DIT

AMCON Distributing Co. - 10-Q Summary (Period Ended March 28, 2003)

Business Context and Reporting Period

This Form 10-Q covers the fiscal second quarter and six-month period ended March 28, 2003. AMCON Distributing Company operates three primary segments: wholesale distribution of consumer products (primarily cigarettes and tobacco), retail health food stores, and a beverage division (Hawaiian natural spring water and other beverages). The company is headquartered in Omaha, Nebraska.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Sales decreased 8.8% for the quarter and 7.3% for the six-month period compared to the prior year. The wholesale distribution segment drove this decline, with cigarette sales down 10.7% in volume. A temporary price reduction on four Philip Morris brands accounted for $8.8 million of the sales decrease.
• Profitability Pressure: Net income turned to a loss of $0.3 million for the quarter, compared to a profit of $0.1 million in the prior year. Operating income dropped $0.7 million quarter-over-quarter.
• Margin Improvement: Despite lower sales, gross profit margin percentage increased to 7.8% (from 7.3% prior year) due to the structure of the Philip Morris price reduction, which did not materially reduce gross profit per carton.
• Segment Performance: The wholesale segment remained profitable but faced margin pressure from reduced private label cigarette incentives. The retail segment remained flat in gross profit. The beverage segment generated $0.2 million in gross profit, up from negligible amounts in the prior year.
• Debt Reduction: The company utilized operating cash flows to reduce debt, paying down approximately $10.0 million on revolving credit facilities during the six-month period.

Guidance, Outlook, and Risks

• Private Label Cigarettes: The company's private label manufacturing agreement with Philip Morris expired in October 2002. Management expects gross margin related to private label cigarettes to decrease by up to $1.4 million in fiscal 2003 due to less favorable renewal terms.
• Industry Trends: The company faces headwinds from declining overall U.S. cigarette consumption and the shift of retailers away from national brands toward value-priced brands, which impacts AMCON's national brand-focused strategy.
• Expansion Plans: The beverage division is expanding its warehouse and packaging facility in Hawaii, with completion expected in Q4 2003. The company is also establishing a nationwide broker network for beverage distribution.
• Accounting Changes: The company adopted SFAS No. 142, ceasing the amortization of goodwill and tradenames. No impairment charges were recorded upon adoption.
• Liquidity: Management believes cash from operations and available credit facilities are sufficient to meet debt service and capital expenditure requirements.

Investor Verification Checklist

• Philip Morris Agreement: Verify the status and terms of the renegotiated private label cigarette manufacturing agreement and the potential $1.4 million margin impact.
• Cigarette Volume Trends: Monitor the 10.7% volume decline in cigarette sales to determine if it is a temporary market fluctuation or a structural loss of market share.
• Debt Covenants: Confirm continued compliance with the 1.0 debt service coverage ratio and 93% fill rate covenants on the $55 million revolving facility.
• Beverage Segment Viability: Assess the timeline for the Hawaiian Natural Water Company (HNWC) to achieve profitability following its expansion and marketing efforts.
• Interest Rate Exposure: Review the impact of the $25 million interest rate swap (fixed at 8.33%) maturing in May 2003 and the company's exposure to variable rates on remaining debt.