10-Q 1 n10q3qd.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended August 7, 2004 [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ________________ Commission file number: 33-63372 Nutritional Sourcing Corporation ----------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 65 -0415593 ------------------------------------ ------------------------------------ (State or other jurisdiction of (I.R.S. employer identification no.) incorporation or organization) 1300 N.W. 22nd Street Pompano Beach, Florida 33069 ------------------------------------ ----------------------------- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (954) 977-2500 Registrant's worldwide web address: www.pueblo.net Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ___ Indicate by check mark whether the registrant is an accelerated filer (as in Rule 12b-2 of the Exchange Act). YES NO X Indicate by check mark whether the registrant has filed all documents and Reports required to be filed by Section 12, 13, or 15(d) of the Securities and Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by the Court. YES X NO ___ Number of shares of the Registrant's Common Stock, $ .10 par value, outstanding as of September 9, 2004 -- 200. INDEX PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS Page(s) ------- Condensed Consolidated Balance Sheets (Unaudited) - August 97, ~~2003~~2004 ~~(Unaudited)~~ and November 21, ~~2002~~2003 . . . . . . . . . . . . . 3-4 Condensed Consolidated Statements of Operations (Unaudited) - Twelve and forty weeks ended August 97, ~~2003~~2004 and August 109, ~~2002~~2003 . . . . . . . . . . . . . . . . . . . . . . 5 Condensed Consolidated Statements of Cash Flows (Unaudited)- Forty weeks ended August 97, ~~2003~~2004 and August 109, ~~2002~~2003 . . . . . ~~. . . . . . . . . . . . . . .~~ 6 Notes to Condensed Consolidated Financial Statements (Unaudited) . . . . . 7-1312 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . . . . . 13. 12-2022 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . 20. 23 ITEM 4. CONTROLS AND PROCEDURES. . . . . . . . . . . . . . . . . . . 21. 23 PART II. OTHER INFORMATION ITEM 36. ~~DEFAULTS~~EXHIBITS ~~UPON SENIOR SECURITIES~~. . . . . . . . . . . . . . . ~~24 ITEM 6~~. ~~EXHIBITS AND REPORTS ON FORM 8-K~~ . . . . . . . . . . . ~~. . . 24~~23

CONDENSED CONSOLIDATED BALANCE SHEETS NUTRITIONAL SOURCING CORPORATION AND SUBSIDIARIES (Dollars in thousands)

(Unaudited) -------------------------------- August 97, November 21, 2004 2003 ~~2002~~ ------------- ------------- ASSETS CURRENT ASSETS Cash and cash equivalents $ ~~586~~536 $ ~~17,992~~651 Accounts receivable, net of allowance for doubtful accounts of $~~367~~138 at August 97, ~~2003~~2004 and $~~321~~410 at November 21, ~~2002~~2003 2,~~835~~972 32,~~226~~735 Inventories 4847,~~276~~094 51,~~660~~718 Prepaid expenses 1112,~~266~~099 118,~~018~~156 Deferred income taxes 1510,~~964~~218 1510,~~964~~218 --------- --------- TOTAL CURRENT ASSETS 7872,~~927~~919 9973,~~860~~478 --------- --------- PROPERTY AND EQUIPMENT Land and improvements 6,~~307~~407 6,~~307~~404 Buildings and improvements 4445,~~875~~671 4045,~~092~~633 Furniture, fixtures and equipment ~~101~~105,~~500~~014 ~~101~~102,~~497~~496 Leasehold improvements 43,~~676~~654 4443,~~511~~670 Construction in progress 913 1,~~196~~009 ~~5,278~~ --------- --------- ~~197~~201,~~554~~659 ~~197~~199,~~685~~212 Less accumulated depreciation and amortization ~~114~~127,~~098~~784 ~~106~~118,~~558~~705 --------- --------- 8373,~~456~~875 9180,~~127~~507 Property under capital leases, net 109,~~969~~533 1110,~~720~~745 --------- --------- TOTAL PROPERTY AND EQUIPMENT 9483,~~425~~408 ~~102~~91,~~847~~252 GOODWILL 5,621 ~~145~~5,~~477~~621 DEFERRED INCOME TAX ~~4,445~~682 ~~6,024~~682 TRADE NAMES 26,574 26,574 DEFERRED CHARGES AND OTHER ASSETS 1715,~~932~~726 1716,~~943~~827 --------- --------- TOTAL ASSETS $ ~~227~~204,~~924~~930 $ ~~398~~214,~~725~~434 ========= =========

The accompanying notes are an integral part of these condensed consolidated financial statements. CONDENSED CONSOLIDATED BALANCE SHEETS NUTRITIONAL SOURCING CORPORATION AND SUBSIDIARIES (Dollars in thousands, except share data)

(Unaudited) -------------------------------- August 97, November 21, 2004 2003 ~~2002~~ ------------- ------------- LIABILITIES AND STOCKHOLDER'S ~~EQUITY~~DEFICIT ~~LIABILITIES NOT SUBJECT TO COMPROMISE~~ CURRENT LIABILITIES Revolving credit facility $ 13,~~349~~792 $ 3211,~~000~~355 Current portion term loans 4,200 -4,200 Accounts payable 3842,~~640~~771 4443,~~387~~018 Accrued interest 1247 3,~~733~~724 73 Accrued expenses 2017,~~717~~928 1618,~~106~~768 Salaries, wages and benefits payable 78,~~719~~870 108,~~358~~661 Current obligations under capital leases ~~621~~545 ~~704~~596 ~~Current deferred tax liability~~ - ~~950~~ ----------- ----------- TOTAL CURRENT LIABILITIES 8688,~~979~~353 ~~104~~90,~~578~~322 CAPITAL LEASE OBLIGATIONS, net of current portion 1110,~~133~~091 1110,~~591~~996 LONG-TERM DEBT, - TERM LOANS, net of current portion 4035,~~100~~900 -39,050 NOTES PAYABLE 90,000 -90,000 RESERVE FOR SELF-INSURANCE CLAIMS 54,~~183~~497 54,~~240~~729 DEFERRED INCOME TAXES 2717,~~176~~818 2717,176 OTHER LIABILITIES AND DEFERRED CREDITS 2928,~~535~~014 2928,~~226~~180 ----------- ----------- TOTAL LIABILITIES ~~NOT SUBJECT TO COMPROMISE 290~~274,~~106~~673 ~~177~~280,~~811~~453 ~~----------- ----------- LIABILITIES SUBJECT TO COMPROMISE - 186,208 ----------- ----------- TOTAL LIABILITIES 290,106 364,019~~ COMMITMENTS AND CONTINGENCIES (Notes 1, ~~2, 4,~~ and 78) STOCKHOLDER'S ~~EQUITY~~DEFICIT Common stock, $.10 par value; 200 shares authorized and issued - - Additional paid-in capital 106,500 91106,500 Accumulated deficit (~~168~~176,~~682~~243) (56172,~~794~~519) ----------- ----------- TOTAL STOCKHOLDER'S ~~EQUITY~~DEFICIT (6269,~~182~~743) 34(66,~~706~~019) ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDER'S ~~EQUITY~~DEFICIT $ ~~227~~204,~~924~~930 $ ~~398~~214,~~725~~434 =========== ===========

The accompanying notes are an integral part of these condensed consolidated financial statements. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS NUTRITIONAL SOURCING CORPORATION AND SUBSIDIARIES (Dollars in thousands)

