UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 10-Q
Commission file number 0-14706.
INGLES MARKETS INCORPORATED
(828) 669-2941
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 No .
As of May 1, 2002, the Registrant had 10,125,632 shares of Class A Common Stock, $.05 par value per share, outstanding and 12,634,207 shares of Class B Common Stock, $.05 par value per share, outstanding.
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TABLE OF CONTENTS
INGLES MARKETS, INCORPORATED
INDEX
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Part I. Financial Information
Item 1. Financial Statements
INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
See notes to unaudited interim financial statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS (CONCLUDED)
LIABILITIES AND STOCKHOLDERS’ EQUITY
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
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CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)SIX MONTHS ENDED MARCH 30, 2002 AND MARCH 31, 2001
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTSSix Months Ended March 30, 2002 and March 31, 2001
A. BASIS OF PREPARATION
In the opinion of management, the accompanying unaudited interim financial statements contain all adjustments necessary to present fairly the Company’s financial position as of March 30, 2002, and the results of operations, changes in stockholders’ equity and cash flows for the three-month and six-month periods ended March 30, 2002 and March 31, 2001. The adjustments made are of a normal recurring nature. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission for Form 10-Q. It is suggested that these unaudited interim financial statements be read in conjunction with the audited financial statements and the notes thereto included in the Annual Report on Form 10-K for the year ended September 29, 2001 filed by the Company under the Securities Exchange Act of 1934 on December 20, 2001.
The results of operations for the three-month and six-month periods ended March 30, 2002 are not necessarily indicative of the results to be expected for the full fiscal year.
Certain amounts for the three-month and six-month periods ended March 31, 2001 have been reclassified for comparative purposes.
B. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Receivables are presented net of an allowance for doubtful accounts of $429,729 and $339,938 at March 30, 2002 and September 29, 2001, respectively.
C. ACCOUNTS PAYABLE, ACCRUED EXPENSES AND CURRENT PORTION OF OTHER LONG-TERM LIABILITIES
Accounts payable, accrued expenses and current portion of other long-term liabilities consist of the following:
Self-insurance reserves are established for workers’ compensation and employee group medical and dental benefits based on claims filed and estimates of claims incurred but not reported. The Company is insured for covered costs in excess of $350,000 per occurrence for workers’ compensation and $175,000 per covered person for medical care benefits for a policy year. Employee insurance expense, including workers’ compensation and medical care
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benefits, net of employee contributions, totaled $5.4 million and $4.3 million for the three-month periods ended March 30, 2002 and March 31, 2001, respectively.
For the six-month periods ended March 30, 2002 and March 31, 2001, employee insurance expense, net of employee contributions, totaled $10.5 million and $7.9 million, respectively.
D. LONG-TERM DEBT
On December 11, 2001 the Company closed an offering of $250 million principal amount of senior subordinated notes to mature in 2011. The notes bear an annual interest rate of 8-7/8% and were issued at a discount to yield 9%. A portion of the proceeds was used to repay $162.4 million in existing indebtedness. In conjunction with the issuance of the notes, the Company renegotiated its lines of credit, extending the maturity dates and increasing available lines of credit from $130 million to $150 million. Of the $150 million of committed lines of credit, $130 million matures in October 2004 and $20 million matures in October 2002.
After tax loan costs of $0.4 million, related to the repayment of debt, were expensed in the first quarter of fiscal 2002 and are classified as an extraordinary item-early extinguishment of debt, on the Company’s income statement.
E. DIVIDENDS
The Company paid cash dividends of $.165 for each share of Class A Common Stock and $.15 for each share of Class B Common Stock on January 16, 2002 and on October 10, 2001 to stockholders of record on January 7, 2002 and October 1, 2001, respectively.
F. SUPPLEMENTARY CASH FLOW INFORMATION
Cash paid for interest and taxes is as follows:
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G. EARNINGS PER COMMON SHARE
The following tables set forth the computation of basic and diluted earnings per share for the three-month period indicated:
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The following table sets forth the computation of basic and diluted earnings per share for the six-month period indicated:
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H. LINES OF BUSINESS
The Company operates three lines of business: retail grocery sales, shopping center rentals, and a fluid dairy processing plant. All of the company’s operations are domestic. Information about the Company’s operations by lines of business (in thousands) is as follows:
Revenue from shopping center rentals is reported on the rental income, net line of the income statements. The other revenues comprise the net sales reported.
