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, 1999
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
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7-ELEVEN, INC.
(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
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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:
409,978,252 shares of common stock, $.0001 par value (the issuer's only
class of common stock), were outstanding as of September 30, 1999.
7-ELEVEN, INC.
INDEX
Page
No.
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Part I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets -
September 30, 1999 and December 31, 1998....................... 1
Condensed Consolidated Statements of Earnings -
Three Months and Nine Months Ended September 30, 1999 and 1998. 2
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1999 and 1998.................. 3
Notes to Condensed Consolidated Financial Statements ............ 4
Independent Auditor's Report..................................... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................... 8
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 (4) - Form of Certificate for Shares of Common Stock of
7-Eleven, Inc......................................Tab 1
Exhibit (15) - Letter re Unaudited Interim Financial Information......Tab 2
Exhibit (27) - Financial Data Schedule................................ *
* Submitted in electronic format only.
(i)
7-ELEVEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
ASSETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 4,085 $ 26,880
Accounts receivable 145,943 148,046
Inventories 109,596 101,045
Other current assets 151,455 162,631
----------- -----------
TOTAL CURRENT ASSETS 411,079 438,602
PROPERTY AND EQUIPMENT 1,872,146 1,652,932
OTHER ASSETS 308,412 324,310
----------- -----------
$ 2,591,637 $ 2,415,844
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Trade accounts payable $ 192,158 $ 136,059
Accrued expenses and other liabilities 349,239 362,398
Commercial paper 7,953 18,348
Long-term debt due within one year 180,413 151,754
----------- -----------
TOTAL CURRENT LIABILITIES 729,763 668,559
DEFERRED CREDITS AND OTHER LIABILITIES 227,716 220,653
LONG-TERM DEBT 1,825,107 1,788,843
CONVERTIBLE QUARTERLY INCOME DEBT SECURITIES 380,000 380,000
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, $.0001 par value 41 41
Additional capital 625,688 625,574
Accumulated deficit (1,205,444) (1,278,009)
Accumulated other comprehensive earnings 8,766 10,183
------------ ------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT ) (570,949) (642,211)
------------ ------------
$ 2,591,637 $ 2,415,844
=========== ===========
See notes to condensed consolidated financial statements.
1
7-ELEVEN, INC. 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
----------------------------- -------------------------
1999 1998 1999 1998
------------- ------------ ---------- ------------
REVENUES:
Merchandise sales (Including $138,526, $127,639,
$391,559 and $343,892 in excise taxes) $ 1,694,636 $ 1,555,659 $ 4,641,592 $ 4,180,498
Gasoline sales (Including $161,471, $153,287,
$468,919 and $423,703 in excise taxes) 547,864 444,639 1,459,512 1,259,282
------------- ------------- ------------ ------------
Net sales 2,242,500 2,000,298 6,101,104 5,439,780
Other income 25,792 23,577 72,013 67,454
------------- ------------- ------------ ------------
2,268,292 2,023,875 6,173,117 5,507,234
COSTS AND EXPENSES:
Merchandise cost of goods sold 1,098,344 1,009,501 3,040,114 2,721,438
Gasoline cost of goods sold 495,017 385,788 1,292,815 1,113,196
------------ -------------- ----------- -----------
Total cost of goods sold 1,593,361 1,395,289 4,332,929 3,834,634
Operating, selling, general and administrative expenses 586,837 548,537 1,651,765 1,525,847
Interest expense, net 25,751 22,962 75,422 67,628
------------- ------------- ----------- -----------
2,205,949 1,966,788 6,060,116 5,428,109
------------- ------------- ----------- -----------
EARNINGS BEFORE INCOME TAXES AND EXTRAORDINARY GAIN 62,343 57,087 113,001 79,125
INCOME TAXES 24,676 21,516 44,726 29,822
------------- ------------- ----------- ----------
EARNINGS BEFORE EXTRAORDINARY GAIN 37,667 35,571 68,275 49,303
EXTRAORDINARY GAIN ON DEBT REDEMPTION (net of tax effect
of $2,743 and $11,425) - - 4,290 17,871
------------- ------------- ---------- -----------
NET EARNINGS $ 37,667 $ 35,571 $ 72,565 $ 67,174
============= ============= =========== ============
EARNINGS BEFORE EXTRAORDINARY GAIN PER COMMON SHARE:
Basic $.09 $.09 $.17 $.12
Diluted .08 .07 .15 .11
EXTRAORDINARY GAIN ON DEBT REDEMPTION PER COMMON SHARE:
Basic $.00 $.00 $.01 $.04
Diluted .00 .00 .01 .04
NET EARNINGS PER COMMON SHARE:
Basic $.09 $.09 $.18 $.16
Diluted .08 .07 .16 .15
See notes to condensed consolidated financial statements.