(Unaudited) (Unaudited) 12 weeks ended 40 weeks ended ------------------------ ----------------------- August 97, August 109, August 97, August 109, 2004 2003 ~~2002~~2004 2003 ~~2002~~ ----------- ---------- ----------- ---------- Net sales $123,060 $127,679 $~~135~~421,~~770~~894 $448,036 ~~$459,240~~ Cost of goods sold 83,040 86,238 91284,~~203~~397 303,420 ~~308,039~~ ----------- ----------- ----------- --------- GROSS PROFIT 40,020 41,441 44137,~~567~~497 144,616 ~~151,201~~ OPERATING EXPENSES Selling, general and administrative expenses 34,~~998~~099 34,~~477~~998 114,469 122,449 ~~120,402 Gain on insurance settlement - (14,693) - (14,693)~~ Store exit cost - 230 - 612 - Depreciation and amortization 4,351 5,108 614,~~296~~786 16,785 ~~21,235~~ ----------- ----------- ----------- --------- OPERATING PROFIT 1,570 1,105 188,~~487~~242 4,770 ~~24,257~~ Interest expense on debt (does not include contractual interest expense on pre-petition debt totaling approximately $900 and $10,000 for the 12 and 40 weeks ended August 9, 2003, respectively) (3,197) (2,705) (510,~~092~~640) (4,961) ~~(16,812)~~ Interest expense on capital lease obligations (~~404~~377) (~~422~~404) (1,~~347~~273) (1,~~402~~347) Interest and investment income (expense), net 5 (48) 7521 168 ~~177~~ Reorganization items - (2,984) - (5,654) - Gain on early extinguishment of debt - 36,508 - 36,508 - ----------- ----------- ----------- --------- (LOSS) INCOME BEFORE INCOME TAXES & CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE (1,999) 31,~~427~~472 13(3,~~048~~650) 29,484 ~~6,220~~ Income tax benefit (expense) 22 (1,250) (~~4,874~~74) (1,516) ~~(4,874)~~ ----------- ----------- ----------- --------- (LOSS) INCOME BEFORE CUMULATIVE EFFECT OF AN ACCOUNTING CHANGE (1,977) 30,222 8(3,~~174~~724) 27,968 ~~1,346~~ Cumulative effect of an accounting change - - - (139,856) - ----------- ----------- ----------- --------- NET ~~INCOME~~ (LOSS) INCOME $ (1,977) $30,222 $ 8(3,~~174~~ 724)$(111,888) ~~$ 1,346~~ =========== ============ =========== =========

The accompanying notes are an integral part of these condensed consolidated financial statements. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NUTRITIONAL SOURCING CORPORATION AND SUBSIDIARIES (Dollars in thousands)

(Unaudited) 40 weeks ended --------------------------------- August 97, August 109, 2004 2003 ~~2002~~ --------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) ~~income~~$ (3,724) $(111,888) ~~$ 1,346~~ Adjustments to reconcile net (loss) ~~income~~ to net cash provided by operating activities: Cumulative effect of an accounting change - 139,856 - Gain on early extinguishment of debt - (36,508) - Depreciation and amortization of property and equipment 10,501 11,732 ~~12,241~~ Amortization of intangibles, other assets and inventories 54,~~053~~285 ~~8,994 Accrual for exit costs on store closing 612 - Amortization of bond discount - 802 Reorganization items~~ 5,~~654~~053 ~~- (~~Provision) ~~benefit~~ for deferred income taxes 642 629 ~~807~~ Gain on disposal of property and equipment, net - (393) - Changes in operating assets and liabilities: ~~Decrease~~ (~~increase~~Increase) decrease in: Accounts receivable (237) 328 ~~946~~ Inventories 1,227 (345) ~~(421)~~ Prepaid expenses (13,~~286~~943) (31,~~125~~286) Other assets 213 (1,486) ~~(719)~~Increase (~~Decrease~~decrease) ~~increase~~ in: Accounts payable, accrued expenses and accrued interest (4,~~704~~564) ~~671~~1,562 Salaries, wages and benefits payable 209 (2,639) ~~1,080 Income taxes currently payable - 1,753 Current deferred tax liability - 2,314~~ Other liabilities and deferred credits and reserve for self-insurance claims ~~252~~ (~~783~~398) 252 --------------- -------------- Net cash provided by operating activities 4,208 5,260 ~~25,867~~ --------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (3,~~313~~145) (43,~~830~~313) Proceeds from disposal of property and equipment 4 3 39 --------------- -------------- Net cash used in investing activities (3,~~310~~141) (43,~~791~~310) --------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: ~~Repayment~~Repayments ofon April 1997 revolving credit facility, net of borrowings - (32,000) ~~2,000~~ Borrowings (repayments) under May 2003 Bank Agreement: Borrowing under revolving credit facility ~~103~~,~~457~~ -net ~~Repayments~~ of ~~revolving~~repayments ~~credit~~2,437 ~~facility (90~~13,~~108)~~349 -Borrowings ~~Principal borrowings~~ on term loans - 45,000 -Repayments ~~Principal payments~~ on term loans (3,150) (700) - Principal payment on Notes and Series C Senior Notes - (59,464) - Proceeds from capital contribution - 15,000 - Principal payments on capital lease obligations (~~541~~469) (~~480~~541) --------------- -------------- Net cash (used in) ~~provided by~~ financing activities (1,182) (19,356) ~~1,520~~ --------------- -------------- Net (decrease) ~~increase~~ in cash and cash equivalents (115) (17,406) ~~22,596~~ Cash and cash equivalents at beginning of period 651 17,992 ~~2,169~~ --------------- -------------- Cash and cash equivalents at end of period $ ~~586~~536 $~~24,765~~ 586 =============== ============== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $14,824 $ 3,254 ~~$11,456~~ Income taxes ~~paid~~ (refunded), ~~net~~paid $ (432) $ 608 Reorganization items $ ~~(597)~~1,731 $ 1,125

