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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 March 31, 2007
| ¨ | 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 0-14706.
INGLES MARKETS, INCORPORATED
(Exact name of registrant as specified in its charter)
| North Carolina | 56-0846267 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
| P.O. Box 6676, Asheville NC | 28816 | |
| (Address of principal executive offices) | (Zip Code) |
(828) 669-2941
Registrant’s telephone number, including area code
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.
As of April 30, 2007, the Registrant had 12,338,860 shares of Class A Common Stock, $0.05 par value per share, outstanding and 12,170,401 shares of Class B Common Stock, $0.05 par value per share, outstanding.
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INDEX
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| Item 1. | Financial Statements |
INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
MARCH 31, 2007 | SEPTEMBER 30, 2006 | |||||
ASSETS | ||||||
Current Assets: | ||||||
Cash and Cash Equivalents | $ | 12,340,895 | $ | 17,540,306 | ||
Receivables, net | 42,771,969 | 43,593,653 | ||||
Inventories | 228,903,193 | 215,368,516 | ||||
Other Current Assets | 9,769,952 | 9,315,413 | ||||
Total Current Assets | 293,786,009 | 285,817,888 | ||||
Property and Equipment – Net | 783,694,933 | 771,627,871 | ||||
Other Assets | 9,983,207 | 17,527,783 | ||||
Total Assets | $ | 1,087,464,149 | $ | 1,074,973,542 | ||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
Current Liabilities: | ||||||
Current portion of long-term debt | $ | 47,098,401 | $ | 33,665,969 | ||
Accounts payable—trade | 123,944,364 | 112,269,275 | ||||
Accrued expenses and current portion of other long-term liabilities | 70,030,289 | 72,925,571 | ||||
Total Current Liabilities | 241,073,054 | 218,860,815 | ||||
Deferred Income Taxes | 17,970,578 | 22,672,578 | ||||
Long-Term Debt | 500,978,036 | 522,649,069 | ||||
Other Long-Term Liabilities | 5,599,682 | 6,118,193 | ||||
Total Liabilities | 765,621,350 | 770,300,655 | ||||
Stockholders’ Equity: | ||||||
Preferred stock, $0.05 par value; 10,000,000 shares authorized; no shares issued | — | — | ||||
Common stocks: | ||||||
Class A, $0.05 par value; 150,000,000 shares authorized; 12,338,783 shares issued and outstanding March 31, 2007; 12,176,485 shares issued and outstanding September 30, 2006 | 616,939 | 608,824 | ||||
Class B, $0.05 par value; 100,000,000 shares authorized; 12,170,476 shares issued and outstanding March 31, 2007; 12,321,774 shares issued and outstanding September 30, 2006 | 608,524 | 616,089 | ||||
Paid-in capital in excess of par value | 118,123,115 | 117,911,423 | ||||
Retained earnings | 202,494,221 | 185,536,551 | ||||
Total Stockholders’ Equity | 321,842,799 | 304,672,887 | ||||
Total Liabilities and Stockholders’ Equity | $ | 1,087,464,149 | $ | 1,074,973,542 | ||
See notes to unaudited interim financial statements.
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INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
| THREE MONTHS ENDED | ||||||||
MARCH 31, 2007 | MARCH 25, 2006 | |||||||
Net sales | $ | 681,164,012 | $ | 606,649,492 | ||||
Cost of goods sold | 514,596,035 | 451,073,963 | ||||||
Gross profit | 166,567,977 | 155,575,529 | ||||||
Operating and administrative expenses | 139,497,979 | 129,068,961 | ||||||
Rental income, net | 1,280,749 | 1,300,500 | ||||||
Income from operations | 28,350,747 | 27,807,068 | ||||||
Other income, net | 246,466 | 79,716 | ||||||
Interest expense | 11,935,469 | 12,225,716 | ||||||
Income before income taxes | 16,661,744 | 15,661,068 | ||||||
Income tax expense (benefit): | ||||||||
Current | 5,623,000 | 9,750,000 | ||||||
Deferred | (2,468,000 | ) | (3,530,000 | ) | ||||
| 3,155,000 | 6,220,000 | |||||||
Net income | $ | 13,506,744 | $ | 9,441,068 | ||||
Per share amounts: | ||||||||
Class A Common Stock | ||||||||
Basic earnings per common share | $ | 0.58 | $ | 0.41 | ||||
Diluted earnings per common share | $ | 0.55 | $ | 0.38 | ||||
Class B Common Stock | ||||||||
Basic earnings per common share | $ | 0.53 | $ | 0.37 | ||||
Diluted earnings per common share | $ | 0.53 | $ | 0.37 | ||||
Cash dividends per common share: | ||||||||
Class A Common Stock | $ | 0.165 | $ | 0.165 | ||||
Class B Common Stock | $ | 0.150 | $ | 0.150 | ||||
See notes to unaudited interim financial statements.
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INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
| SIX MONTHS ENDED | ||||||||
MARCH 31, 2007 | MARCH 25, 2006 | |||||||
Net sales | $ | 1,366,862,600 | $ | 1,230,043,391 | ||||
Cost of goods sold | 1,035,431,723 | 919,980,969 | ||||||
Gross profit | 331,430,877 | 310,062,422 | ||||||
Operating and administrative expenses | 275,962,051 | 260,483,228 | ||||||
Rental income, net | 2,303,506 | 2,584,971 | ||||||
Income from operations | 57,772,332 | 52,164,165 | ||||||
Other income, net | 855,124 | 819,792 | ||||||
Interest expense | 23,941,127 | 24,552,502 | ||||||
Income before income taxes | 34,686,329 | 28,431,455 | ||||||
Income tax expense (benefit): | ||||||||
Current | 14,120,000 | 17,000,000 | ||||||
Deferred | (4,108,000 | ) | (5,780,000 | ) | ||||
| 10,012,000 | 11,220,000 | |||||||
Net income | $ | 24,674,329 | $ | 17,211,455 | ||||
Per share amounts: | ||||||||
Class A Common Stock | ||||||||
Basic earnings per common share | $ | 1.06 | $ | 0.74 | ||||
Diluted earnings per common share | $ | 1.01 | $ | 0.70 | ||||
Class B Common Stock | ||||||||
Basic earnings per common share | $ | 0.96 | $ | 0.67 | ||||
Diluted earnings per common share | $ | 0.96 | $ | 0.67 | ||||
Cash dividends per common share: | ||||||||
Class A Common Stock | $ | 0.33 | $ | 0.33 | ||||
Class B Common Stock | $ | 0.30 | $ | 0.30 | ||||
See notes to unaudited interim financial statements.