For the three months ended March 30, 2002 and March 31, 2001, respectively, the fluid dairy segment has $11.0 and $10.9 million in sales to the grocery sales segment. The fluid dairy segment has $22.3 and $22.5 million in sales to the grocery sales segment in the six months ended March 30, 2002 and March 31, 2001, respectively. These sales have been eliminated in consolidation.
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I. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statements No. 141, “Business Combinations” (“FAS 141”) and No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”). Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company applied the new accounting rules on September 30, 2001. The adoption of FAS 141 and FAS 142 did not have a material impact on the Company’s financial statements.
In August 2001, the FASB issued Statement No. 143 “Accounting for Asset Retirement Obligations” that provides accounting guidance for the costs of retiring long-lived assets and is effective for fiscal years beginning after June 15, 2002. The Company is currently assessing the impact adoption of this statement will have on its financial statements.
In October 2001, the FASB issued Statement No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” Statement No. 144 provides accounting guidance for financial accounting and reporting for the impairment or disposal of long-lived assets. The statement supercedes Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for the Long-Lived Assets to be Disposed Of.” It also supercedes the accounting and reporting provisions of APB Opinion No. 30 “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” related to the disposal of a segment of a business. Statement No. 144 is effective for fiscal years beginning after December 15, 2001, with early adoption encouraged. The Company is currently assessing the impact adopting this statement will have on its financial statements.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Ingles, a leading supermarket chain in the Southeast, operates 201 supermarkets in Georgia (83), North Carolina (61), South Carolina (31), Tennessee (23), Virginia (2) and Alabama (1). The Company locates its supermarkets primarily in suburban areas, small towns and rural communities. Ingles supermarkets offer customers a wide variety of nationally advertised food products, including grocery, meat and dairy products, produce, frozen foods and other perishables, non-food products, including health and beauty care products and general merchandise, as well as quality private label items. In addition, the Company focuses on selling high-growth, high-margin products to its customers through the development of book sections, media centers, floral departments, bakery departments and prepared foods including delicatessen sections. The Company recently began adding fuel centers and pharmacies at select store locations. The Company currently operates 14 in-store pharmacies and nine fuel centers.
Ingles also operates two other lines of business, fluid dairy processing and shopping center rentals. The fluid dairy processing segment sells approximately 32% of its products to the retail grocery segment and approximately 68% of its products to third parties. Real estate ownership (including the shopping center rental segment) is an important component of the Company’s operations, providing both operational and economic benefit.
Critical Accounting Policies
Critical accounting policies are those accounting policies that management believes are important to the portrayal of Ingles’ financial condition and results of operations, and require management’s most difficult, subjective or complex judgements, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Self-Insurance
The Company is self-insured for workers’ compensation and group medical and dental benefits. Risks and uncertainties are associated with self-insurance; however, the Company has limited its exposure by maintaining excess liability coverages. Self-insurance reserves are established based on claims filed and estimates of claims incurred but not reported. The estimates are based on data provided by the respective claims administrators. The majority of the Company’s properties are self-insured for casualty losses and business interruption; however, liability coverage is maintained.
Asset Impairments
The Company accounted for the impairment of long-lived assets in accordance with Statement of Financial Accounting Standards No. 121 and, beginning in 2002, will account for it in accordance with FAS No. 144. For assets to be held and used, the Company tests for impairment using undiscounted cash flows and calculates the amount of impairment using discounted cash flows. For assets held for sale, impairment is recognized based on the excess of remaining book value over expected recovery value. The recovery value is the fair value as determined by independent quotes or expected sales prices developed by internal
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specialists. Estimates of future cash flows and expected sales prices are judgements based upon the Company’s experience and knowledge of local operations and cash flows that are projected for several years into the future. These estimates can be significantly impacted by changes in real estate market conditions, the economic environment, capital spending decisions and inflation.
For properties to be closed that are under long-term lease agreements, the present value of any remaining liability under the lease, discounted using risk-free rates and net of expected sublease recovery, is recognized as a liability and expensed. If the real estate and leasing markets change, the assumptions regarding sublease recovery could significantly impact the Company’s recorded liability.
Results of Operations
Ingles operates on a 52 or 53-week fiscal year ending on the last Saturday in September. There are 13 and 26 weeks of operations included in the unaudited condensed consolidated statements of income for the three and six-month periods ended March 30, 2002 and March 31, 2001. Comparable store sales are defined as sales by grocery stores in operation for the entire duration of the previous and current fiscal years. Replacement stores and major and minor remodels are included in the comparable store sales calculation. A replacement store is a new store that is opened to replace an existing store that is closed nearby. A major remodel entails substantial remodeling of an existing store and may include additional retail square footage. A minor remodel includes repainting, remodeling and updating the lighting and equipment throughout an existing store.