The accompanying notes are an integral part of these condensed consolidated financial statements NUTRITIONAL SOURCING CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands) NOTE 1 -- INTERIM FINANCIAL STATEMENTS Basis of Presentation The unaudited condensed consolidated financial statements include the accounts of Nutritional Sourcing Corporation ("NSC"), and its wholly owned subsidiaries (the "Company"). The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and in accordance with the requirements of Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and changes in cash flows required by GAAP. The Company's fiscal year ends on the Saturday closest to October 31. Interim operating results for the 12 and 40 weeks ended August 7, 2004 and August 9, 2003 are not necessarily indicative of results that may be expected for the full fiscal year. The unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended November 1, 2003. The Property and Equipment components of the balance sheet as of November 1, 2003, have been reclassified to record the gross cost and accumulated depreciation applicable to assets still used in the business, which were previously recorded at a net cost of zero. With respect to the unaudited condensed consolidated financial statements for the 12 and 40 weeks ended August 7, 2004 and August 9, 2003, it is the opinion of the management of the Company that all adjustments necessary to present a fair statement of the results for such interim periods have been included. Such adjustments, other than those related to the cumulative effect of an accounting change as detailed herein, were of a normal and recurring nature. Inter-company accounts and transactions are eliminated in consolidation. In August 2002, NSC defaulted in the payment of interest on its outstanding notes, and consented to the entry of an order for relief under Chapter 11 of the Bankruptcy code the next month. NSC consummated a plan of reorganization and emerged from bankruptcy in June 2003. Consequently, the condensed consolidated statement of operations included herein for the 12 and 40 weeks ended August 9, 2003 include the accounting treatment for the contractual interest expense for pre-petition debt and for reorganization items prescribed by the American Institute of Certified Public Accountants ("AICPA")'s Statement of Position 90-7, "Financial Reporting By Entities in Reorganization Under the Bankruptcy Code," ("SOP 90-7"). The relief under Chapter 11 pertained to NSC only, not to its operating subsidiaries. NOTE 2 -- INVENTORY The results of the Company's operations are based on the application of the last-in, first-out ("LIFO") method of valuing certain inventories of grocery, non-food and dairy products. Since an actual valuation of inventories under the LIFO method is only made at the end of a fiscal year based on inventory levels and costs at that time, interim LIFO calculations are based on management's estimates of expected year-end inventory levels and costs and are subject to year-end adjustments. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands) NOTE 3 - GOODWILL AND TRADE NAMES Goodwill previously represented the excess of cost over the then estimated fair value of the net tangible and other intangible assets acquired in connection with the 1993 purchase of all the outstanding series of the common stock of Pueblo International, Inc. (the "Acquisition"). Trade names acquired at the time of the Acquisition were recorded based on valuations by independent appraisers. Goodwill and trade names were being amortized using the straight-line method over periods of 40 years. During the 40 weeks ended August 9, 2003, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets". Accordingly, beginning November 3, 2002, goodwill and trade names are no longer amortized as a recurring charge to earnings and will thereafter be tested, at least annually, for impairment. As a result of its adoption, the Company had an independent, qualified third party evaluator perform a transitional impairment test on its existing goodwill and intangible assets on November 3, 2002. This impairment test was calculated at the reporting unit level, which are the retail food division and the in-home movie and game entertainment division for the Company. The goodwill impairment test has two steps: the first, identifies potential impairments by comparing the fair value of a reporting unit to its book value including goodwill. Generally, fair value represents a multiple of earnings before interest, taxes, depreciation, and amortization ("EBITDA") or discounted projected future cash flows. The Company determined that the carrying value of its retail food division, which included $139,856 of goodwill, exceeded its fair value. Impairment was not indicated for the goodwill associated with its in-home movie and game entertainment division. Additionally, no impairment was indicated for trade names. The second step of the impairment test calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying amount. If the implied goodwill is less than the carrying amount, a write down is recorded. The third party evaluator performed step two of the impairment test, and as a result of this analysis, the evaluator determined that the retail food division goodwill was entirely impaired. This loss was recorded as a cumulative effect of an accounting change during the first quarter (16 weeks) ended February 22, 2003. There wasn't any change in the Company's goodwill and trade names balance during the 40 weeks ended August 7, 2004. NOTE 4 - CAPITAL LEASE OBLIGATIONS As reported in the Company's 10-Q for the quarter ended May 15, 2004, filed with the Securities and Exchange Commission on June 25, 2004, on April 15, 2004, the Company signed a lease amendment for one of its properties in Puerto Rico. As a result of the amendment, the Company returned approximately 50,000 sq. ft. of vacant land to the landlord, and both long-term capital lease obligations and property under capital leases were reduced by approximately $487. NOTE 5 -- DISCLOSURE OF OPERATING SEGMENTS The Company has two primary operating and reporting segments: the retail food division and the in-home movie and game entertainment division both of which are headquartered in Puerto Rico. The retail food division consisted of 46 supermarkets as of August 7, 2004, 41 of which are in Puerto Rico and 5 of which are in the U.S. Virgin Islands. The in-home movie and game entertainment division consisted of 41 in-home movie and game entertainment stores as of August 7, 2004, 39 of which are in Puerto Rico and 2 of which are in the U.S. Virgin Islands. On May 21, 2004 the Company closed one of its in- NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands) NOTE 5 -- DISCLOSURE OF OPERATING SEGMENTS (continued) home movie and game entertainment stores in Puerto Rico. Any exit costs associated with the closing of this store were immaterial and are included in selling, general and administrative expenses in the condensed consolidated statement of operations in this form 10-Q. Of the 39 in-home movie and game entertainment stores located in Puerto Rico, 16 are adjacent to the Company's supermarkets and 23 are freestanding stores. Of the two in-home movie and game entertainment stores located in the U.S. Virgin Islands, one is free- standing and the other is located adjacent to the Company's store. Certain administrative support functions are located in Florida. Although the Company maintains data by geographic location, its segment decision-making process is based on its two product lines. Reportable operating segment financial information is as follows:

12In-home ~~weeks~~Movie ~~ended~~and 40Game ~~weeks~~Retail ~~ended~~Food Entertainment Total -----------~~------------~~ ------------- ---------- For the 40 Weeks Ended and as of August 97, ~~August~~2004: 10Net sales $ 391,385 ~~August~~$ 930,509 ~~August~~$ 421,894 Depreciation and amortization 10,463 ~~2003~~4,323 ~~2002~~14,786 ~~2003~~Operating ~~2002~~profit ~~----------~~(a) ~~----------~~3,830 ~~----------~~4,412 8,242 Total assets 189,128 15,802 204,930 Capital expenditures 3,027 118 3,145 In-~~---------~~home ~~Reported~~movie ~~net~~and ~~income~~game ~~(loss)~~entertainment $purchases 30N/A 3,~~222~~639 3,639 For the 40 Weeks Ended and as of August 9, 2003: Net sales $ 8416,~~174~~055 $~~(111~~ 31,~~888)~~981 $ 1448,~~346~~036 ~~Add:~~Depreciation ~~Goodwill~~and amortization -11,954 14,~~094~~831 16,785 Store exit costs (b) 612 - 3612 Operating profit (a) (b) 132 4,~~646~~638 ~~Trade~~4,770 ~~names~~Total ~~amortization~~assets -210,120 ~~200~~17,804 -227,924 ~~667~~Capital ~~----------~~expenditures ~~----------~~3,206 ~~----------~~107 3,313 In-~~---------~~home ~~Adjusted~~movie ~~net~~and ~~income~~game ~~(loss)~~entertainment $purchases 30N/A 3,~~222~~889 $3,889 9As of November 1,~~468~~ 2003: Total assets $~~(111~~ 196,~~888)~~891 $ 517,~~659~~543 ~~==========~~$ ~~========== ========== ==========~~214,434

Because the retail food and in-home movie and game entertainment divisions are not segregated by corporate entity structure, the operating segment amounts shown above do not represent totals for any subsidiary of the Company. All overhead expenses including depreciation on assets of administrative departments are allocated to operations. Amounts shown in the total column above correspond to amounts in the consolidated financial statements. (a) See Management's Discussion and Analysis for discussions of gross profit and selling, general and administrative expenses. (b) The 40 weeks ended August 9, 2003 include a $612 loss (before income taxes) for the estimated closure costs of two supermarkets for NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands) NOTE 5 -- DISCLOSURE OF OPERATING SEGMENTS (continued) which the Company had already given notice to the landlords of its intent not to renew the leases and were subsequently closed. One of the supermarkets was in Puerto Rico, and one was on the island of St. Thomas in the U.S. Virgin Islands. Both were closed based on management's view of their profit potential. The exit costs accrued primarily include contractual occupancy costs, property taxes, and other occupancy costs beyond the closing date, employee severance and related benefit costs. NOTE 6 -- RECENT ACCOUNTING PRONOUNCEMENTS In March 2004, the Financial Accounting Standards Board ("FASB"), Emerging Issues Task Force ("EITF"), confirmed as a consensus EITF Issue 03- 16, which requires investments in limited liability corporations that have separate ownership accounts for each investor to be accounted for similar to a limited partnership investment under the AICPA's Statement of Position No. 78- 9 ("SOP 78-9"), Accounting for Investments in Real Estate Ventures. Investors would be required to apply the equity method of accounting to their investments at a much lower ownership threshold (typically any ownership interest greater than 3%-5%) than the 20% threshold applied under Accounting Principles Board ("APB") Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. The consensus is effective for the first period beginning after June 15, 2004 and the change should be reported as a retroactive cumulative effect, with certain exceptions. EITF 03-16 did not have an effect on the Company's condensed consolidated financial statements. The Company has no such investments as all of its subsidiaries and their second tier subsidiaries are 100% owned and consolidated in these financial statements. NOTE 7 -- RETIREMENT BENEFITS In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures about Pensions and Other Post Retirement Benefits." This revision ("No. 132R") requires additional disclosures to those in the original SFAS No. 132 about assets, obligations, cash flows and the periodic benefit cost of defined benefit pension plans and other defined benefit post-retirement plans. The required information should be provided separately for pension plans and for other post-retirement benefit plans. This statement revision is effective for the fiscal years ended after December 14, 2003 and interim periods beginning after December 15, 2003. The Company has a noncontributory defined benefit plan (the "Retirement Plan") covering substantially all full-time and certain part-time associates. Retirement Plan benefits are based on years of service and a base level of compensation. The Company funds retirement plan costs in accordance with the requirements of the Employee Retirement Income Security Act of 1974. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Retirement Plan assets consist primarily of stocks, bonds and U.S. Government securities. Full vesting for the Retirement Plan occurs upon the completion of five years of service. The Company has made approximately $2,271 in contributions to its defined benefit pension plan trust during the 40 weeks ended August 7, 2004. During the remainder of its fiscal year ending October 30, 2004, the Company anticipates contributing approximately $2,114 to the trust. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands) NOTE 7 -- RETIREMENT BENEFITS (continued) Net pension cost under the Retirement Plan includes the following components:

