Friday, October 19, 2007

Keystone Co-Op #4: How Come We're Not Moving?

posted by deep throat

[deep throat left this comment in a previous discussion, and we decided to reproduce it in full here.]

RE the rent situation on 47th Street: though the Co-Op owes $90,000 per month to Certified on that space, it is not clear whether the Co-Op has been able to keep up on those payments, or some portion thereof. And, if there is back-rent due, where is it sitting on the balance sheet? I've noted that there is $960,000 lumped into "other current liabilities" as of the end of FY 2006. Maybe this contains some of the back rent that the Co-Op hasn't been able to pay. However, I doubt the FY 2006 numbers have captured an accurate picture of how much the Co-Op owes its landlords based on President Poueymirou's comments at the annual meeting. He pointed out that the Co-Op's main creditors in that year were vendors (which likely includes Certified). In FY 2007, he contends the mix of creditors has changed (even though the absolute level of debt hasn't shifted materially) such that half is owed to vendors and the other half is owed to landlords (Certified and the University?).

Then, there is the on-going lease commitment on 47th Street that the Co-Op is locked into through FY 2023. That's another 16 years of $1 million in annual rent. There is absolutely no evidence of this liability on the balance sheet because the financial statements only require the Co-Op to recognize a single year's rent expense in each fiscal year.

Yes, it does seem to me that there's a viable business in the 55th Street store. But, whether the new general manager can revive that business and churn out enough profits to satisfy the Co-Op's creditors in a timely manner remains to be seen. In situations of financial distress, time is really the name of the game. The entity will try to bargain for enough time to shed the sink holes and polish up the remaining healthy businesses.

Based on Treasurer Lowenthal's financial report at the annual meeting, it looks like even the 55th Street store has trailed industry benchmarks for the last few years. For example, revenue growth from that store has essentially been flat from FY 2003 through FY 2007. (This was shown in bar chart form, so I don't have actual figures yet).

Just for perspective, supermarket sales typically grow in line with GDP -- unless there have been some changes in the local trading area, like an increase in population. So, we would expect the Co-Op's sales to grow about 2% a year, and we'd throw in another 1% in food inflation (though we expect food inflation to be higher this calendar year thanks to higher feed prices and a worldwide surge in demand for dairy). So, in the absence of any big change in population or nearby competitors, we should be seeing the 55th Street store rack up sales growth in the neighborhood of 3% annually. At the very least, I would have expected to see some modest bump in 55th Street sales in FY 2005 when the 47th Street store closed and shoppers would have shifted to the original location.

We've heard from Neo, the Peapod Guy, that Peapod's business in Hyde Park has increased significantly. So, I would surmise that Peapod is grabbing more share of the Hyde Park stomach.

Elizabeth raises some really good questions about why Certified would put up with this situation or why it hasn't forced the Co-Op into bankruptcy. From what I can tell, there are a lot of intertwining relationships between the two entities. The Co-Op owns some of Certified's common stock, but it also owes Certified over $1 million in notes payable (long-term debt) at the end of FY 2005. Please keep in mind that this LT debt is separate from the $1 million in annual rent the Co-Op owes Certified on 47th Street.

It is sort of a neat little cycle: The Co-Op sells Certified's products, and then sends most of its profits back to Certified in the form of rent, repayment on debt, and payment for inventory.

Certified may have come to the conclusion that it is better off working out some sort of more lenient repayment plan with the Co-Op, than kicking it to the ground.

Then there is also a brothers-in-arms dynamic because Certified itself is a co-operative organization (which is why the Co-Op owns shares). Certified may be willing to cut the Co-Op some more slack in the name of solidarity, even if it takes longer to receive payment.

If it makes people feel any better, I'm lost with the Co-Op's murky financials. And I pick apart financial statements to diagnose companies for a living. This is some of the worst disclosure I've ever run across. The Co-Op is not a privately-held entity where financial conditions can be kept quiet -- it is accountable to its 22,000 members who have an ownership stake in the business.


Famac said...

I woke up this morning and looked out at the lake, and what do you know? There was the new manager of the Co-Op -- strolling around by the water filtration plant.

Elizabeth Fama said...

Silly famac...the new Co-Op manager doesn't have to walk on water, he only has to be able to turn water into wine.

Peter Rossi said...

How does an outlet for Certified Products qualify as a unique shopping experience -- "part of the love affair with food?" sounds more like a badly run Aldi to me.

Note the recent call for board members in the Herald by Hyde Park Hysterical Society President Jay Mulberry -- "no experience necessary." Who is kidding who?

Three cheers for Deep Throats attempts to make sense out of the Co-ops attempts to hide the facts from its ownership. But let's not lose sight the big picture -- this store is a disgrace. Why should we subsidize it?

J/tati said...

I might have read the title of this post wrong, but I interpreted to propose that the Co-op leave the 55th street location and move into the 47th street store.

I'm sure this has been discussed before, but given the long term lease commitment at 47th and the multi-million dollar build-out of that store, then why not? Too risky? I thought the 55th street lease ends in the 2009.

deep throat said...


Your suggestion about moving the 55th Street store to the 47th Street location actually crossed my mind while I was absorbing the audited financials. According to a footnote, the lease on the 55th Street store expires in December 2013 -- a good ten years before the 47th Street lease ends. This is a good question to raise before the board.

