DIT

AMCON Distributing Co. - 10-Q Summary (Period Ended March 31, 2010)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010 (Q2 Fiscal 2010) and the six months ended March 31, 2010. AMCON Distributing Company operates two primary segments: a wholesale distribution segment (ADC) serving approximately 4,200 retail outlets in the Central and Rocky Mountain regions, and a retail health food segment operating 14 stores (Chamberlin's and Akin's) in the Midwest and Florida. The company is classified as a smaller reporting company.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated sales increased 17.9% ($35.1 million) for the quarter and 14.9% ($61.6 million) for the six months compared to the prior year. This growth was driven primarily by the October 2009 acquisition of Discount Distributors ($12.9 million and $22.2 million impact for the quarter and six months, respectively) and manufacturer price increases on cigarettes.
• Margin Compression: Despite revenue growth, gross profit decreased 1.8% for the quarter and increased only 3.3% for the six months. The wholesale segment's gross margin percentage declined from 7.1% to 5.8% (quarterly) due to the loss of a $2.6 million benefit from prior-year price increases and higher volume of lower-margin products.
• Operating Expenses: Operating expenses increased 3.4% for the quarter, largely due to costs associated with the Discount Distributors acquisition (compensation, fuel, amortization).
• Segment Performance: The wholesale segment saw significant sales growth but lower margins. The retail health food segment saw a slight sales decline (0.8% quarterly) attributed to economic weakness in Florida and increased competition, though gross margins improved.

Guidance, Outlook, and Risks

Management Commentary: Management notes that general economic conditions continue to impact consumer confidence. They anticipate that a combination of economic factors, regulatory changes (FDA authority over tobacco), and potential fuel price increases could adversely affect sales and margins. However, the company plans to maintain a conservative strategy of cost containment and liquidity to capture market share.

Liquidity and Debt: The company maintains a $55.0 million revolving credit facility with Bank of America, maturing in June 2011. As of March 31, 2010, $25.9 million was outstanding with $25.0 million available. The company is in compliance with its debt service ratio covenant (minimum 1.0 to 1.0).

Risks and Contingencies:

• Regulatory Risk: Increased excise taxes and FDA regulation of tobacco products pose significant risks to the wholesale segment's primary revenue driver.
• Economic Risk: The retail segment faces challenges from the recession, particularly in Florida.
• Interest Rate Risk: The company does not currently hedge against interest rate fluctuations.
• Acquisition Integration: Ongoing integration of Discount Distributors involves contingent consideration of up to $1.0 million based on revenue targets.

Investor Verification Checklist

• Acquisition Impact: Verify the realization of synergies and revenue targets from the Discount Distributors acquisition to justify the $4.0 million purchase price and contingent consideration.
• Tobacco Margin Trends: Monitor the wholesale segment's gross margin percentage, which has declined, to assess the sustainability of profitability amidst regulatory changes and volume shifts.
• Debt Covenants: Confirm continued compliance with the debt service ratio covenant and the availability of the credit facility, which is critical for working capital needs.
• Retail Segment Turnaround: Assess the performance of the Florida retail stores and the success of the new Tulsa, OK location in offsetting regional economic weakness.
• Preferred Stock Obligations: Note the existence of Series A and Series B convertible preferred stock with liquidation preferences totaling $4.5 million and cumulative dividend requirements.