Ingles Markets, Incorporated
Q2 2008 Earnings Call Transcript

Published: 6 May 2008

[Operator:]

Good day and welcome to the Ingles Markets Inc. second quarter conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Chief Financial Officer, Mr. Ron Freeman. Please go ahead sir.

[Ron Freeman:]

Thank you. Good morning, welcome to the Ingles Markets fiscal 2008 second quarter conference call. With me today are Robert Ingle, Founder of our company and Chief Executive Officer; Robert Ingle II, Chairman of the Board; Jim Lanning, President; and Tom Outlaw, Vice President of Sales and Marketing. Statements made on this call include forward-looking statements as defined by and subject to the safe harbors created by Federal Securities Laws. Words such as expect, anticipate, intend, plan, believe, and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performances and involve risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed on this call. Ingles Markets, Incorporated does not undertake to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. For a description of factors that could cause actual results to differ materially from that anticipated by forward-looking statements, you are referred to the company's public filings including the Form 10-K for the fiscal year ended September 29, 2007. This morning, I'll provide you with a summary of our second quarter and six months results followed by additional comments. After that, we'll be pleased to take your questions. Our press release issued this morning available on our Web site at www.ingles-markets.com. We filed our 10-K for the quarter on Monday, May 5. It is available on our Web site as well. First, our second quarter results. Pretax income for our second fiscal quarter ended March 29, 2008 totaled $21 million, an increase of $4.3 million or 26.1% over pretax income of $16.7 million for the second fiscal quarter of last year. We are discussing pretax income for the second quarter and six months during this call due to the recognition last year of a $3.2 million reduction of second quarter 2007 income tax expense stemming from settlement of certain state income tax issues. This settlement affects the comparability of net income for 2008 versus 2007. Net sales totaled $782.8 million for the March 2008 quarter, an increase of $101.6 million or 14.9% compared with $681.2 million for the quarter that ended in March 2007. This increase occurred in all major categories. Grocery segment comparable store sales grew 15% over the same quarterly periods. Easter occurred during the company's second fiscal quarter of 2008. But in the third fiscal quarter of 2007, excluding the effect of additional Easter sales and excluding gasoline sales, comparable store sales increased 8.4%. In a period of increasing food costs, the number of customer transactions excluding gasoline increased 9.7% while the average transaction amount changed by less than 0.5%. Total square footage increased from 9.6 million square feet in March 2007 to 9.8 million square feet in March 2008. Total gasoline gallons sold increased approximately 19%, while the average price per gallon increased $0.85 comparing the March fiscal 2008 quarter to the same period of fiscal 2007. Fluid dairy sales increased in total dollars due primarily to double digit percentage increases in raw milk prices offset by a decrease in case volume sales. Gross profit for the March 2008 quarter increased 10.8% to $184.5 million, an increase of $17.9 million compared with the second quarter of last fiscal year. Higher relative sales growth in lower margin gasoline resulted in a lower gross profit as a percentage of sales for this quarter. Gross margin as a percentage of sales was 23.6% for the March 2008 quarter versus 24.5% for the same quarter last year. Excluding lower margin gasoline sales, grocery segment gross profit as a percentage of sales was 27.4% and 27.0% for the March 2008 and 2007 quarters respectively. We are pleased with this margin stability during a time when costs and purchasing behaviors can change quickly. Operating expenses as a percentage of sales improved to 19.6% for the March 2008 quarter compared to 20.5% for the March 2007 quarter. In dollars, operating expenses were $13.6 million higher in March 2008 versus March 2007 but were lower than the sales and gross profit dollar increases. Higher energy costs and bank charges for credit and debit card sales make it increasingly difficult for the company to sustain overall expense leverage against non-gasoline sales. As a result of our recent and ongoing store development activities, labor costs and depreciation have increased as well. Net rental income, losses on asset disposals and other income totaled $1.2 million for the March 2008 quarter compared with $1.5 million for the March 2007 quarter. Most of the decrease is attributable to lower rental income as the company's expansion activities have resulted in less tenant space available for lease. Interest expense decreased $300,000 for the three month period ended March 29, 2008 to $11.6 million from $11.9 million for the three month period ended March 31, 2007. Total debt at March 29, 2008 was $626.1 million compared to $548.1 million at March 31, 2007. New debt incurred by the company is generally at lower interest rates compared to existing debt and debt repaid over the preceding 12 months. Because of the company's increased pace of store development, more interest is being capitalized as part of store construction costs. As mentioned earlier, income tax expense was higher this quarter compared to the March 2007 quarter due to the settlement of a tax position last year under an initiative offered by one of the states in which the company conducts its operations. As a result of the