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INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
SIX MONTHS ENDED MARCH 31, 2007 AND MARCH 25, 2006
CLASS A COMMON STOCK | CLASS B COMMON STOCK | PAID-IN CAPITAL IN EXCESS OF PAR VALUE | RETAINED EARNINGS | TOTAL | |||||||||||||||||||
| SHARES | AMOUNT | SHARES | AMOUNT | ||||||||||||||||||||
Balance, September 24, 2005 | 12,080,718 | $ | 604,036 | 12,364,991 | $ | 618,250 | $ | 117,259,716 | $ | 158,366,661 | $ | 276,848,663 | |||||||||||
Net income | — | — | — | — | — | 17,211,455 | 17,211,455 | ||||||||||||||||
Cash dividends | — | — | — | — | — | (7,698,131 | ) | (7,698,131 | ) | ||||||||||||||
Exercise of stock options | 41,450 | 2,073 | — | — | 513,780 | — | 515,853 | ||||||||||||||||
Common stock conversions | 39,467 | 1,973 | (39,467 | ) | (1,973 | ) | — | — | — | ||||||||||||||
Balance, March 25, 2006 | 12,161,635 | $ | 608,082 | 12,325,524 | $ | 616,277 | $ | 117,773,496 | $ | 167,879,985 | $ | 286,877,840 | |||||||||||
Balance, September 30, 2006 | 12,176,485 | $ | 608,824 | 12,321,774 | $ | 616,089 | $ | 117,911,423 | $ | 185,536,551 | $ | 304,672,887 | |||||||||||
Net income | — | — | — | — | — | 24,674,329 | 24,674,329 | ||||||||||||||||
Cash dividends | — | — | — | — | — | (7,716,659 | ) | (7,716,659 | ) | ||||||||||||||
Exercise of stock options | 11,000 | 550 | — | — | 211,692 | — | 212,242 | ||||||||||||||||
Common stock conversions | 151,298 | 7,565 | (151,298 | ) | (7,565 | ) | — | — | — | ||||||||||||||
Balance, March 31, 2007 | 12,338,783 | $ | 616,939 | 12,170,476 | $ | 608,524 | $ | 118,123,115 | $ | 202,494,221 | $ | 321,842,799 | |||||||||||
See notes to unaudited interim financial statements.
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INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
| SIX MONTHS ENDED | ||||||||
MARCH 31, 2007 | MARCH 25, 2006 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net income | $ | 24,674,329 | $ | 17,211,455 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization expense | 29,348,388 | 29,461,083 | ||||||
Losses on disposals of property and equipment | 770,983 | 41,312 | ||||||
Receipt of advance payments on purchase contracts | 2,645,154 | 1,674,403 | ||||||
Recognition of advance payments on purchase contracts | (1,915,247 | ) | (796,094 | ) | ||||
Deferred income taxes | (4,108,000 | ) | (5,780,000 | ) | ||||
Changes in operating assets and liabilities: | ||||||||
Receivables | 821,684 | (2,538,159 | ) | |||||
Inventory | (13,534,677 | ) | (3,507,715 | ) | ||||
Other assets | 5,789,269 | (2,475,994 | ) | |||||
Accounts payable and accrued expenses | 8,268,120 | (2,726,619 | ) | |||||
Net Cash Provided by Operating Activities | 52,760,003 | 30,563,672 | ||||||
Cash Flows from Investing Activities: | ||||||||
Proceeds from sales of property and equipment | 510,809 | 623,321 | ||||||
Capital expenditures | (42,727,205 | ) | (43,703,702 | ) | ||||
Net Cash Used in Investing Activities | (42,216,396 | ) | (43,080,381 | ) | ||||
Cash Flows from Financing Activities: | ||||||||
Proceeds from short-term borrowings | 216,580,400 | — | ||||||
Payments on short-term borrowings | (218,885,400 | ) | — | |||||
Principal payments on long-term debt | (5,933,601 | ) | (8,786,030 | ) | ||||
Proceeds from exercise of stock options | 212,242 | 515,853 | ||||||
Dividends paid | (7,716,659 | ) | (7,698,131 | ) | ||||
Net Cash Used in Financing Activities | (15,743,018 | ) | (15,968,308 | ) | ||||
Net Decrease in Cash and Cash Equivalents | (5,199,411 | ) | (28,485,017 | ) | ||||
Cash and cash equivalents at beginning of period | 17,540,306 | 50,626,448 | ||||||
Cash and Cash Equivalents at End of Period | $ | 12,340,895 | $ | 22,141,431 | ||||
See notes to unaudited interim financial statements.
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INGLES MARKETS, INCORPORATED AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
Six Months Ended March 31, 2007 and March 25, 2006
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 31, 2007, the results of operations for the three-month and six-month periods ended March 31, 2007 and March 25, 2006, and the changes in stockholders’ equity and cash flows for the six-month periods ended March 31, 2007 and March 25, 2006. 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 accounting principles generally accepted in the United States 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 30, 2006 and the Form 10-Q for the fiscal quarter ended March 25, 2006, filed by the Company under the Securities Exchange Act of 1934 on December 1, 2006 and May 2, 2006, respectively.
The results of operations for the three-month and six-month periods ended March 31, 2007 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 25, 2006 have been reclassified to conform to the current year presentation in the accompanying financial statements.
B. NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of FAS 109, “Accounting for Income Taxes” (FIN 48), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition of tax provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of September 30, 2007, as required. The Company is currently evaluating the impact of FIN 48 on its consolidated financial statements.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Receivables are presented net of an allowance for doubtful accounts of $944,000 and $845,000 at March 31, 2007 and September 30, 2006, respectively.
D. ACCRUED EXPENSES AND CURRENT PORTION OF OTHER LONG-TERM LIABILITIES
Accrued expenses and current portion of other long-term liabilities consist of the following:
MARCH 31, 2007 | SEPTEMBER 30, 2006 | |||||
Property, payroll, and other taxes payable | $ | 11,478,827 | $ | 17,865,518 | ||
Salaries, wages and bonuses payable | 16,261,276 | 19,602,902 | ||||
Self-insurance reserves | 8,348,405 | 8,524,499 | ||||
Interest | 11,815,819 | 11,855,031 | ||||
Income taxes | 9,975,446 | 2,175,447 | ||||
Other | 12,150,516 | 12,902,174 | ||||
| $ | 70,030,289 | $ | 72,925,571 | |||
Self-insurance liabilities 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 $750,000 per occurrence for workers’ compensation and $250,000 per covered person for medical care benefits for a policy year. Employee insurance expense, including workers’ compensation and medical care benefits, net of employee contributions, totaled $6.2 million and $5.0 million for the three-month periods ended March 31, 2007 and March 25, 2006, respectively. For the six-month periods ended March 31, 2007 and March 25, 2006, employee insurance expense, net of employee contributions, totaled $11.7 million and $11.3 million, respectively.