~~Retail~~For ~~Food~~the ~~Video~~12 ~~Rental~~weeks ~~Total~~ended For the 40 ~~Weeks~~weeks ~~Ended~~ended ~~and~~---------------------- as---------------------- of August 97, ~~2003:~~August ~~Net sales $ 416~~9,~~055~~ $August 317,~~981~~ $August ~~448~~9,~~036~~ ~~Depreciation~~2004 ~~and~~2003 ~~amortization~~2004 ~~(11,954)~~2003 ~~(4,831)~~---------- ~~(16,785)~~---------- ~~Store~~---------- ~~exit~~---------- ~~costs~~Service ~~(b)~~cost ~~612~~ - ~~612~~benefits ~~Operating~~earned ~~profit~~during ~~(a)~~the ~~(b)~~period ~~132~~$ ~~4,638~~325 ~~4,770~~$ ~~Total~~280 ~~assets 210~~$1,~~120~~083 ~~17,804~~$ ~~227,924~~934 ~~Capital~~Interest ~~expenditures~~cost ~~(3,206)~~on ~~(107)~~projected ~~(3,313)~~benefit ~~Rental~~obligation ~~video~~378 ~~tape~~384 ~~purchases N/A (3~~1,~~889)~~262 (31,~~889)~~279 ~~For~~Expected ~~the~~return 40on ~~Weeks~~plan ~~Ended~~assets ~~August 10, 2002: Net sales $ 427,593 $ 31,647 $ 459,240 Depreciation and amortization~~ (~~16,282~~230) (~~4,953~~192) (~~21,235~~767) ~~Gain on settlement of insurance claim~~ (c639) ~~13,421~~Net ~~1,272~~amortization ~~14,693~~and ~~Operating~~deferrals ~~profit~~ (a1) (c1) ~~18,097 6,160 24,257 Capital expenditures~~ (4~~,780~~) (~~50) (~~4~~,830~~) ~~Rental~~Recognized ~~video~~net ~~tape~~actuarial ~~purchases~~loss ~~N/A~~46 ~~(4,340)~~31 ~~(4,340)~~153 As104 of--------- ~~November~~--------- 2,--------- ~~2002:~~---------- ~~Total~~NET ~~assets~~PENSION COST $ ~~378,529~~518 $ 20502 $ 1,~~196~~727 $ ~~398~~1,~~725~~674 ========= ========= ========= ==========

The Company maintains a Supplemental Executive Retirement Plan (the "SERP"), which is an un-funded plan, for its officers under which the Company will pay, from general corporate funds, a supplemental pension equal to the difference between the annual amount of pension calculated under the SERP and the amount the participant will receive under the Retirement Plan. Effective January 1, 1992, the Board of Directors amended the SERP in order to conform various provisions and definitions with those of the Retirement Plan. The pension benefit calculation under the SERP is limited to a total of 20 years employment and is based on a specified percentage of the average annual compensation received for the five highest consecutive years during a participant's last 10 years of service, reduced by the participant's annual Retirement Plan and social security benefits. Full vesting for the SERP occurs upon the completion of five years of service. The Company has made approximately $285 in payments to its beneficiaries during the 40 weeks ended August 7, 2004. During the remainder of its fiscal year ended October 30, 2004, the Company currently anticipates paying approximately $96 to the beneficiaries of the plan. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands) NOTE 7 -- RETIREMENT BENEFITS (continued) Net pension cost under the SERP includes the following components:

~~Stores~~For inthe ~~Operation:~~12 Atweeks ~~August~~ended ~~10,~~For ~~2002.~~the .40 .weeks .ended ~~. . . . . . . . . 88 Stores opened: Supermarkets . . . . . . . . . . . . . 1 Video tape rental stores . . . . . . . 1 Stores closed: Supermarket . . . . . . . . . . . . . .~~ - ~~Video tape rental stores . . . . . . .~~ --------------------- ---------------------- AtAugust 7, August 9, ~~2003. . . . . . . . . . . . . 90 * ======= Remodels . . . . . . . . . . . . . . . . . - =======~~ August 97, August 109, 2004 2003 ~~2002~~2004 2003 ------------ ---------- -- ~~Store Composition at Quarter~~-~~End: By division: Supermarkets . . . . . . . . . . . . 48 47 Video tape rental stores . . . . . . 42 41~~ ------- ---------- ~~Total~~Service 90cost 88- ~~=======~~benefits ~~=======~~earned Byduring ~~location:~~the ~~Puerto~~period ~~Rico~~$ .73 .$ .84 .$ .244 .$ .279 .Interest .cost .on .projected .benefit .obligation 8295 8095 ~~U.S.~~315 ~~Virgin~~318 ~~Islands~~Net .amortization .and .deferrals .1 .2 .4 .6 .---------- .---------- ~~8 8~~ ---------- ---------- ~~Total~~NET 90PENSION *COST 88$ 169 $ 181 $ 563 $ 603 ========== ========== *========== The stores in operation as of August 9, 2003 include two supermarkets that will be closed (see NOTE 5 ? DISCLOSURE OF OPERATING SEGMENTS included in the notes to the Company's consolidated financial statements included in Item 1 of this Form 10-Q).==========