2
<Page
7-ELEVEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30
-------------------------------
1999 1998
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 72,565 $ 67,174
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Extraordinary gain on debt redemption (4,290) (17,871)
Depreciation and amortization of property and equipment 138,639 130,320
Other amortization 14,974 14,594
Deferred income taxes 21,622 15,273
Noncash interest expense 1,139 1,086
Other noncash (income) expense (3,716) 3,650
Net loss on property and equipment 2,673 2,775
Increase in accounts receivable (11,797) (1,021)
(Increase) decrease in inventories (8,551) 20,453
Increase in other assets (22,180) (15,883)
Increase in trade accounts payable and other liabilities 45,806 9,293
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 246,884 229,843
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for purchase of property and equipment (328,549) (254,207)
Proceeds from sale of property and equipment 5,997 6,527
Acquisition of businesses, net of cash acquired - (31,472)
Other 11,943 3,361
------------- -------------
NET CASH USED IN INVESTING ACTIVITIES (310,609) (275,791)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from commercial paper and revolving credit facilities 3,606,140 5,040,984
Payments under commercial paper and revolving credit facilities (3,458,332) (4,985,231)
Proceeds from issuance of long-term debt - 96,503
Principal payments under long-term debt agreements (105,974) (113,082)
Proceeds from issuance of convertible quarterly income debt securities - 15,000
Other (904) (4,518)
------------- -------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 40,930 49,656
------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (22,795) 3,708
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 26,880 38,605
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,085 $ 42,313
============= =============
RELATED DISCLOSURES FOR CASH FLOW REPORTING:
Interest paid, excluding SFAS No.15 Interest $ (92,122) $ (74,718)
============= =============
Net income taxes paid $ (9,780) $ (8,509)
============= =============
Assets obtained by entering into capital leases $ 34,374 $ 27,108
============= =============
See notes to condensed consolidated financial statements.
3
7-ELEVEN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 1999
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of September 30, 1999, and the
condensed consolidated statements of earnings for the three-month and nine-
month periods ended September 30, 1999 and 1998, and the condensed
consolidated statements of cash flows for the nine-month periods ended
September 30, 1999 and 1998, have been prepared by the Company without
audit. In the opinion of management, all adjustments (which included only
normal, recurring adjustments) necessary to present fairly the financial
position at September 30, 1999, and the results of operations and cash
flows for all periods presented have been made. Certain prior-period
amounts have been reclassified to conform to current-period presentation.
The results of operations for the interim periods are not necessarily
indicative of the operating results for the full year.
Sales and cost of goods sold of stores operated by franchisees are
consolidated with the results of Company-operated stores in the condensed
consolidated statements of earnings. Gross profit from franchise stores is
split between the Company and its franchisees pursuant to the terms of
franchise agreements. The gross profit earned by the franchisees is
included in Operating, Selling, General and Administrative expenses.
The condensed consolidated balance sheet as of December 31, 1998, 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, 1998, include
accounting policies and additional information pertinent to an
understanding of both the December 31, 1998, 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, 1999, and as
discussed in the following notes.
2. COMPREHENSIVE EARNINGS
In January 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting comprehensive earnings
and its components in a full set of general-purpose financial statements.
