focus is on our Members, but we also do business with Non-Member customers.  For the thirteen weeks ended December 31, 2016, approximately 68% of our net sales were to Members.  The Company reports all product sales in its only segment, Wholesale Distribution.  The Company also provides support services, including financing, to its customers through the Wholesale Distribution segment and through separate subsidiaries.  Finance activities are grouped within Unified’s All Other business activities.  The availability of specific products and services may vary by geographic region.

Management identifies segments based on the information monitored by the Company’s chief operating decision maker (the Chief Executive Officer) to manage the business and, accordingly, has identified the following reportable segments:

Non-perishable products consist primarily of dry grocery, frozen food, deli, ethnic, gourmet, specialty foods, natural and organic, general merchandise and health and beauty care products.  They also include (1) retail support services and (2) products and shipping services provided to Non-Member customers through the Company’s wholly-owned subsidiary, Unified International, Inc.  Perishable products consist primarily of service deli, service bakery, meat, eggs, produce, bakery and dairy products.  Net sales within the Wholesale Distribution segment include $650.3 million and $653.6 million, or 67.7% and 67.2% of total Wholesale Distribution segment net sales, for the thirteen weeks ended December 31, 2016 and January 2, 2016, respectively, attributable to sales of non-perishable products, and $310.6 million and $318.8 million, or 32.3% and 32.8% of total Wholesale Distribution segment net sales, for the thirteen weeks ended December 31, 2016 and January 2, 2016, respectively, attributable to sales of perishable products.  Wholesale Distribution segment net sales also include revenues attributable to the Company’s retail support services (other than financing), which comprised less than 1% of total Wholesale Distribution segment net sales, for each of the foregoing respective periods.

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Transactions involving certain vendor direct arrangements are comprised principally of sales of produce in the Pacific Northwest and Northern California and sales of branded ice cream in Southern California.  “Gross billings,” an internal financial metric that adds back gross billings through vendor direct arrangements to net sales and is used by management to assess our operating performance, was $979.9 million and $999.0 million for the thirteen weeks ended December 31, 2016 and January 2, 2016, respectively.

 

 

The All Other category includes the results of operations for the Company’s other support businesses, including its finance subsidiary, Grocers Capital Company, whose services are provided to a common customer base, none of which individually meets the quantitative thresholds of a reportable segment.  As of, and for the thirteen weeks ended, December 31, 2016, the All Other category collectively accounted for approximately 3% of the Company’s total assets, and less than 1% of total net sales.

Information about the Company’s operating segment is summarized below.

 

 

 

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The Company is party to an Amended and Restated Credit Agreement dated as of June 28, 2013, as amended in fiscal 2014, fiscal 2015 and fiscal 2016 (as so amended, the “Credit Agreement”), among the Company, the lenders party thereto, and Wells Fargo Bank, National Association (“N.A.”), as administrative agent (“Administrative Agent”).  See Note 7 to “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the year ended October 1, 2016 for a full description of the Credit Agreement and the amendments thereto.  

The Company’s outstanding revolver borrowings under the Credit Agreement increased to $166.4 million at December 31, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 2.73% per annum) from $137.6 million at October 1, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 3.05% per annum).  The Company’s outstanding FILO borrowings under the Credit Agreement were $13.1 million at December 31, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 4.01% per annum) and $15.5 million at October 1, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 4.29% per annum). The Company’s outstanding term loan borrowings under the Credit Agreement were $80.0 million at December 31, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 2.76% per annum) and $82.5 million at October 1, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 2.52% per annum).

Subsidiary Financing Arrangement

GCC is party to an Amended and Restated Loan and Security Agreement, dated as of September 26, 2014 as amended by Amendment Number One dated as of June 26, 2015 and further amended by Amendment Number Two dated as of September 23, 2016 (as so amended, the “GCC Loan Agreement”), by and among GCC, the lenders party thereto, and ZB, N.A., dba California Bank & Trust (“CBT”), as Arranger and Administrative Agent.  On December 22, 2016, GCC entered into Amendment Number Three (the “GCC Loan Amendment”) to the GCC Loan Agreement, by and among GCC, the lenders party thereto, and CBT, as Arranger and Administrative Agent.  The GCC Loan Amendment extends the maturity date of the GCC Loan Agreement, which was previously December 31, 2016, to March 31, 2018, with a total commitment in the principal amount of $15 million.  See Item 1.01. “Entry into a Material Definitive Agreement” and Item 2.03. “Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant” of the Company’s Current Report on Form 8-K, filed on December 23, 2016, for additional information.

GCC’s revolving loan borrowings outstanding were $15.0 million at both December 31, 2016 and October 1, 2016.

 

 

The Company sponsors a cash balance plan (“Unified Cash Balance Plan”).  The Unified Cash Balance Plan is a noncontributory defined benefit pension plan covering substantially all employees of the Company who are not subject to a collective bargaining agreement.  Participants’ balances receive an annual interest credit, currently tied to the 30-year Treasury rate that is in effect the previous November, but in no event shall the rate be less than 5%.  Benefits under the Unified Cash Balance Plan are provided through a trust.  Prior to the end of fiscal 2014, the Company amended the Unified Cash Balance Plan to close the plan to new entrants effective December 31, 2014.  In addition, the plan was frozen at December 31, 2014 such that current participants will no longer accrue salary-based service credits based on years of service with the Company and pensionable compensation after that date.  The annual interest credit as described above will continue for participants active in the plan as of December 31, 2014.  Selected groups of vested terminated participants were each given one-time opportunities to elect a lump sum distribution of their benefits from the plan’s assets or immediate receipt of an annuity in December 2016 and December 2015.  As a result, benefit payments of $6.3 million and $8.7 million, respectively, were distributed from the plan’s assets to those participants who elected such option prior to the end of the Company’s first quarters ended December 31, 2016 and January 2, 2016.

The Company also sponsors an Executive Salary Protection Plan III (“ESPPIII”) for the executive officers of the Company that provides supplemental post-termination retirement income based on each participant's salary and years of service as an officer of the Company.  This plan was amended in December 2012 to close the plan to new entrants as of September 30, 2012.  This plan was replaced in fiscal 2013 with the Company’s Supplemental Executive Retirement Plan (see discussion below).  The Company has informally funded its obligation to plan participants in a rabbi trust, comprised primarily of life insurance policies reported at cash surrender value and mutual fund assets consisting of various publicly-traded mutual funds reported at estimated fair value based on quoted market prices.  In accordance with ASC Topic 710, “Compensation – General,” the assets and liabilities of a rabbi trust must be accounted for as if they are assets and liabilities of the Company.  In addition, all earnings and expenses of the rabbi trust are reported in the Company’s consolidated condensed statements of earnings (loss).  The cash surrender value of such life insurance policies aggregated to $21.4 million and $22.4 million at December 31, 2016 and October 1, 2016, respectively, and are included in other assets in the Company’s consolidated condensed balance sheets.  Mutual funds reported at their estimated fair value of $7.1 million and $7.3 million at December 31, 2016 and October 1, 2016, respectively, are included in other

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assets in the Company’s consolidated condensed balance sheets.  The assets held in the rabbi trust are not available for general corporate purposes.  The rabbi trust is subject to the Company’s creditors’ claims in the event of its insolvency.  The trust assets are excluded from ESPPIII plan assets as they do not qualify as plan assets under ASC Topic 715, “Compensation – Retirement Benefits.”  The related accrued benefit cost (representing the Company’s benefit obligation to participants) of $40.2 million at both December 31, 2016 and October 1, 2016 is recorded in long-term liabilities, other in the Company’s consolidated condensed balance sheets.

The Company sponsors other postretirement benefit plans that provide certain medical coverage to retired non-union employees and officers and provide unused sick leave benefits for certain eligible union employees.  Those plans are not funded.

The components of net periodic cost for pension and other postretirement benefits for the respective thirteen weeks ended December 31, 2016 and January 2, 2016 consist of the following:

 

 

The Company’s funding policy is to make contributions to the Unified Cash Balance Plan in amounts that are at least sufficient to meet the minimum funding requirements of applicable laws and regulations, but no more than amounts deductible for federal income tax purposes.  During August 2014, legislation to extend pension funding relief was enacted as part of the Highway and Transportation Funding Act of 2014 (“HATFA”).  As a result, the Company expects to make no estimated minimum contributions to the Unified Cash Balance Plan during fiscal 2017 for the 2016 plan year, and there will be no quarterly contributions required for the 2017 plan year.  At its discretion, the Company may contribute in excess of the minimum (zero) requirement.  Additional contributions, if any, will be based, in part, on future actuarial funding calculations and the performance of plan investments.

Additionally, the Company anticipates making benefit payments of $3.9 million to participants in the ESPPIII for the 2017 plan year.  The Company made benefit payments of $0.3 million to participants in the ESPPIII during the thirteen weeks ended December 31, 2016 for the 2017 plan year.

The Company sponsors a supplemental retirement plan for a select group of management or highly compensated employees that are at the Vice President level and above of the Company under the Unified Grocers, Inc. Supplemental Executive Retirement Plan (the “SERP”).  This plan was established to replace the ESPPIII, which has been frozen.  The SERP provides participating officers with supplemental retirement income in addition to the benefits provided under the Company’s Cash Balance and 401(k) plans.

The SERP is a non-qualified defined contribution type plan under which benefits are derived based on a notional account balance to be funded by the Company for each participating officer.  The account balance will be credited each year with a Company contribution based on the officer’s compensation, calculated as base salary plus bonus, earned during a fiscal year and the officer’s executive level at the end of the fiscal year.  Plan participants may select from a variety of investment options (referred to as “Measurement Funds” in the plan document) concerning how the contributions are hypothetically invested.  Assets of the SERP (i.e., the participants’ account balances) will not be physically invested in the investments selected by the participants; rather, the Measurement Funds are utilized for the purpose of debiting or crediting additional amounts to each participant’s account.  The Company informally funds its obligation to plan participants in a rabbi trust, comprised of mutual fund assets consisting of various publicly-traded mutual funds reported at estimated fair value based on quoted market prices.  Mutual funds reported at their estimated fair value of $3.1 million at both December 31, 2016 and October 1, 2016 are included in other assets in the Company’s consolidated condensed balance sheets.  The related accrued benefit cost (representing the Company’s benefit obligation to participants) of $4.7 million and $4.8 million at December 31, 2016 and October 1, 2016, respectively, is recorded in long-term liabilities, other in the Company’s consolidated condensed balance sheets.

The SERP is accounted for pursuant to FASB ASC section 715-70, “Compensation – Retirement Benefits – Defined Contribution Plans” (“ASC 715-70”).  SERP participants are credited with a contribution to an account and will receive,

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upon separation, a benefit based upon the vested amount accrued in their account, which includes the Company’s contributions plus or minus the increase or decrease in the fair market value of the hypothetical investments (Measurement Funds) selected by the participant.  ASC 715-70 requires companies to record, on a periodic basis, that portion of a company’s contribution earned during the period by the participants (the “Expense”).  The Company is accruing the Expense under the assumption that all participants in the SERP will achieve full vesting (five years of service).  The related benefit expense was $ 0.4 million for each of the thirteen weeks ended December 31, 2016 and January 2, 2016, respectively.

 

 

The Company is a party to various litigation, claims and disputes, some of which are for substantial amounts, arising in the ordinary course of business. While the ultimate effect of such actions cannot be predicted with certainty, the Company believes the outcome of these matters will not result in a material adverse effect on its financial condition, results of operations or cash flows.

 

 

The balance and components of the change in accumulated other comprehensive earnings (loss), net of taxes, are as follows:

 

 

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The reclassifications out of accumulated other comprehensive earnings (loss) for the thirteen weeks ended December 31, 2016 and January 2, 2016 were as follows:

 

 

 

 

Members affiliated with directors of the Company make purchases of merchandise from the Company and also may receive benefits and services that are of the type generally offered by the Company to its similarly situated eligible Members.  Such Members may enter into loan agreements, lease guarantees and subleases.  Additionally, during the course of its business, the Company enters into individually negotiated supply agreements with its Members. These agreements typically require the Member to purchase certain agreed amounts of its merchandise requirements from the Company and obligate the Company to supply such merchandise under agreed terms and conditions relating to such matters as pricing and delivery.  Since such programs are only available to Members of the Company, it is not possible to assess whether transactions with Members of the Company, including entities affiliated with directors of the Company, are less favorable to the Company than similar transactions with unrelated third parties. However, management believes such transactions are on terms that are generally consistent with terms available to other Members similarly situated.

The Company has a Related Party Transactions Policy (“RPT Policy”) which was adopted by the Board on May 18, 2016. The RPT Policy requires certain “Related Party Transactions” (as defined therein) to be identified, reviewed and approved by the Company’s Disclosure Committee, which is comprised of selected employees of the Company and which analyzes such Related Party Transactions for disclosure as required by relevant regulations and accounting guidance. The majority of transactions between Unified and its Members are part of the Company’s standard suite of products, services, and programs available to its Members. The criteria for participation in these transactions are the same as for all similarly situated Members. The RPT Policy identifies these transactions as “Ordinary Course” transactions which are not subject to review by the Disclosure Committee, but are otherwise documented within the Company. Such services and programs include gross billings, supply agreements, inventory deferral loan agreements, and other published programs.

Unified occasionally, but not regularly, enters into significant transactions with its Members. The RPT Policy establishes a process for the Disclosure Committee to review and elevate such transactions to the Related Party Sub-Committee (comprised of three independent directors who are not shareholders of the Company) of the Audit Committee of the Board of Directors for review and approval. Transactions required to be reviewed by the Related Party Sub-Committee include, but are not limited to, non-inventory loans which exceed $120,000, all loans which include terms that are not similar to those that would be received by similarly situated Members or customers, guarantees of leases and subleases, and other unique transactions other than the “Ordinary Course” transactions described above.  

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During the first quarter of fiscal 2017, Jon’s Markets, a Member affiliated with John Berberian, a Unified Member-Director, exercised an option to extend a sublease for a five-year term expiring in 2022.  

As of the date of this report, other than as indicated above, there have been no material changes to the related party transactions disclosed in Note 20 to “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” of the Company’s Annual Report on Form 10-K for the year ended October 1, 2016.

 

 

In January 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-04, “Intangibles – Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment” (“ASU No. 2017-04”).  To simplify the subsequent measurement of goodwill, ASU No. 2017-04 eliminates Step 2 from the goodwill impairment test.  In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination.  Instead, ASU No. 2017-04 requires an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount.  An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.  ASU No. 2017-04 also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test.  Therefore, the same impairment assessment applies to all reporting units.  An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets.  An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.  ASU No. 2017-04 is effective for fiscal years beginning after December 15, 2019. The Company will adopt ASU No. 2017-04 commencing in the first quarter of fiscal 2021. The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.  