NOTE 8 -- CONTINGENCIES At August 7, 2004, the Company was party to a number of legal Proceedings involving claims for money damages arising in the ordinary course of conducting its business, which are either covered by insurance or are within the Company's self-insurance program, and in a number of other proceedings, which are not, deemed material. It is not possible to determine the ultimate outcome of these matters; however, management is of the opinion that the final resolution of any threatened or pending litigation at such date is not likely to have a material adverse effect on the financial position or results of operations of the Company. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The Company operates retail supermarkets and in-home movie and game entertainment stores ("in-home entertainment stores") in the Caribbean; specifically on the islands of Puerto Rico, St. Thomas and St. Croix, the latter two being part of the group of islands known as the U.S. Virgin Islands. The population in these markets has grown very slowly (the 1990 U.S. Census indicated there were approximately 3.5 million people in Puerto Rico and the 2002 U.S. Census indicated there were approximately 3.9 million people in Puerto Rico). The Company's strategy for both the supermarkets and the in-home entertainment business is to concentrate on improving the value offering in, and convenience at, its existing locations rather than engaging in an expansion program. In both businesses this involves a greater variety of goods and services than that offered by competitors. Consequently, from January 2000 through August 7, 2004 the Company's supermarkets have decreased from 50 to 46. This net decrease of four stores is the result of closing five stores and opening one new store. The Company's in-home entertainment stores have decreased from 43 in January of 2000 to 41 as of August 7, 2004. This net decrease of two stores is the result of closing four stores and opening two new stores. On May 21, 2004, the Company closed one of its in-home entertainment stores in Puerto Rico. The Company is evaluating replacement sites for this store. For more detail concerning stores for the period from August 9, 2003 through August 7, 2004 see page 17 of this Form 10-Q. For the detail of activity for the fiscal year of 2000 through the end of fiscal year ended November 1, 2003 see ITEM 2 - PROPERTIES in the Company's Form 10-K for the 52 weeks ended November 1, 2003, which was filed with the Securities and Exchange Commission on January 28, 2004. The Company's supermarket markets have been affected by an increasing level of competition from local supermarket chains, independent supermarkets, warehouse club stores, mass merchandisers, department stores, discount drug stores and convenience stores. Warehouse club stores and mass merchandisers, which began entering the Puerto Rico and U.S. Virgin Islands markets in 1990 offering various grocery and general merchandise items, have increased pricing pressures on supermarket retailers including the Company. In addition, low inflation in food prices in recent years has made it difficult for the Company and other supermarket operators to increase prices and has intensified the competitive environment by causing retailers to emphasize promotional activities and discount pricing to maintain or gain market share, in addition to improving cost and expense efficiencies at all levels. Pueblo is the only supermarket operator in its markets that has a customer loyalty program that provides special economic benefits to consumers that have chosen to participate in the program. Since its inception in March 2001, these benefits have included special discounts on selected items. There are approximately 1,000,000 loyalty cards issued by Pueblo. In April 2004, the Company enhanced the program to offer additional savings to participants. The additional savings are based on the points earned by the participants. A point is earned for every dollar spent at Pueblo during the calendar year. Once 600 points have been earned the customer receives a discount on all purchases for the remainder of the calendar year in the department chosen by the participant. The discount is 12% for all departments other than grocery and 6% for grocery. These discounts, when utilized by the consumer-participants, are deducted from gross sales in the accompanying condensed consolidated financial statements as required by GAAP in the United States. The following discussion of the Company's financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q: Risk Factors Forward Looking Statements Statements, other than statements of historical information, under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Form 10-Q may constitute forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are based on Company management's expectations and are subject to various risks and uncertainties. Actual results could differ materially from those anticipated due to a number of factors, including but not limited to the Company's substantial indebtedness and high degree of leverage, which continue as a result of the financial restructuring (including limitations on the Company's ability to obtain additional financing and trade credit, to apply operating cash flow for purposes in addition to debt service, to respond to price competition in economic downturns and to dispose of assets pledged to secure such indebtedness or to freely use proceeds of any such dispositions), the Company's limited geographic markets and competitive conditions in the markets in which the Company operates and buying patterns of consumers. Supermarket Industry The retail grocery industry is extremely competitive and is characterized by high inventory turnover and narrow profit margins. The Company's results of operations are therefore sensitive to, and may be materially adversely impacted by, among other things, competitive pricing, promotional pressures and additional store openings by competitors. The Company competes with national, regional and local supermarkets, warehouse club stores, drug stores, convenience stores, discount merchandisers and other local retailers in the market areas it serves. Competition with these outlets is based on price, store location, advertising and promotion, product mix, quality and service. Some of these competitors may have greater financial resources, lower merchandise acquisition costs and lower operating expenses than the Company, and the Company may be unable to compete successfully in the future. In-home Movie and Game Entertainment Operations The Company's in-home movie and game entertainment franchise faces significant competition and risks associated with technological obsolescence, and the Company may be unable to compete effectively. The in-home movie and game entertainment industry is highly competitive. The Company competes with local video retail stores, and with mass merchants, specialty retailers, supermarkets, pharmacies, convenience stores, bookstores, mail order operations, online stores and other retailers, as well as with noncommercial sources, such as libraries. As a result of direct competition with others, pricing strategies for in-home movies and games is a significant competitive factor in the Company's in-home movie and game entertainment business. The Company's in-home movie and game entertainment business also competes with other forms of entertainment, including cinema, television, sporting events and family entertainment centers. If the Company does not compete effectively with competitors in the in-home movie and game entertainment industry or with providers of other forms of entertainment, its revenues and/or its profit margin could decline and its business, financial condition, liquidity and results of operations could be adversely affected. Further, the division's operations are dependent on the studios that develop and distribute the product. Changes in video formats or distribution practices (for example from VHS tapes to DVD's) are disruptive to the division's operations as these changes may cause significant changes in its product acquisition costs, quantities it is required to purchase, the timing of the period a title may be rented before it is brought to market for sale (which impacts the length of time of high rental volume for a title - better known in the industry as the "rental window") and its per rental revenue depending on the distribution and pricing practices of the studios. The division is also dependent on the movie and game production industry for the development of new product and re-launches of older titles as it has no production or duplication facilities of its own. Geographic Considerations; Regulation The Company is concentrated in Puerto Rico and in the U.S. Virgin Islands. As a result, the Company is vulnerable to economic downturns in those regions, as well as natural and other catastrophic events, such as hurricanes and earthquakes that may impact those regions. These events may adversely affect the Company's sales which may lead to lower earnings, or even losses, and may also adversely affect its future growth and expansion. Further, since the Company is concentrated on three islands, opportunities for future store expansion may be limited, which may adversely affect its business and results of operations. Additionally, the Company is subject to governmental regulations (such as import taxes) that impose obligations and restrictions and may increase its costs. The Company is Highly Leveraged The Company has a substantial amount of indebtedness and debt service obligations, which could adversely affect its financial and operational flexibility and increase its vulnerability to adverse conditions. The Company could incur additional indebtedness in the future, including indebtedness that would be secured by its assets. If the Company increases its indebtedness, the related risks that it now faces could intensify. For example, the Company's current level of indebtedness and/or an increase in indebtedness could: - require the Company to dedicate an increased portion of its cash flow to payments on its indebtedness; - limit the Company's ability to borrow additional funds; - increase the Company's vulnerability to general adverse economic and industry conditions; - limit the Company's ability to fund future working capital, capital expenditures and other general corporate requirements; - limit the Company's flexibility in planning for, or reacting to, changes in its business and the industry in which it operates or taking advantage of potential business opportunities; - limit the Company's ability to execute its business strategy successfully; and - place the Company at a potential competitive disadvantage in its industries. The Company's ability to satisfy its indebtedness will depend on its financial and operating performance, which may fluctuate significantly from quarter to quarter and is subject to economic, industry and market conditions and to risks related to its business and other factors beyond its control. The Company cannot provide assurance that its business will generate sufficient cash flow from operations or that future borrowings will be available to it in amounts sufficient to enable it to pay its indebtedness or to fund its other liquidity needs. Further, as NSC is a holding company, indebtedness at the NSC level is effectively subordinated to indebtedness and other obligations at the operating subsidiary level. See Item 2; MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS included in this Form 10-Q and NOTE 5 - DEBT to the consolidated financial statements included in item 15 of the Company's Form 10-K filed with the Securities and Exchange Commission on January 28, 2004. Market Risk In addition to the foregoing, the market price of the Company's debt securities may be significantly affected by change in market rates of interest, yields obtainable from investments in comparable securities, credit ratings assigned to the Company's debt securities by third parties and perceptions regarding its ability to pay its obligations on its debt securities. Critical Accounting Estimates There have been no material changes in the basis for, or method of computation of, the Company's critical accounting estimates since the year ended November 1, 2003. For a discussion of the Company's critical accounting estimates see the "Critical Accounting Estimates" section of ITEM 7 of the Company's Form 10-K for the year ended November 1, 2003, which was filed with the Securities and Exchange Commission on January 28, 2004. Selected Operating Results (As a percentage of sales) Net sales 100.0% 100.0% 100.0% 100.0% Gross profit 32.5 32.5 32.6 32.3 Selling, general & administrative expenses 27.7 27.4 27.1 27.3 Store exit costs (2) - 0.2 - 0.1 EBITDA, as defined (1) 4.8 4.9 5.5 4.8 Depreciation & amortization 3.5 4.0 3.5 3.7 Operating profit 1.3 0.9 2.0 1.1 Reorganization items - (2.3) - (1.3) Gain on early extinguishment of debt - 28.6 - 8.1 (Loss) income before income taxes and cumulative effect of an accounting change (1.6) 24.6 (0.9) 6.6 (Loss) income before cumulative effect of an accounting change (1.6) 23.7 (0.9) 6.2 Net (loss) income (1.6) 23.7 (0.9) (25.0)

