FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30,1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBERS 0-676 AND 0-16626
-----------------
THE SOUTHLAND CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 75-1085131
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2711 NORTH HASKELL AVE., DALLAS, TEXAS 75204-2906
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code, 214/828-7011
--------------
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
APPLICABLE ONLY TO CORPORATE ISSUERS:
409,922,935 shares of common stock, $.0001 par value (the issuer's only
class of common stock), were outstanding as of September 30, 1998.
THE SOUTHLAND CORPORATION
INDEX
Page
No.
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Part I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997....................... 1
Condensed Consolidated Statements of Earnings -
Three Months and Nine Months Ended September 30, 1998 and 1997. 2
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and 1997.................. 3
Notes to Condensed Consolidated Financial Statements ............ 4
Report of Independent Accountants................................ 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 18
Part II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ........................................... 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................. 19
SIGNATURES............................................................ 20
Exhibit (15) - Letter re Unaudited Interim Financial Information......Tab 1
Exhibit (27) - Financial Data Schedule................................ *
* Submitted in electronic format only.
(i)
THE SOUTHLAND CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
ASSETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
----------- -----------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 42,313 $ 38,605
Accounts receivable 128,815 126,495
Inventories 115,941 125,396
Other current assets 156,918 96,145
----------- -----------
TOTAL CURRENT ASSETS 443,987 386,641
PROPERTY AND EQUIPMENT 1,573,399 1,416,687
OTHER ASSETS 311,455 286,753
----------- -----------
$ 2,328,841 $ 2,090,081
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Trade accounts payable $ 212,831 $ 196,799
Accrued expenses and other liabilities 301,601 275,267
Commercial paper 28,044 48,744
Long-term debt due within one year 289,317 208,839
----------- -----------
TOTAL CURRENT LIABILITIES 831,793 729,649
DEFERRED CREDITS AND OTHER LIABILITIES 208,848 187,414
LONG-TERM DEBT 1,562,915 1,594,545
CONVERTIBLE QUARTERLY INCOME DEBT SECURITIES 380,000 300,000
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, $.0001 par value 41 41
Additional capital 625,574 625,574
Accumulated deficit (1,284,884) (1,352,058)
Accumulated other comprehensive income 4,554 4,916
------------ ------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) (654,715) (721,527)
------------ ------------
$ 2,328,841 $ 2,090,081
=========== ===========
See notes to condensed consolidated financial statements.
1
THE SOUTHLAND CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- -----------------------
1998 1997 1998 1997
------------- ----------- ---------- -----------
REVENUES:
Net sales (Including $280,926, $256,235,
$767,595 and $725,358 in excise taxes) $ 2,000,298 $ 1,873,936 $ 5,439,780 $ 5,260,319
Other income 23,577 22,850 67,454 66,578
------------ ------------ ------------ ------------
2,023,875 1,896,786 5,507,234 5,326,897
COSTS AND EXPENSES:
Cost of goods sold 1,395,289 1,321,793 3,834,634 3,736,076
Operating, selling, general and
administrative expenses 548,537 497,202 1,525,847 1,415,620
Interest expense, net 22,962 22,158 67,628 67,872
------------ ------------ ------------ ------------
1,966,788 1,841,153 5,428,109 5,219,568
------------ ------------ ------------ ------------
EARNINGS BEFORE INCOME TAXES AND
EXTRAORDINARY GAIN 57,087 55,633 79,125 107,329
INCOME TAXES 21,516 22,162 29,822 42,706
------------ ------------ ------------ ------------
EARNINGS BEFORE EXTRAORDINARY GAIN $ 35,571 $ 33,471 $ 49,303 $ 64,623
EXTRAORDINARY GAIN ON DEBT REDEMPTION (net
of tax effect of $11,425) - - 17,871 -
------------ ------------ ------------- ------------
NET EARNINGS $ 35,571 $ 33,471 $ 67,174 $ 64,623
============ ============ ============ =============
EARNINGS BEFORE EXTRAORDINARY GAIN PER COMMON SHARE:
Basic $.09 $.08 $.12 $.16
Diluted .07 .07 .11 .15
EXTRAORDINARY GAIN ON DEBT REDEMPTION PER COMMON SHARE:
Basic $.00 $.00 $.04 $.00
Diluted .00 .00 .04 .00
NET EARNINGS PER COMMON SHARE:
Basic $.09 $.08 $.16 $.16
Diluted .07 .07 .15 .15
See notes to condensed consolidated financial statements.
2
THE SOUTHLAND CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------------
1998 1997
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 67,174 $ 64,623
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Extraordinary gain on debt redemption (17,871) -
Depreciation and amortization of property and equipment 130,320 132,436
Other amortization 14,594 14,270
Deferred income taxes 15,273 36,396
Noncash interest expense 1,086 2,210
Other noncash expense (income) 5,265 (867)
Net loss (gain) on property and equipment 2,775 (331)
(Increase) decrease in accounts receivable (1,021) 23,749
Decrease (increase) in inventories 20,445 (2,744)
Increase in other assets (15,875) (20,647)
Increase (decrease) in trade accounts payable and other liabilities 7,678 (54,115)
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 229,843 194,980
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of property and equipment (254,207) (148,705)
Proceeds from sale of property and equipment 6,527 12,583
Increase in restricted cash (43,213) -
Acquisition of businesses, net of cash acquired (31,472) -
Other 3,361 2,939
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (319,004) (133,183)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from commercial paper and revolving credit facilities 5,040,984 4,034,465
Payments under commercial paper and revolving credit facilities (4,985,231) (4,038,178)
Proceeds from issuance of long-term debt 96,503 225,000
Principal payments under long-term debt agreements (134,869) (273,046)
Proceeds from issuance of Convertible Quarterly Income Debt Securities 80,000 -
Other (4,518) (520)
------------- -------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 92,869 (52,279)
------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,708 9,518
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 38,605 36,494
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 42,313 $ 46,012
============= =============
RELATED DISCLOSURES FOR CASH FLOW REPORTING:
Interest paid, excluding SFAS No.15 Interest $ (74,718) $ (71,708)
============= =============
Net income taxes paid $ (8,509) $ (5,858)
============= =============
Assets obtained by entering into capital leases $ 27,108 $ 13,781
============= =============
See notes to condensed consolidated financial statements.