The components of comprehensive earnings of the Company for the periods
presented are as follows:
Three Months Nine Months
Ended September 30 Ended September 30
1999 1998 1999 1998
------------------ ------------------
Net earnings $ 37,667 $ 35,571 $ 72,565 $ 67,174
Other comprehensive earnings:
Unrealized gains on equity
securities, net of tax (4,630) (5,162) (4,826) 1,765
Foreign currency translation
adjustments 569 (1,403) 3,409 (2,127)
--------- -------- -------- --------
Other comprehensive earnings (4,061) (6,565) (1,417) (362)
--------- -------- -------- --------
Total comprehensive earnings $ 33,606 $ 29,006 $ 71,148 $ 66,812
======== ======== ======== ========
4
3. EARNINGS PER SHARE
The following is a reconciliation 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
---------------------- --------------------
1999 1998 1999 1998
-------- -------- ------ ------
BASIC EPS COMPUTATION:
Earnings (Numerator):
Earnings before extraordinary gain available to
common shareholders $ 37,667 $ 35,571 $ 68,275 $ 49,303
Earnings on extraordinary gain available to
common shareholders - - 4,290 17,871
--------- --------- -------- ---------
Net earnings available to common shareholders $ 37,667 $ 35,571 $ 72,565 $ 67,174
========== ======== ======= =========
Shares (Denominator):
Weighted-average number of common shares outstanding 409,978(A) 409,923 409,959(A) 409,923
========== ======== ======== ========
BASIC EPS:
Earnings per common share before extraordinary gain $ .09 $ .09 $ .17 $ .12
Earnings per common share on extraordinary gain - - .01 .04
---------- --------- ------- -------
Net earnings per common share $ .09 $ .09 $ .18 $ .16
========== ========= ======== ========
DILUTED EPS COMPUTATION:
Earnings (Numerator):
Earnings before extraordinary gain available
to common shareholders $ 37,667 $ 35,571 $ 68,275 $ 49,303
Add interest on convertible quarterly
income debt securities, net of tax 2,626 2,708 7,878 7,761
---------- -------- --------- --------
Earnings before extraordinary gain available to
common shareholders plus assumed conversions 40,293 38,279 76,153 57,064
Earnings on extraordinary gain available to
common shareholders - - 4,290 17,871
--------- -------- -------- --------
Net earnings available to common shareholders
plus assumed conversions $ 40,293 $ 38,279 $ 80,443 $ 74,935
========= ========= ======== ========
Shares (Denominator):
Weighted-average number of common shares outstanding 409,978(A) 409,923 409,959(A) 409,923
Add effects of assumed conversions:
Exercise of stock options 207 153 259 89
Conversion of convertible quarterly income
debt securities 104,620 104,620 104,620 97,912
--------- -------- -------- -------
Weighted-average number of common shares outstanding
plus shares from assumed conversions 514,805 514,696 514,838 507,924
========= ======== ======== ========
DILUTED EPS:
Earnings per common share before extraordinary gain $ .08 $ .07 $ .15 $ .11
Earnings per common share on extraordinary gain - - .01 .04
--------- --------- ------- --------
Net earnings per common share $ .08 $ .07 $ .16 $ .15
========= ========= ======= ========
(A) The increase in the number of common shares outstanding is a result of the issuance of shares
pursuant to the Stock Compensation Plan for Non-Employee Directors. Under this plan, a
non-employee director may elect to receive shares in lieu of cash compensation.
5
4. LEASE FACILITY
In August 1999, the Company entered into a leasing facility that will
provide up to $100 million of off-balance-sheet financing to be used for
the construction of new stores. A trust, funded primarily by a group of
senior lenders, will acquire land and undertake construction projects with
the Company acting as the construction agent. The lease has a maximum
lease term of 66 months. During the construction period following the
lease commencement date, interim rent will be added to the amount funded
for land and construction. Lease payments begin immediately following the
end of the construction period and vary based on changes in LIBOR. As of
September 30, 1999, the trust had funded $6,944 from this facility.
After the initial lease term has expired, the Company has the option of
canceling any leases under this facility by (1) purchasing the property or
arranging its sale to a third party, (2) extending the lease for an
additional period subject to the discretion of the lessor or (3) vacating
the property with certain provisions for the lessor's interest in the
property.
5. RECENTLY ISSUED ACCOUNTING STANDARD
The Company is currently reviewing SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. In June 1999, the effective date of SFAS No. 133 was extended
for one year; consequently, the statement will now be effective for all
fiscal quarters of fiscal years beginning after June 15, 2000, and earlier
application is encouraged. The Company has not yet determined when it will
adopt the provisions of this statement. The impact of the adoption of SFAS
No. 133 has not been determined at this time due to the Company's
continuing investigation of its financial instruments and the applicability
of SFAS No. 133 to them.
6
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders of
7-Eleven, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
7-Eleven, Inc. and Subsidiaries as of September 30, 1999, and the related
condensed consolidated statements of earnings for the three-month and nine-
month periods ended September 30, 1999 and 1998, and the condensed
consolidated statements of cash flows for the nine-month periods ended
September 30, 1999 and 1998. 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 7-Eleven, Inc.
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, 1998, 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 4, 1999, 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, 1998, 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 27, 1999
7
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 $37.7 million and $72.6 million, respectively, compared to net
earnings of $35.6 million and $67.2 million for the same periods in 1998.
Total revenue growth of over 12% for both periods was the primary reason
for the improved results.