(1) EBITDA (as defined) represents earnings before interest, taxes, depreciation, amortization, reorganization items, the gain on early extinguishment of debt and the cumulative effect of an accounting change. EBITDA (as defined) is not intended to represent cash flow from operations as defined by accounting principles generally accepted in the United States of America and should not be considered as an alternative to net income (loss) as an indication of the Company's operating performance or to cash flows as a measure of liquidity. EBITDA (as defined) is included as it is a basis upon which the Company assesses its financial performance. EBITDA (as defined) margin represents EBITDA (as defined) divided by net sales. The bank credit facility and the indenture underlying NSC's publicly issued debt contain various financial covenants. Some of these covenants are based on EBITDA. Consequently, EBITDA is disclosed and discussed as management believes it is an important means by which to measure the Company's liquidity and compliance with its debt covenants, and it is a measure by which management monitors operating results. Furthermore, EBITDA is used, in part, to determine incentive compensation for management. (2) The 12 and 40 weeks ended August 9, 2003, include a $0.2 million and $0.6 million loss, respectively (before income taxes) for the estimated closure costs of two stores. Following is a reconciliation of Net (Loss) Income to EBITDA, as defined (dollars in thousands):

~~Percentage~~For ~~increase (decrease) in sales for~~ the 12 ~~and~~weeks 40 ended ~~August~~For ~~9, 2003, as compared to~~ the ~~12 and~~ 40 weeks ended ~~August 10, 2002~~ ---------------------- ----------------------~~---------~~ 12August ~~Weeks~~7, ~~Ended~~August 409, ~~Weeks~~August ~~Ended~~7, August 9, 2004 2003 2004 2003 ---------- ---------- ---------- ---------- ~~Total~~Net ~~Sales~~ (~~6.0~~loss)% income $(~~2.4~~1,977)% ~~=========~~$30,222 ~~=========~~$ ~~Comparable~~(3,724) ~~Stores~~$(111,888) Add/(Subtract): ~~Retail~~Cumulative ~~Food~~effect ~~Division~~of an accounting change - - - 139,856 Income tax (~~9.8~~benefit)% expense (~~5.9~~22)% ~~=========~~1,250 ~~=========~~74 ~~Video~~1,516 ~~Rental~~Gain ~~Division~~on early extinguishment of debt - (~~6.4~~36,508)% - (036,508) Reorganization items - 2,984 - 5,654 Interest and investment (income) expense, net (5) 48 (21) (168) Interest expense on capital lease obligations 377 404 1,273 1,347 Interest expense on debt 3,197 2,705 10,640 4.961 Depreciation and amortization 4,351 5,108 14,786 16,785 ---------- ---------- ---------- ---------- EBITDA (as defined)% $ 5,921 $ 6,213 $ 23,028 $ 21,555 ========== ========== ~~Total Comparable Store Sales (9.6)% (5.5)%~~ ========== ==========

Please see pages 18-20 of this MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for a discussion of the changes in the components of EBITDA. Results of Operations As of August 7, 2004, the Company operated a total of 46 supermarkets and 41 in-home movie and game entertainment locations in Puerto Rico and the U.S. Virgin Islands. The history of store openings and closings from August 9, 2003 through the end of the third quarter of the current fiscal year on August 7, 2004, as well as the store composition, is set forth in the following tables:

~~INTEREST~~Stores ~~EXPENSE~~in ONOperation: ~~DEBT~~At August 9, 2003 . . . . . . . . . . . . . . . 90 Stores closed: Puerto Rico - Supermarket . . . . . . . . . . 1 U.S. Virgin Islands -~~---------------------------------------------~~ ~~For~~Supermarket ~~the~~. 12. ~~weeks~~. ~~ended~~. ~~For~~. ~~the~~. 401 ~~weeks~~Puerto ~~ended~~Rico - In-~~--------------------~~home movie and game entertainment store 1 -------~~---------------~~ At August 97, ~~August~~2004 ~~10,~~. . . . . . . . . . . 87 ======= August 97, August 109, ~~2003~~2004 ~~2002~~ 2003 ~~2002~~ ---------- --~~--------~~ ---------- --~~--------~~ ~~Interest~~Store ~~expense~~Composition onat ~~debt~~Quarter-End: ~~Liabilities~~Supermarkets ~~subject~~by tolocation: ~~compromise~~Puerto ~~(the~~Rico ~~amount~~. of. ~~contractual~~. ~~interest~~. ~~expense~~. on. ~~pre-petition~~. ~~debt~~. ~~not~~. ~~accrued~~. ~~was~~. ~~$900~~. ~~and~~. ~~$10,000~~. ~~for~~. ~~the~~41 1242 ~~and~~U.S. 40Virgin ~~weeks~~Islands ~~ended~~. ~~August~~. 9,. ~~2003,~~. ~~respectively)~~. $. . . . . . 5 6 ------- $------- ~~4,150~~Subtotal $Supermarkets 46 48 ======= ======= In-home $movie ~~13,754~~and ~~New~~game 10entertainment stores by location: Puerto Rico .~~125~~ ~~Senior~~. ~~Secured~~. ~~Notes,~~. ~~issued~~. ~~6/5/03~~. ~~1,636~~. -. ~~1,636~~. -. ~~Revolver~~. ~~borrowings~~. ~~318~~. ~~501~~. ~~1,351~~. ~~1,649~~. ~~Term~~39 ~~loans~~40 ~~574~~U.S. -Virgin ~~574~~Islands -. ~~Amortization~~. of. ~~debt~~. ~~issuance~~. ~~costs~~. ~~177~~. ~~441~~. ~~1,400~~. ~~1,409~~. . . 2 2 -------~~---~~ ------- Subtotal In---home Movie and game entertainment stores 41 42 -------~~---~~ -------~~---~~ Grand Total $87 ~~2,705~~90 ~~$ 5,092 $ 4,961 $ 16,812~~ =======~~===~~ =======~~=== ========== ==========~~

The following is the summary of total and comparable store sales:

~~For~~Percentage decrease in sales for the 12 and 40 weeks ended ~~For~~August 7, 2004, as compared to the 12 and 40 weeks ended August 9, 2003 ---------------------- ---------------------- ~~August 9, August 10, August 9, August 10, 2003 2002 2003 2002~~ ---------- 12 Weeks 40 Weeks ---------- -- -------- -----~~-----~~ ~~Operating~~Total Sales (~~loss~~3.62) ~~profit~~% $(5.83) ~~1,105~~% ~~$18,487~~========= $========= ~~4,770~~Comparable ~~$24,257 Add~~Stores: ~~Depreciation~~Retail ~~and~~Food ~~amortization~~Division ~~5,108~~(1.53) ~~6,296~~% ~~16,785~~(4.71) ~~21,235~~% ~~----------~~========= ~~----------~~========= In-~~---------~~home ~~----------~~movie ~~EBITDA~~and ~~(as~~game ~~defined)~~entertainment $division (6~~,213~~.18) ~~$24,783~~% ~~$21,555~~(4.67) ~~$45,492~~% ========== ========== Total Comparable Store Sales (1.86) % (4.70) % ========== ==========