3
THE SOUTHLAND CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION:
The condensed consolidated balance sheet as of September 30, 1998, and the
condensed consolidated statements of earnings for the three-month and nine-
month periods ended September 30, 1998 and 1997,and the condensed
consolidated statements of cash flows for the nine-month periods ended
September 30, 1998 and 1997, have been prepared by the Company without
audit. In the opinion of management, all adjustments necessary to present
fairly the financial position at September 30, 1998, and the results of
operations and cash flows for all periods presented have been made. The
results of operations for the interim periods are not necessarily
indicative of the operating results for the full year.
The condensed consolidated balance sheet as of December 31, 1997, is
derived from the audited financial statements but does not include all
disclosures required by generally accepted accounting principles. The notes
accompanying the consolidated financial statements in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997, include
accounting policies and additional information pertinent to an
understanding of both the December 31, 1997, balance sheet and the interim
financial statements. The information has not changed except as a result
of normal transactions in the nine months ended September 30, 1998, and as
discussed in the following notes.
2. COMPREHENSIVE INCOME:
In January 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," which is required for fiscal years beginning after
December 15, 1997. SFAS No. 130 establishes standards for reporting
comprehensive income and its components in a full set of general-purpose
financial statements. The components of accumulated other comprehensive
income, net of tax, of the Company are as follows:
September 30, December 31,
1998 1997
----------- ------------
Unrealized gain on equity securities $ 10,957 $ 9,192
Foreign currency translation adjustments (6,403) (4,276)
----------- ------------
Accumulated other comprehensive income $ 4,554 $ 4,916
=========== ============
The components of comprehensive income of the Company for the three-month
and nine-month periods ended September 30, 1998 and 1997, are as follows:
Three Months Nine Months
Ended September 30, Ended September 30
------------------ --------------------
1998 1997 1998 1997
------ -------- -------- ---------
Net earnings $ 35,571 $ 33,471 $ 67,174 $ 64,623
Other comprehensive income (expense), net of tax:
Unrealized gains on equity securities (5,162) 1,509 1,765 (63)
Foreign currency translation adjustments (1,403) 57 (2,127) (56)
-------- -------- -------- --------
Other comprehensive income (expense) (6,565) 1,566 (362) (119)
-------- -------- -------- --------
Comprehensive income $ 29,006 $ 35,037 $ 66,812 $ 64,504
========= ========= ======== ========
4
3. EARNINGS PER SHARE:
In December 1997, the Company adopted the provisions of SFAS No. 128,
"Earnings per Share," which requires the following reconciliation of the
numerators and the denominators of the basic and diluted per-share
computations for net earnings for the periods presented:
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ------------------
1998 1997 1998 1997
-------- -------- -------- ---------
BASIC EPS COMPUTATION:
Earnings (Numerator):
Earnings before extraordinary gain available to common shareholders $ 35,571 $ 33,471 $ 49,303 $ 64,623
Earnings on extraordinary gain available to common shareholders - - 17,871 -
----------- -------- -------- ---------
Net earnings available to common shareholders $ 35,571 $ 33,471 $ 67,174 $ 64,623
========== ========= ======== =========
Shares (Denominator):
Weighted average number of common shares outstanding 409,923 409,923 409,923 409,923
========== ========= ======== =========
BASIC EPS:
Earnings per common share before extraordinary gain $ .09 $ .08 $ .12 $ .16
Earnings per common share on extraordinary gain - - .04 -
---------- --------- ------- --------
Net earnings per common share $ .09 $ .08 $ .16 $ .16
========== ========= ======== ========
DILUTED EPS COMPUTATION:
Earnings (Numerator):
Earnings before extraordinary gain available to common shareholders $ 35,571 $ 33,471 $ 49,303 $ 64,623
Add interest on Convertible Quarterly Income Debt Securities,
net of tax 2,708 2,066 7,761 6,201
---------- -------- -------- ---------
Earnings before extraordinary gain available to common shareholders
plus assumed conversions 38,279 35,537 57,064 70,824
Earnings on extraordinary gain available to common shareholders - - 17,871 -
--------- -------- -------- -------
Net earnings available to common shareholders plus assumed
conversions $ 38,279 $ 35,537 $ 74,935 $ 70,824
========== ======== ======== =========
Shares (Denominator):
Weighted average number of common shares outstanding 409,923 409,923 409,923 409,923
Add effects of assumed conversions:
Conversion of Convertible Quarterly Income Debt Securities 104,620 72,112 97,912 72,112
Exercise of stock options 153 - 89 227
--------- --------- -------- --------
Weighted average number of common shares outstanding plus shares
from assumed conversions 514,696 482,035 507,924 482,262
========= ======== ======== ========
DILUTED EPS :
Earnings per common share before extraordinary gain $ .07 $ .07 $ .11 $ .15
Earnings per common share on extraordinary gain - - .04 -
--------- --------- ------- --------
Net earnings per common share $ .07 $ .07 $ .15 $ .15
=========== ========= ======= =========
5
4. ACQUISITIONS:
On May 4, 1998, the Company purchased 100% of the common stock of Christy's
Market, Inc., a Massachusetts company that operates 132 convenience stores
in the New England area. On May 12, 1998, the Company purchased the assets
of 20 'red D mart' convenience stores in the South Bend, Indiana, area from
MDK Corporation of Goshen, Indiana.