settlement, the company reduced a previously established reserve for uncertain tax positions by $3.2 million and reduced 2007 income tax expense by the same amount. As a result, the company's effective tax rate was 38.1% for the second quarter of 2008 compared to 18.9% for the second quarter of 2007. Net income for the March 2008 quarter totaled $13 million compared with net income of $13.5 million for the March 2007 quarter. Basic and diluted earnings per share for the company's publicly traded Class A common stock were $0.56 and $0.53 per share respectively for the March 2007 quarter compared to $0.58 and $0.55 per share respectively for the March 2007 quarter. Now, I'll discuss our six month results. Pretax income for the six months ended March 29, 2008 totaled $41.7 million, which was 20.3% higher than pretax income of $34.7 million for the first six months of fiscal 2007. Most of the factors mentioned earlier during the second quarter discussions also drove the first half-year results. Consistent with our quarterly results, six-month profit growth began with increased sales. Net sales for the six months ended March 29, 2008 totaled $1.56 billion, which was $193 million or 14.1% higher than the first six months of fiscal year 2007. Grocery segment comparable store sales grew 13.9% over the same six months period. Excluding the effect of additional Easter sales and excluding gasoline sales, comparable store sales increased 18.4%. Number of customer transactions, excluding gasoline, increased 9.6% while the average transaction amount changed by less than 0.5%. Gross profit for the six-month fiscal 2008 period totaled $365.1 million, an increase of $33.7 million or 10.2% over the comparable fiscal 2007 period. Gross profit as a percentage of sales was 23.4% and 24.2% for the six months ended March 2008 and 2007, respectively. Excluding higher growth, lower margin gasoline sales, the gross margin comparison is 29% year-to-date fiscal 2008 versus 26.6% year-to-date fiscal 2007. Operating expenses as a percentage of sales improved to 19.5% for the March 2008 six-month period compared to 22.2% for the March 2007 six-month period. Operating expenses totaled $303.3 million for the first half of fiscal 2008, $27.4 million higher than the first half of fiscal 2007. The cost increase factors discussed earlier for the quarter also contributed to the first half increase. Net rental income, losses on asset disposals and other income totaled $3.1 million for the March 2008 six-month period compared to $3.2 million for the March 2007 six-month period. Decreased tenant rental income was partially offset by increased sales of waste paper and packaging. Interest expense decreased $800,000 for the six-month period ended March 29, 2008 to $23.1million from $23.9 million for the six-month period ended March 2007. As previously mentioned, total debt increased by $78 million between March 2007 and March 2008, but the average interest on the new debt is generally lower compared with existing non-line of credit debt and debt repaid over the preceding 12 months. We'll provide more details on the new borrowings later in the call. As discussed earlier during the quarterly discussion, the state income tax settlement and associated $3.2 million reduction of income tax expense in 2007 resulted in an effective tax rate of 28.9% for the six months ended March 31, 2007, compared to an effective tax rate of 38.4% for the six months ended March 29, 2008. Summarizing our six-month results, first half 2008 net income totaled $25.7 million compared with net income of $24.7 million for the first six months of fiscal 2007. Net income as a percentage of sales was 1.7% for the March 2008 and 1.8% for the March 2007 six-month periods respectively. Basic and diluted earnings per share for publicly traded class A common stock were $1.10 and $1.05 for the March 2008 six-month period compared with $1.06 and $1.01 respectively for the March 2007 six-month period. During the March 2008 six-month period, Ingles completed four replacement stores, one remodeled store, purchase nine land parcels, added five fuel centers, and purchased two shopping centers where the company operated lease stores. Capital expenditures for the March 2008 six-month period totaled $114.1 million. For the balance of the fiscal year, Ingles expects to open two new stores, three remodeled stores, three replacement stores and added a total of eight new fuel stations. Capital expenditures for the entire fiscal year are expected to be approximately $200 million, including expenditures for stores to open in fiscal 2009. This increased level of CapEx reflects our confidence in our store development process even during current economic uncertainties. Our baseline annual CapEx range is between $150 million and $175 million. Total borrowing availability under the company's $185 million line of credit facilities at the end of March 2007 was $171.5 million and this was after deducting $13.5 million outstanding on those lines. During the first half of fiscal 2008, the company entered into new collateralized debt agreements of $87.1 million. The new debt reduced outstanding balances on the company's lines of credit and funded the company's increased capital expenditures. Most of the debt is at fixed rates and can be repaid in three years or less without penalty. Our $349.8 million of 8.875% senior subordinated notes are now called at a call price of 102.903%, with a call price that decreases to 101.369% on December 1, 2008. We believe we have sufficient available collateral and line of credit availability to fund current and future growth and operations, and we're continuously evaluating options available to us related to current debt and future needs. We will now take your questions.