Interestingly, Sydney Simmons, who was hired from Whole Foods on the Gold Coast (and who has since left employment with the Co-Op), pointed out that the kitchen facilities at the 53rd Street store were inadequate for producing the type of prepared foods program he'd been hired to initiate, and the facilities at the 55th Street store were even worse. (Board minutes from 2/26/07).

While I don't have a lot details about the kitchen facilities at the 47th Street store, the board minutes from the same meeting mention that there is a commercial chiller available there -- this is used to quickly cool freshly cooked foods to an edible temp, in accordance with food safety ordinances.

Now that the 53rd Street store is closed, the Co-op has investigated other kitchen facility alternatives. One option would be to rent the kitchen at KAM Israel. However, to comply with food safety law, any foods cooked in the kitchen at KAM Israel will need to be transported to the 55th Street store in a refrigerated truck, which apparently the Co-Op does not have.

This is really a pity since prepared foods are often a high-margin category, and it would be helpful if the Co-Op could shift its product mix to include more of them.

Elizabeth Fama said...

"This is a real pity"? Deep Throat, do I detect some softening towards the Co-Op's plight? Next thing you know, you'll be toying with joining the Board!

deep throat said...


Maybe I'm going soft in my old age :-) At the very least, I'd like to examine the Co-Op's situation with an open mind and tally up the evidence and data points.

I echo what others on the blog have said before -- I'm not interested in "building" my own supermarket in the same way I'm not interested in making my own clothes or furniture. I'd much rather vote with my dollars, which is why I still make a trip to the north side every week to do get the groceries.

Having said that, it's difficult not to see how pathetic the Co-Op has become, both from self-inflicted bone-headed decisions (e.g., the expansion into the 47th Street store, and the purchase of Mr. G's in order to secure the rights to the 47th Street space, as of 4/2007 the Co-Op was still committed to a long 52-month lease on the now-unused front end point-of-sale equipment at the 53rd Street store), as well as from random events that have come about--arguably--due to inept and/or negligent operations management (e.g., oversight of the senior cashier at 53rd Street who apparently had been engaging in undetected embezzlement activity for some time, 18 years of postponed investment in information systems that led to the catastrophic failure of the check-out scanners due to an errant squirrel in the fall of 2006, the destruction of the original accounting software in a cleaning procedure, a membership database that is so corrupted that the organization really has no clue as to how many of its members have even shopped at the Co-Op in the last three years).

Seriously, there is a distinct keystone cop-like flavor to what is relayed in the Evergreen and board minutes. It would be comical if it weren't so pathetic. It almost seems like the Co-Op is operating under the mother of all negative karmic clouds.

I'm heartened by a few glimmers in the darkness. The new GM, Bruce Brandfon, has definitely been around the block in the supermarket industry and he's already making some key improvements (re-pricing, better merchandising, upgrading certain departments). Also, President Poueymirou has been quite committed to increasing the disclosure from the board, along with several other individuals, including new director Richard Buchner. Finally, Nominating Committee member Jay Mulberry has been extremely helpful in asking very pointed questions of the board and advocating for further transparency. He's making a real effort to hold the board's collective feet to the fire, as any activist shareholder should.

The big question in my mind is whether these small improvements are just too little too late. In financial distress situations, the critical dynamic is to buy enough time to reorganize, shed non-performing assets/operations, and fix the issues with the remaining viable business. It's really a race against the clock, which is why the cash burn rate that I calculated previously is so important. The slower cash is burned, the longer you have for your fixes to take root.

It's not clear whether the Co-Op should attempt a quick and usually painful turnaround (i.e., ripping the band-aid off), or if it should file for Chapter 11 (i.e., go to rehab like LiLo). I'm sure there are other folks in Hyde Park who have more extensive knowledge of the data behind financial distress situations.

Elizabeth Fama said...

Interesting insight. These small changes may be the very reason the U of C is being so lenient with its rent for the Co-Op. That is, it's giving the Co-Op one last chance to turn around, because the direction is at least positive. Do you think?

But I still have this image of my mom, who stopped shopping at the Co-Op 30 years ago (at the time, in favor of the new Jewel at 55th and Pulaski). A cockroach crawled across her hand while she was choosing an item, and she left an entire cart full of food. Just walked out of the store and never set foot in it again. She had already been peeved about the fact that (at the time, before your time, Deep Throat) the produce was chosen for you in trays wrapped with cellophane, and if there were 4 tomatoes (pears, etc.) in there, one would almost always be rotten underneath, carefully shielded from view. And the milk was left to sit on the dock or in the back before they loaded the fridge, so that she'd regularly open a fresh gallon (with an appropriate sell-by) only to find it was sour. She made many treks back with the milk each time to get her money back.

What I'm getting at is this: it's hard to win back people like that who have already voted with their feet -- who have found satisfaction at the Roosevelt Road stores, and/or with Peapod. The Co-Op must earn back customers' trust quickly in order to save the sinking ship. It's a daunting task, whereas a changeover to a new brand might signal regime change and win customers immediately. (I remember people waiting to try Homemade Pizza Co. with bated breath after they put up their Coming Soon sign.)