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E. LONG-TERM DEBT
At March 31, 2007, the Company had lines of credit with six banks totaling $150.0 million, of which $1.6 million was outstanding at March 31, 2007. The lines of credit mature between October 2007 and February 2010. At March 31, 2007, the Company had issued $15.7 million in unused letters of credit that reduced the amounts available to be drawn under its lines of credit. The letters of credit mature from May 2007 to February 2008. 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 lines of credit contain provisions that under certain circumstances would permit lending institutions to terminate or withdraw their respective extensions of credit to the Company. Included among the triggering factors permitting the termination or withdrawal of lines of credit to the Company are certain events of default, including both monetary and non-monetary defaults, the initiation of bankruptcy or insolvency proceedings, and the failure of the Company to meet certain financial covenants designated in its respective loan documents. The Company was in compliance with all financial covenants related to these lines of credit at March 31, 2007.
Long-term debt and lines of credit agreements contain various restrictive covenants requiring, among other things, minimum levels of net worth and maintenance of certain financial ratios. One of the covenants has the effect of restricting funds available for dividends to approximately $113.9 million, based on tangible net worth at March 31, 2007. As of March 31, 2007, the Company was in compliance with these covenants.
F. DIVIDENDS
The Company paid cash dividends of $0.165 for each share of Class A Common Stock and $0.15 for each share of Class B Common Stock on January 30, 2007 and October 26, 2006 to stockholders of record on January 16, 2007 and October 12, 2006, respectively.
G. COMMON STOCK AND CALCULATION OF EARNINGS PER COMMON SHARE
The Company has two classes of common stock: Class A which is publicly traded, and Class B, which has no public market. The Class B Common Stock has restrictions on transfer; however, each share is convertible into one share of Class A Common Stock at any time. During the six months ended March 31, 2007, 151,298 shares of Class B Common Stock were converted to Class A Common Stock, including 125,000 shares of Class B Common Stock owned by the Ingles Investment/Profit Sharing Plan (the “Plan”). The Plan then sold the Class A Common Stock to meet distribution and asset diversification requests from Plan participants. Each share of Class A Common Stock has one vote per share and each share of Class B Common Stock has ten votes per share. Each share of Class A Common Stock is entitled to receive cash dividends equal to 110% of any cash dividend paid on Class B Common Stock.
The Company has determined that, under Emerging Issues Task Force (EITF) Issue 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share,” the two-class method of computing earnings per share is required.
The two-class method of computing basic earnings per share for each period reflects the cash dividends paid per share for each class of stock, plus the amount of allocated undistributed earnings per share computed using the participation percentage, which reflects the dividend rights of each class of stock. Diluted earnings per share is calculated assuming the exercise of dilutive stock options outstanding and the conversion of all shares of Class B Common Stock to shares of Class A Common Stock on a share-for-share basis. The tables below reconcile the numerators and denominators of basic and diluted earnings per share for current periods.
Three Months Ended March 31, 2007 | Six Months Ended March 31, 2007 | |||||||||||||
| Class A | Class B | Class A | Class B | |||||||||||
Numerator: Allocated net income | ||||||||||||||
Net income allocated, basic | $ | 7,052,497 | $ | 6,454,247 | $ | 12,871,083 | $ | 11,803,246 | ||||||
Conversion of Class B to Class A shares | 6,453,566 | 11,802,121 | ||||||||||||
Effect of assumed stock options exercised on allocated net income | 681 | (681 | ) | 1,125 | (1,125 | ) | ||||||||
Net income allocated, diluted | $ | 13,506,744 | $ | 6,453,566 | $ | 24,674,329 | $ | 11,802,121 | ||||||
Denominator: Weighted average shares outstanding | ||||||||||||||
Weighted average shares outstanding, basic | 12,213,914 | 12,294,512 | 12,200,473 | 12,303,667 | ||||||||||
Conversion of Class B to Class A shares | 12,294,512 | 12,303,667 | ||||||||||||
Assumed stock options exercised | 3,458 | 3,243 | ||||||||||||
Weighted average shares outstanding, diluted | 24,511,884 | 12,294,512 | 24,507,383 | 12,303,667 | ||||||||||
Earnings per share | ||||||||||||||
Basic | $ | 0.58 | $ | 0.53 | $ | 1.06 | $ | 0.96 | ||||||
Diluted | $ | 0.55 | $ | 0.53 | $ | 1.01 | $ | 0.96 | ||||||
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Three Months Ended March 25, 2006 | Six Months Ended March 25, 2006 | |||||||||||||
| Class A | Class B | Class A | Class B | |||||||||||
Numerator: Allocated net income | ||||||||||||||
Net income allocated, basic | $ | 4,897,006 | $ | 4,544,062 | $ | 8,922,158 | $ | 8,289,297 | ||||||
Conversion of Class B to Class A shares | 4,541,572 | 8,284,022 | ||||||||||||
Effect of assumed stock options exercised on allocated net income | 2,490 | (2,490 | ) | 5,275 | (5,275 | ) | ||||||||
Net income allocated, diluted | $ | 9,441,068 | $ | 4,541,572 | $ | 17,211,455 | $ | 8,284,022 | ||||||
Denominator: Weighted average shares outstanding | ||||||||||||||
Weighted average shares outstanding, basic | 12,114,025 | 12,350,715 | 12,101,623 | 12,357,830 | ||||||||||
Conversion of Class B to Class A shares | 12,350,715 | 12,357,830 | ||||||||||||
Assumed stock options exercised | 21,632 | 21,175 | ||||||||||||
Weighted average shares outstanding, diluted | 24,486,372 | 12,350,715 | 24,480,628 | 12,357,830 | ||||||||||
Earnings per share | ||||||||||||||
Basic | $ | 0.41 | $ | 0.37 | $ | 0.74 | $ | 0.67 | ||||||
Diluted | $ | 0.38 | $ | 0.37 | $ | 0.70 | $ | 0.67 | ||||||
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:
| Three Months Ended | Six Months Ended | |||||||||||||
MARCH 31, 2007 | MARCH 25, 2006 | MARCH 31, 2007 | MARCH 25, 2006 | |||||||||||
Revenues from unaffiliated customers: | ||||||||||||||
Grocery sales | $ | 652,050 | $ | 579,155 | $ | 1,310,433 | $ | 1,174,978 | ||||||
Shopping center rentals | 3,198 | 3,164 | 6,393 | 6,369 | ||||||||||
Fluid dairy | 29,115 | 27,494 | 56,430 | 55,065 | ||||||||||
Total revenues from unaffiliated customers | $ | 684,363 | $ | 609,813 | $ | 1,373,256 | $ | 1,236,412 | ||||||
Income from operations: | ||||||||||||||
Grocery sales | $ | 23,639 | $ | 23,756 | $ | 49,103 | $ | 44,362 | ||||||
Shopping center rentals | 1,281 | 1,300 | 2,304 | 2,584 | ||||||||||
Fluid dairy | 3,430 | 2,751 | 6,365 | 5,218 | ||||||||||
Total income from operations | $ | 28,350 | $ | 27,807 | $ | 57,772 | $ | 52,164 | ||||||
MARCH 31, 2007 | SEPTEMBER 30, 2006 | |||||||||||||
Assets: | ||||||||||||||
Grocery sales | $ | 940,698 | $ | 927,510 | ||||||||||
Shopping center rentals | 120,626 | 121,083 | ||||||||||||
Fluid dairy | 27,186 | 28,125 | ||||||||||||
Elimination of intercompany receivable | (1,046 | ) | (1,744 | ) | ||||||||||
Total assets | $ | 1,087,464 | $ | 1,074,974 | ||||||||||
Revenue from shopping center rentals is reported on the rental income, net line of the Condensed Consolidated Statements of Income. Grocery and fluid dairy revenues comprise net sales on the Condensed Consolidated Statements of Income.