These acquisitions were accounted for under the purchase method of
accounting and, accordingly, the results of operations of the acquired
businesses have been included in the accompanying consolidated financial
statements from their dates of acquisition. Pro forma information is not
provided as the impact of the acquisitions does not have a material effect
on the Company's results of operations, cash flows or financial position.
The following preliminary information is provided as supplemental cash flow
disclosure for the acquisitions of businesses as reported in the Condensed
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998:
Fair value of assets acquired $ 69,007
Fair value of liabilities assumed 36,243
---------
Cash paid 32,764
Less cash acquired 1,292
---------
Net cash paid for acquisitions $ 31,472
=========
5. FINANCIAL INSTRUMENTS:
YEN LOAN - On April 30, 1998, funding occurred on a yen-denominated loan
for 12.5 billion yen or $96.5 million of proceeds. The loan has an
interest rate of 2.325% and will be repaid from the Seven-Eleven Japan area
license royalty income beginning in 2001, after the existing yen loan has
been retired. Both principal and interest of the loan are nonrecourse to
the Company. The proceeds included exercising a put option at the strike
price of 129.53 yen per dollar. The purchase of this put option was
financed by the Company by selling a call option at a strike price of
125.08 yen per dollar with the same yen amount and maturity as the put
option, thereby committing the Company to exchange at a rate of 125.08.
The call option was marked to market and, as a result, income of
$1.5 million was recognized during the first quarter of 1998. The call
option expired unexercised on April 28, 1998. Proceeds of the loan will be
used for general corporate purposes.
INTEREST RATE SWAP AGREEMENT - The Company is using derivative financial
instruments to reduce its exposure to market risk resulting from interest
rates. On June 26, 1998, the Company entered into an interest rate swap
agreement that fixes the interest rate at 5.395% on $250 million notional
principal amount of floating rate debt until June 26, 2003. A major
financial institution, as counterparty to the agreement, will pay the
Company a floating interest rate based on three-month LIBOR during the term
of the agreement in exchange for the Company paying the fixed interest
rate. Interest payments commenced September 28, 1998, and will be made
quarterly by both parties. The Company is at risk of loss from this swap
agreement in the event of nonperformance by the counterparty.
Upon expiration of the initial swap term, the agreement is extendible for
an additional five years at the option of the counterparty. If such
election is made, the Company will pay a fixed interest rate of 5.87% for
the period after the original termination date. This option component of
the agreement is recognized at fair value and is marked to market. Due to
declining interest rates throughout the quarter, the Company recognized
$3.2 million of expense related to the option component. However, with
respect to its unhedged floating rate debt, the Company experienced a
positive economic benefit from the declining interest rates during the
quarter.
6
SFAS NO. 133 - The Company is currently reviewing SFAS No. 133, "Accounting
for Derivative and Similar Financial Instruments and for Hedging
Activities." The statement establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. SFAS No. 133
becomes effective for all fiscal quarters of fiscal years beginning after
June 15, 1999, and earlier application is permitted as of the beginning of
any fiscal quarter subsequent to June 15, 1998. The Company intends to
adopt the provisions of this statement as of January 1, 2000, but does not
anticipate that its adoption will have a material effect on the Company's
earnings, with the exception of the impact of the interest rate swap
agreement noted above.
7
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
The Southland Corporation
We have reviewed the accompanying condensed consolidated balance sheet of
The Southland Corporation and Subsidiaries as of September 30, 1998, and
the related condensed consolidated statements of earnings for the three-
month and nine-month periods ended September 30, 1998 and 1997, and the
condensed consolidated statements of cash flows for the nine-month periods
ended September 30, 1998 and 1997. These financial statements are the
responsibility of the company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical
procedures to financial data and making inquiries of persons responsible
for financial and accounting matters. It is substantially less in scope
than an audit conducted in accordance with generally accepted auditing
standards, the objective of which is the expression of an opinion regarding
the financial statements taken as a whole. Accordingly, we do not express
such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying financial statements of The Southland
Corporation and Subsidiaries for them to be in conformity with generally
accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of December 31, 1997, and the
related consolidated statements of earnings, shareholders' equity
(deficit), and cash flows for the year then ended (not presented herein);
and in our report dated February 5, 1998,(except as to items 2 and 3 in
Note 17, for which the date is March 12, 1998) we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 1997, is fairly stated, in all material respects,
in relation to the consolidated balance sheet from which it has been
derived.
PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
October 22, 1998
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Some of the matters discussed in this quarterly report contain
forward-looking statements regarding the Company's future business which
are subject to certain risks and uncertainties, including competitive
pressures, adverse economic conditions and government regulations. These
issues, and other factors, which may be identified from time to time in the
Company's reports filed with the SEC, could cause actual results to differ
materially from those indicated in the forward-looking statements.
RESULTS OF OPERATIONS
SUMMARY OF RESULTS OF OPERATIONS
The Company's reported net earnings for the third quarter and nine
months were $35.6 million and $67.2 million, respectively, compared to net
earnings of $33.5 million and $64.6 million for the same periods in 1997.
The increase in third quarter earnings resulted from growth in gross
profits, offset by higher store labor and incremental costs associated with
the further implementation of several strategic initiatives. The year-to-
date results included a $17.9 million (after tax) extraordinary gain from
the redemption of the Company's 12% Senior Subordinated Debentures ("12%
Debentures"), which was substantially offset by $14.9 million (after tax)
of costs in the first quarter associated with a lease termination,
severance and write-off of slow-moving inventory.
MANAGEMENT STRATEGIES
Since 1992, the Company has been committed to several key strategies
that it believes, over the long term, will provide further differentiation
from competitors and allow 7-Eleven to maintain its position as the premier
convenience retailer. These strategies include:
* Upgrading the Company's store base through developing or acquiring new
stores, continuing the upgrading of existing stores and closing
underachieving stores. In 1998, new store openings will significantly
outpace closings, with the expansion occurring in existing markets to
support the Company's fresh food and combined-distribution initiatives.
* A customer-driven approach to merchandising, which focuses on
providing the customer an expanded selection of quality products at a good
value.
* An everyday-fair-pricing strategy which provides consistent,
reasonable prices on all items.
* Daily delivery of time-sensitive or perishable items, along with high-
quality, ready-to-eat foods, through the use of combined distribution
centers, fresh-food commissaries and bakery facilities. These facilities,
which are generally third party operated, are designed to provide fresher
products, improve in-stock conditions and lower product costs.
* The development of a retail information system which initially has
automated accounting and other store-level tasks. The current phase
involves the installation of point-of-sale registers with scanning and
ordering capabilities.
(EXCEPT WHERE NOTED, ALL PER-STORE NUMBERS REFER TO AN AVERAGE OF ALL
STORES RATHER THAN ONLY STORES OPEN MORE THAN ONE YEAR.)
9
SALES
The Company recorded net sales of $2.00 billion for the third quarter
and $5.44 billion for the nine months, compared to $1.87 billion and $5.26
billion during the same periods in 1997. Despite a decline in gasoline
sales for the quarter, due to significantly lower retail prices, total
sales increased as a result of the Company's acquisition of 152 stores in
May, combined with growth in same-store merchandise sales. Results of
merchandise sales growth per store were as follows:
PERIODS ENDING SEPTEMBER 30, 1998
----------------------------------
INCREASE (DECREASE) FROM PRIOR YEAR THREE MONTHS NINE MONTHS
- ----------------------------------- ------------ -----------
U.S. same-store sales 7.2% 5.2%
U.S. same-store real growth; excluding inflation 5.0% 3.3%
7-Eleven inflation 2.1% 1.8%
Third quarter same-store merchandise sales increase of 7.2% was the
largest such increase this decade and continues a trend of strong same-
store growth over the last five quarters.
Regionally, per-store merchandise sales growth for the quarter was
consistent throughout the U.S., as well as with Canadian stores in Canadian
currency. Categories that contributed the most to the quarter results were
noncarbonated beverages, cigarettes and Slurpee. CAFE COOLER, a frozen
noncarbonated drink introduced in the spring, provided substantial
incremental growth in per-store sales. CIGARETTE SALES increased primarily
due to price increases in response to manufacturer-led cost increases,
which have had an unfavorable impact on margin. SLURPEE AND NONCARBONATED
DRINK sales are up substantially, partially due to the introduction of new
products, flavors and packaging.
Gasoline sales dollars per store declined 11.6% for the third quarter
and 10.7% for the nine months, compared to last year. The decline in
gasoline sales dollars resulted from lower average retail prices, which
dropped 19 and 18 cents per gallon during the quarter and nine months,
respectively. Although sales dollars decreased, average per-store gallon
sales increased 4.2% during the third quarter primarily due to newly
developed stores, which have considerably higher volumes.
OTHER INCOME
Other Income of $23.6 million for the third quarter and $67.5 million
for the year was $0.7 million and $0.9 million higher than the same periods
in 1997, respectively. Approximately 80% of other income is derived from
royalty income of licensed operations, some of which could be unfavorably
impacted by fluctuating exchange rates. Over 70% of the Company's
royalties are from area license agreements with Seven-Eleven Japan Co.,
Ltd. ("SEJ"). Though the dollar equivalent of the SEJ royalty income will
fluctuate with exchange rate movements, the Company has hedged this
exposure by designating the royalty income to repay principal and interest
payments on its yen-denominated loans (see Liquidity & Capital Resources).
