Business context and reporting period
Ingles Markets, Incorporated operates 200 supermarkets across six southeastern states, with grocery retail as its primary business and additional fluid-dairy and shopping-center rental operations. This Form 10-K reports the 52-week fiscal year ended September 29, 2018. Fiscal 2017 had 53 weeks, so annual comparisons are affected by the extra prior-year week. The filing also provides unaudited fourth-quarter results.
Financial performance and position
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $4.093 billion | $4.003 billion |
| Gross profit and margin | $980.2 million; 24.0% | $963.6 million; 24.1% |
| Operating income and margin | $124.8 million; 3.1% | $127.9 million; 3.2% |
| Income before taxes | $80.3 million | $84.3 million |
| Net income | $97.4 million | $53.9 million |
| Diluted EPS, Class A / Class B | $4.81 / $4.49 | $2.66 / $2.49 |
| Cash from operations | $161.2 million | $156.3 million |
| Capital expenditures | $150.5 million | $127.7 million |
| Interest expense | $47.6 million | $47.5 million |
Sales rose 2.3% year over year, but the extra week in FY 2017 contributed $71.9 million of prior-year retail sales. On a 52-week comparable basis, retail sales excluding gasoline increased 2.0%; transactions rose 0.3% and average transaction size 2.2%. Gasoline gallons increased 2.3% and average per-gallon prices rose 19.1% on the same comparison basis. The grocery category declined to $1.413 billion from $1.425 billion, while non-foods, perishables and gasoline sales increased.
Net income growth was principally tax-driven, not the result of higher pretax earnings. Tax-law changes and an adopted tax depreciation method generated $37.3 million in tax expense reductions. Excluding those reductions, management reported an effective tax rate of 25.2%, versus 36.1% in FY 2017. Pretax income fell 4.7%, with the prior year’s extra week a key factor. Operating expenses increased, particularly wages and insurance; the overall operating margin declined to 3.1%.
Fourth-quarter FY 2018 sales were $1.060 billion and net income was $18.4 million, compared with $1.089 billion and $19.4 million in fourth-quarter FY 2017. The prior-year quarter contained 14 weeks versus 13 weeks in FY 2018.
Operating cash flow exceeded capital expenditures by approximately $10.8 million. Cash and cash equivalents were $10.5 million at year-end, down from $23.9 million. Current assets were $496.7 million and current liabilities $260.1 million. Total debt was $865.6 million, down from $877.9 million; the company had no borrowings under its $175 million credit line and reported $165.6 million available. Stockholders’ equity was $595.4 million. Annual dividends were $0.66 per Class A share and $0.60 per Class B share.
Material changes versus the prior comparable period
- Gross profit increased $16.6 million, although gross margin edged down 0.1 percentage point. Excluding gasoline, grocery gross margin as a percentage of sales improved 31 basis points.
- Operating income declined $3.1 million; increased costs included $9.3 million in salaries and wages and $3.8 million in insurance, notwithstanding the shorter fiscal year.
- Other-segment revenue, including dairy and rentals, decreased to $121.4 million from $142.0 million. Management attributed lower fluid-dairy income to decreased milk demand; real-estate income increased.
- Capital expenditures increased to $150.5 million. The company opened five stores and closed four, ending the year with 200 supermarkets; it also purchased three shopping centers containing previously leased Ingles stores.
- Debt decreased by $12.3 million. A rate swap initiated in December 2017 fixed the rate on a portion of floating-rate debt at 3.92%.
Outlook, risks and unusual items
Management expected non-gasoline sales to be higher in FY 2019, planned new-store openings, continued remodeling, and additional fuel stations and pharmacies. It forecast FY 2019 capital expenditures of approximately $120 million to $160 million and expected ongoing annual net capital expenditures of roughly $100 million to $160 million. Management expects to continue quarterly dividends, subject to board discretion, financial results and debt restrictions. It stated that available cash, operating cash flow and expected financing should meet planned needs, while cautioning that financing may not be available on acceptable terms.
Key risks include intense grocery competition, including online and nontraditional formats; regional economic or severe-weather disruption; labor availability and cost; volatility in gasoline prices, fuel supply and energy costs; food safety and distribution interruptions; information-system and data-security risks; and the execution and returns of store expansion and renovation. The company is substantially leveraged and subject to financial covenants and cross-default provisions. Robert P. Ingle II held approximately 75% of combined voting power, giving him control over director elections and many shareholder actions. The company also self-insures significant employee, general-liability and property risks.
Management said pending ordinary-course legal claims were not expected to materially affect the company. Self-insurance reserves were $34.7 million. Construction commitments totaled $12.6 million. The company reported compliance with debt covenants and effective disclosure controls and internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Assess underlying earnings excluding the $37.3 million of tax-related expense reductions, and distinguish those benefits from recurring operating performance and cash taxes.
- Compare sales and earnings on an equivalent-week basis, particularly the 13-week FY 2018 fourth quarter versus the 14-week FY 2017 fourth quarter.
- Review the maturity and refinancing exposure of the $700 million 5.75% senior notes due 2023, alongside total debt, interest-rate exposure and covenant restrictions.
- Track labor, insurance and other operating-cost increases against comparable-store growth and gross-margin trends.
- Evaluate whether planned store investment and remodels generate adequate returns, and whether gasoline-price changes are driving reported sales growth.
- Confirm the sustainability of dividends given capital spending, debt-service requirements and financing covenants.