For the three-month periods ended March 31, 2007 and March 25, 2006, respectively, the fluid dairy segment had $13.4 million and $12.2 million in sales to the grocery sales segment. The fluid dairy segment had $26.2 million and $24.5 million in sales to the grocery sales segment for the six-month periods ended March 31, 2007 and March 25, 2006, respectively. These sales have been eliminated in consolidation and are excluded from the amounts in the table above.
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I. TAX CONTINGENCY SETTLEMENT
During the quarter ended March 31, 2007 the Company settled a tax position under an initiative offered by one of the states in which the Company conducts its operations. As a result of this settlement, the Company reduced its reserve for contingent income tax liabilities by $3.2 million. This reduction is reflected as a reduction of income tax expense for the three- and six-month periods ended March 31, 2007. Without this reduction, the effective tax rate would have been 38.1% for the six months ended March 31, 2007.
| Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
Ingles, a leading supermarket chain in the Southeast, operates 196 supermarkets in Georgia (73), North Carolina (65), South Carolina (35), Tennessee (20), 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 and 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, premium coffee kiosks, certified organic products, bakery departments and prepared foods including delicatessen sections. During fiscal 2000, the Company began adding fuel centers and pharmacies at select store locations. As of March 31, 2007, the Company operated 47 in-store pharmacies and 39 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 judgments, 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 liabilities 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. These estimates can fluctuate if historical trends are not predictive of the future. 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 accounts for the impairment of long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” 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 associates. Estimates of future cash flows and expected sales prices are judgments 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 fluctuate significantly due to changes in real estate market conditions, the economic environment, capital spending decisions and inflation. The Company monitors the carrying value of long-lived assets for potential impairment each quarter based on whether any indicators of impairment have occurred.
Closed Store Accrual
For properties closed prior to December 31, 2002 that were 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. For all store closures subsequent to the adoption of Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” effective December 31, 2002, the liability is recognized and expensed based on the difference between the present value of any remaining liability under the lease and the present value of the estimated market rate at which the Company expects to be able to sublease the properties. The Company’s estimates of market rates are based on its experience, knowledge and typical third-party advice or market data. If the real estate and leasing markets change, sublease recovery
could vary significantly from the recoveries originally assumed, resulting in a material change in the Company’s recorded liability. The closed store accrual is included in accrued expenses on the consolidated balance sheet.
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Vendor Allowances
The Company receives funds for a variety of merchandising activities from the many vendors whose products the Company buys for resale in its stores. These incentives and allowances are primarily comprised of volume or purchase based incentives, advertising allowances, slotting fees, and promotional discounts. The purpose of these incentives and allowances is generally to help defray the costs incurred by the Company for stocking, advertising, promoting and selling the vendor’s products. These allowances generally relate to short term arrangements with vendors, often relating to a period of a month or less, and are negotiated on a purchase-by-purchase or transaction-by-transaction basis. Whenever possible, vendor discounts and allowances that relate to buying and merchandising activities are recorded as a component of item cost in inventory and recognized in merchandise costs when the item is sold. Due to system constraints and the nature of certain allowances, it is sometimes not practicable to apply allowances to the item cost of inventory. In those instances, the allowances are applied as a reduction of merchandise costs using a rational and systematic methodology, which results in the recognition of these incentives when the inventory related to the vendor consideration received is sold. Vendor allowances applied as a reduction of merchandise costs totaled $24.3 million and $24.9 million for the fiscal quarters ended March 31, 2007 and March 25, 2006, respectively. For the six-month periods ended March 31, 2007 and March 25, 2006, vendor allowances applied as a reduction of merchandise costs totaled $45.9 million and $46.3 million, respectively. Vendor advertising allowances that represent a reimbursement of specific identifiable incremental costs of advertising the vendor’s specific products are recorded as a reduction to the related expense in the period that the related expense is incurred. Vendor advertising allowances recorded as a reduction of advertising expense totaled $2.4 million for each of the fiscal quarters ended March 31, 2007 and March 25, 2006, respectively. For the six-month periods ended March 31, 2007 and March 25, 2006, vendor advertising allowances recorded as a reduction of advertising expense totaled $4.8 million and $4.6 million, respectively.
If vendor advertising allowances were substantially reduced or eliminated, the Company would likely consider other methods of advertising as well as the volume and frequency of its product advertising, which could increase or decrease our expenditures.
Similarly, the Company is not able to assess the impact of vendor advertising allowances on the creation of additional revenues, as it has no way to measure whether such allowances directly generate revenue for its stores.
Tax Contingencies
Despite the Company’s belief that its tax positions are consistent with applicable tax laws, the Company believes that certain positions it has taken are likely to be challenged by taxing authorities. Settlement of any challenge can result in no change, a complete disallowance, or some partial adjustment reached through negotiations or litigation. Significant judgment is required in evaluating the Company’s tax contingencies. The Company’s contingencies are adjusted in light of changing facts and circumstances, such as the progress of its tax audits as well as evolving case law. Income tax expense includes the impact of contingency provisions and changes to contingencies that the Company considers appropriate. Unfavorable settlement of any particular issue would require use of cash. Favorable resolution would be recognized as a reduction to income tax expense at the time of resolution.
During the quarter ended March 31, 2007 the Company settled a tax position under an initiative offered by one of the states in which the Company conducts its operations. As a result of this settlement, the Company reduced its reserve for contingent income tax liabilities by $3.2 million. This reduction is reflected as a reduction of income tax expense for the three- and six-month periods ended March 31, 2007.
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 31, 2007 and March 25, 2006. Comparable store sales are defined as sales by grocery stores in operation for the entire duration of the previous and current fiscal periods. Sales from replacement stores, major remodels, minor remodels and the addition of fuel stations to existing stores are included in the comparable store sales calculation from the date thereof. A replacement store is a new store that is opened to replace an existing nearby store that is closed. 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. For the three- and six-month periods ended March 31, 2007 and March 25, 2006, comparable store sales include 194 and 193 stores, respectively.