The following table sets forth, for the periods indicated, selected financial information as a percentage of net sales. For information regarding the various segments of the business, see Note H “Lines of Business” to the Unaudited Consolidated Financial Statements.
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Three Months Ended March 30, 2002 Compared to the Three Months Ended March 31, 2001
Net Sales
Net sales for the three months ended March 30, 2002 increased 3.8% to $493.2 million, compared to $475.2 million for the three months ended March 31, 2001, in spite of the closing of seven stores since March 2001. Ingles is currently operating 201 stores, a net decrease of six stores from this time last year.
Comparable store sales for the same period grew 4.7%. In the current fiscal year, Easter fell on the day following the quarter end; therefore Easter related sales were included in the second quarter. In the prior fiscal year, Easter sales fell in the third quarter. Comparable store sales growth for the quarter excluding the effect of Easter sales grew 4.0%.
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Gross Profit
Gross profit for the quarter ended March 30, 2002 increased 5.7% to 26.9% of sales compared to 26.4% of sales for the second quarter last year. The improvement, as a percentage of sales, results from a combination of increased sales in the expanded higher margin perishable departments, effective purchasing and inventory management, and an increased focus on loss control.
Operating and Administrative Expenses
Operating and administrative expenses for the quarter ended March 30, 2002 increased 4.1% to 23.7% of sales compared to 23.6% of sales for the second quarter last year.
The largest increase in operating and administrative expenses was insurance expense. Insurance expense for the March 2002 quarter increased 29.8% over the same quarter last year, primarily as a result of rising health care costs.
Payroll costs, as a percentage of sales, decreased to 9.3% of sales in the March 2002 quarter from 9.6% of sales in the March 2001 quarter due to the revision of the Company’s labor standards in October 2001 to reflect changes made in the merchandising and operation of the stores. The Company expects this improvement to continue as it has recently embarked on a new labor management initiative to schedule store labor more effectively.
Advertising expense during the March 2002 quarter, as compared to the same quarter of 2001, increased due to the timing of certain promotions and the receipt of an advertising rebate in fiscal 2001.
A breakdown of the major increases (decreases) in operating and administrative expenses, expressed as a percentage of sales, is as follows:
Rental Income, Net
Rental income, net declined slightly for the March 2002 quarter over the comparable period in fiscal 2001. Gross rental income increased $0.2 million, while shopping center expenses (primarily depreciation) increased $0.2 million.
Other Income, Net
Other income, net declined $0.2 million for the March 2002 quarter over the comparable period in fiscal 2001. Interest income increased $0.3 million for the March 2002 quarter over the same quarter last year. Gains on the sales of assets of $0.3 million are included in other income, net in the March 2001 quarter. There were no significant sales of assets in the March 2002 quarter. The balance of the decrease resulted from various miscellaneous items.
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Interest Expense
Interest expense increased $2.0 million to $13.6 million for the three months ended March 30, 2002 from $11.6 million for the three months ended March 31, 2001 due to the issuance in December 2001 of the Company’s $250 million 8-7/8% Senior Subordinated Notes, due December 2011 (the “Notes”). A portion of the net proceeds of the Notes were used to repay $162.4 million of existing debt.
Income Taxes
Income tax expense, as a percentage of pre-tax income, remained stable at 38.4% for both periods.
Net Income
Net income for the March 2002 quarter increased 4.6% to $3.3 million compared to $3.2 million, for the March 2001 quarter. Net income, as a percentage of sales, was 0.7% for both three-month periods. Basic earnings per common share were $.15 for the March 2002 quarter compared to $.14 for the March 2001 quarter. Diluted earnings per common share were $.14 for both the March 2002 and the March 2001 quarters.
Six Months Ended March 30, 2002 Compared to the Six Months Ended March 31, 2001
Net sales for the six months ended March 30, 2002 increased 1.3% to $992.6 million, compared to $979.9 million for the six months ended March 31, 2001. Comparable store sales increased 1.8% for such period. During the March 2002 quarter, net sales growth and comparable store sales growth returned to the levels Ingles has experienced over the last few years. During the first quarter of 2002, unseasonably warm weather and a more conservative consumer-spending pattern had a negative effect on sales.
Gross profit for the six months ended March 30, 2002 increased 2.6% to $260.5 million, or 26.3% of sales, compared to $253.9 million, or 25.9% of sales, for the six months ended March 31, 2001. Increased sales distribution in the higher margin perishable departments, effective purchasing and promotional strategies and an increased focus on loss control accounted for the increase.