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805) – Clarifying the Definition of a Business” (“ASU No. 2017-01”).  ASU No. 2017-01 provides additional guidance to help evaluate whether transactions should be accounted for as acquisitions or disposals of assets or businesses.  ASU No. 2017-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company will adopt ASU No. 2017-01 commencing in the first quarter of fiscal 2019. The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.

In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers” (“ASU No. 2016-20”). The amendments in ASU No. 2016-20 make certain clarifications on topics that are not deemed to be within the scope of Topic 606.  For example, the standard clarifies that when performing impairment testing pursuant to ASC subtopic 340-40, “Other Assets and Deferred Costs—Contracts with Customers,” an entity should consider expected contract renewals and extensions and include both the amount of consideration it already has received but has not recognized as revenue and the amount it expects to receive in the future.  In addition, the amendments in ASU No. 2016-20 provide optional exemptions from the disclosure requirement for remaining performance obligations for specific situations in which an entity need not estimate variable consideration to recognize revenue and also expand the information that is required to be disclosed when an entity applies one of the optional exemptions.  ASU No. 2016-20 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company will adopt ASU No. 2016-20 commencing in the first quarter of fiscal 2019. The Company does not believe this standard will have a material impact on its consolidated financial statements; however, the Company is currently assessing the impact this standard may have on the related expansion of its footnote disclosures.

In December 2016, the FASB issued ASU No. 2016-19, “Technical Corrections and Improvements” (“ASU No. 2016-19”). The amendments in ASU No. 2016-19, among other things, simplify and improve certain guidance on the term “participating insurance” (as applied to defined benefit pension and postretirement plans and insurance) and remove the term “debt” as used in troubled debt restructuring from the Master Glossary to avoid confusion with other topics. The changes are not expected to affect current accounting practices, rather they are intended to simplify and improve the readability of certain guidance. ASU No. 2016-19 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 14, 2016.  The Company adopted ASU No. 2016-19 commencing in the first quarter of fiscal 2017. The adoption of ASU No. 2016-19 did not have a material impact on the Company’s consolidated financial statements or the related footnote disclosures.

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force)” (“ASU No. 2016-18”). The amendments in ASU No. 2016-18 require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and

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amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU No. 2016-18 does not provide a definition of restricted cash or restricted cash equivalents. ASU No. 2016-18 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company will adopt ASU No. 2016-18 commencing in the first quarter of fiscal 2019. The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” (“ASU No. 2016-16”). ASU No. 2016-16 requires recognition of the income tax consequences of an intraentity transfer of an asset other than inventory when the transfer occurs. ASU No. 2016-16 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company will adopt ASU No. 2016-16 commencing in the first quarter of fiscal 2019. The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force)” (“ASU No. 2016-15”). ASU No. 2016-15 clarifies how certain cash receipts and payments should be presented in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company will adopt ASU No. 2016-15 commencing in the first quarter of fiscal 2019. The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326)” (“ASU No. 2016-13”).  ASU No. 2016-13 requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected by using a valuation account to deduct credit loss allowances from the amortized cost basis of the financial asset(s).  In addition, credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses.  ASU No. 2016-13 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019.  Early adoption of ASU No. 2016-13 is permitted. The Company will adopt ASU No. 2016-13 commencing in the first quarter of fiscal 2021.  The Company is currently assessing the impact this standard may have on its financial statements and the related expansion of its footnote disclosures.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU No. 2016-02”). The principal objective of ASU No. 2016-02 is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet. ASU No. 2016-02 continues to retain a distinction between finance and operating leases but requires lessees to recognize a right-of-use asset representing its right to use the underlying asset for the lease term and a corresponding lease liability on the balance sheet for all leases with terms greater than twelve months. ASU No. 2016-02 is effective for fiscal years and interim periods beginning after December 15, 2018.  Early adoption of ASU No. 2016-02 is permitted. The Company will adopt ASU No. 2016-02 commencing in the first quarter of fiscal 2020. The Company is currently assessing the impact this standard may have on its financial statements and the related expansion of its footnote disclosures.

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU No. 2016-01”).  The principal objective of ASU No. 2016-01 is to improve the reporting of financial instruments in order to provide users of financial statements with more decision-useful information.  ASU No. 2016-01 requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income.  The amendment also affects the presentation and disclosure requirements for financial instruments.  ASU No. 2016-01 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017.  The Company will adopt ASU No. 2016-01 commencing in the first quarter of fiscal 2019.  The Company is currently assessing the impact this standard may have on its financial statements and the related expansion of its footnote disclosures.

In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes,” which changes how deferred taxes are classified on organizations’ balance sheets.  ASU No. 2015-17 eliminates the current requirement for organizations to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet.  Instead, organizations will be required to classify all deferred tax assets and liabilities as noncurrent.  The amendments apply to all organizations that present a classified balance sheet.  The amendments are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods.  The Company will adopt ASU No. 2015-17 commencing in the first quarter of fiscal 2018.  The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.

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In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330) – Simplifying the Measurement of Inventory” (“ASU No. 2015-11”).  ASU No. 2015-11 requires entities to measure most inventory at the “lower of cost and net realizable value” and options that currently exist for “market value” will be eliminated. The ASU defines net realizable value as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” ASU No. 2015-11 will not apply to inventories that are measured by using either the last-in, first-out (LIFO) method or the retail inventory method (RIM).  No other changes were made to the current guidance on inventory measurement.  ASU No. 2015-11 is effective for interim and annual periods beginning after December 15, 2016.  Early application is permitted and should be applied prospectively.  The Company will adopt ASU No. 2015-11 commencing in the first quarter of fiscal 2018.  The Company does not believe this standard will have a material impact on its consolidated financial statements or the related footnote disclosures.

In April 2015, the FASB issued ASU No. 2015-04, “Compensation – Retirement Benefits (Topic 715) – Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets” (“ASU No. 2015-04”).  ASU No. 2015-04 provides an entity whose fiscal year does not coincide with a calendar month-end to utilize a practical expedient for the measurement of the entity’s defined benefit plan assets.  The practical expedient allows an entity to measure its plan assets as of the nearest calendar month-end that is closest to the entity’s fiscal year-end.  The month-end selected must be consistently used amongst all plans if an entity has more than one plan and must be applied consistently from year to year.  ASU No. 2015-04 also provides guidance for significant events that occur between the entity’s fiscal year-end and the month-end selected for measurement.  If the event is an entity-initiated event that results in a plan remeasurement, then the plan assets must also be revalued (there is a practical expedient allowed similar to the overall practical expedient).  If the event is out of the entity’s control (for example, changes in market prices or interest rates), the entity is not required to remeasure the assets.  An entity must disclose the practical expedient election and the date used to measure the assets and obligations.  ASU No. 2015-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015.  The Company adopted ASU No. 2015-04 commencing in the first quarter of fiscal 2017.  The adoption of ASU No. 2015-04 did not have a material impact on the Company’s consolidated financial statements or the related footnote disclosures.

In April 2015, the FASB issued ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs” (“ASU No. 2015-03”).  ASU No. 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in ASU No. 2015-03.  Entities should apply the amendments in ASU No. 2015-03 on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance.

Since the issuance of ASU No. 2015-03, it has been unclear whether and, if so, how ASU No. 2015-03 applies to revolving debt arrangements.  At the Emerging Issues Task Force’s June 18, 2015 meeting, the SEC staff clarified that ASU No. 2015-03 does not address debt issuance costs associated with such arrangements and announced that it would “not object to an entity deferring and presenting such costs as an asset and subsequently amortizing the costs ratably over the term of the revolving debt arrangement.”  The Company has elected to apply the accounting policy outlined by the SEC staff as stated above.  Under that policy, an entity presents remaining unamortized debt issuance costs associated with a revolving debt arrangement as an asset even if the entity currently has a recognized debt liability for amounts outstanding under the arrangement.  Further, such costs are amortized over the life of the arrangement even if the entity repays previously drawn amounts.

For public entities, ASU No. 2015-03 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015.  The Company adopted ASU No. 2015-03 commencing in the first quarter of fiscal 2017.  The adoption of ASU No. 2015-03 did not have a material impact on the Company’s consolidated financial statements or the related footnote disclosures.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU No. 2014-09”).  ASU No. 2014-09 clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and International Financial Reporting Standards that (1) removes inconsistencies and weaknesses in revenue requirements; (2) provides a more robust framework for addressing revenue issues; (3) improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provides more useful information to users of financial statements through improved disclosure requirements; and (5) simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer.  The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The original effective date for ASU 2014-09 would have required the Company to adopt commencing in the first quarter of fiscal 2018.  In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of ASU No. 2014-09

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for an additional year and provided the option to elect early adoption of ASU No. 2014-09 on the original effective date.  In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606) – Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (“ASU No. 2016-08”).  ASU No. 2016-08 does not change the core principle of the guidance under ASU No. 2014-09; however, it does clarify the implementation guidance on principal versus agent considerations and includes indicators to assist in evaluating whether an entity controls the good or the service before it is transferred to the customer. In April 2016, the FASB issued ASU No. 2016-10 “Revenue from Contracts with Customers (Topic 606) – Identifying Performance Obligations and Licensing” (“ASU No. 2016-10”).  ASU No. 2016-10 does not change the core principle of the guidance under ASU No. 2014-09; however, it does clarify the implementation guidance on identifying performance obligations and licensing while retaining the related principles for those areas.  In May 2016, the FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients” (“ASU No. 2016-12”).  ASU No. 2016-12 does not change the core principle of the guidance under ASU No. 2014-09; however, it does clarify the guidance on assessing collectability, presentation of sales taxes, noncash consideration, contract modifications at transition, and completed contracts at transition.  The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption.  Accordingly, the Company will adopt ASU No. 2014-09 commencing in the first quarter of fiscal 2019.  The Company is currently assessing the impact this standard may have on its consolidated financial statements and the related expansion of its footnote disclosures.

 

 

 

Subsequent events have been evaluated by the Company through the date the financial statements were issued.

 

 

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

FORWARD-LOOKING INFORMATION

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to expectations concerning matters that (a) are not historical facts, (b) predict or forecast future events or results, or (c) embody assumptions that may prove to have been inaccurate. These forward-looking statements involve risks, uncertainties and assumptions. When we use words such as “believe,” “expect,” “anticipate” or similar expressions, we are making forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we cannot give readers any assurance that such expectations will prove correct. The actual results may differ materially from those anticipated in the forward-looking statements as a result of numerous factors, many of which are beyond our control. Important factors that could cause actual results to differ materially from our expectations include, but are not limited to, the factors discussed in the sections entitled “Risk Factors” and “Critical Accounting Policies and Estimates” within “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All forward-looking statements attributable to us are expressly qualified in their entirety by the factors that may cause actual results to differ materially from anticipated results. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinion only as of the date hereof. We undertake no duty or obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in this document as well as in other documents we file from time to time with the Securities and Exchange Commission (the “SEC”) for an understanding of the negative variables that can affect our business and results of operations.

COMPANY OVERVIEW

General

Unified Grocers, Inc. (referred to in this Form 10-Q, together with its consolidated subsidiaries, as “Unified,” “the Company,” “we,” “us” or “our”), a California corporation organized in 1922 and incorporated in 1925, is a retailer-owned, grocery wholesale cooperative serving supermarket, specialty, restaurant supply (through Cash & Carry Stores, LLC, a wholly-owned subsidiary of Smart & Final, Inc.) and convenience store operators located primarily in the western United States and the Pacific Rim.  We operate our business in one reportable business segment, Wholesale Distribution.  All remaining business activities are grouped into All Other (see Note 5 of “Notes to Consolidated Condensed Financial Statements – Unaudited” in Part I, Item 1, “Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q for additional discussion).

We sell a wide variety of products typically found in supermarkets, including dry grocery, frozen food, deli, ethnic, gourmet, specialty foods, natural and organic, general merchandise, health and beauty care, service deli, service bakery, meat, eggs, produce and dairy products.  We also provide financing services to our customers, as well as various support services, including merchandising, retail pricing, advertising, promotional planning, retail technology, equipment purchasing and real estate services.  Our Wholesale Distribution segment represents nearly 100% of our total net sales.  The availability of specific products and services may vary by geographic region.  We have three separate geographical and marketing regions:  Southern California, Northern California and the Pacific Northwest.

Our customers are comprised of our owners (“Members”) and non-owners (“Non-Members”).  Our focus is on our members, but we also do business with Non-Member customers.  Our Members operate grocery stores and supermarkets that range in size from single store operators to regional supermarket chains.  Members are required to meet specific requirements, which include ownership of our capital shares and may include required cash deposits.  Customers who purchase less than $1 million annually from us would not generally be considered for membership, while customers who purchase over $3 million annually from us are typically required to become Members.  See Part I, Item 1. “Business – Member Requirements,” Part I, Item 1. “Business – Capital Shares” and Part I, Item 1. “Business – Customer Deposits” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.  The membership requirements, including purchase and capitalization requirements, may be modified at any time at the discretion of our Board of Directors (the “Board”).

Earnings from patronage activities, excluding our finance and international subsidiaries, conducted with our Members (“Patronage Business”) are eligible for distribution to our Members in the form of patronage dividends based upon our earnings from such Patronage Business during a fiscal year. An entity that does not meet Member purchase requirements may conduct business with us as a Non-Member customer.  We may also grant an entity that meets our Member purchase requirements the ability to conduct business with us as a Non-Member customer. Non-Member customers are not entitled to receive patronage dividends. We retain the earnings from our subsidiaries and from business conducted with Non-Members (collectively, “Non-Patronage Business”).

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Historically, the Board has approved the payment of patronage dividends and the form of such payment for our three patronage earnings divisions:  the Cooperative Division, the Southern California Dairy Division (through June 2016) and the Pacific Northwest Dairy Division (through May 2016).  In July 2016, we ceased operating our Southern California Dairy Division manufacturing facility but continue offering fluid milk and other products, including our private label brands, to our Members and customers through Alta-Dena Certified Dairy, LLC, a wholly-owned subsidiary of Dean Foods Company (“Dean Foods Company”).  Coincident with this change, we no longer pay patronage dividends on products supplied by Dean Foods Company for the Southern California Dairy Division.  In addition, the Pacific Northwest Dairy Division ceased paying patronage dividends on sales of dairy products after May 2016.   Upon discontinuing our dairy patronage dividend program to our Members, we reduced the pricing on our dairy products accordingly.  We have no expectation of paying dairy patronage dividends in the future.