10
GROSS PROFITS
PERIODS ENDING SEPTEMBER 30, 1998
-----------------------------------
THREE MONTHS NINE MONTHS
------------- -------------
MERCHANDISE GASOLINE MERCHANDISE GASOLINE
----------- -------- ----------- -------
Gross Profit - DOLLARS IN MILLIONS $ 546.2 $ 58.9 $ 1,459.1 $ 146.1
INCREASE/(DECREASE) FROM PRIOR YEAR - ALL STORES
- ------------------------------------------------
Average per-store gross profit dollar change 3.9% 17.5% 2.9% 6.1%
Margin point change (gasoline in cents per gallon) (.79) 1.63 (.69) .32
Average per-store sales (gasoline in gallons) 6.2% 4.2% 5.0% 3.4%
Merchandise gross profit dollars increased in both the third quarter
($40.3 million) and nine months ($66.4 million) when compared to the same
periods in 1997. Higher average per-store merchandise sales were partially
offset by a lower merchandise margin. Merchandise margin has been reduced
as a result of product cost increases and continuing refinement of the
everyday-fair-pricing policy to better reflect market conditions.
Merchandise margin was also impacted by introductory costs associated with
new product offerings, combined with the further roll-out of our fresh food
initiatives into four new markets.
During the third quarter, gasoline gross profits increased $12.5
million, with the nine months higher by $14.5 million when compared to the
same periods in 1997. Improved margins, combined with the per-store gallon
sales increase and more gasoline outlets, contributed to the improvement in
the third quarter.
OPERATING, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("OSG&A")
PERIODS ENDING SEPTEMBER 30, 1998
----------------------------------
THREE MONTHS NINE MONTHS
---------------- ----------------
1998 1997 1998 1997
---- ---- ---- ------
Total OSG&A expenses $548.5 $497.2 $1,525.8 $1,415.6
Ratio of OSG&A to sales 27.4% 26.5% 28.0% 26.9%
Operating, selling, general and administrative expenses increased
$51.3 million and $110.2 million, respectively, during the third quarter
and nine months, compared to the same periods in 1997. The ratio of OSG&A
expenses to sales increased .9 and 1.1 percentage points during the quarter
and nine months, respectively. Contributing to the higher ratios were
first quarter expenses of $19 million relating to severance costs and
termination of a computer equipment lease, combined with the retail price
of gasoline being 18 cents per gallon lower for the nine months. Excluding
the first quarter items and adjusting for comparable gasoline prices, the
ratio of OSG&A to sales was unchanged and slightly favorable, for the
quarter and nine months, respectively compared to 1997.
In addition to the items discussed above, a portion of the increase in
OSG&A expenses resulted from the Company's implementation of its retail
information system and other strategic initiatives, as well as from higher
store labor, all of which were partially offset by lower insurance
expenses. Expenses associated with the Company's retail information
system were approximately $7 million higher than during the first nine
months of last year. While the ratio of OSG&A expenses to sales will vary
on a quarterly basis, management believes this ratio will not improve
during the rollout phase of the retail information system.
11
The Company continues to review the functions necessary to enable its
stores to respond faster and more cost efficiently to rapidly changing
customer needs and preferences. In conjunction with this review, management
continues to realign and reduce personnel in order to eliminate
non-essential costs, while devoting resources to the implementation of its
retail information system and other strategic initiatives (see Management
Strategies). In the first quarter of 1998, an accrual of $7.1 million was
made representing severance benefits for more than 150 management and
administrative employees to be terminated. The benefit from these
reductions on an annualized basis approximates the first quarter charge,
with the majority of the benefit carrying forward to future years.
The Company is a defendant in two legal actions, which are referred to
as the 7-Eleven OFFF and Valente cases, filed by franchisees in 1993 and
1996, respectively, asserting various claims against the Company. A
nationwide settlement was negotiated and, in connection with the
settlement, these two cases have been combined on behalf of a class of all
persons who operated 7-Eleven convenience stores in the United States at
any time between January 1, 1987 and July 31, 1997, under franchise
agreements with the Company. Class members have overwhelmingly approved
the settlement, and the court presiding over the settlement process gave
its final approval of the settlement on April 24, 1998. The settlement
provides that former franchisees will share in a settlement fund and that
certain changes will be made to the franchise agreements with current
franchisees.
Notices of appeal of the order approving the settlement were filed on
behalf of three of the attorneys who represented the class, six former
franchisees and two current franchisees. One of these current franchisees
has dismissed his appeal. The settlement agreement will not become
effective until the appeals are resolved, which could be more than two
years. However, the settlement agreement provides that while the appeals
are pending the Company will pay certain maintenance and supply expenses
relating to the cash registers and retail information system equipment of
current franchisees that are members of the settlement class. If the
settlement is overturned on appeal, the Company has the right to require
franchisees to repay the amounts that the Company paid for these expenses
while the appeals were pending. The Company's payment of these expenses
will have no material impact on 1998 earnings, and the Company's accruals
are sufficient to cover the total settlement costs, including the payment
due to former franchisees when the settlement becomes effective.
INTEREST EXPENSE, NET
Net interest expense increased $0.8 million during the third quarter
of 1998, compared to the same period in 1997, but decreased $0.2 million
from 1997 during the first nine months. The decrease from the first nine
months of 1997 was primarily due to the write-off of deferred costs
associated with the Company's refinancing of its credit agreement in
February 1997.
