FARM FRESH HAS DEADLINE TO DECIDE ON DEBT STRATEGY

ELLIOT ZWIEBACH

NORFOLK, Va. -- Farm Fresh here said last week it has just under a year to decide what course to take to extricate itself from its debt burden.

Ron Johnson, president and chief operating officer, said the ultimate deadline for any decision on the chain's long-term future is April 1, 1998, when the company will have to make a cash payment of more than $19 million.

However, high-yield securities analysts and other observers contacted by SN said a decision is more likely to come by Oct. 1, 1997, when the company's next $12.25 million interest payment is due to bondholders of the operating company -- the same date bonds from its holding company begin accruing cash interest that is expected to total approximately $7 million by April 1.

If Farm Fresh cannot meet the April 1 payments, it would be in default, and the holding company would take over all equity in the operating company.

In a 10-K filing earlier this month with the Securities and Exchange Commission, Farm Fresh said, "There can be no assurance that the company will be able to secure sufficient capital to enable it to meet its obligations in the event of an acceleration of the notes. In that event, the company may be required to enter into some form of reorganization."

In a phone call with securities analysts last week that was monitored by SN, Johnson acknowledged that the departure of Michael E. Julian as Farm Fresh president and chief executive officer in February had slowed down the review of strategic alternatives being conducted by Donaldson Lufkin & Jenrette, New York-based investment bankers.

"With the change in top management, DLJ hasn't gotten as far in the process as they or we would have liked," Johnson said. "But they are fully involved at this point, and we are fully absorbed with them in working through the process to identify and evaluate all strategic alternatives available to the company."

In other developments:

Farm Fresh disclosed a 7% decline in same-store sales for the first quarter ended March 22, though operating cash flow rose 1.1%.

The company said it is adopting a short-term strategy to bring costs into line and refocus most of its efforts at store level.

Farm Fresh said it is not making any plans for capital expenditures beyond 1997, with cap-ex limited this year to $6 million, compared with $21 million in 1996.

Farm Fresh operates 48 stores in Richmond, Hampton Roads and the Shenandoah Valley areas of Virginia. Last year's sales fell 14% to $761.5 million.

Most observers told SN they anticipate a decision on the company's future sooner rather than later.

Bob Lupo, an analyst with BA Securities, Chicago, said Farm Fresh "has got to do something quickly," noting that the situation could move into "an emergency state by mid-year if it becomes clear the company can't continue to pay the interest on its bonds."

A market observer in the Southeast, who asked not to be identified, said he expects Farm Fresh to come to some conclusion "within the next 90 days," although he was not sure if the resolution would involve an outright sale of the company or some form of financial restructuring.

Fred Taylor, an analyst with Salomon Bros., New York, said he believes a restructuring is a very viable option. If Farm Fresh can reach some accommodation with bondholders to restructure the debt, he said, "then Farm Fresh can probably survive."

Another observer, who also asked for anonymity, said he found it "curious that, in the face of its precipitous decline, the company made its interest payment earlier this month, which leads me to suspect a sale or restructuring is imminent. Otherwise, why make the payment if there's no form of relief in sight?"

Ted Bernstein, an analyst with Grantchester Securities, New York, told SN he anticipates Farm Fresh will work out its financial obligations with bondholders prior to Oct. 1, probably through a pre-packaged bankruptcy, "which makes the most sense because it holds the bondholders' feet to the fire and makes them acknowledge there is not enough value left in the company to compensate them completely, even if they were to drag the bankruptcy process out."

Farm Fresh said sales for the 12-week quarter fell 9.7% to $161.7 million, while same-store sales plunged 7% "as a result of the impact of competitive store openings over the last 12 months."

However, operating cash flow rose 1.1% to $9.1 million, and gross profit as a percentage of sales rose from 23.3% a year ago to 24%, which the company said was due to improved promotional pricing practices, particularly in grocery.

According to Johnson, "The benefits of our new short-term strategy to improve financial performance and liquidity -- by conserving capital, reducing administrative expenses and directing management attention toward the operation of existing stores -- will be reflected in our results for the remainder of the year."

Johnson told analysts he expects same-store sales to remain negative through the year, "though they should improve from first-quarter levels," he said.

Rick Coleman, Farm Fresh's chief financial officer, told analysts the sales decline in the quarter included a 12.5% drop in grocery sales, which was offset by a 13% gain in the chain's pharmacy business.

Despite the grocery declines, Johnson said Farm Fresh improved grocery pricing during the quarter by offering special incentives to frequent-shopper cardholders -- passing on temporary price reductions exclusively to them rather than dropping shelf prices storewide -- and by imposing limits on quantity discounts.

While those efforts helped improve the chain's margins, a drop in its nonfood business, combined with pricing pressures from competitors, resulted in lower promotional allowances that had a negative effect on margins, Johnson said.

To deal with its immediate problems, Johnson said, "Farm Fresh is working under a short-term strategy to eliminate all unnecessary administrative expenses, review all operating expenses at store level and refocus the company's attention on operating its existing stores."

The company said in the 10-K document that it does not intend to begin any new-store construction for the balance of 1997.

Johnson said in the conference call Farm Fresh will continue to put a hold on new-store openings through 1998.

While he did not comment on remodeling efforts next year, he said the decision not to remodel any stores this year would leave approximately 12 units vulnerable to competitive new-store openings.

According to the 10-K, cap-ex this year will be limited to $6 million -- one-half of which has already been spent to open a new store whose construction began last year, with the other half committed to maintenance programs at existing stores.

Analysts told SN last week that DLJ has been distributing a sales prospectus to potential buyers. Ever since DLJ was hired late last year, observers have speculated that Farm Fresh would have to consider an asset sale among its other options. However, it was not until the 10-K filing that the company itself acknowledged a sale was possible.

"That's always been an option," Johnson told SN. "It's simply that, in our current filing, we've made the decision to be more detailed than the previous [Farm Fresh] management -- simply because that's the way we wanted to present the information."

It was not clear last week which companies had received the Farm Fresh prospectus.