Net sales for the 12 and 40 weeks ended August 7, 2004 were $123.1 million and $421.9 million, respectively, versus $127.7 million and $448.0 million for the 12 and 40 weeks ended August 9, 2003, decreases of $4.6 million and $26.1 million or 3.6% and 5.8%, respectively. A portion of the decline in net sales is a result of closing two supermarkets during the fourth quarter of the year (52 weeks) ended November 1, 2003. Of the $4.6 million and $26.1 million decline, net sales declined approximately $2.2 million and $7.9 million for the 12 and 40 weeks ended August 7, 2004, respectively, compared to the 12 and 40 weeks ended August 9, 2003, respectively, as a result of closing these two stores. The stores were closed as a result of unsatisfactory operating results and management's belief that satisfactory results were not attainable in the future. Same store net sales decreased by 1.9% and 4.7%, respectively. For the 12 and 40 weeks ended August 7, 2004, same store net sales were $123.1 million and $404.3 million, respectively, versus $125.4 million and $424.3 million, respectively for the 12 and 40 comparable weeks ended August 9, 2003. "Same stores" are defined as those stores that were open as of the beginning of both periods and remained open through the end of the periods. Same store net sales in the retail food division decreased 1.5% and 4.7%, respectively, from the 12 and 40 comparable weeks ended August 9, 2003. The principal factors contributing to the decline in same stores net sales in the retail food division is continued growth in competition and a softening of the economy in Puerto Rico. The factors discussed above concerning the decline in same store net sales have created severe pressure on the Company's retail food division as well as its competitors to reduce retail prices in the Company's markets. Subsequent to introducing the additional benefits to participants in Pueblo's customer loyalty program (discussed on page 13 of this Form 10-Q) the decline in same store net sales in the retail food division abated somewhat. More specifically, the same store retail sales went from a decline of 5.8% for the 28 weeks ended May 15, 2004, to a decline of 1.53% for the 12 weeks ended August 7, 2004. In-home movie and game entertainment division same store net sales decreased 6.2% and 4.7%, respectively, from the 12 and 40 comparable weeks ended August 9, 2003 primarily due to a decline in rental revenue. As the popularity of DVD's has increased over the past several years, so has competition in this industry. This is because DVD titles are primarily released for rental and sale at the same time, whereas VHS tapes had generally been released for rental prior to being released for sale allowing the Company to benefit from a "rental window". Currently, substantially all DVD's and tapes are simultaneously released for rental and sale resulting in lower sell-through prices and a negative impact on rental from selling the DVDs or tapes. These sell-through offering and pricing practices accelerate consumer interest in the DVD format, but also increase competition from mass merchant retailers. Gross profit decreased for the 12 and 40 weeks ended August 7, 2004 by $1.4 million and $7.1 million, respectively, to $40.0 million and $137.5 million, respectively, from $41.4 million and $144.6 million for the 12 and 40 weeks ended August 9, 2003. The decrease in gross profit was a result of the decline in net sales. The rate of gross profit (as a percentage of net sales) was 32.5% for both the 12 weeks ended August 7, 2004 and August 9, 2003. For the 40 weeks ended August 7, 2004, the rate of gross profit increased by 0.3% to 32.6% from 32.3% for the comparable period of the prior year. Of the 0.3% increase in the 40 weeks ended August 7, 2004, 0.2% is attributable to the company's retail food division. This improvement in the retail food division's gross margin is a result of utilizing management information systems to better manage the division's promotions and their impact on the mix of sales and gross margin. The remainder of the improvement in the gross profit rate for the 40 weeks ended August 7, 2004 versus the comparable period of the prior year is primarily attributable to the sales and gross margin of the in-home movie and game entertainment division being a larger portion of consolidated sales and gross margin. Selling, general and administrative expenses were $34.1 million and $114.5 million, respectively, for the 12 and 40 weeks ended August 7, 2004 compared to $35.0 million and $122.4 million, respectively, for the 12 and 40 weeks ended August 9, 2003, decreases of $0.9 million and $7.9 million, respectively. These decreases are a result of the decline in sales and the cost reductions achieved through the third stage of the Company's "Challenge Program" which is part of the Company's cost containment effort to combat the highly competitive nature of its markets. Depreciation and amortization was $4.4 million and $14.8 million, respectively, for the 12 and 40 weeks ended August 7, 2004 compared to $5.1 million and $16.8 million for the 12 and 40 weeks ended August 9, 2003, decreases of $0.7 million and $2.0 million, respectively. The reasons for these decreases are the closure of two of the Company's supermarkets and the write down of impaired assets the Company recorded during the fourth quarter of the fiscal year (52 weeks) that ended November 1, 2003. Interest expense, net of interest income, increased by $0.4 million and $5.8 million between the 12 and 40 weeks ended August 7, 2004 and the comparable period of the prior year, primarily as a result of an increase in interest expense on debt. As shown in the table below, the primary factor affecting the change in interest expense on debt, between the 12 and 40 weeks ended August 7, 2004 and the 12 and 40 comparable weeks ended August 9, 2003, was the reorganization, which concluded on June 5, 2003. Included below is a more detailed summary of interest expense on debt for the 12 and 40 weeks ended August 7, 2004 and August 9, 2003 (dollars in thousands). Interest expense on debt: (1) New 10.125% Senior Secured Notes, issued 6/5/03 2,101 1,636 6,985 1,636 Revolver borrowings 267 318 839 1,351 Term loans 665 574 2,277 574 Amortization of debt issuance costs 164 177 539 1,400 ----------- ----------- ----------- ----------- Total $ 3,197 $ 2,705 $ 10,640 $ 4,961 =========== =========== =========== =========== Note (1): Does not include contractual interest expense on pre-petition debt that totaled approximately $900 and $10,000 for the 12 and 40 weeks ended August 9, 2003, respectively.