Approximately 38% of the Company's debt contains floating rates that
will be unfavorably impacted by rising interest rates. As of June 1998,
over one-third of the Company's floating rate debt exposure to rising
interest rates has been eliminated as a result of an interest rate swap
agreement (see Interest Rate Swap Agreement). The weighted-average
interest rate for such debt, including the impact of the interest rate swap
agreement, was 5.7% for the third quarter of 1998 and 5.8% for the first
nine months, while the rate in 1997 was 5.8% for both the third quarter and
first nine months. The Company expects net interest expense in 1998 to
remain relatively flat, based upon anticipated levels of debt and interest
rate projections. Factors increasing 1998 interest expense include higher
borrowings to finance new store development and the redemption of the
Company's 12% Debentures. With regard to the 12% Debentures, no interest
expense was recorded in the Consolidated Statements of Earnings in
12
accordance with SFAS No. 15, "Accounting by Debtors and Creditors for
Troubled Debt Restructuring" (see Liquidity and Capital Resources). Items
that will decrease 1998 interest expense include a lower interest rate on
the existing yen-denominated loan (see Liquidity and Capital Resources) and
the new 2.325% yen-denominated loan (which will reduce short-term
borrowings). The interest rate on the existing yen-denominated loan was
reset in March of 1998, resulting in a rate reduction of 315 basis points.
In accordance with SFAS No. 15, no interest expense is recognized on
the Company's public debt securities. These securities were recorded at an
amount equal to the future undiscounted cash payments, both principal and
interest, and accordingly, the cash interest payments are charged against
the recorded amount of such securities and are not treated as interest
expense.
INTEREST RATE SWAP AGREEMENT
In June 1998, the Company entered into an interest rate swap agreement
that fixes the interest rate on $250 million notional principal amount of
existing floating rate debt at 5.395%, through June 2003. A major
financial institution, as counterparty to the agreement, will pay the
Company a floating interest rate based on three-month LIBOR during the term
of the agreement in exchange for the Company paying a fixed interest rate.
Interest payments by both parties commenced in September 1998, and will be
made quarterly. The impact on net interest expense for the third quarter
was nominally favorable as a result of this agreement.
Upon expiration of the initial swap term, the counterparty has the
option of extending the agreement for an additional five years at a fixed
interest rate of 5.87%. This option component of the agreement is
recognized at fair value and is marked to market. Due to declining
interest rates in the third quarter, the Company recognized $3.2 million of
OSG&A expense related to the option component.
EXTRAORDINARY GAIN
In March 1998, redemption of the Company's 12% Debentures resulted
in a $17.9 million after-tax gain from the retirement of future
undiscounted interest payments as recorded under SFAS No. 15. The cash
outlay of the Company was $22.5 million, which was financed through the
issuance of 4-1/2% Convertible Quarterly Income Debt Securities ("1998
Convertible Debt") due 2013. The securities were issued to Ito-Yokado Co.,
Ltd. and Seven-Eleven Japan Co., Ltd., the joint owners of IYG Holding
Company, the Company's majority shareholder.
LIQUIDITY AND CAPITAL RESOURCES
The majority of the Company's working capital is provided from three
sources: i) cash flows generated from its operating activities; ii) a $400
million commercial paper facility (guaranteed by Ito-Yokado Co., Ltd.); and
iii) short-term seasonal borrowings of up to $400 million (reduced by
outstanding letters of credit) under its revolving credit facility. The
Company believes that operating activities, coupled with available short-
term working capital facilities will provide sufficient liquidity to fund
current commitments for operating and capital expenditure programs, as well
as to service debt requirements. Actual capital expenditures funding will
be dependent on the level of cash flow generated from operating activities
and the funds available from financings.
13
In April 1998, the Company entered into a financing agreement for
12.5 billion yen, or $96.5 million, monetizing its future yen royalty
stream. The financing, which bears interest at 2.325%, is secured by a
pledge (secondary to the existing yen loan) of the future royalty payments
from Seven-Eleven Japan associated with the Company's Japanese 7-Eleven
trademarks. Payment of principal and interest on the debt is non-recourse
to the Company and will commence when the existing yen denominated loan is
paid in full, which is currently estimated to be in 2001. It is
anticipated that this loan will be fully repaid in 2006.
In February 1998, the Company issued $80 million of 1998
Convertible Debt, which is subordinated to all existing debt except the
1995 Convertible Quarterly Income Debt Securities due 2010, which have the
same priority ranking. The debt has a 15-year life, no amortization and an
interest rate of 4.5%. The instrument gives the Company the right to defer
interest payments thereon for up to 20 consecutive quarters. The debt
mandatorily converts into 32,508,432 shares of the Company's common stock
if the Company's stock achieves certain levels after the third anniversary
of issuance. A portion of the proceeds from the 1998 Convertible Debt was
used to redeem the Company's 12% Debentures at par.
The credit agreement contains certain financial and operating
covenants requiring, among other things, the maintenance of certain
financial ratios, including interest and rent coverage, fixed-charge
coverage and senior indebtedness to net earnings before extraordinary items
and interest, taxes, depreciation and amortization ("EBITDA"). The
covenant levels established by the credit agreement generally require
continuing improvement in the Company's financial condition. In May 1998,
the financial covenant levels required by these instruments were amended
prospectively in order to allow the Company flexibility to continue its
store growth strategy. In addition, a maximum amount of annual capital
expenditures was established, which does permit the levels of capital
spending within the Company's strategic plans.
