| SAFEWAY INC Item 1A Risk Factors We wish to caution you that there are risks and uncertainties that could affect our business |
| These risks and uncertainties include, but are not limited to, the risks described below and elsewhere in this report, particularly in “Forward-Looking Statements |
| ” The following is not intended to be a complete discussion of all potential risks or uncertainties, as it is not possible to predict or identify all risk factors |
| Competitive Industry Conditions We face intense competition from traditional grocery retailers, non-traditional competitors such as “supercenters” and “club stores,” as well as from specialty supermarkets, drug stores, dollar stores, convenience stores and restaurants |
| Some of our competitors are larger than we are, have greater financial resources available to them and, as a result, may be able to devote greater resources to sourcing, promoting and selling their products |
| Increased competition may have an adverse effect on profitability as the result of lower sales, lower gross profits and/or greater operating costs such as marketing |
| Our ability to attract customers is dependent, in large part, upon a combination of price, quality, product mix, brand recognition, store location, in-store marketing and design, promotional strategies and continued growth into new markets |
| In each of these areas, traditional and non-traditional competitors compete with us and may successfully attract our customers to their stores by aggressively matching or exceeding what we offer |
| In recent years, many of our competitors have increased their presence in our markets |
| Our responses to competitive pressure, such as additional promotions and increased advertising, could adversely affect our profitability |
| Also, we cannot assure that our actions will succeed in gaining or maintaining market share |
| Additionally, we cannot predict how our customers will react to the entrance of certain of our non-traditional competitors into the grocery retailing business |
| Because we face intense competition, we must anticipate and quickly respond to changing consumer demands more effectively than our competitors |
| In April 2005, we launched a dlra100 million marketing campaign to reposition our brand |
| For this campaign to be successful, we must achieve and maintain favorable recognition of our unique and exclusive private-label brands, effectively market our products to consumers in several diverse market segments, competitively price our products and maintain and enhance a perception of value for consumers |
| Finally, we must source and market our merchandise efficiently and creatively |
| Failure to accomplish these objectives could impair our ability to compete successfully and adversely affect our growth and profitability |
| Labor Relations A significant majority of our employees are unionized, and our relationship with unions, including work stoppages, could have an adverse impact on our financial results |
| These expiring agreements cover approximately 4prca of our union-affiliated employees |
| In future negotiations with labor unions, we expect that rising health care, pension and employee benefit costs, among other issues, will be important topics for negotiation |
| If, upon the expiration of such collective bargaining agreements, we are unable to negotiate acceptable contracts with labor unions, it could result in strikes by 8 ______________________________________________________________________ [36]Table of Contents SAFEWAY INC AND SUBSIDIARIES the affected workers and thereby significantly disrupt our operations |
| Further, if we are unable to control health care and pension costs provided for in the collective bargaining agreements, we may experience increased operating costs and an adverse impact on future results of operations |
| Profit Margins Profit margins in the grocery retail industry are very narrow |
| In order to increase or maintain our profit margins, we develop strategies to reduce costs, such as productivity improvements, shrink reduction, distribution center efficiencies and other similar strategies |
| Our failure to achieve forecasted cost reductions might have a material adverse effect on our business |
| Changes in our product mix also may negatively affect certain financial measures |
| For example, we continue to add supermarket fuel centers, which generate low profit margins but significant sales |
| Although this negatively affects our gross profit margin, fuel sales provide a positive effect on operating and administrative expense as a percent of sales |
| Opening and Remodeling of Stores Our inability to open and remodel stores as planned could have a material adverse effect on our results |
| Our business plans include the opening and remodeling of a significant number of stores |
| In 2006, we anticipate opening approximately 20 to 25 Lifestyle stores while completing approximately 280 Lifestyle remodels |
| If, as a result of labor relations issues, supply issues, environmental and real estate delays, these capital projects do not stay within the time and financial budgets that we have forecast, our future financial performance could be materially adversely affected |
| Further, we cannot ensure that the new or remodeled stores will achieve anticipated same-store sales or profit levels |
| Food Safety, Quality and Health Concerns We could be adversely affected if consumers lose confidence in the safety and quality of certain food products |
| Adverse publicity about these types of concerns, whether or not valid, may discourage consumers from buying our products or cause production and delivery disruptions |
| The real or perceived sale of contaminated food products by us could result in product liability claims and a loss of consumer confidence, which could have a material adverse effect on our sales and operations |
| Economic Conditions that Impact Consumer Spending Our results of operations are sensitive to changes in overall economic conditions that impact consumer spending, including discretionary spending |
| Future economic conditions such as employment levels, business conditions, interest rates, energy costs and tax rates could reduce consumer spending or change consumer purchasing habits |
| A general reduction in the level of consumer spending or our inability to respond to shifting consumer attitudes regarding products, store location and other factors could adversely affect our growth and profitability |
| Unfavorable Changes in Government Regulation Our stores are subject to various federal, state, local and foreign laws, regulations and administrative practices affecting our business |
| We must comply with numerous provisions regulating health and sanitation standards, food labeling, equal employment opportunity, minimum wages and licensing for the sale of food, drugs and alcoholic beverages |
| We cannot predict the nature of future laws, regulations, interpretations or applications, or determine what effect either additional government regulations or administrative orders, when and if promulgated, or disparate federal, state, local and foreign regulatory schemes would have on our future business |
| They could, however, require the reformulation of certain products to meet new standards, the recall or discontinuance of certain products not able to be reformulated, additional record keeping, expanded documentation of the properties of certain products, expanded or different labeling and/or scientific substantiation |