Operating and administrative expenses increased 2.8% to $231.4 million for the six months ended March 30, 2002, from $225.1 million for the six months ended March 31, 2001. As a percentage of sales, operating and administrative expenses increased to 23.3% for the March 2002 six-month period from 23.0% for the same period last year.
The total cost of insurance increased 24.4% or $2.3 million for the six months ended March 30, 2002 compared to the six months ended March 31, 2001. Health care costs for the same period, included in total insurance costs, increased $2.1 million or 42.5%. Effective in April
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2002, the Company made comprehensive changes to its medical plan to curb the growth of health care costs, including increased employee contributions and higher deductibles, employee co-payments and out of pocket maximums.
Increased equipment rent expense and depreciation and amortization result primarily from the remodeling and replacement of existing stores. Payroll costs, as a percentage of sales, were reduced for the same reasons mentioned above in the three-month discussion.
Rental income, net remained stable at $5.3 million for both the March 2002 and the March 2001 six-month periods. Gross rental income increased $0.4 million, while shopping center expenses (primarily depreciation) increased $0.4 million.
Other income, net increased $2.4 million for the March 2002 six-month period over the comparable period in fiscal 2001. During the March 2002 six-month period, Ingles sold three tracts of land, all adjacent to store properties, for a gain of $1.8 million. An increase in interest income of $0.4 million for the March 2002 six-month period over the March 2001 six-month period resulted from interest received on the invested proceeds of the Notes.
Interest expense increased $2.3 million to $25.0 million for the six months ended March 30, 2002 from $22.7 million for the six months ended March 31, 2001 primarily due to the issuance of the Notes on December 11, 2001. The increase is the net result of interest accrued on the Notes, partially offset by the early extinguishment of approximately $162.4 million in other debt with a portion of the Note proceeds.
Income tax expense as a percentage of pre-tax income decreased to 37.4% in the March 2002 six-month period compared to 37.7% in the March 2001 six-month period. The decrease is primarily attributable to higher state income taxes in the March 2001 six-month period.
Income Before Extraordinary Item
Income before the extraordinary item (discussed below) increased 3.3% to $7.9 million for the March 2002 six-month period compared to $7.6 million for the March 2001 six-month period. Diluted earnings per common share before the extraordinary item were $.34 in both six-month periods.
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Extraordinary Item – Early Extinguishment of Debt
The Company incurred $0.4 million in costs, net of income tax benefit of $0.3 million, in connection with the early retirement of $162.4 million of debt with a portion of the proceeds from the Notes in December 2001.
Net income for the March 2002 six-month period was $7.4 million compared to $7.6 million for the March 2001 six-month period. Net income, as a percentage of sales, was 0.8% for both six-month periods. Basic earnings per common share were $.33 for the March 2002 six-month period compared to $.34 for the March 2001 six-month period. Diluted earnings per common share were $.32 for the March 2002 six-month period compared to $.34 for the March 2001 six-month period.
Liquidity and Capital Resources
Capital Expenditures
The Company believes that a key to its ability to continue to develop a loyal customer base is providing conveniently located, clean and modern stores which provide customers with good service and a broad selection of competitively priced products. As such, the Company has invested and will continue to invest significant amounts of capital toward the modernization of its store base. The Company’s modernization program includes the opening of new stores, the completion of major remodels and expansion of selected stores, the relocation of selected stores to larger, more convenient locations and the completion of minor remodeling of its remaining stores.
Capital expenditures totaled $15.4 million for the six months ended March 30, 2002, including expenditures related to the major remodel/expansion of two stores and the minor remodeling of five stores completed during this period. Capital expenditures also included costs related to new stores to be opened and remodels to be completed during the balance of fiscal 2002 and in fiscal 2003, as well as costs of upgrading and replacing store equipment, technology investments, the purchase of future store sites, and capital expenditures related to the Company’s distribution operation and its milk processing plant. During the balance of this fiscal year Ingles plans to open one new store and one replacement store and complete four minor remodels. Ingles’ capital expenditure plans for the balance of fiscal year 2002 include investments of approximately $59.6 million, the majority of which will be spent for projects to be completed in fiscal 2003.
Liquidity
The Company generated $13.6 million of cash from operations for the six months ended March 30, 2002.
Net cash used by investing activities totaled $8.4 million. The primary use of this cash was the $15.4 million of capital expenditures during the period, which was partially offset by $7.0 million of net proceeds from the sale of assets.