For the period ended September 30, 1998, the Company was in compliance
with all of the covenants required under the credit agreement, including
compliance with the principal financial and operating covenants under the
credit agreement (calculated over the latest 12-month period) as follows:
REQUIREMENTS:
--------------------
COVENANTS ACTUALS MINIMUM MAXIMUM
--------- ------- ------- -------
Interest and rent coverage * 2.07 to 1.0 1.80 to 1.0
Fixed charge coverage 1.77 to 1.0 1.50 to 1.0
Senior indebtedness to EBITDA 3.50 to 1.0 4.10 to 1.0
Capital expenditure limit
(tested annually) $425 million
* INCLUDES EFFECTS OF THE SFAS NO. 15 INTEREST PAYMENTS NOT RECORDED
IN INTEREST EXPENSE.
During the first nine months of 1998, the Company repaid $134.9
million of debt of which $22.6 million related to the redemption of the
Company's 12% Debentures and $10.9 million was for debt assumed in the
Christy's acquisition (see Capital Expenditures - Acquisitions). The
remaining principal reduction of $101.4 million included $42.2 million for
quarterly installments due on the Term Loan, $30.2 million for principal
payments on the Company's yen-denominated loan (secured by the royalty
income stream from SEJ) and $9.9 million for SFAS No. 15 interest.
Outstanding balances at September 30, 1998, for commercial paper, Term Loan
and Revolver, were $378.0 million, $182.8 million and $140.0 million,
respectively. As of September 30, 1998, outstanding letters of credit
issued pursuant to the credit agreement totaled $75.0 million.
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CASH FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $229.8 million for the
nine months of 1998, an increase of $34.9 million from the same period of
1997 (see Results of Operations section).
CAPITAL EXPENDITURES
In the first nine months, net cash used in investing activities
consisted primarily of payments of $254.2 million for property and
equipment and $31.5 million for acquisitions (see Capital Expenditures -
Acquisitions). The majority of the property and equipment capital was used
for new store development, continued implementation of the Company's retail
information system, remodeling stores, new equipment to support
merchandising initiatives, upgrading retail gasoline facilities, replacing
equipment and complying with environmental regulations.
The Company expects 1998 capital expenditures, excluding lease
commitments, to exceed $375 million. Capital expenditures are being used to
develop or acquire new stores, upgrade store facilities, further implement
a retail information system, replace equipment, upgrade gasoline facilities
and comply with environmental regulations. The amount of expenditures
during the year will be materially impacted by the proportion of new store
development funded through working capital versus leases and the speed at
which new sites/acquisitions can be located, negotiated, permitted and
constructed.
CAPITAL EXPENDITURES - ACQUISITIONS
In May 1998, the Company purchased all of the capital stock of
Christy's Market, Inc., of Brockton, Mass, thereby acquiring 132 Christy's
Market convenience stores, located in the New England area. Also in May
1998, the Company purchased the assets of 20 'red D mart' convenience
stores in the South Bend, Indiana, area from MDK Corporation of Goshen,
Indiana.
CAPITAL EXPENDITURES - GASOLINE EQUIPMENT
The Company incurs ongoing costs to comply with federal, state and
local environmental laws and regulations primarily relating to underground
storage tank ("UST") systems. The Company anticipates it will spend
approximately $10 million in 1998 on capital improvements required to
comply with environmental regulations relating to USTs, as well as above-
ground vapor recovery equipment at store locations, and approximately an
additional $25 million on such capital improvements from 1999 through 2001.
ENVIRONMENTAL
In December 1988, the Company closed its chemical manufacturing
facility in New Jersey. As a result, the Company is required to conduct
environmental remediation at the facility and has submitted a clean-up plan
to the New Jersey Department of Environmental Protection (the "State"),
which provides for active remediation of the site for approximately a
three-to-five-year period, as well as continued groundwater monitoring and
treatment for a projected 15-year period. The projected 15-year clean-up
period represents a reduction from the previously reported 20-year period
and is a result of revised estimates as determined by an independent
15
environmental management company in the first quarter of 1997. These
revised estimates, which generally resulted from the conditional approval
of the Company's plan, reduced both the estimated time and the estimated
costs to complete the project. While conditional approval was received on
its clean-up plan, the Company must supply additional information to the
State before the plan can be finalized. The Company has recorded
undiscounted liabilities representing its best estimates of the clean-up
costs of $9.3 million at September 30, 1998. In 1991, the Company and the
former owner of the facility executed a final settlement pursuant to which
the former owner agreed to pay a substantial portion of the clean-up costs.
Based on the terms of the settlement agreement and the financial resources
of the former owner, the Company has a receivable recorded of $5.4 million
at September 30, 1998.
Additionally, the Company accrues for the anticipated future costs and
the related probable state reimbursement amounts for remediation activities
at its existing and previously operated gasoline sites where releases of
regulated substances have been detected. At September 30, 1998, the
Company's estimated undiscounted liability for these sites was
$35.4 million. This estimate is based on the Company's prior experience
with gasoline sites and its consideration of such factors as the age of the
tanks, location of tank sites and experience with contractors who perform
environmental assessment and remediation work. The Company anticipates
that substantially all of the future remediation costs for detected
releases at these sites as of September 30, 1998 will be incurred within
the next five years.