Reorganization items during the 12 and 40 weeks ended August 9, 2003 consisted primarily of the costs of financial and legal professionals providing financial and legal services to both the Company and the Company's note-holders on matters pertaining to NSC's Chapter 11 proceedings. The 12 and 40 weeks ended August 9, 2003 include a $36.5 million gain resulting from consummation of the Plan of Reorganization in which NSC provided consideration to the pre-petition note-holders equal to $59.5 million in cash and $90.0 million in New 10.125 Senior Secured Notes. The effective tax rate for the 12 and 40 weeks ended August 7, 2004 was 1.1% and (2.0%), respectively, compared to 4.0% and 5.1% for the comparable 12 and 40 weeks ended August 9, 2003. Variances in the effective tax rates were primarily due to the relationship of items of permanent difference between Income (Loss) Before Income Taxes and Cumulative Effect of an Accounting Change for financial reporting purposes and pretax income for income tax return reporting purposes to Income (Loss) Before Income Taxes and Cumulative Effect of an Accounting Change. The Company recorded net losses, before the cumulative effect of an accounting change, for the 12 and 40 weeks ended August 7, 2004 of $2.0 million and $3.7 million, respectively, versus net income, before the cumulative effect of an accounting change, of $30.2 million and $28.0 million for the comparable 12 and 40 weeks of the prior year, respectively, decreases of $32.2 million and $31.7 million, respectively. The preceding paragraphs in this MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERTATIONS discuss the reasons for the variances. During the 40 weeks ended August 9, 2003, the Company recorded a $139.9 million charge as the cumulative effect of an accounting change as a result of its adoption of SFAS No. 142 (see NOTE 3 - Goodwill and Trade Names to the notes to the condensed consolidated financial statements included in this Form 10-Q). Liquidity and Capital Resources As discussed in ITEM 1, Note 1 - INTERIM FINANCIAL STATEMENTS, in August 2002, NSC defaulted in the payment of interest on its outstanding notes, and consented to the entry of an order for relief under Chapter 11 of the Bankruptcy code the next month. NSC consummated a plan of reorganization and emerged from bankruptcy in June 2003. The relief under Chapter 11 pertained to NSC only, not to its operating subsidiaries. However, the bank debt of the operating subsidiaries, which was guaranteed by NSC, was due on February 1, 2003. On January 30, 2003 a new bank lender assumed the existing bank debt under an Extension & Modification Agreement and committed to lend the operating subsidiaries additional funds at the time NSC emerged from bankruptcy. The new bank lender also obtained the guarantee of NSC. On May 23, 2003 the Company's operating subsidiaries entered into a new Loan and Security Agreement, and NSC entered into an Amended and Restated Guarantor General Security Agreement (collectively the "May 2003 Bank Agreement") with the lender there under (the "2003 Bank Lender"). Funding took place on June 5, 2003. The New 10.125% Senior Secured Notes issued by NSC at the time it emerged from Chapter 11 and the May 2003 Bank Agreement are discussed in NOTE 5 - DEBT in the notes to the consolidated financial statements for NSC included in ITEM 15 of NSC's Form 10-K for the 52 weeks ended November 1, 2003. Certain financial requirements (covenants), of the Company, in the May 2003 Bank Agreement were amended effective May 14, 2004. NSC has no operations of its own, and its only assets are its equity interests in Pueblo International, LLC and Pueblo Entertainment, Inc. and inter-company notes issued to NSC by these subsidiaries. NSC has no source of cash to meet its obligations, including its obligations under the New 10.125% Senior Secured Notes ("New Notes"), other than payments by its subsidiaries on such inter-company notes. The inter-company notes are subordinated to the obligations of the subsidiaries under the May 2003 Bank Agreement and to the trade creditors of Pueblo International, LLC, and Pueblo Entertainment, Inc. Certain restrictive covenants in the May 2003 Bank Agreement impose limitations on the declaration or payment of dividends by NSC. Additionally, dividend payments by Pueblo International, LLC and Pueblo Entertainment, Inc. to NSC are restricted under the terms of the May 2003 Bank Agreement. The May 2003 Bank Agreement, however, provides that so long as no default or event of default (as defined in the May 2003 Bank Agreement) exists, or would exist as a result, and certain other conditions are satisfied, Pueblo International, LLC and Pueblo Entertainment, Inc. are permitted to pay their inter-company interest on their inter-company notes payable to NSC in accordance with the terms thereof. As to cash provided or used during the 40 weeks ended August 7, 2004, the following pertains: Net cash provided by operating activities for the 40 weeks ended August 7, 2004 was approximately $4.2 million versus approximately $5.3 million for the comparable 40 weeks ended August 9, 2003. The primary reasons for the $1.1 million decrease in cash provided by operating activities are the variance in timing of the interest payments on the new 10.125% Senior Secured Notes, the impact of the payment of restructuring costs and the variance in timing of volume of business tax payments. Net cash used in investing activities for purchases of property and equipment, net of proceeds on sales of property and equipment, was $3.1 million for the 40 weeks ended August 7, 2004 versus $3.3 million for the 40 comparable weeks ended August 9, 2003. During the 40 weeks ended August 7, 2004, the Company's capital expenditures were primarily to enhance its distribution, ordering and certain point of sale systems. During the comparable period of the prior year, the Company's capital expenditures were primarily for the completion of a new supermarket that opened during the period. In addition, the Company made normal recurring expenditures for the replacement of equipment at its stores and distribution center during both periods. The cash used for financing activities was approximately $1.2 million for the 40 weeks ended August 7, 2004 versus $19.4 million for the 40 comparable weeks ended August 9, 2003 a decrease of approximately $18.2 million. During the 40 weeks ended August 9, 2003 the Company consummated its Plan of Reorganization, in which the Company paid consideration to the holders of its Notes and Series C Senior Notes totaling $59.9 million in cash and $90.0 million in New 10.125 Senior Secured Notes. Also as part of its Plan of Reorganization, the Company received a capital contribution from its equity holder totaling $15.0 million and additional financing related to its May 2003 Bank Agreement, including $45.0 million principal amount of term loans. The Company also repaid its existing revolving credit facility, which totaled $32.0 million on November 2, 2002, and borrowed funds under its May 2003 Bank Agreement. Net revolver borrowings under its May 2003 Bank Agreement totaled approximately $13.3 million during the forty weeks ended August 9, 2003. During the 40 weeks ended August 7, 2004, borrowings under this agreement were approximately $2.4 million. This cash provided by financing activities was offset by approximately $3.2 million and $0.7 million of cash used to repay term loans during the 40 weeks ended August 7, 2004 and August 9, 2003, respectively. As of August 7, 2004, after giving effect to cash borrowings of approximately $13.8 million and outstanding letters of credit of approximately $2.4 million the amount available to be borrowed under the revolving credit facility was approximately $6.7 million. Working capital deficit was $15.4 million as of August 7, 2004, an improvement of $1.4 million from the $16.8 million working capital deficit as of November 1, 2003, producing a current ratio of 0.83:1 as of August 7, 2004, versus 0.81:1 as of November 1, 2003. The improvement in the working capital deficit is a result of normal fluctuations during this period of the year. Current liabilities include the liability for cash borrowed under the revolving credit facility as the terms of the facility effectively require the balance fluctuate daily and availability is based on inventory levels. Since the facility was funded on June 5, 2003, cash borrowings have fluctuated from a high of $18.0 million to a low of $1.6 million. The total balance outstanding is not expected to be repaid in full in the current period. Off-Balance Sheet Arrangements At August 7, 2004, the Company did not have any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which might have been established for the purpose of facilitating off-balance sheet arrangements. Contractual Obligations In accordance with the Securities and Exchange Commission's regulation 17 CFR 228, 229 and 249, release 33-8182, the Company has not had any material changes in contractual obligations from those presented in ITEM 7 of the Company's Form 10-K for the year ended on November 1, 2003, which was filed with the Securities and Exchange Commission on January 28, 2004. Impact of Inflation and Currency Fluctuations The Company's primary costs, products and labor, usually increase with inflation. Increases in product costs can typically be passed on to the customer. Other cost increases must by recovered through operating efficiencies. Currency in Puerto Rico and the U.S. Virgin Islands is the U.S. Dollar. As such, the Company has no exposure to foreign currency fluctuations. ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to certain market risks from transactions that are entered into during the normal course of business. The Company does not trade or speculate in derivative financial instruments. The Company's primary market risk exposure relates to interest rate risk. The Company manages its interest rate risk in order to balance its exposure between fixed and variable rates while attempting to minimize its interest costs. ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, Company management carried out an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information required to be disclosed in the Company's periodic reports filed with the Securities and Exchange Commission. PART II. OTHER INFORMATION ITEM 6. EXHIBITS Exhibits incorporated by reference: None. Exhibits attached to this Form 10-Q: 31.1 CEO CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 31.2 CFO CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 32.1 CEO CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 32.2 CFO CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 SIGNATURE Pursuant to the requirement of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NUTRITIONAL SOURCING CORPORATION Dated: September 9, 2004 /s/ Daniel J. O'Leary ----------------------------- Daniel J. O'Leary, Executive Vice President and Chief Financial Officer 17 - 17 -

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