DIT

AMCON Distributing Co. - 10-Q Summary (Period Ended June 30, 2006)

Business Context and Reporting Period

This Form 10-Q covers the third fiscal quarter and the first nine months ended June 30, 2006. AMCON Distributing Company operates primarily in the wholesale distribution of consumer products (cigarettes, confectionery, groceries) in the Great Plains and Rocky Mountain regions. It also operates retail health food stores and a non-alcoholic beverage business (Hawaiian Natural Water Company). The filing notes that prior period financial statements for 2005 have been restated due to accounting errors regarding inventory and interest allocation.

Key Financial Metrics

Material Changes vs. Prior Period

• Sales: Quarterly sales increased 4.1% ($8.8 million) compared to the prior year, driven by higher cigarette excise taxes, price increases, and volume growth in tobacco and confectionery. Year-to-date sales decreased slightly ($0.9 million) primarily due to a reporting period change that added an extra week of sales in the prior year's nine-month period.
• Profitability: Net income for the quarter turned positive ($0.35 million) compared to a loss of $(0.23) million in the prior year. However, the nine-month period resulted in a net loss of $(1.34) million, an improvement from the prior year's loss of $(2.59) million, largely due to reduced losses from discontinued operations.
• Discontinued Operations: The subsidiary Trinity Springs, Inc. (TSI) ceased operations in March 2006 and is classified as discontinued. Losses from discontinued operations decreased significantly year-over-year ($1.53 million loss for nine months vs. $3.08 million in the prior year).
• Cash Flow: Operating cash flow turned negative for the nine-month period ($(9.24) million) compared to positive cash flow ($1.35 million) in the prior year, primarily due to increased inventory purchases.

Guidance, Outlook, Risks, and Unusual Items

• Liquidity and Debt: The company is heavily leveraged with approximately $54.8 million outstanding on its revolving credit facility. As of June 30, 2006, the company was over its borrowing base limit by $0.3 million but remained within the $1.5 million over-advance provision. Management expects to remain in compliance with EBITDA covenants, though December 2006 and February 2007 monthly covenants may be at risk.
• Restatement: Financial statements for the nine months ended June 30, 2005, were restated to correct inventory accounting errors at the Hawaiian Natural Water Company (HNWC) and incorrect interest expense allocations to a discontinued subsidiary.
• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of June 30, 2006, due to material weaknesses identified in inventory accounting and oversight at HNWC. Remedial actions include hiring new accounting staff and consultants.
• Litigation: A settlement was reached regarding litigation over the ownership of TSI assets, resolving most disputes. However, claims between AMCON/TSI and the former asset owners (CPH) remain pending, and the potential financial impact cannot be estimated.
• Outlook: Management believes current cash resources and the credit facility are sufficient to fund operations through fiscal 2007. The company is exploring alternatives for the HNWC business, including potential sale or outside capital infusion.

Investor Verification Checklist

• Covenant Compliance: Verify the company's ability to meet the specific EBITDA covenants required by the credit facility for the months of December 2006 and February 2007.
• Inventory Valuation: Review the impact of the restatement and the new internal controls on inventory valuation, specifically regarding LIFO reserves and obsolescence at the HNWC subsidiary.
• Discontinued Operations: Monitor the resolution of the remaining litigation claims between AMCON/TSI and CPH, as this could result in unexpected liabilities.
• Debt Structure: Assess the risk associated with the company being over its borrowing base limit and the reliance on the over-advance provision for liquidity.
• Preferred Stock: Note the issuance of Series C preferred stock ($2.0 million) and the cumulative dividend requirements that reduce net income available to common shareholders.