Included in the year-to-date 1999 results is a $4.3 million after-tax
extraordinary gain on the partial redemption of the Company's 5% First
Priority and 4.5% Series A Debentures ("5% and 4.5% Debentures"). The
year-to-date 1998 results include a $17.9 million (after tax) extraordinary
gain from the redemption of the Company's 12% Senior Subordinated
Debentures ("12% Debentures"), which was mostly offset by $14.9 million
(after tax) of costs associated with a lease termination, severance and
write-off of slow-moving inventory.
MANAGEMENT STRATEGIES
The Company is 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:
* Increasing the Company's store base through developing or acquiring
new stores, upgrading existing stores and closing underachieving stores.
In 1999, new store openings are expected to significantly outpace closings,
with the expansion occurring in existing markets to support the Company's
fresh food and combined-distribution initiatives. Through September 30,
102 new stores have been opened, while 59 stores have closed, primarily due
to lease expirations.
* A customer-driven approach to merchandising, which focuses on
providing the customer a selection of quality products at a good value.
* An everyday-fair-pricing strategy which provides consistent,
reasonable prices on all items.
* Daily delivery of high-quality ready-to-eat foods, along with other
time-sensitive or perishable items, 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
capabilities, as well as tools on the in-store processor to assist with
ordering and product assortment, and a hand-held unit for
8
ordering product from the sales floor. These enhancements will allow
each store to manage inventory on an item-by-item basis, forecast
demand for fast-selling items and identify and eliminate slow selling
items. At the end of September 1999, point-of-sale register
installation has been completed in nearly 5,200 U.S. stores.
(EXCEPT WHERE NOTED, ALL PER-STORE NUMBERS REFER TO AN AVERAGE OF ALL
STORES RATHER THAN ONLY STORES OPEN MORE THAN ONE YEAR.)
SALES
The Company recorded net sales of $2.24 billion for the third quarter
and $6.10 billion in the nine months of 1999, compared to net sales of
$2.00 billion and $5.44 billion during the same periods last year. The
sales increase is due to a combination of higher per-store sales and more
stores. Merchandise sales growth (U.S. same-store) was 7.7% during the
third quarter and 8.7% for the nine-month period.
Through nine months, regional per-store merchandise sales growth was
fairly consistent, with the Southwest Division and Central Division (Texas
and Colorado) and Florida leading the country with double-digit growth.
Categories contributing the most to growth were cigarettes, prepaid cards
(primarily cellular service), ready-to-drink (non-carbonated) beverages and
frozen non-carbonated beverages. A significant portion of the improvement
is attributable to the introduction of new products/services, combined with
manufacturer cost increases (net of buy-downs) on cigarettes, which
contributed an estimated 4% to year-to-date per-store sales growth. As a
direct result of changing customer preferences and competitor pricing,
certain categories have had slight declines in per-store sales. These
categories include fountain/soft drinks and newspapers.
Gasoline sales dollars per-store increased 19.4% for the third quarter
and 9.6% for the first nine months, compared to last year. The sales
increase for the third quarter was a combination of a 19 cent per gallon
increase in the retail price of gasoline, combined with 1.4% growth in per-
store gallonage and more stores selling gasoline. The increase in sales
dollars for the first nine months was due to an increase of 6 cents per
gallon in the retail price of gasoline, plus a 3.9% increase in per-store
gallonage and more stores selling gasoline. For both the third quarter and
first nine months, the per-store gallonage increase was primarily due to
newly developed stores, which have considerably higher volumes.
OTHER INCOME
Other Income of $25.8 million for the third quarter and $72.0 million
for year-to-date was $2.2 million and $4.6 million favorable to the same
periods in 1998, respectively. Approximately 80% of other income is
derived from royalty income from licensed operations, some of which could
be unfavorably impacted by fluctuating exchange rates. More than 70% of
the royalties are from an area license agreement 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 effectively
hedged this exposure by pledging the royalty income to make principal and
interest payments on its yen-denominated loans.
9
GROSS PROFITS
PERIODS ENDING SEPTEMBER 30, 1999
-----------------------------------
THREE MONTHS NINE MONTHS
------------- -------------
MERCHANDISE GASOLINE MERCHANDISE GASOLINE
----------- -------- ----------- -------
Gross Profit - (DOLLARS IN MILLIONS) $ 596.3 $ 52.8 $ 1,601.5 $ 166.7
Gross profit margin % (gasoline in cents per gallon) 35.2% 12.3 34.5% 13.3
INCREASE/(DECREASE) FROM PRIOR YEAR - ALL STORES
- ------------------------------------------------
Average per-store gross profit dollar change 8.5% (12.9)% 7.2% 7.9%
Margin % point change (gasoline in cents per gallon) 0.08 (2.04) (.40) 0.49
Average per-store sales (gasoline in gallons) 8.3% 1.4% 8.4% 3.9%
Total merchandise gross profit dollars increased $50.1 million and
$142.4 million in the third quarter and the first nine months of 1999,
respectively, compared to the same periods in 1998. Per-store sales growth
was the primary reason for the improved results. Although merchandise
gross profit margin declined 40 bp for the nine months compared to last
year, it improved slightly during the third quarter. The improvement was a
result of increased sales of some higher margin categories, combined with
the timing of cost and retail pricing changes associated with cigarettes.