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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.
| Three Months Ended | Six Months Ended | |||||||||||
MARCH 31, 2007 | MARCH 25, 2006 | MARCH 31, 2007 | MARCH 25, 2006 | |||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||
Gross profit | 24.5 | % | 25.7 | % | 24.2 | % | 25.2 | % | ||||
Operating and administrative expenses | 20.5 | % | 21.3 | % | 20.2 | % | 21.2 | % | ||||
Rental income, net | 0.2 | % | 0.2 | % | 0.2 | % | 0.2 | % | ||||
Income from operations | 4.2 | % | 4.6 | % | 4.2 | % | 4.2 | % | ||||
Other income, net | 0.1 | % | 0.0 | % | 0.1 | % | 0.1 | % | ||||
Interest expense | 1.8 | % | 2.0 | % | 1.8 | % | 2.0 | % | ||||
Income before income taxes | 2.5 | % | 2.6 | % | 2.5 | % | 2.3 | % | ||||
Income taxes | 0.5 | % | 1.0 | % | 0.7 | % | 0.9 | % | ||||
Net income | 2.0 | % | 1.6 | % | 1.8 | % | 1.4 | % | ||||
Three Months Ended March 31, 2007 Compared to the Three Months Ended March 25, 2006
Net income for the second quarter of fiscal 2007 totaled $13.5 million, 43.1% higher than net income of $9.4 million earned for the second quarter of fiscal 2006. Total and comparable store sales increases were strong and gross profit dollars grew despite a decrease in gross profit as a percentage of sales. Settlement of a state income tax position decreased income tax expense by approximately $3.2 million during the second quarter of fiscal 2007.
Net Sales.Net sales increased 12.3% to $681.2 million for the three months ended March 31, 2007 from $606.6 million for the three months ended March 25, 2006. Ingles operated 196 stores at March 31, 2007, compared to 197 stores at March 25, 2006. Retail square footage was approximately 9.6 million at March 31, 2007 and 9.5 million at March 25, 2006. Sales improved in each department except video, with the largest percentage increases in the gasoline, pharmacy, deli and bakery departments. The Company operated six additional pharmacy departments and eight additional fuel centers at March 31, 2007 compared to March 25, 2006. Pharmacy sales increased due to an increase in the number of prescriptions. Increases in the Company’s deli and bakery departments reflect its customers’ desire for convenience and quality in prepared foods.
Grocery segment comparable store sales grew $71.9 million, or 12.4%, in the second quarter of fiscal 2007 compared to the second quarter of fiscal 2006. Excluding gasoline sales, comparable store sales increased $48.1 million, or 8.9%, for the three months ended March 31, 2007. Total gasoline gallons sold increased approximately 62% while the average price per gas gallon was somewhat level comparing the March fiscal 2007 quarter to the same period of fiscal 2006.
Changes in grocery segment sales for the quarter ended March 31, 2007 are summarized as follows (in thousands):
Total grocery sales for the three months ended March 25, 2006 | $ | 579,155 | ||
Comparable store sales increase (including gasoline) | 71,875 | |||
Impact of stores opened in fiscal 2006 and 2007 | 2,827 | |||
Impact of stores closed in fiscal 2006 and 2007 | (1,980 | ) | ||
Other | 173 | |||
Total grocery sales for the three months ended March 31, 2007 | $ | 652,050 | ||
Net sales to outside parties for the Company’s milk processing subsidiary increased $1.6 million or 5.9% in the March 2007 quarter compared to the March 2006 quarter. The sales increase is primarily attributable to an increase in the case volume of products sold which offset lower raw milk costs, which are generally passed on to customers in the pricing of milk products.
Gross Profit.Gross profit for the three-month period ended March 31, 2007 increased $11.0 million, or 7.1%, to $166.6 million, or 24.5% of sales, compared to $155.6 million, or 25.7% of sales, for the three-month period ended March 25, 2006.
Gross profit dollars increased due to the higher sales volume in the grocery segment. Gross profit as a percentage of sales decreased primarily due to higher relative sales growth in the gasoline and pharmacy departments, which generally have lower gross margins. Excluding gasoline sales, grocery segment gross profit as a percentage of sales was 27.0% for the three months ended March 31, 2007 compared to 27.5% for the same quarter of last fiscal year. Increased competitive pressures, especially in gasoline, and food cost increases also contributed to lower grocery segment margins. The Company elected to accept lower margins in order to increase sales, maintain market share and keep prices low for its customers.
Gross profit for the Company’s milk processing subsidiary for the March 2007 quarter increased $1.1 million, or 21.5%, to $6.3 million, or 14.8% of sales, compared to $5.2 million, or 13.0% of sales, for the March 2006 quarter. Gross profit dollars increased due to higher case sales volume. Gross profit as a percentage of sales increased due to relatively level per-gallon margins applied to a lower per-gallon sales price.
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In addition to the direct product cost, cost of goods sold line for the grocery segment includes inbound freight charges. The milk processing segment is a manufacturing process; therefore, the inbound freight charges as well as purchasing and receiving costs, production costs, inspection costs, warehousing costs, internal transfer costs, and other costs of distribution incurred by the milk processing segment are included in the cost of sales line item, while these items are included in operating and administrative expenses by the grocery segment.
The Company’s gross margins may not be comparable to those of other retailers, since some retailers include all of the costs related to their distribution network in cost of goods sold and others, like the Company, exclude a portion of the costs from gross profit, characterizing the costs as operating and administrative expenses.
Operating and Administrative Expenses.Operating and administrative expenses increased $10.4 million, or 8.1%, to $139.5 million for the three months ended March 31, 2007, from $129.1 million for the three months ended March 25, 2006. As a percentage of sales, operating and administrative expenses decreased to 20.5% for the three months ended March 31, 2007 compared to 21.3% for the three months ended March 25, 2006. A variety of factors contributed to the dollar increase.
A breakdown of the major increases (decreases) in operating and administrative expenses is as follows:
Increase (decrease) in millions | Increase (decrease) as a % of sales | |||||
Salaries and wages | $ | 5.0 | (0.26 | )% | ||
Warehouse expense | $ | 1.1 | 0.01 | % | ||
Repairs and maintenance | $ | 0.9 | 0.01 | % | ||
Bank charges | $ | 0.8 | 0.05 | % | ||
Advertising and promotions | $ | 0.8 | 0.04 | % | ||
Insurance | $ | 0.7 | 0.01 | % | ||
Salaries and wages increased in dollars due to additional labor hours required for the increased sales volume, but decreased as a percentage of sales due to the allocation of management salaries over higher sales dollars and sales growth in less labor-intensive departments such as gasoline.
