Ingles Markets, Inc. — Fiscal 2019 First-Quarter 10-Q
Reporting period: Three months ended December 29, 2018 (13 weeks), compared with the three months ended December 30, 2017. Ingles operated 200 supermarkets across six Southeastern states, plus a fluid dairy business and shopping-center rentals.
Financial performance and position
| Metric | Quarter ended Dec. 29, 2018 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $1,061.8 million | $1,013.8 million | +4.7% |
| Gross profit / margin | $258.4 million / 24.3% | $244.7 million / 24.1% | +5.6%; margin +0.2 percentage points |
| Operating income / margin | $39.5 million / 3.7% | $35.9 million / 3.5% | +10.0%; margin +0.2 percentage points |
| Income before taxes | $28.1 million | $25.4 million | +10.9% |
| Income tax expense (benefit) | $6.0 million | $(19.8) million | Prior period included a substantial tax benefit |
| Net income | $22.2 million | $45.1 million | −50.9% |
| Class A basic / diluted EPS | $1.12 / $1.09 | $2.29 / $2.23 | Lower, principally reflecting prior-period tax benefit |
| Operating cash flow | $63.6 million | $37.4 million | +$26.2 million |
| Capital expenditures | $71.0 million | $56.8 million | +$14.2 million |
Operating and administrative expenses rose 4.7% to $218.7 million and remained 20.6% of sales. Interest expense increased to $12.2 million from $11.5 million, as higher LIBOR increased the cost of floating-rate debt, partly offset by scheduled principal payments. The current-quarter effective tax rate was 21.3%; the prior-year quarter’s 77.8% tax benefit included a $26.7 million reduction in deferred tax liabilities from the Tax Act.
At December 29, 2018, cash was $14.1 million; current assets were $488.8 million and current liabilities $254.7 million. Total debt was approximately $879.9 million, including $12.8 million current and $867.1 million long-term. Stockholders’ equity was $614.7 million. The $175 million credit line had $16.5 million drawn; the company reported covenant compliance and approximately $421 million of additional borrowing capacity under its most restrictive covenant.
Cash from investing activities was $(70.9) million, primarily reflecting capital spending. Financing activities provided $10.9 million, including net short-term borrowing. Cash increased $3.6 million during the quarter. The company paid quarterly dividends of $0.165 per Class A share and $0.15 per Class B share.
Material changes and operating drivers
- Sales grew 4.7%; comparable grocery sales excluding gasoline rose 3.9%. Excluding gasoline, customer transactions increased 1.7% and average transaction size increased 2.6%.
- Gasoline sales benefited from 0.8% more gallons sold and a 6.4% higher retail price per gallon. Gasoline gross profit dollars and margin also improved.
- Excluding gasoline, grocery gross margin declined 19 basis points. Management attributed higher operating expenses to increased labor hours and labor competition, worse self-insurance claims experience, property taxes and licenses, and card-processing costs.
- Quarterly capital expenditures were unusually high in part because Ingles purchased a shopping center containing a store it had previously leased. The company also invested in planned store openings, site acquisition, remodeling, equipment and technology.
- The company adopted the revenue-recognition standard during the quarter and said its impact was immaterial. The lease-accounting standard was expected to be adopted in fiscal 2020; its impact was still under evaluation.
Outlook, risks and contingencies
- Fiscal 2019 planned capital expenditures were approximately $140 million to $180 million; the company expected annual spending of approximately $100 million to $160 million thereafter to maintain and improve its store base. Construction commitments were $15.0 million at quarter-end.
- Management expected operating cash flow, the credit line and other financing to be sufficient for planned capital spending, working capital and debt service for the foreseeable future, but cautioned that financing may not be available on acceptable terms or when needed.
- The company expected to continue regular quarterly cash dividends, subject to board discretion, financial performance and debt-agreement restrictions.
- Key disclosed risks include competition, regional economic conditions, food supply and weather disruptions, labor and utility cost increases, gasoline-price changes, financing availability, and the performance of new, remodeled or expanded stores.
- Self-insurance reserves totaled $34.2 million. They depend on claims estimates and actuarial assumptions; employee insurance expense increased to $10.2 million from $8.6 million. Management said ordinary-course legal claims were not expected to materially affect financial position, results or cash flows.
- Debt agreements include financial covenants and cross-default provisions. The company was in compliance at quarter-end; a default could permit lenders to terminate credit or accelerate obligations. A $53 million interest-rate swap hedged floating-rate debt.
Important facts for investors to verify
- How much of sales growth and gross-margin improvement is sustainable, particularly given the contribution from higher gasoline prices and the decline in ex-gas grocery gross margin.
- Whether the prior-year $26.7 million tax benefit is correctly separated from underlying year-over-year earnings trends.
- Progress and returns on the $140 million–$180 million fiscal 2019 capital-spending plan, including the acquired shopping center and planned store projects.
- Debt costs and liquidity headroom if interest rates rise, capital needs increase or operating results weaken; review covenant definitions and cross-default terms.
- Developments in self-insurance claims and reserves, labor costs, and the expected balance-sheet impact of lease-accounting adoption.