For the nine months, despite increased sales of higher margin items and the
successful introduction of new high margin products, the cigarette category
caused overall margin to decline. Although several cigarette cost and
excise tax increases (net of manufacturer buy-downs) over the past twelve
months have caused the overall gross profit margin to decrease, per-store
gross profit dollars in this category have increased.
Although gasoline gross profit declined $6.0 million during the third
quarter of 1999, the first nine months exceeded last year's total by $20.6
million. Almost half the decline in the third quarter gross profit was a
result of a LIFO adjustment, primarily due to higher product costs, which
were 21 cents per gallon above last year. Costs during the quarter were
impacted by worldwide reduction in crude oil production and several U.S.
refinery problems, which resulted in less favorable market conditions, when
compared to 1998. Market conditions have shown improvement early in the
fourth quarter, but this trend would need to improve further to outperform
1998's fourth quarter margin. The year-to-date gross profit increase was
due to a greater number of gasoline outlets, higher per-store gallon sales
and increased margin.
OPERATING, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("OSG&A")
PERIODS ENDING SEPTEMBER 30, 1999
----------------------------------
THREE MONTHS NINE MONTHS
----------------- ----------------
1999 1998 1999 1998
---- ---- ---- ------
Total OSG&A expenses - (DOLLARS IN MILLIONS) $586.8 $548.5 $1,651.8 $1,525.8
Ratio of OSG&A to sales 26.2% 27.4% 27.1% 28.0%
Operating, selling, general and administrative expenses ("OSG&A")
increased $38.3 million and $126.0 million during the third quarter and
first nine months of 1999, compared to the same periods in 1998,
respectively. During the same periods, the ratio of OSG&A expense to sales
declined 1.2% and 0.9%, respectively, compared to the third quarter and
first nine months. The third quarter ratio also dropped due to a higher
retail price of gasoline, which increased 19 cents per gallon over 1998.
The nine month ratio dropped primarily due to the combination of higher
gasoline prices (6 cents per gallon) and $19 million of charges included in
1998's OSG&A for a computer equipment lease termination and severance
costs. After adjusting for the charges and change in gasoline price, the
nine month ratio of OSG&A expense to sales declined 0.3%.
10
Other factors impacting OSG&A expense included incremental costs, when
compared to 1998, related to the franchisees' portion of improved gross
profits of $43 million during the first nine months and $15 million in the
third quarter, combined with higher expenses associated with the Company's
retail information system initiative of $33 million year-to-date and nearly
$15 million for the quarter. In addition, a portion of the increase in
OSG&A expense for both year-to-date and third quarter results were due to
costs related to operating more stores and the Company's implementation of
various merchandising and other strategic initiatives. Also, insurance
expense was approximately $7 million higher in the third quarter of 1999,
when compared to the prior year due to a one-time reduction in the third
quarter of 1998. This was more than offset by a reduction of $8.7 million
in environmental expense primarily resulting from legislative changes in
California (see Environmental section). While the ratio of OSG&A expense
to sales will vary on a quarterly basis, management believes this ratio
will not significantly improve while major enhancements continue to be made
to the retail information system.
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. 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 had no material impact on earnings for
1998 or 1999 and should have no material impact on future earnings. 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 $2.8 million during the third quarter
of 1999 and $7.8 million during the first nine months, when compared to the
same periods in 1998. The Company expects net interest expense in 1999 to
increase approximately $10 million over 1998 based on anticipated levels of
debt and interest rate projections. Factors increasing 1999 interest
expense include higher borrowings to finance new store development and
other initiatives, combined with the redemption of $65 million of the
Company's public debt securities in 1998 and early 1999, which had been
accounted for under Statement of Financial Accounting Standards No. 15
("SFAS No. 15") (see Extraordinary Gain).
11
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. Accordingly, interest expense on debt used to redeem public debt
securities results in an increase in the Company's reported interest
expense.