Beginning in fiscal 2015, earnings from sales of food products such as Hispanic, other ethnic, gourmet, natural, organic and other specialty foods sold to Members through our Market Centre division (included in our Wholesale Distribution segment) are included in patronage earnings and may be eligible for patronage distributions. See Part I, Item 1. “Business – Company Structure and Organization – Wholesale Business – Wholesale Distribution” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional discussion.

Facilities and Transportation

We operate various warehouse and office facilities that are located in Commerce, Los Angeles, Santa Fe Springs and Stockton, California, as well as Milwaukie, Oregon and Seattle, Washington.  We also operated a bakery manufacturing facility (through December 31, 2016) in Los Angeles, which primarily served the Southern California region.  In July 2016, we ceased operating our milk, water and juice processing plant in Los Angeles, but continue offering our products to our Members and customers through Dean Foods Company.

We consider our corporate offices, warehouses and manufacturing properties to be generally in good condition, well maintained, suitable and adequate to carry on our business as presently conducted.

Our customers may choose either of two delivery options for the distribution of our products.  They may have us deliver orders to their stores or warehouses, or they may pick-up their orders from our distribution centers.  For delivered orders, we primarily utilize our fleet of tractors and trailers.

INDUSTRY OVERVIEW AND THE COMPANY’S OPERATING ENVIRONMENT

Competition

We compete in the wholesale grocery industry with many regional and local grocery, general food, meat, produce, specialty, bakery and dairy wholesalers and distributors, as well as with national food wholesalers, namely C&S Wholesale Grocers, Inc., Supervalu, Inc., United Natural Foods, Inc. (UNFI) and KeHE Distributors, LLC.  Many of our customers, including Members, buy from such competing wholesalers and distributors in addition to us, such that we are competing for business at the wholesale grocery level on a daily basis.  This competition is intense with respect to, among other things, price, selection, availability and service.

Our customers include grocery retailers with a broad range of store sizes and types targeting a diverse range of consumers.  Depending on the nature of their stores and consumer focus, our customers may compete directly with vertically integrated regional and national chains, such as Albertsons Companies Inc. (including Safeway Inc., Vons and Pavilions), Kroger Co. (including Ralphs, Food 4 Less and QFC), Trader Joe’s Company and WinCo Foods, which operate traditional and specialty format full-service grocery stores.  They may also compete with warehouse club stores and supercenters such as Costco Wholesale Corp., Sam’s Club and Wal-Mart Stores, Inc., hard discount stores such as ALDI, drug channel stores, alternative format stores such as Target Corp., and the various “dollar” stores, stores focused on upscale and natural and organic products such as Sprouts Farmers Markets, LLC and Whole Foods Market Inc., and various convenience stores.  The marketplace in which our customers compete continues to evolve and present challenges.  These challenges include such recent trends as the continued proliferation of discount stores, supercenters and warehouse club stores and the efforts of many of the non-traditional format stores to expand their offerings of product to cover a greater range of the products offered by the traditional format full-service grocery store.

The success of our customers in attracting consumers to shop at their stores, as opposed to any of their various competitors, has a direct and significant impact on our sales and earnings. For more information about the competitive environment we and our customers face, please refer to “Risk Factors.”

In helping our customers remain competitive, whether they operate a traditional full-service grocery store or a non-traditional format store targeting particular consumers, we emphasize providing a diverse line of high quality products, competitive pricing and timely and reliable deliveries. We also provide a wide range of other services, including

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merchandising, retail pricing support, advertising, promotional planning, retail technology, equipment purchasing, real estate services and financing, to further support our customers’ businesses.

Economic Factors

We and others in the grocery industry are impacted by changes in the overall economic environment, including such factors as consumer confidence and the employment rate, shifts in consumer tastes and buying patterns, and changes in government spending that supports grocery purchases.  Overall, recent economic growth has produced a gradual improvement in consumer confidence and unemployment, conditions which caused consumers to be highly price sensitive and seek lower-cost alternatives in their grocery purchases.  These conditions have improved slowly in some of our operating markets; however, in other of our operating markets, these conditions have substantially improved and consumers, while continuing to seek value in their purchases, have increasingly opted for higher priced, higher quality products.  The significant industry growth in sales of natural and organic products is an example of this trend.  One trend that appears to be continuing in all market areas is the willingness of consumers to shop at multiple stores of various formats, for both greater selection and value, rather than obtaining all of their grocery needs from one full-service store.  This trend has continued to benefit the various specialty, discount and other alternative format stores.

We are impacted by the level of inflation and deflation in a variety of areas, including, but not limited to, sales, cost of sales, employee wages and benefits, workers’ compensation insurance and energy and fuel costs.  We typically experience significant volatility in the cost of packaged goods purchased from manufacturers and the cost of manufactured products supplied through vendor direct arrangements.  Our operating programs are designed to give us the flexibility to pass these costs on to our customers; however, we may not always be able to pass such increases on to customers on a complete or timely basis.  Any delay may result in our recovering less than all of a price increase.  It is also difficult to predict the effect that possible future purchased or manufactured (through vendor direct arrangements) product cost decreases might have on our profitability.  The effect of deflation in purchased or manufactured (through vendor direct arrangements) product costs would depend on the extent to which we had to lower selling prices of our products to respond to sales price competition in the market. For example, in both the current and prior fiscal year, the deflation we have experienced in meat product cost has negatively impacted our sales; however, our margins were not similarly impacted.  Our earnings are impacted by inventory holding gains or losses, such that during inflationary periods we benefit from increased product pricing, while during periods of low inflation or deflation, these gains are reduced or eliminated.  We are subject to changes in energy costs (excluding fuels) which we may not be able to pass along to customers.  With respect to fuel costs, we assess a fuel surcharge on product shipments to address the potential volatility in fuel costs.  The fuel surcharge is indexed to allow us to recover costs over a specified level.  Our continual focus on cost control and operational efficiency improvements helps us mitigate other changes in operating costs.  See “Risk Factors – We are vulnerable to changes in general economic conditions” for additional discussion.

We (and our customers) are subject to changes in federal, state or local minimum wage and overtime laws that could cause us to incur additional wage costs, which could adversely affect the profitability of our business and that of our customers.  See “Risk Factors – We (and our customers) are subject to changes in laws and regulations” for additional discussion.

Additionally, we are impacted by changes in prevailing interest rates or interest rates that have been negotiated in conjunction with our credit facilities.  A lower interest rate (used, for example, to discount our pension and postretirement unfunded obligations) may increase certain expenses, particularly pension and postretirement benefit costs, while decreasing potential interest expense for our credit facilities.  An increase in interest rates may have the opposite impact.  Consequently, it is difficult for us to accurately predict the impact that inflation, deflation or changes in interest rates might have on our operations.

We invest in life insurance policies (reported at cash surrender value) and various publicly-traded mutual funds (reported at estimated fair value based on quoted market prices) to fund obligations pursuant to our Executive Salary Protection Plan III, Supplemental Executive Retirement Plan and Deferred Compensation Plan (see Note 7 of “Notes to Consolidated Condensed Financial Statements – Unaudited” in Part I, Item 1, “Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q for additional discussion).  Life insurance and mutual fund assets with values tied to the equity markets are impacted by overall market conditions.  During the thirteen weeks ended December 31, 2016, net earnings and net comprehensive earnings experienced a decrease corresponding to the decline in the value of life insurance and mutual fund assets, respectively. The decline in the value of such assets is deemed by management to be temporary in nature.

RECENT DEVELOPMENTS AND UPDATES

Sale of Los Angeles Bakery Facility.  On December 31, 2016, we completed the sale of our Bakery operations.  The buyer will continue to offer our Members a private label offering for bread and an expanded product offering for our Southern California Members.  The buyer paid $3.0 million for our Bakery facility, related equipment, inventory, and customer list.  

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In addition, the buyer intends to retain substantially all union and non-union Bakery associates and assume the related union contract and union pension obligations. We recorded a $1.4 million loss on the sale of the Bakery operations.

 

New Supplier for Private Label Products.  In February 2016, we joined Topco Associates, LLC (“Topco”) as a member.  Topco is a privately held company that provides procurement, quality assurance, packaging and other services exclusively for its member-owners, which include supermarket retailers, food wholesalers and foodservice companies.  Commencing in the fourth quarter of fiscal 2016, we began transitioning to Topco as our primary supplier for our Springfield national brand equivalent corporate brand and our value-oriented Special Value corporate brand products.  In addition, Topco serves as our sole-source supplier for general merchandise and health and beauty care products under its TopCare label.

In June 2016, Western Family Foods Inc. (“Western Family”) reached an agreement with Topco authorizing Topco to procure, manage and market Western Family’s private label brands, including the Western Family and Natural Directions national brand equivalent corporate brands that are sold through us.  Western Family will continue to own its private label brands and we will continue our ownership in Western Family.  Western Family announced that the transition of procurement and marketing to Topco will take several months, with all orders and invoices continuing through Western Family until that time.  When the transition of the products is complete, Western Family’s headquarters in Oregon will close and Western Family will lay off the majority of its workforce.  In conjunction with its agreement with Topco, Western Family provided its investors an estimate of the anticipated costs for the closure of its headquarters, and we accordingly reduced our investment in Western Family by our proportionate share of such costs in the amount of $0.4 million in fiscal 2016.  In addition, Western Family provided its investors updated financial information as of November 30, 2016, and we further reduced our investment by our proportionate ownership share in the amount of $0.2 million as of December 31, 2016.

Discontinued Operations.  On October 7, 2015 (the “Closing Date”), we completed the sale of all of the outstanding shares of our wholly owned subsidiary, Unified Grocers Insurance Services (“UGIS”), to AmTrust Financial Services, Inc. (“AmTrust”) pursuant to the terms of a Stock Purchase Agreement (the “Stock Purchase Agreement”) by and between the Company and AmTrust dated as of April 16, 2015.  As of the Closing Date, UGIS owned all of the outstanding shares of the capital stock of Springfield Insurance Company (“SIC”) and Springfield Insurance Company Limited (Bermuda) (“SICL”).  Subsequent to the sale of UGIS to AmTrust, we refer to UGIS, SIC and SICL collectively as the “former Insurance segment.”  

At the Closing Date, we also entered into a Master Services Agreement with AmTrust for a term of five (5) years, pursuant to which, among other things, AmTrust agreed to pay us an annual payment following each of the first five years (ended December 31) of the term of the Master Services Agreement (each, an “Earn-Out Payment”) based on premiums written on or attributable to all insurance policies purchased through AmTrust during the applicable year by Unified and our Members or customers.  We recorded a receivable of $0.8 million due in Earn-Out Payments through December 31, 2016.

Under the terms of the Stock Purchase Agreement with AmTrust, if during the five-year period following the Closing Date of the sale of the Insurance segment, the insurance reserves in respect of any accident arising prior to the closing of the sale of UGIS and covered by an insurance policy written by an insurance subsidiary prior to January 1, 2015 increase as a result of adverse development, we must pay AmTrust for the amount of the insurance reserve increase on a dollar for dollar basis, up to a maximum of $1 million in the aggregate. In addition, to the extent the increase in insurance reserves as a result of adverse development exceeds $1 million, AmTrust is entitled to offset up to a maximum of an additional $2 million of that increase from future Earn-Out Payments due to us under the Stock Purchase Agreement.  We believe that these insurance reserves were adequate at the time of the sale of UGIS.  Our potential exposure under the Stock Purchase Agreement as a result of adverse development as of December 31, 2016 was $1.8 million. AmTrust performs its actuarial studies once a year as of December 31. The first reserve measurement that would be taken into account for purposes of determining the amount of any payment or offset pursuant to the Stock Purchase Agreement with respect to adverse development affecting these insurance reserves covered the period ended December 31, 2016.  In late January 2017, AmTrust provided us with its initial assessment of adverse development with respect to these insurance reserves. AmTrust’s assessment is that the amount of adverse development as of December 31, 2016 exceeds $1.8 million, the full amount of our exposure as of December 31, 2016 described above.  Once we have received adequate information as contemplated in the Stock Purchase Agreement, management will evaluate AmTrust’s assessment and determine whether there is any material impact on the insurance reserves and the Earn-Out Payment earned by us.  

See Note 2, “Discontinued Operations/Assets Held For Sale” in Part I, Item 1, “Financial Statements – Unaudited” for additional information.

Audit Committee Investigation.  In September 2014, the Audit Committee of the Company’s Board of Directors announced that it was conducting, with the assistance of independent legal counsel, an investigation of issues relating to the setting

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of case reserves and management of claims by our former insurance subsidiaries and related matters (the “Audit Committee Investigation”).  On or about November 2015, the Audit Committee Investigation concluded. We incurred approximately $2.8 million in expenses through the fiscal year ended October 1, 2016 and $0.2 million and $0.7 million, respectively, for the thirteen weeks ended December 31, 2016 and January 2, 2016 in connection with the Audit Committee Investigation.  Expenses incurred during the first quarter of fiscal 2017 are comprised primarily of legal and consulting fees.  We anticipate that these expenses will continue to diminish during fiscal 2017.  Approximately zero and $0.2 million, respectively, of these expenses were included in our loss on sale of our discontinued operations for the thirteen weeks ended December 31, 2016 and January 2, 2016.  For additional information on the Audit Committee Investigation, see Part I, Item 1, “Business –Audit Committee Investigation,” Note 2, “Audit Committee Investigation,” of “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” and Part II, Item 9A, “Controls and Procedures” of our Annual Report on Form 10-K for the year ended October 1, 2016.

Haggen.  In December 2014, we entered into an agreement (the “Supply Agreement”) with Haggen, a Member, to be its primary supplier in California, Arizona and Nevada (the “Pacific Southwest” stores) and a substantial supplier in Washington and Oregon.