Warehouse expense increased due to additional labor costs needed to process increased volume of both incoming and outgoing product shipments.
Repairs and maintenance increased due to the replacement and upgrade of refrigeration equipment, product display and other store fixtures.
Bank charges rose primarily due to increased fees for processing debit and credit cards. The increase is a result of both increased usage of cards and increased transaction fees related to the usage.
Advertising and promotion costs increased in the frequency of print advertising and in additional promotions to targeted holders of the Company’s Ingles Advantage Savings and Reward customer loyalty card.
Insurance expense increased due to increased employee health insurance costs.
Rental Income, Net.Rental income, net totaled $1.3 million for both the quarters ended March 31, 2007 and March 25, 2006. Overall tenant activity and shopping center expenses have been relatively stable over the past twelve months.
Other Income, Net.Other income, net increased $0.1 million to $0.2 million for the three-month period ended March 31, 2007 from $0.1 million for the three-month period ended March 25, 2006. The increase was due primarily to increased sales of waste paper and packaging, offset by decreased interest income.
Interest Expense.Interest expense decreased $0.3 million for the three-month period ended March 31, 2007 to $11.9 million from $12.2 million for the three-month period ended March 25, 2006. Total debt at March 31, 2007 was $548.1 million compared to $560.6 million at March 25, 2006.
Income Taxes.Income tax expense as a percentage of pre-tax income decreased to 18.9% in the quarter ended March 31, 2007 compared to 39.7% in the quarter ended March 25, 2006 due to the settlement of a tax position under an initiative offered by one of the states in which the Company conducts its operations. As a result of this settlement the Company reduced its reserve for contingent income taxes by $3.2 million and reduced income tax expense by the same amount during the three months ended March 31, 2007. Without this reduction, the effective tax rate would have been 38.3% for the three months ended March 31, 2007.
Net Income.Net income increased $4.1 million, or 43.1%, for the three-month period ended March 31, 2007 to $13.5 million compared to $9.4 million for the three-month period ended March 25, 2006. Net income, as a percentage of sales, was 2.0% for the
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quarter ended March 31, 2007 and 1.6% for the quarter ended March 25, 2006. Basic and diluted earnings per share for Class A Common Stock were $0.58 and $0.55 for the quarter ended March 31, 2007 compared to $0.41 and $0.38, respectively, for the quarter ended March 25, 2006. Basic and diluted earnings per share for Class B Common Stock were each $0.53 for the quarter ended March 31, 2007 compared to $0.37 of basic and diluted earnings per share for the quarter ended March 25, 2006.
Six Months Ended March 31, 2007 Compared to the Six Months Ended March 25, 2006
Net income for the first six months of fiscal 2007 totaled $24.7 million, 43.4% higher than net income of $17.2 million earned for the first six months of fiscal 2006. Total and comparable store sales increases were strong and gross profit dollars grew despite a decrease in gross profit as a percentage of sales. Gross profit dollar growth exceeded operating expense growth by approximately $5.9 million. Settlement of a state income tax position decreased income tax expense by approximately $3.2 million during the second quarter of fiscal 2007.
Net Sales. Net sales for the six months ended March 31, 2007 increased 11.1% to $1.37 billion, compared to $1.23 billion for the six months ended March 25, 2006. Sales improved in each department except video, with the largest percentage increases in the gasoline, pharmacy, and deli departments, as noted above in the three-month discussion.
Grocery segment comparable store sales for the period grew $133.7 million, or 11.4%. Excluding gasoline sales, comparable store sales increased $89.2 million, or 8.1%, for the six months ended March 31, 2007. Total gasoline gallons sold increased approximately 66% while the average price per gallon decreased approximately 4% comparing the March fiscal 2007 six months to the same period of fiscal 2006.
Changes in grocery segment sales for the six months ended March 31, 2007 are summarized as follows (in thousands):
Total grocery sales for the six months ended March 25, 2006 | $ | 1,174,978 | ||
Comparable store sales increase (including gasoline) | 133,701 | |||
Impact of stores opened in fiscal 2006 and 2007 | 4,523 | |||
Impact of stores closed in fiscal 2006 and 2007 | (3,043 | ) | ||
Other | 274 | |||
Total grocery sales for the six months ended March 31, 2007 | $ | 1,310,433 | ||
Net sales to outside parties for the Company’s milk processing subsidiary increased $1.4 million, or 2.5%, in the six-month period ended March 31, 2007 compared to the six-month period ended March 25, 2006. The sales increase is primarily attributable to an increase in the case volume of products sold which offset lower raw milk costs in the six-month period ended March 31, 2007 compared to the six-month period ended March 25, 2006. Raw milk cost decreases are typically passed on to customers in the pricing of milk products.
The Company expects sales growth for the remainder of fiscal 2007 to approximate the rate of growth experienced in the first six months of this fiscal year. Sales growth for the remainder of fiscal year 2007 will be influenced to some extent by market fluctuations in the per gallon price of gasoline, and by the success of promotional efforts to retain and grow its customer base. The Company also expects that the maturation of new and expanded stores will contribute to sales growth.
In addition to the factors discussed above, the Company expects to accelerate the completion of new, remodeled or replacement stores and add additional fuel centers during the last six months of fiscal 2007.
Gross Profit.Gross profit for the six months ended March 31, 2007 increased $21.3 million, or 6.9%, to $331.4 million compared to $310.1 million, for the six months ended March 25, 2006. As a percent of sales, gross profit decreased to 24.2% for the six months ended March 31, 2007 from 25.2% for the six months ended March 25, 2006.
Gross profit dollars increased due to the higher sales volume in the grocery segment. Gross profit as a percentage of sales decreased primarily due to higher relative sales growth in the gasoline and pharmacy departments, which generally have lower gross margins. Excluding gasoline sales, grocery segment gross profit as a percentage of sales was 26.6% for the six months ended March 31, 2007 compared to 26.9% for the same period of last fiscal year. Gasoline gross profit margin was lower in fiscal 2007 following historically higher margins experienced following the fall 2005 hurricanes. Increased competitive pressures and food cost increases also contributed to lower grocery segment margins. The Company elected to accept lower margins in order to increase sales, maintain market share and keep prices low for its customers.
Gross profit for the Company’s milk processing subsidiary for the six-month period ended March 31, 2007 increased $1.8 million, or 18.4%, to $11.6 million, or 14.1%, of sales compared to $9.8 million, or 12.4%, of sales for the six-month period ended March 25, 2006. Gross profit dollars increased due to higher case sales volume. Gross profit as a percentage of sales increased due to relatively level per-gallon margins applied to a lower per gallon sales price.