As of September 30, 1999, approximately 47% of the Company's debt
contains floating rates that could be unfavorably impacted by rising
interest rates. The Company has entered into an interest rate swap
agreement, which effectively lowers the amount of debt exposed to floating
rates from 47% to 34% (see Interest Rate Swap Agreement). The weighted-
average interest rate for such debt, including the impact of the interest
rate swap agreement, was 5.5% for the first nine months of 1999 versus 5.8%
for the same time period in 1998.
INTEREST RATE SWAP AGREEMENT
In June 1998, the Company entered into an interest rate swap agreement
that fixed the interest rate on $250 million notional principal amount of
existing floating rate debt at 5.4% through June 2003. A major financial
institution, as counterparty to the agreement, agreed to 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. The
swap agreement granted the counterparty the option, upon expiration of the
initial swap term, of extending the agreement for an additional five years
at a fixed interest rate of 5.9%.
In February 1999, the Company amended the terms of the interest rate
swap agreement. The fixed rate was increased to 6.1% and the term of the
swap was extended to February 2004; the remaining terms of the swap
agreement were unchanged. In exchange for the increase in the fixed rate,
the five-year extension option held by the counterparty was terminated.
EXTRAORDINARY GAIN
During the first quarter of 1999, the Company redeemed a portion of
its 5% and 4.5% Debentures, resulting in an after-tax gain of $4.3 million
from the retirement of future undiscounted interest payments as recorded
under SFAS No. 15, combined with purchasing the debentures below their face
value. 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. Both the 1998 and 1999 redemptions were
financed with proceeds from the issuance of $80 million of 4-1/2%
Convertible Quarterly Income Debt Securities due 2013, to Ito-Yokado Co.,
Ltd., and Seven-Eleven Japan Co., Ltd., the joint owners of IYG Holding
Company, which is the Company's majority shareholder.
12
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 $650
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 and a pending sale-leaseback transaction,
which the Company anticipates will close in early December 1999, will
provide sufficient liquidity to fund current commitments for operating and
capital expenditure programs, as well as to service debt requirements.
Actual capital expenditure funding will be dependent on the level of cash
flow generated from operating activities and the funds available from
financings.
In August 1999, the Company entered into a leasing facility that will
provide up to $100 million of off-balance-sheet financing to be used for
the construction of new stores. Funding under this facility is available
through August of 2001. See Note 4 to the Condensed Consolidated Financial
Statements for more detailed information on this facility.
In January 1999, the Company expanded the existing commercial paper
facility from $400 million to $650 million. The commercial paper is
unsecured but is fully and unconditionally guaranteed by Ito-Yokado Co.,
Ltd.
7-Eleven's credit agreement, established in February 1997, includes a
term loan with a balance of $127 million and a $400 million revolving
credit facility, which has a sublimit of $150 million for letters of credit
("Credit Agreement"). 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 March 1999, the financial covenant levels required by these
instruments were amended prospectively in order to allow the Company
flexibility to continue its strategic initiatives including store growth.
In connection with this amendment, the interest rate on borrowings was
changed to a reserve-adjusted Eurodollar rate plus .475% instead of the
previous increment of .225%.
For the period ended September 30, 1999, 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 * 2.04 to 1.0 1.90 to 1.0
Fixed charge coverage 1.66 to 1.0 1.50 to 1.0
Senior indebtedness to EBITDA 3.75 to 1.0 3.95 to 1.0
Total expenditure limit
(tested annually) $475 million
* INCLUDES EFFECTS OF THE SFAS NO. 15 INTEREST PAYMENTS.
13
For the first nine months ending September 30,1999, the Company repaid
$106.0 million of debt, which included principal payments of $42.2 million
for quarterly installments due on the term loan, $34.7 million on the
Company's yen-denominated loan (secured by the royalty income stream from
its area licensee in Japan), $15.7 million related to capital lease
obligations and $8.9 million for SFAS No. 15 interest. Outstanding
balances at September 30, 1999 for commercial paper, revolver and term
loan, were $608.0 million, $210.0 million and $126.6 million, respectively.
As of September 30, 1999, outstanding letters of credit issued pursuant to
the Credit Agreement totaled $71.0 million.
CASH FROM OPERATING ACTIVITIES
Net cash provided by operating activities was $246.9 million for the
first nine months of 1999, compared to $229.8 million during the same
period of 1998 (see Results of Operations section).
CAPITAL EXPENDITURES
In the first nine months of 1999, net cash used in investing
activities consisted primarily of payments of $328.5 million for the
purchase of property and equipment. The majority of the property and
equipment spending 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 1999 capital expenditures,
excluding lease commitments, to exceed $400 million.