In September 2015, Haggen filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Prior to Haggen’s bankruptcy filing, we terminated our product Supply Agreement with Haggen. In October 2015, we entered into a trade agreement (the "Trade Agreement") with Haggen under which we continued to supply product to Haggen as a critical vendor during Haggen's Chapter 11 case. Pursuant to the Trade Agreement, Haggen paid a substantial portion of our prepetition receivable in exchange for certain shipping terms from Unified. Haggen also agreed to stipulate to an allowed administrative expense priority claim under section 503(b)(9) of the Bankruptcy Code for the balance of our prepetition claim for goods shipped to Haggen.  We also filed a proof of claim against Haggen for breach of contract damages related to the termination of the Supply Agreement and various ancillary agreements. Such claim would be treated as a general unsecured claim in the Haggen chapter 11 cases. Haggen has moved the Bankruptcy Court for a final extension of the debtors’ exclusive period to file a chapter 11 plan through  March 8, 2017; and thus, Haggen has not yet filed a plan or determined the projected recoveries on general unsecured claims. Relatedly, on September 7, 2016, the Official Committee of Unsecured Creditors (the “Committee”) filed a complaint against Comvest Group Holdings, LLC, the private equity owner of Haggen, and certain of Haggen's non-debtor affiliates (the "Defendants") in the Bankruptcy Court. On December 9, 2016, the Defendants filed their answer to the Committee's complaint generally denying the allegations asserted therein.  The Committee and the Defendants have agreed to a scheduling order with a trial currently scheduled for October 2017.   The Committee Litigation seeks to recover additional funds for Haggen's bankruptcy estate for the benefit of unsecured creditors, including the potential payment of Unified’s general unsecured claim.

 

Effective November 21, 2015, we ceased supplying product to Haggen’s Pacific Southwest stores.  Sales to Haggen’s Pacific Southwest stores were approximately $9.6 million for the first quarter of fiscal 2016.  Pursuant to the Trade Agreement, we continued to supply Haggen’s Washington and Oregon stores with product during Haggen’s bankruptcy case through June 2016.  

 

RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated condensed financial statements and notes to the consolidated condensed financial statements, specifically Note 5 of “Notes to Consolidated Condensed Financial Statements – Unaudited,” “Segment Information,” included in Part I, Item 1, “Financial Statements (Unaudited)” of this report.  Certain statements in the following discussion are not historical in nature and should be considered to be forward-looking statements that are inherently uncertain.

Sales and Earnings Highlights – Fiscal 2017.  During the thirteen weeks ended December 31, 2016, net sales decreased in our Wholesale Distribution segment compared to the same period in fiscal 2016 primarily due to the loss of business from Haggen’s Pacific Southwest stores (effective November 21, 2015), lost customers and lower meat sales prices due to declines in the related commodity cost that were passed along to our customers, partially offset by the growth in sales to existing customers.

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The following table sets forth our selected consolidated financial data expressed as a percentage of net sales for the periods indicated and the percentage increase or decrease in such items over the prior year period.

 

 

We present sales and cost of sales related to certain transactions involving vendor direct arrangements on a net basis to conform to GAAP.  Transactions involving vendor direct arrangements are comprised principally of sales of produce in the Pacific Northwest and Northern California and sales of branded ice cream in Southern California.  These transactions are reported within our Wholesale Distribution segment.  “Gross billings,” an internal financial metric that adds back gross billings through vendor direct arrangements to net sales and is used by management to assess our operating performance, were $980.1 million for the thirteen weeks ending December 31, 2016 as compared to $999.2 million in the thirteen weeks ending January 2, 2016, a decrease of $19.1 million, or 1.9%.  By comparison, net sales (which do not include gross billings through vendor direct arrangements) decreased 1.2% for the same periods.

THIRTEEN WEEK PERIOD ENDED DECEMBER 31, 2016 (“2017 13-WEEK PERIOD”) COMPARED TO THE THIRTEEN WEEK PERIOD ENDED JANUARY 2, 2016 (“2016 13-WEEK PERIOD”)

Overview of the 2017 13-Week Period.  We experienced an overall net sales decrease of $11.7 million, or 1.2%, to $961.2 million for the 2017 13-Week Period as compared to $972.9 million for the 2016 13-Week Period. Our net sales for the Wholesale Distribution segment decreased to $960.9 million, or 1.2%, for the comparable 2017 and 2016 13-Week Periods.  Net sales decreased primarily due to the loss of business from Haggen’s Pacific Southwest stores (effective November 21, 2015), lost customers and lower meat sales prices due to declines in the related commodity cost that were passed along to our customers, partially offset by the growth in sales to existing customers.  Net sales in our All Other business activities were relatively consistent at $0.3 million for the comparable 2017 and 2016 13-Week Periods.

Our consolidated operating income increased $1.4 million to earnings of $4.6 million in the 2017 13-Week Period compared to earnings of $3.2 million in the 2016 13-Week Period.

The overall activity in operating income is summarized in our operating segments and other business activities as follows:

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The following tables summarize the performance of each business segment for the 2017 and 2016 13-Week Periods.

 

 

 

Net sales.  Consolidated net sales decreased $11.7 million, or 1.2%, to $961.2 million in the 2017 13-Week Period compared to $972.9 million for the 2016 13-Week Period.  Factors impacting net sales are as follows:

 

 

Sales decreased primarily due to the loss of business from Haggen’s Pacific Southwest stores (effective November 21, 2015) and lost customers. We were also impacted by lower meat sales prices due to declines in the related commodity cost that were passed along to our customers.  These decreases were partially offset through the growth in sales to continuing customers.

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Cost of sales.  Consolidated cost of sales were $890.0 million for the 2017 13-Week Period and $899.5 million for the 2016 13-Week Period and comprised 92.6% and 92.5% of consolidated net sales for the 2017 and 2016 13-Week Periods, respectively.  Factors impacting cost of sales were as follows:

Distribution, selling and administrative expenses.  Consolidated distribution, selling and administrative expenses were $66.5 million in the 2017 13-Week Period compared to $70.2 million in the 2016 13-Week Period, reflecting a decrease of $3.7 million, and comprised 6.9% and 7.2% of consolidated net sales for the 2017 and 2016 13-Week Periods, respectively.  Factors impacting distribution, selling and administrative expenses are as follows:

 

 

Interest.  Interest expense increased $0.3 million to $2.8 million in the 2017 13-Week Period compared to $2.5 million for the 2016 13-Week Period and comprised 0.3% of consolidated net sales for each of the 2017 and 2016 13-Week Periods.  Factors impacting interest expense are as follows:

■Interest expense on our primary debt instruments (as described below) increased $0.3 million to $2.7 million in the 2017 13-Week Period compared to $2.4 million in the 2016 13-Week Period.

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Borrowings under Unified’s credit agreement are subject to market rate fluctuations.  A 25 basis point change in the market rate of interest over the period would have resulted in a $0.2 million increase or decrease in corresponding interest expense.

Estimated patronage dividends.  Estimated patronage dividends for the 2017 13-Week Period were zero, compared to estimated patronage dividends of $2.4 million in the 2016 13-Week Period. This decrease is due to the change in our dairy program that occurred when we discontinued our Southern California dairy manufacturing operations in July 2016 and outsourced our supply of fluid milk and other products, including our private label brands, to Dean Foods Company.  At that time, we discontinued our dairy patronage dividend program to our Members and reduced the pricing on our dairy products accordingly.  We have no expectation of paying dairy patronage dividends in the future.  In fiscal 2017, earnings from Patronage Business conducted with our Members through the Cooperative Division (including Market Centre) are eligible for distribution to our Members in the form of patronage dividends based upon our earnings from such Patronage Business during a fiscal year. Estimated patronage dividends for the 2016 13-Week Period consisted of the patronage activities from our three patronage earnings divisions: the Southern California Dairy Division, the Pacific Northwest Dairy Division and the Cooperative Division (including Market Centre).  The Cooperative Division experienced a $0.5 million loss in the 2017 13-Week Period compared to a loss of $3.0 million in the 2016 13-Week Period.   The improvement in the 2017 13-Week Period was due to improved margins and decreased distribution, selling and administrative costs.  Patronage dividends produced by the Cooperative Division are distributed annually, historically in cash, Class B and Class E Shares (see Part I, Item 1. “Business – Patronage Dividends” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information), while patronage dividends produced by the dairy divisions were paid quarterly (prior to July 2016), historically in cash.  As of July 2016, as discussed in “Company Overview – General,” we no longer pay patronage dividends on sales of dairy products from the Southern California Dairy Division and the Pacific Northwest Dairy Division.

Income taxes. Our effective income tax rate was 0% for the 2017 13-Week Period compared to (0.8)% for the 2016 13-Week Period.  The zero effective tax rate for the 2017 13-Week Period was attributable to the utilization of our net operating loss carryforward which had been offset by a valuation allowance in prior periods.  The negative effective rate for the 2016 13-Week Period was due to a valuation allowance provided to offset the income tax benefit associated with the 2016 13-Week Period pre-tax loss.

LIQUIDITY AND CAPITAL RESOURCES

We finance our capital needs through a combination of internal and external sources. These sources include cash flows from operations, Member capital and other Member investments, bank borrowings, various types of long-term debt and lease financing.

The acquisition, holding and redemption of our capital shares and making of deposits by our Members, and our policies with respect to such matters, can significantly affect our liquidity and capital resources.  Our Bylaws, which may be changed by the Board at its discretion, currently require each Member to own 350 Class A Shares.  In addition, we currently require each Member to own such amount of Class B Shares as may be established by the Board.  This requirement to own Class B Shares is referred to as the “Class B Share Requirement.”  Members who do not satisfy the Class B Share Requirement solely from their holdings of Class B Shares are generally required to make a subordinated deposit (a “Required Deposit”) with us.  Member and Non-Member customers may be required to provide us a Credit Deposit in order to purchase products on credit terms established by us.  “Credit Deposit” means any non-subordinated deposit that is required to be maintained by a Member or Non-Member customer in accordance with levels established by our credit office from time to time in excess of the amount of the Required Deposit set by the Board.  We do not pay interest on Required Deposits or Credit Deposits; however, interest is paid at the prime rate for deposits in excess of a Member’s Required Deposit (an “Excess Deposit”).  See Part I, Item 1. “Business – Capital Shares,” Part I, Item 1. “Business – Customer Deposits” and Part I, Item 1. “Business – Pledge of Shares and Guarantees” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

At December 31, 2016, we had $1.4 million of tendered Class A Shares, $29.3 million of tendered Class B Shares and $1.9 million of eligible Class E Shares pending redemption or repurchase, whose redemption or repurchase is subject to final approval by the Board, and in the case of Class B Shares, subject to the 5% limitation on redemptions contained in our redemption policy (see Part I, Item 1. “Business – Capital Shares – Redemption of Class A and Class B Shares and Repurchase of Class E Shares” of our Annual Report on Form 10-K for the year ended October 1, 2016 for further information).

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Our obligations to repay a Member’s Required Deposit on termination of Member status (once the Member’s obligations to us have been satisfied) is reported as a long-term liability within “Members’ and Non-Members’ deposits” on our consolidated condensed balance sheets.  Excess Deposits are not subordinated to our other obligations and are reported as short-term liabilities within “Members’ deposits and estimated patronage dividends” on our consolidated condensed balance sheets.  At December 31, 2016 and October 1, 2016, we had $9.3 million and $8.8 million, respectively, in “Members’ and Non-Members’ deposits” and $9.1 million and $8.9 million, respectively, in “Members’ deposits and estimated patronage dividends” (of which $9.1 million and $8.9 million, respectively, represented Excess Deposits).

 

As discussed in “Recent Developments and Updates,” on December 31, 2016, we completed the sale of our Bakery operations.  We accrued proceeds of $3.0 million for the sale of our Bakery facility, related equipment, inventory, and customer list.  We recorded a $1.4 million loss on the sale of the Bakery operations.

 

We believe that the combination of cash flows from operations, current cash balances and available lines of credit will be sufficient to service our debt, redeem or repurchase Members’ capital shares, make income tax payments and meet our anticipated needs for working capital and capital expenditures through at least the next fiscal year.

CASH FLOW

We had positive cash flow from financing activities during the 2017 13-Week Period.  Cash flows from financing activities were used to partially offset cash utilized for operating and investing activities.  

As a result of these activities, net cash, consisting of cash and cash equivalents, was $1.6 million as of December 31, 2016 compared to $3.4 million as of October 1, 2016.

Our discontinued operations provided cash of zero in the 2017 13-Week Period compared to cash provided of $0.3 million in the 2016 13-Week Period.  In the 2016 13-Week Period, discontinued operations provided cash resulting from the final sales price adjustment related to the sale of our former insurance subsidiaries.

The following table summarizes the impact of operating, investing and financing activities on our cash flows from continuing operations for the 2017 and 2016 13-Week Periods:

 

 

Net cash flows from continuing operating, investing and financing activities decreased by $1.6 million, resulting in a $1.8 million decrease in cash for the 2017 13-Week Period compared to a decrease of $0.2 million in cash for the 2016 13-Week Period. The decrease in net cash flow for the 2017 13-Week Period consisted of cash utilized by operating activities of $22.8 million and investing activities of $1.2 million, partially offset by cash provided by financing activities of $22.2 million.  The primary factors contributing to the changes in cash flow are discussed below.  At December 31, 2016 and October 1, 2016, working capital was $161.8 million and $130.4 million, respectively, and the current ratio was 1.5 and 1.4 at December 31, 2016 and October 1, 2016, respectively.

Operating Activities:    Net cash utilized by continuing operating activities increased by $3.3 million to $22.8 million utilized in the 2017 13-Week Period compared to $19.5 million utilized in the 2016 13-Week Period.  The increase in cash utilized by continuing operating activities compared to the 2016 13-Week Period was attributable to (1) an increase in net cash utilized related to inventories of $29.1 million (we had decreased inventory in the prior 2016 13-Week Period due primarily to the loss of the Haggen Pacific Southwest business), (2) a decrease in other long-term liabilities of $0.7 million and (3) a decrease in prepaid expenses and other current assets of $1.7 million.  The foregoing increase of $31.5 million in cash utilized was partially offset by (1) reduced cash used to pay accounts payable and accrued liabilities of $23.9 million and (2) an increase between the periods in net cash provided by other operating activities of $4.3 million.

Investing Activities:    Net cash provided by investing activities decreased by $21.1 million to $1.2 million utilized in the 2017 13-Week Period compared to cash provided of $19.9 million in the 2016 13-Week Period.  The decrease in cash provided by investing activities during the 2017 13-Week Period as compared to the 2016 13-Week Period was due mainly to (1) proceeds of $26.2 million received from the sale of our discontinued insurance operations during the 2016 13-Week Period and (2) a decrease in cash provided by net notes receivable activities of $0.2 million, reflecting normal fluctuation in loan activity to Members for their inventory and equipment financing. The foregoing decreases of $26.4 million in cash provided were partially offset by (1) a decrease in cash used for other assets of $5.0 million and (2) a

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reduction in our cash used for capital expenditures of $0.3 million.  Spending on future investing activities is expected to be funded by existing cash balances, cash generated from operations or additional borrowings.

