Business Context and Reporting Period
Weis Markets, Inc. operates 204 conventional supermarkets in Pennsylvania and six surrounding states, with approximately 23,000 associates. The company reports one operating segment and self-distributes approximately 67% of products. This unaudited Form 10-Q covers the 13 and 39 weeks ended September 30, 2017, compared with September 24, 2016.
Financial Highlights
| Metric | 13 Weeks Ended | 39 Weeks Ended |
|---|---|---|
| Net sales | $854.3 million, up 15.0% | $2.583 billion, up 16.8% |
| Gross profit | $222.8 million | $692.5 million |
| Gross margin | 26.1%, versus 27.6% | 26.8%, versus 27.8% |
| Operating income | $6.2 million, down 61.2% | $54.2 million, down 24.0% |
| Operating margin | 0.7%, versus 2.1% | 2.1%, versus 3.2% |
| Net income | $4.4 million, down 58.1% | $34.8 million, down 24.5% |
| Diluted EPS | $0.16, versus $0.40 | $1.29, versus $1.71 |
- Comparable-store sales increased 1.5% in the quarter and 1.6% year to date; excluding fuel, increases were 1.1% and 1.2%, respectively.
- Net sales benefited substantially from the 2016 acquisitions. The acquired Mars, Food Lion and Nell’s stores contributed approximately $118.0 million of third-quarter sales and $361.1 million for the first 39 weeks of 2017.
- Operating cash flow was $105.7 million year to date, compared with $111.9 million in the prior-year period.
- Capital expenditures were $65.4 million year to date, versus $96.7 million in 2016. Management planned approximately $90.0 million of 2017 capital investment.
- Cash and cash equivalents were $20.2 million at September 30, 2017, compared with $14.7 million at December 31, 2016. Marketable securities totaled $63.9 million.
- Long-term debt was $52.1 million, down from $64.5 million at December 31, 2016. The revolving facility provides $100.0 million of committed capacity plus an additional discretionary $50.0 million; reported unused availability was $32.6 million after borrowings and letters of credit.
- Dividends paid during the first 39 weeks were $24.2 million, or $0.90 per share. The board approved a further quarterly dividend of $0.30 per share payable November 20, 2017.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven primarily by the 2016 acquisitions, while comparable-store growth remained modest.
- Gross margin declined 150 basis points in the third quarter and 100 basis points year to date. Management attributed the quarterly decline principally to lower profits in fresh departments, including produce, deli/food service, bakery, seafood and floral, due to deflation, competitive pricing and inventory-management challenges at recently acquired stores.
- Operating expenses increased 14.7% in the quarter and 17.6% year to date, largely reflecting the acquired stores, higher depreciation, rent, advertising, financial transaction fees and third-party services.
- Operating and net margins contracted materially despite higher sales. Year-to-date results also reflected $11.8 million of long-term incentive payments to associates, which reduced operating cash flow.
- Financing cash flow changed from a $15.9 million source in the prior-year period to a $36.6 million use, primarily because the company repaid $12.4 million of revolving debt while maintaining dividend payments.
Guidance, Outlook, Risks and Unusual Items
- Management expects operating cash flow and available revolver capacity to fund working capital, debt obligations, capital expenditures, acquisitions and dividends. No formal earnings guidance was provided.
- The 2016 acquisition group generated positive cash flow in 2017. The company stated that it has no pending acquisitions but continues to evaluate acquisition opportunities and organic expansion.
- Management cited intense competition, price pressures, general economic conditions, regulatory changes, technology developments and retail-industry conditions as risks. Competitors may have greater financial resources.
- The company remains concerned about future operating-cost effects from the Affordable Care Act; self-insured health-care expense increased $0.9 million in the quarter.
- The revolving credit agreement matures September 1, 2019 and requires trailing twelve-month EBITDA of at least $75.0 million. Letters of credit totaled $15.3 million, and management does not anticipate drawing on them.
- The company expects to adopt revenue-recognition guidance under ASC 606 using the modified retrospective method beginning December 31, 2017. Management expects primarily presentation changes and no material earnings effect, but customer loyalty programs and gift cards are affected.
- Lease accounting guidance is expected to have a significant balance-sheet impact when adopted; the filing does not provide a quantified estimate.
- A discrete tax item increased the year-to-date effective tax rate to 38.0%, compared with 37.2% in 2016. A favorable $0.6 million LIFO valuation adjustment in 2017 contrasted with a $0.8 million expense in 2016.
- Management stated that disclosure controls were effective and that no material change occurred in internal control over financial reporting during the quarter.
Investor Verification Points
- Verify whether margins recover as the acquired stores mature, particularly in fresh departments.
- Monitor comparable-store sales excluding fuel and the effects of fuel-price changes.
- Assess progress against the approximately $90.0 million 2017 capital program and its effect on cash generation.
- Confirm revolver availability, covenant compliance and debt repayments before the September 2019 maturity.
- Review the quantified impact of ASC 606 and lease-accounting adoption when subsequently disclosed.
- Evaluate the sustainability of the $0.30 quarterly dividend given earnings, capital needs and acquisition activity.