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 nearly
$2 million in 1999 on capital improvements required to comply with
environmental regulations relating to USTs as well as above-ground vapor
recovery equipment at store locations, with approximately $15-20 million
spent on such capital improvements from 2000 through 2002.
ENVIRONMENTAL
In December 1988, the Company closed its chemical manufacturing
facility in New Jersey. The Company is required to conduct environmental
remediation at the facility, including groundwater monitoring and treatment
for a projected 15-year period, which commenced in 1998. The Company
has recorded undiscounted liabilities representing its best estimates of
the clean-up costs of $8.2 million at September 30, 1999. In 1991, the
Company and the former owner of the facility entered into a settlement
agreement 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 $4.8 million at September 30, 1999.
14
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, 1999, the
Company's estimated undiscounted liability for these sites was
$34.4 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, 1999, will be incurred within
the next four to 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, 1999, the Company has recorded a net receivable of $53.9 million for
the estimated probable state reimbursements, which includes an increase of
approximately $10 million resulting from recent legislative changes in
California (see below). 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 $7.0 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 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.
Because of recent legislative changes in California, which have expanded
and extended that state's program, the Company now estimates it will
receive reimbursement of most of its identified remediation expenses in
California, although it may take one to ten years to receive these
reimbursement funds. The Company has present valued (at a discount rate of
5.8%) the portion of the recorded receivable amount that relates to
remediation activities that have already been conducted. Thus, the recorded
receivable amount is also net of a discount of $11.7 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.
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 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 completed testing all of its remediated legacy
"mission critical" systems, the recently installed Y2K compliant financial
systems and the retail information system. Based on these tests, the
Company is satisfied that its systems are now ready for the date change on
January 1, 2000. Although all systems have been tested, testing will
continue through the end of this year for all operating, middleware and
application systems to determine if any unremediated or non-compliant
software, previously undetected, can be found, and to be certain that all
such systems continue to execute as expected.
15
The Company has contacted all its primary information systems ("IS"),
non-IS, merchandise, equipment, financial institution, insurance and public
utility vendors in regards to their Y2K readiness. Based on the responses
from these primary vendors, the Company has determined that these vendors
believe that the necessary steps have been taken so that the date change
will not disrupt their operations. In addition, based on the results of
contacts with third-party vendors to verify their compliance and the
compliance of their vendors, the Company is confident that the ordering
process and supply of product to its stores in the US and Canada will not
be interrupted as a result of the date change. The Company has been
successfully testing data interfaces with primary vendors and will continue
to test with vendors until year-end. In addition, the Company does not
have any direct Y2K responsibility for operations in foreign countries
(except Canada) and does not anticipate any material Y2K related impact
from foreign affiliates or licensees. Canadian operations upgrades are
included in the readiness statement shown below.
The Company has identified and prioritized all major Y2K-related
issues that may affect its operations. The following table reflects
management's assessment of the Company's Y2K state of readiness:
STATE OF READINESS AS OF NOVEMBER 12, 1999
PHASE: STATUS
- ------ -------
INTERNAL IS SYSTEMS & EQUIPMENT
- --------------------------------
Awareness Completed
Assessment of changes required Completed
Remediation of code Completed (1)
Testing Completed (2)
Analyze contingency plan requirements Completed
Develop contingency plans & test Completed
INTERNAL NON-IS SYSTEMS & EQUIPMENT
- -----------------------------------
Awareness Completed
Assessment of changes required Completed
Remediation/replacement of applications Completed
Testing Completed
Contingency planning, development and test Completed
SUPPLIERS, THIRD-PARTY PROVIDERS, 7-ELEVEN OPERATIONS
- -----------------------------------------------------
Awareness (identify companies) Completed
Assessment & review of questionnaires Completed
Risk assessment Completed
Analyze contingency plan requirements Completed
Develop contingency plans Completed
Testing with vendors, operations personnel (field) Completed (3)
(1) Y2K compliant upgrades of the retail information system have been
installed in all except approximately 55 stores. Those upgrades are
expected to be completed by the first week of December 1999.
(2) Retail information system testing of leap year related data will be
completed December 1, 1999.
(3) Some credit card processing capabilities, involving approximately
2,700 stores, are currently being migrated to a Y2K compliant network,
which is expected to be completed by December 15, 1999.
16
During the third quarter, the Company coordinated efforts of its Cash
Management, Accounting, Field Operations, Merchandising, Logistics,
Maintenance, Security/Safety and Information Systems areas to develop a
comprehensive plan for handling such contingencies as might occur on
December 31 and beyond. The primary focus is on keeping the Company's
stores open and the products in stock. Staffing and security concerns have
been addressed, as well as assigning centralized responsibility for each
geographic region. The Company's contingency plans for the stores include
special ordering procedures and quantity recommendations during December in
anticipation of increased demand for certain products prior to December 31,
as well as providing the stores with sufficient products in the event
orders cannot be filled by some vendors.