Financing Activities:    Net cash provided by financing activities was $22.2 million for the 2017 13-Week Period compared to cash utilized of $0.7 million in the 2016 13-Week Period.  The net increase of $22.9 million in cash provided by financing activities for the 2017 13-Week Period as compared to the 2016 13-Week Period was due to an increase in cash provided of $25.1 million related to higher revolver borrowings partially offset by notes payable repayments related to the “first-in last-out” tranche in our credit agreement.  This increase in cash provided was partially offset by an increase of $2.2 million in cash utilized for the repurchase of Members’ shares.  Financing to meet future capital spending requirements is expected to be provided by our continuing operating cash flow or additional borrowings.

OFF-BALANCE SHEET ARRANGEMENTS

As of the date of this report, we do not participate in transactions that result in relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually, narrow or limited purposes.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS

Other than items discussed below in “Outstanding Debt and Other Financing Arrangements,” there have been no material changes in our contractual obligations and commercial commitments outside the ordinary course of our business during the thirteen week period ended December 31, 2016.  See “Contractual Obligations and Commercial Commitments” discussed in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

OUTSTANDING DEBT AND OTHER FINANCING ARRANGEMENTS

Other than discussed below, there have been no material changes in our outstanding debt and other financing arrangements outside the ordinary course of our business during the thirteen week period ended December 31, 2016.  Amounts outstanding related to our secured credit agreements and other debt agreements are disclosed below.  See “Credit Facilities” and “Outstanding Debt and Other Financing Arrangements” discussed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 7 “Notes Payable” of “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

Secured Credit Agreements

Credit Agreement – Consent and Waiver

We are party to an Amended and Restated Credit Agreement dated as of June 28, 2013, as amended in fiscal 2014, fiscal 2015 and fiscal 2016 (as so amended, the “Credit Agreement”), among the Company, the lenders party thereto, and Wells Fargo Bank, National Association (“N.A.”), as administrative agent (“Administrative Agent”).  See “Credit Facilities – Secured Credit Agreement” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the year ended October 1, 2016 for further information regarding the Credit Agreement.

Our outstanding revolver borrowings under the Credit Agreement increased to $166.4 million at December 31, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 2.73% per annum) from $137.6 million at October 1, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 3.05% per annum), with access to approximately $129.7 million of additional capital available under the Credit Agreement to fund our continuing operations and capital spending requirements for the foreseeable future.  Our outstanding FILO borrowings under the Credit Agreement were $13.1 million at December 31, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 4.01% per annum) and $15.5 million at October 1, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 4.29% per annum).  Our outstanding term loan borrowings under the Credit Agreement were $80.0 million at December 31, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 2.76% per annum) and $82.5 million at October 1, 2016 (Eurodollar and Base Rate Loans at a blended average rate of 2.52% per annum).  As of December 31, 2016, we are in compliance with all applicable covenants of the Credit Agreement.  While we are currently in compliance with all required covenants and expect to remain in compliance, this does not guarantee that we will remain in compliance in future periods.

Subsidiary Financing Arrangement

Our wholly-owned finance subsidiary, Grocers Capital Company (“GCC”), is party to an Amended and Restated Loan and Security Agreement, dated as of September 26, 2014 as amended by Amendment Number One dated as of June 26, 2015 and further amended by Amendment Number Two dated as of September 23, 2016 (as so amended, the “GCC

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Loan Agreement”), by and among GCC, the lenders party thereto, and ZB, N.A., dba California Bank & Trust (“CBT”), as Arranger and Administrative Agent.  On December 22, 2016, GCC entered into Amendment Number Three (the “GCC Loan Amendment”) to the GCC Loan Agreement, by and among GCC, the lenders party thereto, and CBT, as Arranger and Administrative Agent.  The GCC Loan Amendment extends the maturity date of the GCC Loan Agreement, which was previously December 31, 2016, to March 31, 2018, with a total commitment in the principal amount of $15 million.  See Item 1.01. “Entry into a Material Definitive Agreement” and Item 2.03. “Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant” of our Current Report on Form 8-K, filed on December 23, 2016, for additional information.  Additionally, see “Credit Facilities – Subsidiary Financing Arrangement” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended October 1, 2016 for further information regarding the GCC Loan Agreement.

GCC had revolving loan borrowings outstanding of $15.0 million at both December 31, 2016 and October 1, 2016.  As of December 31, 2016, we are not in violation of any applicable covenants of the GCC Loan Agreement.  While we are currently in compliance with all required covenants and expect to remain in compliance, this does not guarantee that we will remain in compliance in future periods.

Other Debt Agreements

During fiscal 2013, we entered into three secured credit facilities to finance our purchase of tractors.  These agreements bear interest at a rate of 2.2% and mature in fiscal 2018.  At December 31, 2016 and October 1, 2016, respectively, the outstanding loan balance under the three agreements totaled $0.6 million and $0.8 million, respectively.

Capital Lease Agreements

During fiscal 2015, we entered into three capital lease agreements for equipment purchases.  Two of the capital lease agreements bear an interest rate of 2.09% and one capital lease agreement bears an interest rate of 2.26%.  The three capital lease agreements mature in fiscal 2020.  At December 31, 2016 and October 1, 2016, respectively, the outstanding loan balance under the three capital leases totaled $1.6 million and $1.7 million.

During fiscal 2016, we entered into two capital lease agreements for equipment purchases.  These capital lease agreements bear an interest rate of 2.10% and mature in fiscal 2021.  At December 31, 2016 and October 1, 2016, respectively, the outstanding loan balance under the two capital lease agreements totaled $1.1 million and $1.2 million.

REDEMPTION OF CAPITAL STOCK

Our Articles of Incorporation and Bylaws provide that the Board has the absolute discretion to repurchase, or not repurchase, any Class A, Class B or Class E Shares of any outgoing Member regardless of when the membership terminated, and any Class B Shares in excess of the Class B Share Requirement held by a current Member, whether or not the shares have been tendered for repurchase and regardless of when the shares were tendered.  Historically, the Board considers the redemption of eligible Class A Shares at each board meeting.  All other shares eligible for redemption or repurchase are considered by the Board on an annual basis, usually in December.  Class E Shares will only be repurchased upon approval of the Board, and the repurchase price for the Class E Shares is fixed at $100 per share.  The Class E Shares become eligible for repurchase at the discretion of the Board at a price of $100 per share ten years after their issuance date, with the outstanding Class E Shares becoming eligible for repurchase between the end of fiscal 2013 and the end of fiscal 2018.  During the thirteen week period ended December 31, 2016, we repurchased 1,050 Class A Shares and 7,170 Class B Shares for approximately $0.2 million and $1.7 million, respectively.  The foregoing share repurchases were made in conjunction with Member settlements, and the proceeds were applied against amounts previously owed to us by Members that were in default on their obligations.  In addition, we repurchased 1,977 Class E Shares (1,493 related to Member settlements and 484 in accordance with the Board’s continuing repurchase authorization, which were eligible for repurchase in fiscal 2015 and 2016) for approximately $0.2 million during the thirteen week period ended December 31, 2016.

See Part I, Item 1. “Business – Capital Shares – Classes of Shares” and Part I, Item 1. “Business – Capital Shares – Redemption of Class A and Class B Shares and Repurchase of Class E Shares” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

PENSION AND POSTRETIREMENT BENEFIT PLANS

We sponsor a cash balance plan (“Unified Cash Balance Plan”).  The Unified Cash Balance Plan is a noncontributory defined benefit pension plan covering substantially all of our employees who are not subject to a collective bargaining agreement.  Under the Unified Cash Balance Plan, participants are credited with an annual accrual based on their years of service with us.  Participants’ balances receive an annual interest credit, currently tied to the 30-year Treasury rate that is in effect the previous November, but in no event shall the rate be less than 5%.  Our funding policy is to make contributions to the Unified Cash Balance Plan in amounts that are at least sufficient to meet the minimum funding

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requirements of applicable laws and regulations, but no more than amounts deductible for federal income tax purposes.  Through December 31, 2014, all of our qualifying employees not subject to a collective bargaining agreement accrued benefits pursuant to the Unified Cash Balance Plan.  Prior to the end of fiscal 2014, we amended the Unified Cash Balance Plan to close the plan to new entrants effective December 31, 2014.  In addition, the plan was frozen effective December 31, 2014 such that current participants will no longer be credited with any future benefit accruals based on their years of service and pensionable compensation after that date.  The annual interest credit as described above will continue for participants active in the plan as of December 31, 2014.  Selected groups of vested terminated participants were each given one-time opportunities to elect a lump sum distribution of their benefits from the plan’s assets or immediate receipt of an annuity in December 2016 and December 2015.  As a result, benefit payments of $6.3 million and $8.7 million, respectively, were distributed from the plan’s assets to those participants who elected such option prior to the end of our first quarters ended December 31, 2016 and January 2, 2016.

We also sponsor an Executive Salary Protection Plan (“ESPPIII”) for our executive officers that provides supplemental post-termination retirement income based on each participant’s salary and years of service as an officer with us.  This plan was amended in December 2012 to close the plan to new entrants as of September 30, 2012.  We have internally funded our obligation to plan participants in a rabbi trust (not considered plan assets for actuarial valuation purposes), consisting primarily of life insurance policies tied to underlying investments in the equity market (reported at cash surrender value) and mutual fund assets consisting of various publicly-traded mutual funds (reported at estimated fair value based on quoted market prices).

We sponsor a supplemental retirement plan for a select group of management or highly compensated employees that are at the Vice President level and above of the Company under the Unified Grocers, Inc. Supplemental Executive Retirement Plan (the “SERP”).  This plan was established to replace the ESPPIII, which has been frozen.  The SERP is a non-qualified defined contribution type plan that provides participating officers with supplemental retirement income in addition to the benefits provided under the Unified Cash Balance Plan and 401(k) plan.

We sponsor other postretirement benefit plans that provide certain medical coverage to retired non-union employees and officers and provide unused sick leave benefits for certain eligible union employees.  Those plans are not funded.

Our net periodic benefit plan credit for our combined pension and other postretirement benefits was approximately $0.3 million and $0.6 million for the thirteen weeks ended December 31, 2016 and January 2, 2016, respectively.

During August 2014, legislation to extend pension funding relief was enacted as part of the Highway and Transportation Funding Act of 2014 (“HATFA”).  As a result, we expect to make no estimated minimum contributions to the Unified Cash Balance Plan during fiscal 2017 for the 2016 plan year, and there will be no quarterly contributions required for the 2017 plan year.  At our discretion, we may contribute in excess of the minimum (zero) requirement.  Additional contributions, if any, will be based, in part, on future actuarial funding calculations and the performance of plan investments.

Additionally, we anticipated making benefit payments of $3.9 million to participants in the ESPPIII for the 2017 plan year.  We made benefit payments of $0.3 million to participants in the ESPPIII during the thirteen weeks ended December 31, 2016 for the 2017 plan year.

Benefit expense for the SERP is accrued under the assumption that all participants in the SERP will achieve full vesting (five years of service).  Our benefit expense was $0.4 million for each of the thirteen weeks ended December 31, 2016 and January 2, 2016.  See Note 7 of “Notes to Consolidated Condensed Financial Statements – Unaudited” in Part I, Item 1, “Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q and Item 5.02. “Compensatory Arrangements of Certain Officers” of our Current Report on Form 8-K, filed on May 14, 2013, for additional discussion.

On December 28, 2015, the Compensation Committee and the Board, as applicable, approved amendments to our Long-Term Incentive Plan (“LTIP”), originally implemented in June 2013 to align, motivate and reward executives for their contributions to our long-term financial success and growth.  Effective for fiscal 2016, the LTIP was amended to expand the awards that may be granted thereunder to include Full-Value Units. Full-Value Units entitle the award recipient the “maturity value” on the units at the end of the four-fiscal year performance period (the “Performance Cycle”) assigned to the units. The “maturity value” for a Full-Value Unit is our Exchange Value per Share for a share of the Class A or Class B stock of the Company (see Part II, Item 6, “Selected Financial Data” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information on the calculation of the Exchange Value Per Share), plus cumulative cooperative division patronage dividends, cash dividends and non-allocated retained earnings attributable to such share Exchange Value per Share, as calculated from our financial statements for the fiscal year end that coincides with the end of the performance period assigned to the Full-Value Units. The Full-Value Units will vest in equal monthly installments over the Performance Cycle, and the settlement of vested Full-Value Units will be paid in a lump sum cash payment as soon as administratively practicable following the end of the Performance Cycle, but in no event later than December 31 that immediately follows the end of the Performance Cycle.

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On January 18, 2017, the Compensation and Talent Management Committee approved an amendment to the LTIP to remove changes in non-allocated earnings from the calculation of earnings attributable to Appreciation Units and Full-Value Units (collectively “Units”) awarded for the 2017 Performance Cycle and future Performance Cycles.  In addition, the LTIP was amended to eliminate full vesting of Units upon a change in control event for the Units awarded for the 2017 Performance Cycle and future Performance Cycles.  Pursuant to the amendment, participants will only be eligible for the amount of the award that has vested to the point of the change in control.  

For fiscal 2017, an officer’s LTIP award is comprised of Full-Value Units, equaling 25% of the targeted compensation gap, and Appreciation Units, equaling 75% of the targeted compensation gap.  Appreciation Units entitle the award recipient to the positive difference of the “maturity value” on the units at the end of the four-fiscal year performance period assigned to the units, minus the “base value” assigned to the units at the time of grant. The maturity value for an Appreciation Unit is determined in the same manner as a Full-Value Unit as described above.  For the 2017 LTIP awards, a total of 6,170 Full-Value Units were granted and a total of 147,448 Appreciation Units were granted with a base value per unit of $200.27.  We anticipate these grants to have a cash value between $4.4 million and $7.9 million, utilizing compound annual growth rates from 2.5% to 5.0%.  

During fiscal year 2010, comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590) and the Health Care Education and Affordability Reconciliation Act (HR 4872) (collectively, the “Acts”) was passed and signed into law.  The Acts contain provisions that could impact our retiree medical benefits in future periods, including the related accounting for such benefits, such as the 40% excise tax beginning in 2020 that will be imposed on the value of health insurance benefits exceeding a certain threshold.  However, the full extent of the impact of the Acts, if any, cannot be determined until all regulations are promulgated under the Acts (or changed as a result of ongoing litigation) and additional interpretations of the Acts become available.  We will continue to assess the accounting implications of the Acts as related regulations and interpretations of the Acts become available.  In addition, we may consider plan amendments in future periods that may have accounting implications.

RISK FACTORS

The risks and uncertainties described below are those that we believe are the material risks related to our business. If any of the following risks occur, our business, prospects, financial condition, operating results and cash flows could be adversely affected in amounts that could be material.