| Any or all of such requirements could have an adverse effect on our results of operations and financial condition |
| Substantial Indebtedness We currently have, and expect to continue to have, a significant amount of debt, which could adversely affect our financial health |
| As of December 31, 2005, we had approximately dlra6dtta4 billion in total consolidated debt outstanding |
| This substantial indebtedness could increase our vulnerability to general adverse economic and industry conditions |
| If debt markets do not permit us to refinance certain maturing debt, we may be required to: dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions, development efforts and other general corporate purposes; limit our 9 ______________________________________________________________________ [37]Table of Contents SAFEWAY INC AND SUBSIDIARIES flexibility in planning for, or reacting to, changes in our business; place ourselves at a competitive disadvantage relative to our competitors that have less debt; and limit, along with the financial and other restrictive covenants in the documents governing our indebtedness, among other things, our ability to borrow additional funds |
| Changes in our credit ratings may have an adverse impact on our financing costs and structure in future periods, such as the ability to participate in the commercial paper market and higher interest costs on future financings |
| Additionally, interest expense could be materially and adversely affected by changes in the interest rate environment, changes in our credit rating, fluctuations in the amount of outstanding debt, decisions to incur premiums on the early redemption of debt and any other factor that results in an increase in debt |
| Retirement Plans We maintain defined benefit retirement plans for substantially all employees not participating in multi-employer pension plans |
| Expenses from defined benefit pension plans may be significantly affected by changes in the actual return on plan assets and actuarial assumptions |
| In addition, we participate in various multi-employer pension plans for substantially all employees represented by unions |
| We are required to make contributions to these plans in amounts established under collective bargaining agreements |
| Pension expense for these plans is recognized as contributions are funded |
| Benefits generally are based on a fixed amount for each year of service |
| Based on the most recent information available to us, we believe a number of these multi-employer plans are underfunded |
| As a result, we expect that contributions to these plans may continue to increase, although at a slower rate than in recent years |
| Additionally, the benefit levels and related issues will continue to create collective bargaining challenges |
| Most recently completed labor negotiations resulted in a reduction of pension liabilities (and, therefore, a reduction of projected contribution increases) |
| Under current law, an employer that withdraws or partially withdraws from a multi-employer pension plan may incur withdrawal liability to the plan, which represents the portion of the plan’s underfunding that is allocable to the withdrawing employer under very complex actuarial and allocation rules |
| The amount of any increase or decrease in our required contributions to these multi-employer pension plans will depend upon the outcome of collective bargaining, actions taken by trustees who manage the plans, government regulations, the actual return on assets held in the plans, and the potential payment of a withdrawal liability if we choose to exit a market, among other factors |
| Legal Proceedings From time to time, we are a party to legal proceedings, including matters involving personnel and employment issues, personal injury, antitrust claims and other proceedings arising in the ordinary course of business |
| In addition, there is an increasing number of cases being filed against companies generally, which contain class-action allegations under federal and state wage and hour laws |
| We estimate our exposure to these legal proceedings and establish reserves for the estimated liabilities |
| Assessing and predicting the outcome of these matters involves substantial uncertainties |
| Although not currently anticipated by management, unexpected outcomes in these legal proceedings, or changes in management’s evaluations or predictions, could have a material adverse impact on our financial results |
| Insurance Plan Claims We use a combination of insurance and self-insurance to provide for potential liabilities for workers’ compensation, automobile and general liability, property insurance, director and officers’ liability insurance, and employee health care benefits |
| We estimate the liabilities associated with the risks that are retained by us, in part, by considering historical claims experience, demographic and severity factors and other actuarial assumptions which, by their nature, are subject to a high degree of variability |
| Any actuarial projection of losses concerning workers’ compensation and general liability is subject to a high degree of variability |
| Among the causes of this variability are unpredictable external factors affecting future inflation rates, discount rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns |
| The majority of the Company’s workers’ compensation liability is from claims occurring in California |
| California workers’ compensation has received intense scrutiny from the state’s politicians, insurers, employers and providers, as well as the public in general |
| Recent years have seen escalation in the number of legislative reforms, judicial rulings and social phenomena affecting this business |
| Some of the many sources of uncertainty in the Company’s reserve estimates include changes in benefit levels, medical fee schedules, medical utilization guidelines, vocation rehabilitation and apportionment |
| 10 ______________________________________________________________________ [38]Table of Contents SAFEWAY INC AND SUBSIDIARIES Goodwill/Impairment of Long-Lived Assets We have dlra2dtta4 billion of goodwill on our balance sheet that is subject to periodic testing for impairment |
| Our long-lived assets, primarily stores, also are subject to periodic testing for impairment |
| Failure to achieve sufficient levels of cash flow at specific divisions or specific stores could result in impairment charges on goodwill and/or long-lived assets |
| We have incurred significant impairment charges to earnings in the past for goodwill and for long-lived assets |
| Information Technology Risks The Company has large, complex information technology systems that are important to business operations |
| The Company could encounter difficulties developing new systems or maintaining and upgrading existing systems |
| Such difficulties could lead to significant expenses or to losses due to disruption in business operations |
| Despite the Company’s considerable efforts and technology to secure our computer network, security could be compromised, confidential information could be misappropriated, or system disruptions could occur |
| This could lead to loss of sales or profits or cause the Company to incur significant costs to reimburse third parties for damages |