Safeway 2005 Annual Report Download - page 42

SAFEWAY INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
22
Operating and administrative expense increased 128 basis points in 2003. Higher Dominick’s impairment charges increased
operating and administrative expense 30 basis points. Reduced sales from the Southern California strike increased operating
and administrative expense by an estimated 29 basis points. Higher pension expense added 28 basis points, and higher
workers’ compensation expense added 15 basis points. The remaining 26-basis-point increase was primarily due to higher
employee benefit costs, soft sales and settlement income from the termination of an in-store banking agreement recorded in
2002 operating and administrative expense.
Interest Expense Interest expense was $402.6 million in 2005, compared to $411.2 million in 2004 and $442.4 million in
2003. Interest expense decreased in 2005 primarily due to lower average borrowings in 2005 compared to 2004, partially
offset by a higher average interest rate. Interest expense also decreased in 2004, primarily due to lower average borrowings
in 2004 compared to 2003. Interest expense increased in 2003, primarily due to higher average borrowings in 2003
compared to 2002.
Other Income (Loss) Other income consists of interest income, minority interest in a consolidated affiliate and equity in
earnings from Safeway’s unconsolidated affiliates. Interest income was $12.7 million in 2005, $9.7 million in 2004 and $5.4
million in 2003. Equity in earnings (losses) of unconsolidated affiliates was income of $15.8 million in 2005, income of $12.6
million in 2004 and a loss of $7.1 million in 2003.
Income Taxes The Company’s effective tax rates for 2005, 2004 and 2003 were 33.9%, 29.4% and 220.3%, respectively.
The effective tax rate for 2005 includes a tax benefit from the repatriation of foreign earnings under the American Jobs
Creation Act of 2004, and a benefit from the favorable resolution of certain tax issues. In 2004, the effective tax rate
included benefits related to tax law changes and the resolution of certain tax issues. The higher effective tax rate in 2003
reflects the tax effect of a charge for nondeductible goodwill impairment.
Critical Accounting Policies and Estimates
Critical accounting policies are those accounting policies that management believes are important to the portrayal of
Safeway’s financial condition and results of operations and require management’s most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Workers’ Compensation The Company is primarily self-insured for workers’ compensation, automobile and general liability
costs. It is the Company’s policy to record its self-insurance liability, as determined actuarially, based on claims filed and an
estimate of claims incurred but not yet reported, discounted at a risk-free interest rate. 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. A 25-basis-point increase in the Company’s discount
rate would reduce its liability by approximately $4.7 million.
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.
Store Closures Safeway’s policy is to recognize losses relating to the impairment of long-lived assets when expected net
future cash flows are less than the assets’ carrying values. When stores that are under long-term leases close, Safeway
records a liability for the future minimum lease payments and related ancillary costs, net of estimated cost recoveries. In both
cases, fair value is determined by estimating net future cash flows and discounting them using a risk-adjusted rate of interest.
The Company estimates future cash flows based on its experience and knowledge of the market in which the closed store is
located and, when necessary, uses real estate brokers. However, these estimates project future cash flows several years into
the future and are affected by factors such as inflation, real estate markets and economic conditions.
Employee Benefit Plans The determination of Safeway’s obligation and expense for pension benefits is dependent, in part,