Risks Related to the Company’s Internal Control Over Financial Reporting and Related Matters

We may not be able to provide assurance that remediation efforts will prevent future material weaknesses.    Our management is responsible for establishing and maintaining adequate internal control over financial reporting, and the Sarbanes-Oxley Act of 2002 and SEC rules require that our management report annually on the effectiveness of the Company’s internal control over financial reporting and our disclosure controls and procedures. Among other things, our management must conduct an assessment of the Company’s internal control over financial reporting to allow management to report on the effectiveness of the Company’s internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. As disclosed in Part II, Item 9A, “Controls and Procedures” of our Annual Report on Form 10-K for the year ended October 1, 2016, our management had previously determined that we had a material weakness in the Company’s internal control over financial reporting as of October 1, 2016 related to controls over ensuring accurate and complete financial statement disclosures.

A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. We have implemented a remediation plan that has rectified such material weakness as of December 31, 2016. However, additional material weaknesses in the Company’s internal control over financial reporting may be identified in the future. Any failure to implement or maintain required new or improved controls, or any difficulties we encounter in their implementation, could result in additional material weaknesses, or could result in material misstatements in our consolidated financial statements. The possibility of such future additional misstatements could cause us to delay filing our consolidated financial statements on a timely basis and result in noncompliance with covenants in our credit facilities, which could limit or suspend our access to working capital, which in turn could cause us to curtail or cease doing business altogether. Any such future misstatements in our publicly filed financial statements may impose upon us a requirement to restate such financial results. In addition, if we are unable to successfully remediate future material weaknesses in our internal controls or if we are unable to produce accurate and timely financial statements, our Members may lose confidence in our ability to effectively protect their investments in us, which in turn could lead Members to seek to withdraw such investments and to seek other sources to fulfill their supply needs. There is also the possibility that one or more Members or a regulatory agency could commence civil litigation against us as a result

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of any such future misstatement. Any such future misstatement or occurrence could result in increased audit, legal and any investigation-related fees, which could severely adversely affect our operations and financial results.

Future determinations that there are material weaknesses in the effectiveness of the Company’s internal control over financial reporting could also adversely affect our ability to attract new Members and their associated investments, as well as severely adversely affect our ability to retain existing financing or obtain, if at all, future financing on reasonable or acceptable terms. The failure to obtain acceptable or any financing could cause our existing Members to request the redemption of their shares which, depending upon the magnitude and extent of any such redemption, could have a material adverse effect on our business.

For more information relating to the Company’s internal control over financial reporting (and disclosure controls and procedures) and the remediation plan implemented by us, see Part II, Item 9A, “Controls and Procedures” of our Annual Report on Form 10-K for the year ended October 1, 2016 and Part I, Item 4, “Controls and Procedures” of this Quarterly Report on Form 10-Q.

The markets in which we operate are highly competitive, characterized by high volume, low profit margins and industry consolidation, and many of our competitors have greater financial resources than us which could place us at a competitive disadvantage and adversely affect our financial performance.     The grocery distribution business is generally characterized by a relatively high volume of sales with relatively low profit margins.  Price competition among food wholesalers is intense.  In addition, we compete with such food wholesalers with regard to quality, variety and availability of products offered, strength of corporate brand labels offered, schedule and reliability of deliveries and the range and quality of services provided.

Some of our competitors, including C&S Wholesale Grocers, Inc., Supervalu, Inc. and United Natural Foods, Inc. (UNFI), are significantly larger and have greater financial resources than us.  In addition, industry consolidation has in the past increased, and may continue in the future to increase, the number of large competitors that we face.  These large national distributors have the resources to compete aggressively on price and may be able to offer customers a wider range of products and services and a wider area of distribution than we do.  We also face intense competition from regional or specialized distributors and, from time to time, new entrants in various niche markets, with such competitors often able to compete very aggressively in such niches with unique or highly tailored products and services.

To compete effectively, we must keep our costs down to maintain margins while simultaneously increasing sales by offering the right products and services at competitive prices, with the expected quality, variety and availability, to appeal to consumers.  If we are unable to compete effectively in our highly competitive industry, we may suffer reduced net sales and/or reduced margins and operating income, or suffer further losses, and our business, financial condition, results of operations and cash flows could suffer.

We may experience reduced sales and earnings if Members or other customers lose market share to larger, often fully integrated traditional full-service grocery store chains or to warehouse club stores, supercenters and discount stores, many of which have greater financial resources than our Members or other customers.     Our Members continue to face intense competition from large, often fully integrated traditional full-service grocery store chains.  Most of these store chains have greater resources than our Members or our other customers and benefit from local or national brand name recognition and efficiencies of scale from a fully integrated distribution network, standardization across stores, concentrated buying power and shared overhead costs.  In addition, traditional format full-service grocery stores, which include most of our customers, have in recent years faced intense competition from, and lost market share to, non-traditional format stores, including warehouse club stores, supercenters, discount stores and specialty or niche stores focused on upscale and natural and organic products.  Many of these non-traditional format stores are very large, with considerable resources, national brand names and economies of scale.  This competition from non-traditional format stores has been particularly intense, and significant market share has been lost, with respect to categories of non-perishable products that we sell.  Traditional format grocery stores, including our customers, have tended to move to expand their offerings and sales of perishable products, which generally have lower margins for us than non-perishable products.  A continued decline in our sales of non-perishable products may adversely affect our profitability.

The market share of non-traditional format stores may grow in the future, potentially resulting in continued losses of sales volume and reduced earnings for our Members or our other customers and, in turn, for us.  Continued losses of market share by our Members, whether to other traditional full-service grocery store chains or to non-traditional format stores, could reduce our net sales, margins and operating income, or cause us to incur further losses.  As a result, our business, financial condition, results of operations and cash flows could suffer.

We have an increasingly concentrated customer base, which has in the past reduced, and may continue in the future to reduce, our margins and expose us to an increase in risk concentration, including in the areas of credit risk and the sudden loss of significant customer business.     Our operating results are highly dependent upon

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maintaining or growing our sales to our customers.  Our largest customer, Cash & Carry Stores, LLC, a wholly-owned subsidiary of Smart & Final, Inc., a Non-Member customer, constituted approximately 16% of our total net sales for the thirteen week period ended December 31, 2016.  In recent years, we have seen our sales become increasingly concentrated with our large customers, with our top ten customers having increased from 42% of our total net sales in fiscal 2008 to 50% of our total net sales in fiscal 2016.  Our top ten customers constituted approximately 52% of our total net sales for the thirteen week period ended December 31, 2016.  A significant loss in membership or volume by one of our larger customers could have a sudden and material adverse effect on our operating results.  For example, in the third quarter of fiscal 2011, we lost one of our top ten customers who represented $144.9 million in net sales for the fifty-two weeks immediately preceding the date they ceased purchasing from us.  Between fiscal 2011 and fiscal 2012, this resulted in a loss of $87.2 million in annual net sales, or 2% of total net sales in fiscal 2012.  We have also experienced an overall decline in the number of Members every year since the end of fiscal 2008.  Since then, the number of Members has declined from 520 to 345 at the end of fiscal 2016, an average decline of 5.0% per year in our membership base.  We believe this decline has been due to a number of factors, including smaller-volume retailers deciding to conduct business with us as Non-Members, Members discontinuing operations due to competition they face or challenging economic conditions, Members consolidating with other Members and Members choosing other wholesale distributors.  This decline is also currently due to our not admitting new Members as a result of our having suspended issuance of Class A and Class B Shares because we had not been current in our periodic SEC filings.

 

Any such loss of a large customer, the loss of a number of smaller customers, the continued erosion of our membership base, or the inability to attract new customers, could have a material and adverse effect on our net sales.  In addition, to the extent we have suffered, and may in the future suffer, a decline in net sales, our margins and profitability have been and will be further negatively impacted to the extent we are unable to correspondingly reduce our fixed costs, such as warehouses, equipment and headcount.  As it is difficult to quickly make significant reductions in fixed costs, if we were to suffer a significant and rapid decline in our net sales, such as from the loss of one or more significant customers, our margins and operating profitability may be adversely impacted, we may incur losses and our business, financial condition, results of operations and cash flows could suffer.

We will continue to be subject to the risks associated with consolidation within the grocery industry. When independent retailers are acquired by large chains with self-distribution capacity, are driven from business by larger grocery chains, or become large enough to purchase directly from manufacturers or develop their own self-distribution capabilities, we will lose distribution volume. Members may also select other wholesale providers. Reduced volume is normally injurious to profitable operations since fixed costs must be spread over a lower sales volume if the volume cannot be replaced.  In addition, as a higher percentage of our sales go to larger customers, our margins tend to be adversely affected as these larger customers typically receive discounts based upon the higher volume of their purchases, which may adversely impact our operating profitability.

We are also exposed to concentrations of credit risk related primarily to trade receivables, notes receivable and lease guarantees for certain Members.  Additionally, we are exposed to risk to master landlords if subtenants default under their subleases with us.  Our ten customers with the largest accounts receivable balances accounted for approximately 43% and 41% of total accounts receivable at December 31, 2016 and at October 1, 2016, respectively.  These concentrations of credit risk may be affected by changes in economic or other conditions affecting the western United States, particularly Arizona, California, Nevada, Oregon and Washington.  We could suffer losses as a result of our concentrated credit risk in the event of a significant adverse change in economic or other conditions.

We may experience reduced sales if Members or other customers purchase directly from manufacturers or decide to self-distribute.    Increased industry competitive pressure is causing some of our Members and other customers that can qualify to purchase directly from manufacturers to increase their level of direct purchases from manufacturers and expand their self-distribution activities.  Our operating results could be adversely affected if a significant reduction in distribution volume occurred in the future as a result of such a shift to direct purchases and self-distribution by our customers.

The requirement that Members invest in our shares and/or make Required Deposits, and the lack of liquidity with respect to such investments and Required Deposits, may make attracting new Members difficult and may cause existing Members to withdraw from membership.    Members are required to meet specific requirements, which include ownership of our capital shares and may include required cash deposits. These investments by Members are a principal source of our capital, and for the thirteen weeks ended December 31, 2016, approximately 68% of our net sales were to Members.  We compete with other wholesale suppliers who are not structured as cooperatives and therefore have no investment requirements for customers.  Our requirements to purchase shares or maintain cash deposits may become an obstacle to retaining existing business and attracting new business. For a discussion of required Member equity investments and deposits, see Part I, Item 1, “Business – Capital Shares” and Part I, Item 1, “Business – Customer Deposits” of our Annual Report on Form 10-K for the year ended October 1, 2016.

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Our Bylaws give the Board complete discretion with respect to the redemption of shares held by terminated Members and excess shares held by Members.  Our redemption policy currently provides that the number of Class B Shares that we may redeem in any fiscal year is limited to no more than 5% of the outstanding Class B Shares (after patronage dividends payable in Class B Shares).  During the thirteen weeks ended December 31, 2016, as part of settlements with Members that were in default on their obligations to us, we redeemed 3,889 Class B Shares that had been tendered at the close of fiscal 2016, leaving 97,935 Class B Shares, or 24% of our outstanding Class B Shares at the close of fiscal 2016 with an aggregate redemption value of $28.8 million, which have been tendered for redemption but not yet redeemed.  This percentage has steadily increased in recent years, from 23%, 21% and 17% of our outstanding Class B Shares at the close of fiscal 2015, 2014 and 2013, respectively, as we have (1) suspended redemptions of Class A Shares and Class B Shares because we had not been current in our periodic SEC filings, (2) had an increase in the number of shares our Members have sought to redeem and (3) redeemed less than the 5% limit in fiscal 2016, 2015, 2014 and 2013.  The increase in the number of shares our Members have sought to redeem has been driven by our having an overall decline in the number of Members every year since the end of fiscal 2008.  Since then, the number of Members has declined from 520 to 345 at the end of fiscal 2016, an average decline of 5.0% per year in our membership base.  Our annual redemption rate has been less than the 5% limit in recent years due in significant part to our Board deciding to conserve capital during years of limited profit or a net loss. Based on our recent history of redemptions as compared to the number of shares tendered for redemption, Members seeking to redeem shares may be required to wait a number of years.  In addition, our ability to attract and issue shares to new Members, or redeem shares held by terminated Members and excess shares held by Members, was impacted by the Audit Committee Investigation.  Members may have even less liquidity with respect to shares in Unified should the Board, in its discretion, cease or reduce redemptions of stock.  See Part II, Item 8, “Financial Statements and Supplementary Data – Note 12” of our Annual Report on Form 10-K for the year ended October 1, 2016 for recent redemption activity and the number of outstanding shares tendered for redemption but which have not yet been redeemed.  Furthermore, required cash deposits are contractually subordinated and subject to the prior payment in full of our senior indebtedness.  For a discussion of the limitations on the redemption of capital shares and the subordination of cash deposits, see Part I, Item 1, “Business – Capital Shares – Redemption of Class A and Class B Shares and Repurchase of Class E Shares,” Part I, Item 1, “Business – Customer Deposits” and Part I, Item 1, “Business – Pledge of Shares and Guarantees” of our Annual Report on Form 10-K for the year ended October 1, 2016.  These limitations on our obligation to redeem capital shares or repay the cash deposits of Members may cause Members to withdraw from membership or potential Members may decide not to become Members.

We are vulnerable to changes in general economic conditions.    We are affected by certain economic factors that are beyond our control, including changes in the overall economic environment.  In recent periods, we have experienced significant volatility in the cost of packaged goods purchased from manufacturers.  An inflationary economic period could impact our operating expenses in a variety of areas, including, but not limited to, employee wages and benefits, workers’ compensation insurance and energy and fuel costs.  A portion of the risk related to employee wages and benefits is mitigated by bargaining agreements that contractually determine the amount of inflationary increases.  General economic conditions also impact our pension plan liabilities, as the assets funding or supporting these liabilities are invested in securities that are subject to interest rate and stock market fluctuations.  Our debt is at floating interest rates and an inflationary economic cycle typically results in higher interest costs.  We operate in a highly competitive marketplace and passing on such cost increases to customers could be difficult.  It is also difficult to predict the effect that possible future purchased or manufactured (through vendor direct arrangements) product cost decreases might have on our profitability.  A lack of inflation in the cost of food products may also adversely impact our margins when we are unable to take advantage of forward buying opportunities whereby we purchase product at a lower price and, by the time we sell the product, the market price and the price at which we are able to sell the product has risen to a higher price as a result of inflation.  The effect of deflation in purchased or manufactured (through vendor direct arrangements) product costs would depend on the extent to which we had to lower selling prices of our products to respond to sales price competition in the market.  Additionally, we are impacted by changes in prevailing interest rates or interest rates that have been negotiated in conjunction with our credit facilities.  A lower interest rate (used, for example, to discount our pension and postretirement unfunded obligations) may increase certain expenses, particularly pension and postretirement benefit costs, while decreasing potential interest expense for our credit facilities.  An increase in interest rates may have the opposite impact.  Consequently, it is difficult for us to accurately predict the impact that inflation, deflation or changes in interest rates might have on our operations.  To the extent we are unable to mitigate increasing costs, or retain the benefits from decreases in costs, patronage dividends may be reduced and/or the value of our Class A and Class B Shares may decrease.