Under state reimbursement programs, the Company is eligible to receive
reimbursement for a portion of future remediation costs, as well as a
portion of remediation costs previously paid. Accordingly, at September
30, 1998, the Company has recorded a net receivable of $44.7 million for
the estimated probable state reimbursements. In assessing the probability
of state reimbursements, the Company takes into consideration each state's
fund balance, revenue sources, existing claim backlog, status of clean-up
activity and claim ranking systems. As a result of these assessments, the
recorded receivable amount is net of an allowance of $9.7 million. While
there is no assurance of the timing of the receipt of state reimbursement
funds, based on its experience, the Company expects to receive the majority
of state reimbursement funds, except from California, within one to three
years after payment of eligible remediation expenses, assuming that the
state administrative procedures for processing such reimbursements have
been fully developed. The Company estimates that it may take one to seven
years to receive reimbursement funds from California. Therefore, the
portion of the recorded receivable amount that relates to sites where
remediation activities have been conducted have been discounted at 4.1% to
reflect their present value. Thus, the recorded receivable amount is also
net of a discount of $4.7 million.
The estimated future assessment and remediation expenditures and
related state reimbursement amounts could change within the near future as
governmental requirements and state reimbursement programs continue to be
implemented or revised.
ENVIRONMENTAL - ACQUISITIONS
Both the 'red D mart' and Christy's Market acquisitions include
retail gasoline outlets that are subject to certain environmental
regulations. Under the terms of the acquisition agreements, the sellers
are responsible for ensuring compliance with all applicable environmental
regulations existing as of the closing date. In addition, the acquisition
agreements provide that the sellers will remain responsible for the expense
of any future environmental cleanup resulting from existing conditions at
the sites, which is required under applicable legal requirements (see
Capital Expenditures - Acquisitions).
16
YEAR 2000
The Year 2000 issue "Y2K" is the result of computer software programs
being coded to use two digits rather than four to define the applicable
year. Some of the Company's older computer programs that have date-
sensitive coding may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or
miscalculations causing disruptions of operations.
The Company has approached the Y2K issue in phases. A Year 2000
Project Office Manager, together with a strong support organization, has
designed a Y2K work plan that is currently being implemented. The Y2K work
plan includes: (1) identifying and inventorying all Year 2000 items; (2)
assigning priorities to all items; (3) remediation of information systems
"IS" applications code, testing and reintegration to production, as well as
testing all replaced systems software and non-remediated applications; (4)
contacting third party vendors to verify their compliance and perform
selected interface tests with major vendors; (5) determining the Company's
Y2K responsibilities to its franchisees, subsidiaries and affiliates.
The Company is progressing favorably in its completion of the various
tasks and target dates identified in the Y2K work plan. The Company
believes it has identified and prioritized all major Y2K related items. In
addition, numerous non-IS, merchandise, equipment, financial institution,
insurance and public utility vendors have been contacted, inquiring as to
their readiness and the readiness of their respective vendors. Follow-up
efforts are underway where the initial response from a vendor was
uncertain. Testing compliance with major vendors is now being planned. In
addition, the company has completed certain IS related items such as
automated remediation of noncompliant software code and is progressing with
the manual remediation according to an established schedule. Testing and
test verification, post remediation and time dimensional testing is taking
place as remediation is completed. The testing of compliant applications
such as the retail information system, financial systems and a gasoline
billing system are currently being planned. The exchange of information
has taken place with area licensees and operating subsidiaries and will
continue. The Company expects to complete all scheduled preparation of the
planned Year 2000 tasks before the end of 1999.
The Company estimates that the total cost of the Year 2000 Project will
be approximately $6 to $7 million, of which about $3 million will be capital
costs. The remaining portion, of which approximately $500,000 has already
been incurred, will be expensed. These costs are being funded through
operating cash flow. This estimate includes costs related to the upgrade
and/or replacement of computer software and hardware, costs of remediated
code testing, verification of test results and the reintegration to
production of all remediated applications. In addition, the costs include
the testing of applications and software certified as Year 2000 compliant.
Due to the general uncertainty inherent in the Year 2000 process,
resulting in part from the incertitude surrounding the Y2K readiness of
third-party suppliers and vendors, the Company is unable to determine a
reasonable worst case scenario at this time. Although currently considered
unlikely, failure of the Company's primary merchandise vendors to receive
orders and deliver merchandise or the failure of public utility companies
to provide telephone and electrical services are the Company's primary
areas of concern. The development of contingency plans for non-IS and IS
related vendors and issues is scheduled for the first quarter of 1999 after
the Company has received and evaluated responses from all its major
vendors. These contingency plans are scheduled to be complete by June
1999.
17
The costs of the Y2K project and the date on which the Company plans
to complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future
events including the continued availability of certain resources, third
party modification plans and other factors. As a result, there can be no
assurance that these forward looking estimates will be achieved and the
actual costs and vendor compliance could differ materially from the
Company's current expectations, resulting in a material financial risk.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Required.
18
PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
There are no reportable suits or proceedings pending or threatened
against the Company, other than as previously reported.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
1. Exhibit (15) - Letter re Unaudited Interim Financial
Information. Letter of
PricewaterhouseCoopers LLP Independent
Accountants.
2. Exhibit (27) - Financial Data Schedule.
Submitted in electronic format only.
(b) 8-K Reports:
During the third quarter of 1998, the Company filed no
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 this report to be signed on its behalf by
the undersigned thereunto duly authorized.
THE SOUTHLAND CORPORATION
(Registrant)
Date: October 23, 1998 /s/ Clark J. Matthews II
-------------------------
(Officer)
Clark J. Matthews, II
President and Chief Executive Officer
Date: October 23, 1998 /s/ Donald E. Thomas
--------------------------
(Principal Accounting Officer)
Donald E. Thomas
Vice President and Controller
20