Safeway 2007 Annual Report Download - page 45

SAFEWAY INC. AND SUBSIDIARIES
Operating and administrative expense decreased 29 basis points to 24.55% of sales in 2007 from 24.84% of sales in
2006. Higher fuel sales in 2007 reduced operating and administrative expense by 16 basis points. The remaining 13 basis
point decline is primarily the result of reduced employee costs as a percentage of sales and higher gains on disposal of
property, partly offset by higher depreciation expense.
Operating and administrative expense decreased 93 basis points to 24.84% of sales in 2006 from 25.77% of sales in
2005. The store exit activities and employee buyouts in 2005 reduced operating and administrative expense by 44 basis
points. Higher fuel sales in 2006 reduced operating and administrative expense by 13 basis points. The remaining decline
is primarily the result of increased sales and reduced costs as a percentage of sales from store labor, workers’
compensation and pension expense.
Operating and administrative expense decreased 53 basis points in 2005 to 25.77% of sales from 26.30% in 2004. The
significant pre-tax charges previously discussed (impairment of long-lived assets, store exit activities and employee
buyouts in 2005) combined with store exit activities, health and welfare contributions and an accrual for rent holidays in
2004 increased operating and administrative expense, as a percentage of sales, by 20 basis points. Stock option expense,
labor costs associated with the grand opening of Lifestyle stores and higher energy costs also increased operating and
administrative expense, as a percentage of sales. These items were more than offset by restructured labor agreements,
increased fuel sales and reduced workers’ compensation costs.
Interest Expense Interest expense was $388.9 million in 2007, compared to $396.1 million in 2006 and $402.6 million
in 2005. Interest expense decreased in 2007, 2006 and 2005 primarily due to lower average borrowings, partially offset
by a higher average interest rate.
Other Income Other income consists of interest income, minority interest in a consolidated affiliate and equity in
earnings from Safeway’s unconsolidated affiliates. Interest income was $11.8 million in 2007, $11.1 million in 2006 and
$12.7 million in 2005. Equity in earnings of unconsolidated affiliates was $8.7 million in 2007, $21.1 million in 2006 and
$15.8 million in 2005.
Income Taxes The Company’s effective tax rates for 2007, 2006 and 2005 were 36.7%, 29.8% and 33.9%,
respectively. The effective tax rate for 2006 included a benefit of $62.6 million related to interest, net of income tax, on
federal and state income tax refunds, a benefit of $13.6 million from the utilization of net operating loss carryforwards
and various other favorable items. The effective tax rate for 2005 included a tax benefit from the repatriation of foreign
earnings under the American Jobs Creation Act of 2004 and a tax benefit from the favorable resolution of certain tax
issues.
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. For example, a 25-basis-point
increase in the Company’s discount rate would reduce its liability by approximately $5 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 an 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.
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