Changes in the economic environment could adversely affect our customers’ ability to meet certain obligations to us or leave us exposed for obligations we have guaranteed.  Loans to Members, trade receivables, Member compliance with subleases and lease guarantees could be at risk in a sustained economic downturn. We establish reserves for notes receivable, trade receivables and lease commitments for which the customer may be at risk for default. Under certain circumstances, we would be required to foreclose on assets provided as collateral or assume payments for leased

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locations for which we have guaranteed payment. Although we believe our reserves to be adequate, our operating results could be adversely affected in the event that actual losses exceed available reserves.

We may on occasion hold investments in the common and/or preferred stock of Members and suppliers.  These investments are generally held at cost or the equity method and are periodically evaluated for impairment.  As a result, changes in the economic environment that adversely affect the business of these Members and suppliers could result in the write-down of these investments. This risk is unique to a cooperative form of business in that investments are made to support Members’ businesses, and those economic conditions that adversely affect the Members can also reduce the value of our investment, and hence the value of our Class A and Class B Shares.  We do not currently hold any equity investments in our Members.

Legal proceedings could lead to unexpected losses.    From time to time during the normal course of carrying on our business, we may be a party to various legal proceedings through private actions, class actions, administrative proceedings, regulatory actions or other litigations or proceedings.  The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. In the event that management determines that the likelihood of an adverse judgment in a pending litigation is probable and that the exposure can be reasonably estimated, appropriate reserves are recorded at that time pursuant to the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 450, “Contingencies.”  The final outcome of any litigation could adversely affect operating results if the actual settlement amount exceeds established reserves and insurance coverage.

We are subject to existing and changing environmental, health, food safety and safety laws and regulations.    We own and operate various facilities and equipment for the manufacture (through December 31, 2016), warehousing and distribution of products to our customers. We are subject to increasingly stringent federal, state and local laws, regulations and ordinances that (1) govern activities or operations that may have adverse effects on the environment, health and safety (e.g., discharges to air and water and handling and disposal practices for solid and hazardous waste), and (2) impose liability for the costs of cleaning up, and certain damages resulting from, past or present spills, disposals or other releases of hazardous materials. In particular, under applicable environmental laws, we may be responsible for remediation of environmental conditions and may be subject to associated liabilities (including liabilities resulting from lawsuits brought by private litigants) relating to our facilities and the land on which our facilities are situated, regardless of whether we lease or own the facilities or land in question and regardless of whether such environmental conditions were created by us or by a prior owner or tenant.  In addition, we may be subject to pending federal and state legislation that if ultimately passed, may require us to incur costs to improve facilities and equipment to reduce emissions in order to comply with regulatory limits or to mitigate the financial consequences of a “cap and trade” regime.  We are unable to predict the ultimate outcome of such legislation; however, should such legislation require us to incur significant expenditures, our business, results of operations and financial condition may be adversely affected.

We (and our customers) are subject to changes in laws and regulations.    Our business is subject to various federal, state and local laws, regulations and administrative practices. We must comply with numerous provisions regulating, among other things, health and sanitation standards, food labeling and safety, equal employment opportunity, and licensing for the sale of food and other products. Changes in federal, state or local minimum wage and overtime laws could cause the Company to incur additional wage costs, which could adversely affect the profitability of our business and that of our customers. The Patient Protection and Affordable Care Act (the “PPACA”) may impact our ability to operate profitably, as the full extent of the impact of the PPACA, if any, cannot be determined until all regulations are promulgated under the PPACA (or changed as a result of ongoing litigation) and additional interpretations of the PPACA become available.  We cannot predict future laws, regulations, interpretations, administrative orders, or the effect they will have on our operations. Additional requirements or restrictions could be imposed on the products that we sell, or require that we discontinue or recall the sale of certain products, make substantial changes to our facilities or operations, or otherwise change the manner in which we operate our business.  Any of these events could significantly increase the cost of doing business, which could adversely impact our operations and financial condition.  The occurrence of any of these events could have a similar impact on the operations and financial condition of our customers, which could adversely impact our business, operations, and financial condition.

We may engage in merger and acquisition activity from time to time and may not achieve the contemplated benefits from such activity.    Achieving the contemplated benefits from such activity may be subject to a number of significant challenges and uncertainties, including integration issues, coordination between geographically separate organizations, and competitive factors in the marketplace. We could also encounter unforeseen transaction and integration-related costs or other circumstances such as unforeseen liabilities or other issues. Any of these circumstances could result in increased costs, decreased revenue, decreased synergies and the diversion of management time and attention.  If we are unable to achieve our objectives within the anticipated time frame, or at all, the expected benefits may not be realized fully or at all, or may take longer to realize than expected, which could have an adverse effect on our business, financial condition and results of operations, or cash flows.

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We are exposed to potential product liability claims and potential negative publicity surrounding any assertion that our products caused illness or injury.    The packaging, marketing and distribution of food products purchased from others or manufactured by us (excluding bakery and milk products no longer manufactured by us after December 2016 and July 2016, respectively) involves an inherent risk of product liability, product recall and adverse publicity. Such products may contain contaminants that may be inadvertently distributed or redistributed by us. These contaminants may result in illness, injury or death if such contaminants are not eliminated.  Product liability claims in excess of insurance coverage, as well as the negative publicity surrounding any assertion that our products caused illness, injury or death could have a material adverse effect on our reputation, business, financial condition, results of operations and cash flows.

We will owe money to AmTrust if our insurance reserves for certain policies increase.    Our former insurance subsidiaries were subject to the rules and regulations promulgated by various regulatory agencies, including, but not limited to, the California Department of Insurance and the Commonwealth of Bermuda.  Historically, our established policy was to record insurance reserves based on estimates made by management and validated by third party actuaries to ensure such estimates were within acceptable ranges. Actuarial estimates were based on detailed analyses of health care cost trends, claims history, demographics, industry trends and federal and state law. As a result, the amount of reserve and related expense has been significantly affected by the outcome of these studies.  In addition, our former Insurance segment has in the past experienced significant volatility in its reserves based on actuarial estimates, including volatility resulting from its relatively small size and concentration of business in the California workers’ compensation marketplace.

Significant and adverse changes in the experience of claims settlement and other underlying assumptions have negatively impacted our operating results.  For example, in fiscal 2013, we increased reserves in our former Insurance segment by $9.1 million due to a combination of adverse development and case reserving practices and related accounting within the insurance subsidiaries that deviated from the established policy of setting case reserves at the best estimate of ultimate cost.  Thereafter, in fiscal 2014, we further increased the workers’ compensation reserves in our former Insurance segment by an additional $10.0 million. See Note 2, “Audit Committee Investigation,” in Part II, Item 8, “Financial Statements and Supplementary Data,” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

Under the terms of the Stock Purchase Agreement with AmTrust, if during the five-year period following the Closing Date of the sale, the insurance reserves in respect of any accident arising prior to the closing of the sale of UGIS and covered by an insurance policy written by an insurance subsidiary prior to January 1, 2015 increase as a result of adverse development, we must pay AmTrust for the amount of the insurance reserve increase on a dollar for dollar basis, up to a maximum of $1 million in the aggregate. In addition, to the extent the increase in insurance reserves as a result of adverse development exceeds $1 million, AmTrust is entitled to offset up to a maximum of an additional $2 million of that increase from future Earn-Out Payments due to us under the Stock Purchase Agreement.  See Note 2 of “Notes to Consolidated Condensed Financial Statements – Unaudited” in Part I, Item 1, “Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q, Item 1.01, “Entry into a Material Definitive Agreement,” including Exhibit 99.1, “Stock Purchase Agreement by and between Unified Grocers, Inc. and AmTrust Financial Services, Inc. dated as of April 16, 2015” thereto, of our Current Report on Form 8-K, filed on April 22, 2015, and Item 2.01, “Completion of Acquisition or Disposition of Assets,” including Exhibit 99.2, “Master Services Agreement by and between Unified Grocers, Inc. and AmTrust Financial Services, Inc. dated as of October 7, 2015” thereto, of our Current Report on Form 8-K, filed on October 14, 2015, for additional information.

We may not have adequate financial resources to fund our operations.    We rely primarily upon cash flow from our operations and Member investments to fund our operating activities. In the event that these sources of cash are not sufficient to meet our requirements, additional sources of cash are expected to be obtained from our credit facilities to fund our daily operating activities.  Our credit agreement, which matures on June 28, 2018, requires compliance with various covenants.  See Note 7 of Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data” of our Annual Report on Form 10-K for the year ended October 1, 2016 and “Outstanding Debt and Other Financing Arrangements” in this Quarterly Report on Form 10-Q for additional information.  While we are currently in compliance with all required covenants and expect to remain in compliance, this does not guarantee we will remain in compliance in future periods.

As of December 31, 2016, we believe we have sufficient cash flow from operations and availability under the credit agreement to meet our operating needs, capital spending requirements and required debt repayments through June 28, 2018.  However, if access to operating cash or to the credit agreement becomes restricted, we may be compelled to seek alternate sources of cash. We cannot assure that alternate sources will provide cash on terms favorable to us or at all.  Consequently, the inability to access alternate sources of cash on terms similar to our existing agreement could adversely affect our operations.

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The value of our benefit plan assets and liabilities is based on estimates and assumptions, which may prove inaccurate.     Our non-union employees participate in a Company sponsored defined benefit pension plan and Company sponsored postretirement benefit plans.  Certain eligible union employees participate in a separate plan providing payouts for unused sick leave.  Our officers also participate in a Company sponsored Executive Salary Protection Plan III (“ESPPIII”), which provides additional post-termination retirement income based on each participant’s salary and years of service as an officer of the Company. The postretirement plans provide medical benefits for retired non-union employees, life insurance benefits for retired non-union employees for which active non-union employees are no longer eligible and lump-sum payouts for unused sick days covering certain eligible union employees.  Liabilities for the ESPPIII and postretirement plans are not funded.  We account for these benefit plans in accordance with ASC Topic 715, “Compensation – Retirement Benefits” and ASC Topic 712, “Compensation – Nonretirement Postemployment Benefits,” which require us to make actuarial assumptions that are used to calculate the carrying value of the related assets, where applicable, and liabilities and the amount of expenses to be recorded in our consolidated financial statements. Assumptions include the expected return on plan assets, discount rates, health care cost trend rate, projected life expectancies of plan participants and anticipated salary increases. While we believe the underlying assumptions are appropriate, the carrying value of the related assets and liabilities and the amount of expenses recorded in the consolidated financial statements could differ if other assumptions are used.  See Notes 13 and 14 of “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

The credit and liquidity crisis in the United States and throughout the global financial system in 2008-2009 triggered substantial volatility in the world financial markets and banking system.  As a result, the investment portfolio of the Unified Cash Balance Plan incurred a significant decline in the fair value of plan assets during fiscal 2008.  The value of the plan’s investment portfolio increased in fiscal 2012, 2013, 2014 and 2016, declined in 2015 and increased for the thirteen weeks ended December 31, 2016.  The values of the plan’s individual investments have and will fluctuate in response to changing market conditions, and the amount of gains or losses that will be recognized in subsequent periods, if any, cannot be determined.

Authoritative accounting guidance may necessitate companies who issue and redeem shares based on book value to redefine the method used to value their shares.     Authoritative accounting guidance that requires adjustments to shareholders’ equity has the potential to impact companies whose equity securities are issued and redeemed at book value (“book value companies”) disproportionately more than companies whose share values are market-based (“publicly traded”).  While valuations of publicly traded companies are primarily driven by their income statement and cash flows, the traded value of the shares of book value companies, however, may be immediately impacted by adjustments affecting shareholders’ equity upon implementation.  Therefore, such guidance may necessitate companies who issue and redeem shares based on book value to redefine the method used to value their shares.  As such, we modified our Exchange Value Per Share calculation to exclude accumulated other comprehensive earnings (loss) from Book Value (see Part II, Item 6, “Selected Financial Data” of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information on the calculation of the Exchange Value Per Share), thereby excluding the potentially volatile impact that (1) ASC Topic 715-20, “Compensation – Retirement Benefits – Defined Benefit Plans – General” and (2) changes in unrealized gains and losses, net of taxes, on available for sale investments would have on shareholders’ equity and Exchange Value Per Share.

A system failure, a breach of system or network security or events of force majeure could delay or interrupt services to our customers or subject us to significant liability.     We have implemented security measures such as firewalls, virus protection, intrusion detection and access controls to address the risk of computer viruses and unauthorized access. A business continuity plan has been developed focusing on the offsite restoration of computer hardware and software applications.  We have also developed business resumption plans, which include procedures to ensure the continuation of business operations in response to the risk of damage from energy blackouts, natural disasters, terrorism, war and telecommunication failures, and we have implemented change management procedures and quality assurance controls designed to ensure that new or upgraded business management systems operate as intended.  However, there can be no assurances that any of these efforts will be adequate to prevent a system failure, accident or security breach, any of which could result in a material disruption to our business.  In addition, substantial costs may be incurred to remedy the damages caused by any such disruptions.

Our success depends on our retention of our executive officers and senior management, and our ability to hire and retain additional key personnel.     Our success depends on the skills, experience and performance of our executive officers, senior management and other key personnel. The loss of service of one or more of our executive officers, senior management or other key employees could have a material adverse effect on our business, prospects, financial condition, operating results and cash flows.  Our future success also depends on our continuing ability to attract and retain highly qualified technical, sales and managerial personnel. Competition for these personnel is intense, and

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there can be no assurance that we can retain our key employees or that we can attract, assimilate or retain other highly qualified technical, sales and managerial personnel in the future.

We depend on third parties for the supply of products and raw materials and for marketing and promotional programs.     We depend upon third parties for the supply of products, including corporate brand products, and raw materials (through December 31, 2016).  Any disruption in the services provided by any of these suppliers, or any failure by them to handle current or higher volumes of activity, could have a material adverse effect on our business, prospects, financial condition, operating results and cash flows.