The Company has generally funded its capital expenditures with cash provided from operations and borrowings under lines of credit. The lines of credit are later refinanced with
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secured long-term debt. During the March 2002 six-month period, the Company’s financing activities provided $70.8 million in cash. Proceeds from long-term debt totaled $272.3 million, including the issuance of the $250 million Notes, while payments on long-term debt were $195.6 million, including the $162.4 million of early debt retirement with a portion of the proceeds from the Notes. At March 30, 2002, the Company had lines of credit with seven banks totaling $150 million; all of which were unused. Of the $150 million of committed lines of credit, $130 million matures in October 2004 and $20 million matures in October 2002. The Company does not anticipate drawing on its lines of credit for the balance of fiscal 2002, as cash proceeds from the Notes are used to repay current maturities of debt and fund capital expenditures. The lines provide the Company with various interest rate options generally at rates less than prime. The Company is not required to maintain compensating balances in connection with these lines of credit. The Company was in compliance with all financial covenants related to these lines of credit at March 30, 2002.
The Company’s principal sources of liquidity are expected to be cash flow from operations, borrowings under its lines of credit and long-term financing. As of March 30, 2002, the Company had unencumbered real property and equipment with a net book value of approximately $272 million. The Company believes, based on its current results of operations and financial condition, that its financial resources, including existing bank lines of credit, short- and long-term financing expected to be available to it and internally generated funds, will be sufficient to meet planned capital expenditures and working capital requirements for the foreseeable future, including any debt service requirements of additional borrowings. However, there can be no assurance that any such sources of financing will be available to the Company on acceptable terms, or at all.
In addition, it is possible that, in the future, the Company’s results of operations and financial condition will be different from that described in this report based on a number of intangible factors. These factors may include, among others, increased competition, changing regional and national economic conditions, adverse climatic conditions affecting food production and delivery and changing demographics as well as the additional factors discussed below under “Forward Looking Statements”. It is also possible, for such reasons, that the results of operations from new, expanded, remodeled and/or replacement stores will not meet or exceed the results of operations from existing stores that are described in this report.
Quarterly Cash Dividends
Since December 27, 1993, the Company has paid regular quarterly cash dividends of $.165 (sixteen and one-half cents) per share on its Class A Common Stock and $.15 (fifteen cents) per share on its Class B Common Stock for an annual rate of $.66 and $.60 per share, respectively.
The Company expects to continue paying regular cash dividends on a quarterly basis. However, the Board of Directors periodically reconsiders the declaration of dividends. The Company pays these dividends at the discretion of the Board of Directors and the continuation of these payments, the amount of such dividends, and the form in which the dividends are paid (cash or stock) depends upon the results of operations, the financial condition of the Company and other factors which the Board of Directors deems relevant. In addition, certain loan agreements containing provisions providing minimum tangible net worth requirements restrict the ability of the Company to pay additional dividends to approximately $28.8 million, based on tangible net worth at March 30, 2002. Further, the Company is prevented from paying dividends at any time that it is in default under the indenture governing the Notes.
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Impact of Inflation
Inflation in food prices during the first six months of fiscal 2002 and during fiscal 2001 was slightly higher than the overall increase in the Consumer Price Index. One of the Company’s significant costs is labor, which increases with inflation.
Forward Looking Statements
This Quarterly Report contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, relating to, among other things, capital expenditures, cost reduction, operating improvements and expected results. The words “expect”, “anticipate”, “intend”, “plan”, “believe”, “seek” and similar expressions are intended to identify forward-looking statements. Such statements are subject to inherent risks and uncertainties including, among others: business and economic conditions generally in the Company’s operating area; pricing pressures and other competitive factors; results of the Company’s programs to reduce costs and achieve improvements in operating results; and the availability and terms of financing. Consequently, actual events affecting the Company and the impact of such events on the Company’s operations may vary significantly from those described in this report or contemplated or implied by statements in this report.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
On December 11, 2001 the Company closed the offering of the Notes. The Notes bear interest at a rate of 8-7/8% and were issued at a discount to yield 9%. There have been no material changes in the market interest rates subsequent to the closing.
Part II. Other Information.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of Ingles Markets, Incorporated was held Tuesday, February 12, 2002. Two matters were submitted to a vote of the stockholders at this meeting, (1) the election of ten directors to serve until the 2003 Annual Meeting of Stockholders and (2) the Proposal to Approve the Ingles Markets, Incorporated Amended and Restated 1997 NonQualified Stock Option Plan. The voting results are as follows:
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused the report to be signed on its behalf by the undersigned thereunto duly authorized.
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