The store contingency plans have been delivered to each store in the
form of a "Communications Manual" and an "Emergency Reference Manual" which
provide answers to questions most likely to be confronted if disruptions in
service from utilities or other vendors are experienced. In addition,
store staff will be given training to insure familiarity with the plans.
The consolidation and testing of non-store contingency plans are now
underway and the plans will be in place by December 1, 1999.
The Company estimates that the cost of the Year 2000 Project will be
approximately $8.8 million, of which nearly $3.8 million is capital costs.
The costs incurred to date are $8.7 million, which includes nearly $3.7
million of capital costs. The Company does not separately track the
internal costs incurred for the Y2K project, which are primarily the
related payroll costs for the IS and various user personnel participating
in the project.
Due to the general uncertainty inherent in the Year 2000 process,
primarily due to issues surrounding the Y2K readiness of third-party
suppliers and vendors, a reasonable worst-case scenario is difficult to
determine. The Company has developed contingency plans which address the
gradual build-up and continued availability of an adequate supply of
merchandise, including gasoline, which will allow the Company to provide
product to its customers before and into the Year 2000. The Company does
not anticipate more than temporary isolated disruptions attributed to Year
2000 issues to affect either the Company or its primary vendors. To the
extent vendors are unable to deliver products due to their own Year 2000
issues, the Company believes it will generally have alternative sources for
comparable products and does not expect to experience any material business
disruptions. Although considered unlikely, the failure of public utility
companies to provide telephone and electrical service could have material
consequences, but the Company anticipates that any such failures would be
in limited geographical areas and would therefore affect only a small
percentage of the Company's stores.
17
The costs of the Y2K project and the Company's Y2K readiness
assessment 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 if the actions
taken by the Company have not identified, remediated or addressed all Y2K
related issues. In addition, while the Company is making significant
efforts in addressing all anticipated Year 2000 risks within its control,
this event is unprecedented and consequently there can be no assurance that
Year 2000 issues will not have a material adverse impact on the Company's
operating results and financial condition.
MARKET-SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The Company held a number of financial and derivative instruments at
September 30, 1999, which are sensitive to changes in interest rates,
foreign exchange rates and equity prices. The Company uses interest-rate
swaps to manage the primary market exposures associated with underlying
liabilities and anticipated transactions. The Company uses these
instruments to reduce risk by essentially creating offsetting market
exposures. In addition, the two yen-denominated loans serve to effectively
hedge the Company's exposure to yen-dollar currency fluctuations. The
instruments held by the Company are not leveraged and are held for purposes
other than trading. There are no material quantitative changes in market
risk exposure at September 30, 1999, when compared to December 31, 1998.
In the normal course of business, the Company also faces risks that
are either nonfinancial or nonquantifiable. Such risks principally include
country risk, credit risk and legal risk and are not represented in this
discussion.
RECENTLY ISSUED ACCOUNTING STANDARD
The Company is currently reviewing SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." The statement establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities. In June 1999, the effective date of SFAS No. 133 was extended
for one year; consequently, the statement will now be effective for all
fiscal quarters of fiscal years beginning after June 15, 2000, and earlier
application is encouraged. The Company has not yet determined when it will
adopt the provisions of this statement. The impact of the adoption of SFAS
No. 133 has not been determined at this time due to the Company's
continuing investigation of its financial instruments and the applicability
of SFAS No. 133 to them.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Management's Discussion and Analysis," above,
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 (4) - Instruments Defining the Rights of Security Holders,
Including Indentures
Form of Certificate for Shares of Common Stock of
7-Eleven, Inc.
2. Exhibit (15) - Letter re Unaudited Interim Financial Information.
Letter of PricewaterhouseCoopers LLP
3. Exhibit (27) - Financial Data Schedule.
Submitted in electronic format only.
(b) 8-K Reports:
During the third quarter of 1999, the Company filed no reports on Form 8-K.
19
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.
7-ELEVEN, INC.
-------------------
(Registrant)
Date: November 12, 1999 /s/ Clark J. Matthews II
----------------- -------------------------
(Officer)
Clark J. Matthews, II
President and Chief Executive Officer
Date: November 12, 1999 /s/ Don Thomas
---------------- --------------------------
(Principal Accounting Officer)
Donald E. Thomas
Vice President and Controller
20