We participate in various marketing and promotional programs to increase sales volume and reduce merchandise costs. Failure to continue these relationships on terms that are acceptable to us, or to obtain adequate marketing relationships, could have a material adverse effect on our business, prospects, financial condition, operating results and cash flows.

Increased electricity, diesel fuel and gasoline costs could reduce our profitability.     Our operations require and are dependent upon the continued availability of substantial amounts of electricity, diesel fuel and gasoline to manufacture (through December 31, 2016), store and transport products.  Our trucking operations are extensive and diesel fuel storage capacity represents approximately two weeks average usage.  The prices of electricity, diesel fuel and gasoline fluctuate significantly over time.  Given the competitive nature of the grocery industry, we may not be able to pass on increased costs of production (through December 31, 2016), storage and transportation to our customers. As a result, either a shortage or significant increase in the cost of electricity, diesel fuel or gasoline could disrupt distribution activities and negatively impact our business and results of operations.

A strike or work stoppage by employees could disrupt our business and/or we could face increased operating costs from higher wages or benefits we must pay our employees.     Approximately 56% of our employees are covered by collective bargaining agreements, which have various expiration dates ranging from 2017 through 2020.  If we are unable to negotiate acceptable contracts with labor unions representing our unionized employees, we may be subject to a strike or work stoppage that disrupts our business and/or increased operating costs resulting from higher wages or benefits paid to union members or replacement workers.  Any such outcome could have a material adverse effect on our operations and financial results.

If we fail to maintain an effective system of internal controls, we may not be able to detect fraud or report our financial results accurately, which could harm our business and subject us to regulatory scrutiny.     Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we perform an annual evaluation of our internal controls over financial reporting.  See risk factor entitled “We may not be able to provide assurance that remediation efforts will prevent future material weaknesses.”  We have implemented a remediation plan that has rectified a material weakness in our internal control over financial reporting as of December 31, 2016.  However, additional material weaknesses in our internal control over financial reporting may be identified in the future.  Any failure to implement or maintain required new or improved controls, or difficulties encountered in their implementation, could result in material misstatements in our consolidated financial statements and could harm our operating results or cause us to fail to meet our reporting obligations.

A loss of our cooperative tax status could increase tax liability.     Subchapter T of the Internal Revenue Code sets forth rules for the tax treatment of cooperatives.  As a cooperative, we are allowed to offset patronage earnings with patronage dividends that are paid in cash or through qualified written notices of allocation.  However, we are taxed as a typical corporation on the remainder of our earnings from our Member business and on earnings from our Non-Member business.  If we are not entitled to be taxed as a cooperative under Subchapter T, our revenues would be taxed when earned by us and the Members would be taxed when dividends are distributed.  The Internal Revenue Service can challenge the tax status of cooperatives.  The Internal Revenue Service has not challenged our tax status, and we would vigorously defend any such challenge.  However, if we were not entitled to be taxed as a cooperative, taxation at both the Company and the Member level could have a material adverse impact on us and our Members.

Each method used to meet the Class B Share Requirement has its own tax consequences.     Class B Shares required to be held by a new Member may be purchased directly at the time of admission as a Member or may be acquired over the five consecutive fiscal years commencing with the first year after admission as a Member at the rate of 20% per year.  In addition, certain Members, including former shareholders of United Grocers, Inc. or Associated Grocers, Incorporated, may satisfy their Class B Share Requirement only with respect to stores owned at the time of admission as a Member solely from their patronage dividend distributions.  Each of these purchase alternatives may have tax consequences which are different from those applicable to other purchase alternatives.  Members and prospective Members are urged to consult their tax advisers with respect to the application of U.S. federal income, state or local tax rules to the purchase method selected.

Members’ Class A, Class B and Class E Shares are subject to risk of loss, and the Exchange Value Per Share is not intended to and should not be viewed as the amount for which such shares could be sold.    Our Articles of

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Incorporation and Bylaws provide that the Board may redeem or repurchase such shares in its sole discretion at certain times.  When such redemptions or repurchases occur, shares of Class A and Class B are purchased and sold at purchase prices equal to the Exchange Value Per Share at the close of the last fiscal year end prior to the date the shares are purchased or tendered for redemption.  Class E Shares become eligible for repurchase at the discretion of the Board at a price of $100 per share ten years after their issuance date, with the outstanding Class E Shares becoming eligible for repurchase between the end of fiscal 2013 and the end of fiscal 2018.  

There is no assurance that our financial condition will enable us to, or our Board will determine to, redeem or repurchase Class A, Class B or Class E Shares at such time they become eligible for redemption or repurchase, or ever.  Our ability to redeem or repurchase shares is subject to the limitations and restrictions set forth in (1) the California General Corporation Law; (2) our Articles of Incorporation and Bylaws; (3) our redemption policy; and (4) any credit agreements to which we are a party.  For more detail on those restrictions, see Part I, Item 1, “Business – Redemption of Class A and Class B Shares and Repurchase of Class E Shares” of our Annual Report on Form 10-K for the year ended October 1, 2016.  During the thirteen weeks ended December 31, 2016, as part of settlements with Members that were in default on their obligations to us, we redeemed 3,889 Class B Shares that had been tendered for redemption as of the close of fiscal 2016, leaving 97,935 Class B Shares, or 24% of our outstanding Class B Shares at the close of fiscal 2016 with an aggregate redemption value of $28.8 million, which have been tendered for redemption but not yet redeemed. This percentage has steadily increased in recent years, from 23%, 21% and 17% of our outstanding Class B Shares at the close of fiscal 2015, 2014 and 2013, respectively, as we (1) suspended redemptions of Class A Shares and Class B Shares because we had not been current in our periodic SEC filings, (2) had an increase in the number of shares our Members have sought to redeem and (3) redeemed less than the 5% limit in fiscal 2012 through fiscal 2016. Based on the current level of redemption as compared to the number of shares tendered for redemption, such shares may not be redeemed for years under our redemption policy, if at all. Members may have even less liquidity with respect to shares in Unified should the Board, in its discretion, cease or reduce redemptions of stock. While during fiscal 2016 we repurchased 91,013 Class E Shares at a price of $9.1 million that were eligible for repurchase in fiscal 2015 and 2016, there is no assurance that our financial condition will enable us to, or our Board will determine to, repurchase Class E Shares in the fiscal year they become eligible for repurchase.  Accordingly, Members may lose all or a portion of their investment in the Class A, Class B or Class E Shares.  See “The requirement that Members invest in our shares and/or make Required Deposits, and the lack of liquidity with respect to such investments and Required Deposits, may make attracting new Members difficult and may cause existing Members to withdraw from membership.”

If the Board decides in any year to retain a portion of our earnings from our Non-Patronage Business, and not to allocate those earnings to the Exchange Value Per Share, the redemption price of Class A and Class B Shares that are repurchased in the year of such retention and in future years will be reduced.

Finally, there is no established public trading market for our shares. The Exchange Value Per Share is not intended to and should not be viewed as the amount for which any of our shares of capital stock or, in the aggregate, the Company or our net assets could be sold. Accordingly, there can be no assurance that a holder of our Class A or Class B Shares will ever receive the Exchange Value Per Share or a holder of our Class E Shares $100 per such share.  

 

Severe weather, natural disasters and adverse climate changes may adversely affect our financial condition and results of operations.     Severe weather conditions, such as hurricanes or tornadoes, or natural disasters, such as earthquakes, fires or tsunamis in areas in which we have distribution facilities, in which customers’ stores are located or from which we obtain products may adversely affect our results of operations. Such conditions may cause physical damage to our properties, closure of one or more of our distribution facilities, closure of customers’ stores, lack of an adequate work force in a market, temporary disruption in the supply of products, disruption in the transport of goods, delays in the delivery of goods to our distribution centers or customer stores or a reduction in the availability of products we offer.  In addition, adverse climate conditions and adverse weather patterns, such as droughts and floods, impact growing conditions and the quantity and quality of crops yielded by food producers and may adversely affect the availability or cost of certain products within the grocery supply chain.  Our business resumption plans may not be effective in a timely manner and a significant disruption to our business could occur in the event of a natural disaster, terrorism or war.  In addition, while we carry insurance to cover business interruption and damage to buildings and equipment, some of the insurance carries high deductibles.  Any of these factors may disrupt our business and adversely affect our financial condition, results of operations and cash flows.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our consolidated condensed financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates, assumptions and judgments that affect the amount of assets and liabilities reported in the consolidated condensed financial statements, the disclosure of contingent assets and liabilities as of the date of the consolidated condensed financial statements and reported amounts of revenues

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and expenses during the year. We believe our estimates and assumptions to be reasonable; however, future results could differ from those estimates under different assumptions or conditions.

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated condensed financial statements.  On an ongoing basis, we evaluate our estimates, including those related to allowances for doubtful accounts, lease loss reserves, investments, goodwill and intangible assets, long-lived assets, income taxes, insurance reserves, pension and postretirement benefits and contingencies and litigation.  We base our estimates on historical experience and on various other assumptions and factors that we believe to be reasonable under the circumstances.  Based on our ongoing review, we make adjustments we consider appropriate under the facts and circumstances.  The accompanying consolidated condensed financial statements are prepared using the same critical accounting policies and estimates discussed in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended October 1, 2016.

RECENTLY ADOPTED AND RECENTLY ISSUED AUTHORITATIVE ACCOUNTING GUIDANCE

Refer to Note 11 of “Notes to Consolidated Condensed Financial Statements – Unaudited” in Part I, Item 1, “Financial Statements (Unaudited)” of this Quarterly Report on Form 10-Q for management’s discussion of recently adopted and recently issued authoritative accounting guidance and their expected impact, if any, on our consolidated condensed financial statements.

AVAILABILITY OF SEC FILINGS

We make available, free of charge, through our website (http://www.unifiedgrocers.com) our Forms 10-K, 10-Q and 8-K, as well as our registration statements, proxy statements and all amendments to those reports, as soon as reasonably practicable after those reports are electronically filed with the SEC.  A copy of any of the reports filed with the SEC can be obtained from the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.  A copy may also be obtained by calling the SEC at 1-800-SEC-0330. All reports filed electronically with the SEC are available on the SEC’s web site at http://www.sec.gov.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion of the market risks we face contains forward-looking statements. Forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements.  See “Quantitative and Qualitative Disclosures About Market Risk” discussed in Part II, Item 7A of our Annual Report on Form 10-K for the year ended October 1, 2016 for additional information.

We are subject to interest rate changes on certain of our notes payable under our credit agreements that may affect the fair value of the notes payable, as well as cash flow and earnings. Based on the notes payable outstanding at December 31, 2016 and the current market condition, a one percent change in the applicable interest rates would impact our annual cash flow and pretax earnings by approximately $2.7 million.  See Note 3 of “Notes to Consolidated Condensed Financial Statements – Unaudited” in Part I, Item 1, “Financial Statements (Unaudited)” for additional discussion regarding the fair value of notes payable.

We are exposed to credit risk on accounts receivable through the ordinary course of business and we perform ongoing credit evaluations. Concentration of credit risk with respect to accounts receivable is limited due to the nature of our customer base (i.e., primarily Members).  We currently believe our allowance for doubtful accounts is sufficient to cover customer credit risks.

Life insurance and mutual fund assets with values tied to the equity markets are impacted by overall market conditions.  During the thirteen weeks ended December 31, 2016, net earnings and net comprehensive earnings experienced a decrease corresponding to the decline in the value of life insurance and mutual fund assets, respectively.  The decline in the value of such assets is deemed by management to be temporary in nature.  

ITEM 4.  CONTROLS AND PROCEDURES

Disclosure controls and procedures.    Disclosure controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.  Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in disclosure controls and procedures. These include the fact that human judgment in decision-making can be faulty and that

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breakdowns in internal control can occur because of human failures such as simple errors, mistakes or intentional circumvention of the established processes.

At the end of the period covered by this report, our management, with the participation of our CEO and CFO, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934).  Our CEO and CFO concluded that these disclosure controls and procedures were effective at the reasonable assurance level described above as of the end of the period covered in this report.  

Changes in internal controls over financial reporting.    Our management, with the participation of our CEO and CFO, has evaluated any changes in our internal control over financial reporting that occurred during the most recent fiscal quarter.  Based on that evaluation, our management concluded that no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the quarter ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

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PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

We are a party to various litigation, claims and disputes, some of which are for substantial amounts, arising in the ordinary course of business. While the ultimate effect of such actions cannot be predicted with certainty, we believe the outcome of these matters will not have a material adverse effect on our financial condition or results of operations.

ITEM 1A.  RISK FACTORS

As of the first quarter ended December 31, 2016, we eliminated the risk factor included in our Annual Report on Form 10-K for the fiscal year ended October 1, 2016 entitled “Expenses relating to or arising from the Audit Committee Investigation, including diversion of management’s time and attention, may adversely affect our business and results of operations” due to the conclusion of the Audit Committee Investigation and related matters as well as our incurring relatively minor expenses in association therewith during the first quarter of fiscal 2017.  In addition, we modified the risk factor included in our Annual Report on Form 10-K for the fiscal year ended October 1, 2016 previously entitled “Our management has identified material weaknesses in the Company’s internal control over financial reporting which could, if not remediated, result in material misstatements in our financial statements. We may not be able to fully address the material weaknesses in our internal controls or provide assurance that remediation efforts will prevent future material weaknesses” to currently state that “We may not be able to provide assurance that remediation efforts will prevent future material weaknesses” so as to eliminate references to material weaknesses in internal control over financial reporting that have been fully remediated as of December 31, 2016.  Similarly, we modified the risk factor included in our Annual Report on Form 10-K for the fiscal year ended October 1, 2016 entitled “If we fail to maintain an effective system of internal controls, we may not be able to detect fraud or report our financial results accurately, which could harm our business and subject us to regulatory scrutiny” so as to eliminate the reference to the material weakness in internal control over financial reporting that has been fully remediated as of December 31, 2016.  Other than the foregoing, there are no material changes from risk factors as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended October 1, 2016, filed on December 16, 2016.  Refer to “Risk Factors” in Part I, Item 2 of this Quarterly Report on Form 10-Q for discussion of our risk factors.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

COMPANY PURCHASES OF EQUITY SECURITIES

 

 

Refer to “Redemption of Capital Stock” in Part I, Item 2 of this Quarterly Report on Form 10-Q for discussion of our share redemptions.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

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ITEM 5.  OTHER INFORMATION

None.

ITEM 6.  EXHIBITS

 

 

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

 

Dated: February 14, 2017

 

 

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