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Operating and Administrative Expenses.Operating and administrative expenses increased $15.5 million, or 5.9%, to $276.0 million for the six months ended March 31, 2007, from $260.5 million for the six months ended March 25, 2006. As a percentage of sales, operating and administrative expenses decreased to 20.2% for the six-month period ended March 31, 2007 from 21.2% for the six-month period ended March 25, 2006. A variety of factors contributed to the dollar increase.
A breakdown of the major increases (decreases) in operating and administrative expenses is as follows:
Increase (decrease) in millions | Increase (decrease) as a % of sales | ||||||
Salaries and wages | $ | 9.5 | (0.20 | )% | |||
Equipment rent expense | $ | (1.8 | ) | (0.15 | )% | ||
Repairs and maintenance | $ | 1.8 | 0.03 | % | |||
Warehouse expenses | $ | 1.6 | (0.02 | )% | |||
Bank charges | $ | 1.3 | 0.04 | % | |||
Professional fees | $ | (1.3 | ) | (0.12 | )% | ||
Salaries and wages increased in dollars due to additional labor hours required for the increased sales volume, but decreased as a percentage of sales due to the allocation of management salaries over higher sales dollars and sales growth in less labor-intensive departments such as gasoline.
Equipment rent expense decreased due to the expiration of operating leases on equipment used in the Company’s distribution facility and in its stores. Much of this equipment was purchased by the Company at the expiration of the lease term.
Repairs and maintenance increased due to the replacement and upgrade of refrigeration equipment, product display and other store fixtures.
Warehouse expenses increased due to additional labor costs needed to process increased volume of both incoming and outgoing product shipments.
Bank charges rose primarily due to increased fees for processing debit and credit cards. The increase is a result of both increased usage of cards and increased transaction fees related to the usage.
Professional fees decreased due to reduced audit and compliance costs associated with the implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 that occurred late in fiscal 2005 and the first six months of fiscal 2006.
Rental Income, Net.Rental income, net decreased $0.3 million to $2.3 million for the six-month period ended March 31, 2007 from $2.6 million in the March 2006 comparable period due to an increase in shopping center expenses. Tenant activity has been relatively stable over the past twelve months.
Other Income, Net.Other income, net totaled $0.9 million and $0.8 million for the six-month periods ended March 31, 2007 and March 25, 2006, respectively. Losses on assets taken out of service were offset by increased sales of waste paper and packaging.
Interest Expense.Interest expense decreased $0.7 million to $23.9 million for the six months ended March 31, 2007 from $24.6 million for the six months ended March 25, 2006 due primarily to $12.5 million of principal debt repayment during the twelve months ended March 31, 2007.
Income Taxes.Income tax expense as a percentage of pre-tax income decreased to 28.9% for the six-month period ended March 31, 2007 compared to 39.5% for the six-month period ended March 25, 2006 due to the settlement of a tax position under an initiative offered by one of the states in which the Company conducts its operations. As a result of this settlement the Company reduced its reserve for contingent income taxes by $3.2 million and reduced income tax expense by the same amount during the six months ended March 31, 2007. Without this reduction, the effective tax rate would have been 38.1% for the six months ended March 31, 2007.
Net Income.Net income increased $7.5 million, or 43.4%, for the six-month period ended March 31, 2007 to $24.7 million compared to $17.2 million for the six-month period ended March 25, 2006. Net income, as a percentage of sales, was 1.8% for the six-month period ended March 2007 and 1.4% for the March 2006 comparable period. Basic and diluted earnings per share for Class A Common Stock were $1.06 and $1.01 for the six-month period ended March 31, 2007 compared to $0.74 and $0.70, respectively, for the March 2006 comparable period. Basic and diluted earnings per share for Class B Common Stock were each $0.96 for the fiscal period ended March 31, 2007 compared to $0.67 of basic and diluted earnings per share for the March 2006 comparable period.
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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. Therefore, 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 existing stores, the relocation of selected existing stores to larger, more convenient locations and the completion of minor remodeling of its remaining existing stores. The Company will also add fuel centers and other products complementary to grocery sales where market conditions and real estate considerations warrant.
Capital expenditures totaled $42.7 million for the six-month period ended March 31, 2007, including the completion of one new store, one remodeled store, one convenience store/fuel center, the purchase of six future store sites, and the addition of two fuel centers and pharmacies to existing store locations. Capital expenditures also included the costs of upgrading and replacing store equipment, technology investments, capital expenditures related to the Company’s distribution operation and its milk processing plant, and expenditures for stores to open later in fiscal 2007 and in fiscal 2008.
Ingles’ capital expenditure plans for all of fiscal 2007 include investments of approximately $100 million. For the balance of fiscal 2007, the Company plans to open two remodeled and three replacement stores, and add approximately three new fuel stations at existing stores. Expenditure plans will also include investments in stores expected to open in fiscal 2008, as well as technology improvements, upgrading and replacing existing store equipment, warehouse and transportation equipment, and improvements to the Company’s milk processing plant.
The Company expects that its net annual capital expenditures will be in the range of approximately $90 to $100 million going forward in order to maintain a modern store base. In general, the Company is increasing the average size of stores being built, which could affect both the number of projects pursued at any given time and the cost of these projects. The number of projects may also fluctuate due to the varying costs of the types of projects pursued including new stores, major remodel/expansions or minor remodels. The Company makes decisions on the allocation of capital expenditure dollars based on many factors, including the competitive environment, other Company capital initiatives and its financial condition.
The Company does not generally enter into commitments for capital expenditures other than on a store-by-store basis at the time it begins construction on a new store or begins a major or minor remodeling project. The Company generally engages in major remodeling and new store development in no more than three or four locations at a time. Construction commitments at March 31, 2007 totaled $26.0 million.
Liquidity
The Company generated net cash from operations of $52.8 million for the six months ended March 31, 2007 compared to $30.6 million for the comparable 2006 period. In addition to the $7.5 million increase in net income over the comparative six-month periods, inventory increased $13.5 million during the six months ended March 31, 2007 to support increased growth.
Cash used by investing activities for the six-month period ended March 31, 2007 totaled $42.2 million, comprised primarily of $42.7 million of capital expenditures during the period, partially offset by $0.5 million of proceeds from the sale of assets.
Cash used by financing activities during the six-month period ended March 31, 2007 totaled $15.7 million, including principal payments on long-term debt of $5.9 million, dividend payments of $7.7 million and net repayments on line of credit borrowings of $2.3 million.
At March 31, 2007, the Company had committed lines of credit with six banks totaling $150.0 million. $1.6 million was borrowed under the lines of credit at March 31, 2007; in addition, unused letters of credit totaling $15.7 million reduced the amount available to be drawn under these lines to $132.7 million at March 31, 2007. The lines of credit mature in October 2007 and February 2010. 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 31, 2007.
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At March 31, 2007, the Company had $349.8 million principal amount of senior subordinated notes (the “Notes”) outstanding to mature in December 2011. The indenture governing the Notes contains certain restrictive covenants relating to, among other things, the issuance of indebtedness and the payment of dividends. The Notes are currently redeemable by the Company at a redemption premium of 104.438%. The redemption premium decreases to 102.903% on December 1, 2007 and to 101.369% on December 1, 2008. Beginning December 1, 2009 the Notes can be redeemed at par. The Company was in compliance with all financial covenants related to the Notes at December 30, 2006.
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 31, 2007, the Company had unencumbered real property and equipment with a net book value of approximately $497.3 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.
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 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 the 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.
Contractual Obligations and Commercial Commitments
There have been no material changes in contractual obligations and commercial commitments subsequent to September 30, 2006.
Off Balance Sheet Arrangements
The Company is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.
Quarterly Cash Dividends
Since December 27, 1993, the Company has paid regular quarterly cash dividends of $0.165 (sixteen and one-half cents) per share on its Class A Common Stock and $0.15 (fifteen cents) per share on its Class B Common Stock for an annual rate of $0.66 and $0.60 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 outlining minimum tangible net worth requirements restrict the ability of the Company to pay additional dividends to approximately $113.9 million based on tangible net worth at March 31, 2007. Further, the Company is prevented from declaring dividends at any time that it is in default under the indenture governing the Company’s senior subordinated debt. In addition, the terms of the indenture may restrict the ability of the Company to pay additional dividends based on certain financial parameters.
Seasonality
Sales in the grocery segment of the Company’s business are subject to a slight seasonal variance due to holiday related sales and due to sales in areas where seasonal homes are located. Sales are traditionally higher in the Company’s first fiscal quarter due to the inclusion of sales related to Thanksgiving and Christmas. The Company’s second fiscal quarter traditionally has the lowest sales of the year. In the third and fourth quarter, sales are affected by the return of customers to seasonal homes in our market area. The fluid dairy segment of the Company’s business has slight seasonal variation to the extent of its sales into the grocery industry. The Company’s real estate segment is not subject to seasonal variations.
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Impact of Inflation
The following table from the United States Bureau of Labor Statistics lists changes in the Consumer Price Index that could have an effect on the Company’s operations. One of the Company’s significant costs is labor, which increases with general inflation. Inflation in energy costs affects both the Company’s gasoline sales and distribution expenses.
| Three Months Ended | Twelve Months Ended | |||||||||||
MARCH 31, 2007 | MARCH 25, 2006 | MARCH 31, 2007 | MARCH 25, 2006 | |||||||||
All items | 4.7 | % | 4.3 | % | 2.8 | % | 3.4 | % | ||||
Food and beverages | 7.4 | % | 2.7 | % | 3.3 | % | 2.6 | % | ||||
Energy | 22.9 | % | 21.8 | % | 4.4 | % | 17.3 | % | ||||
Forward Looking Statements
This Quarterly Report contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek” and similar expressions are intended to identify forward-looking statements. While these forward-looking statements and the related assumptions are made in good faith and reflect the Company’s current judgment regarding the direction of the Company’s business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. Such statements are based upon a number of assumptions and estimates which are inherently subject to significant risks and uncertainties many of which are beyond the Company’s control. Some of these assumptions inevitably will not materialize, and unanticipated events will occur which will affect the Company’s results. Some important factors (but not necessarily all factors) that affect the Company’s revenues, growth strategies, future profitability and operating results, or that otherwise could cause actual results to differ materially from those expressed in or implied by any forward-looking statement, include business and economic conditions generally in the Company’s operating area; the Company’s ability to successfully implement its expansion and operating strategies and to manage rapid expansion; pricing pressures and other competitive factors; reduction in per gallon retail gasoline prices; the maturation of new and expanded stores; the Company’s ability to reduce costs and achieve improvements in operating results; the availability and terms of financing; increases in labor and utility costs; success or failure in the ownership and development of real estate; changes in the laws and government regulations applicable to the Company; and changes in accounting policies, standards, guidelines or principles as may be adopted by regulatory agencies as well as the Financial Accounting Standards Board.
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 |
There have been no material changes in market interest rates subsequent to September 30, 2006.
| Item 4. | CONTROLS AND PROCEDURES |
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and pursuant to the regulations of the Securities and Exchange Commission. Disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act, include controls and procedures designed to ensure the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that the Company’s system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.
As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with participation of its management including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of March 31, 2007, the end of the period covered by this report. In making this evaluation, it considered matters previously identified and disclosed in connection with the filing of its Form 10-K for fiscal 2006. After consideration of the matters discussed above, the Company has concluded that its controls and procedures were effective as of March 31, 2007.
(b) Changes in Internal Control over Financial Reporting
No other change in internal control over financial reporting occurred during the Company’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.
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| Item 5. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
The Annual Meeting of Stockholders of Ingles Markets, Incorporated was held Tuesday, February 13, 2007. At this meeting, the Company’s stockholders voted on the following proposals:
| 1. | Elect nine members of the Board of Directors by holders of Class A Common Stock and Class B Common Stock to serve until the 2008 Annual Meeting of Stockholders: |
Name | Common Stock | Votes For | Votes Withheld | |||
Fred D. Ayers | Class A | 11,026,042 | 185,985 | |||
John O. Pollard | Class A | 10,651,481 | 560,546 | |||
Ronald B. Freeman | Class B | 12,114,709 | — | |||
Charles L. Gaither, Jr. | Class B | 12,114,709 | — | |||
Robert P. Ingle | Class B | 12,114,709 | — | |||
Robert P. Ingle, II | Class B | 12,114,709 | — | |||
James W. Lanning | Class B | 12,114,559 | 150 | |||
Charles E. Russell | Class B | 12,114,709 | — | |||
Laura Ingle Sharp | Class B | 12,114,709 | — |
| 2. | Consider and vote on a stockholder proposal for the Board of Directors to establish a policy requiring each independent director to invest at least 20% of his Ingles compensation in shares of the Company: |
| Class A | Class B | |||
For | 550,893 | 195,209 | ||
Against | 8,018,216 | 11,919,500 | ||
Abstain | 67,764 | — | ||
Broker non-votes | 2,575,154 | — |
| Item 6. | EXHIBITS |
| (a) | Exhibits. |
| 1) | Exhibit 31.1 Rule 13a-14(a) Certificate |
| 2) | Exhibit 31.2 Rule 13a-14(a) Certificate |
| 3) | Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350 |
| 4) | Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350 |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.
| INGLES MARKETS, INCORPORATED | ||
| Date: May 4, 2007 | /s/ Robert P. Ingle | |
| Robert P. Ingle | ||
| Chief Executive Officer | ||
| Date: May 4, 2007 | /s/ Ronald B. Freeman | |
| Ronald B. Freeman | ||
| Vice President-Finance and Chief Financial Officer | ||
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