[Operator:]

Thank you. (Operator instructions) We'll go first to Bryan Hunt with Wachovia.

[Bryan Hunt:]

Thank you and good morning. Hello?

[Ron Freeman:]

Yes, Bryan, how are you today?

[Bryan Hunt:]

I'm well. How about you, Ron?

[Ron Freeman:]

Good, thanks.

[Bryan Hunt:]

I was wondering if you can divide it the CapEx for us into classification, new stores, remodels, purchased land, as well as let us know how much will be spent on projects that will be open in fiscal 2009?

[Ron Freeman:]

Well, it is hard to speculate on fiscal 2009 because so much can affect construction schedules and timing. I think the best way to characterize our capital expenditures is, as always, most of it is devoted to store development whether it is new stores, remodels or replacement stores and we gave those numbers a couple of minutes ago on what we've done on the first half of the year and what we expect to do for the second half of the year. And that is a large, large majority of the total CapEx.

[Bryan Hunt:]

Could you give us an idea of how much you spend on property this year alone?

[Ron Freeman:]

No, we don't typically provide that kind of breakdown.

[Bryan Hunt:]

And then when I look at your new store locations, throwing dirt out the window because land costs can vary dramatically – how much does it cost for you to develop a new store?

[Ron Freeman:]

Bryan, we have not disclosed in the past our per square foot construction cost and again, especially in mountainous terrain, that can have a pretty wide-ranging effect on any individual store construction cost. So it would be misleading to give you a number.

[Bryan Hunt:]

Could you give us a range then?

[Ron Freeman:]

No, I'm sorry, I really can't.

[Bryan Hunt:]

Looking at the current environment and your traffic numbers are spectacular, are you seeing any change in sales mix? Do you see consumers trading down to private label or do you see a growth in family-style or family-size packaging?

[Ron Freeman:]

We haven't seen a lot of behavior changes ourselves so far. But there is certainly a lot of industry speculation that consumers are trading down. They are buying more private label. But that hasn't really been our experience. Again, I think we are seeing some decreases in restaurant dining. And that certainly helps out our deli and bakery department.

[Bryan Hunt:]

Okay. And what is your label of private mix? Are you all trying to increase that?

[Ron Freeman:]

It is about the same as we disclosed in last year's 10-K. And again, we try to maintain a good mix between national brands and private label products. It may not be the same as what everyone else does, but it is a mix that works for us we believe.

[Bryan Hunt:]

All right, and what is the maturity of that $87 million of financing? I know you can repay it, I guess, in three years without penalty, but how long could you keep that in place?

[Ron Freeman:]

We could keep some of it as long as 20 years. They're commercial mortgages.

[Bryan Hunt:]

Okay. And my last question is – and I have asked this I guess for the last couple of quarters – considering your sales growth and your new store expansion and how tight you are in your warehouse, are there any plans to build out your warehouse? And if so, what is the CapEx associated with that?

[Ron Freeman:]

We certainly have the land and we certainly have plans that we're taking a look at but it is way early to speculate when that process might start and what the ultimate cost might be. We're doing fine; we're getting everything out to the stores on time and we're keeping them full.

[Bryan Hunt:]

Okay, I'll get back into queue and I'll let someone else ask some questions. Thank you.

[Ron Freeman:]

Thanks, Bryan.

[Operator:]

(Operator instructions) We'll go next to Andrew Berg with Post Advisory Group.

[Andrew Berg:]

Give me the CapEx (inaudible) – I have two questions. One, I would like to go back to Bryan's question, at the very least, can you please provide us some indication what the average cost per store is, ex the land?

[Ron Freeman:]

No, again that's just something that we haven't provided in the past at all. And it is not in the public documents, so I can't talk about it here.

[Andrew Berg:]

You can't talk about it here because then it would be public.

[Ron Freeman:]

Right.

[Andrew Berg:]

At $175 million CapEx, given the interest expense and where you guys are, you're spending pretty much every dollar you have that you are earning between interest and CapEx, what are the thoughts here – how does the company delever going forward?

[Ron Freeman:]

Well, we're concerned about sales. And we believe that to continue to increase sales, we need to improve and develop our store base. The company has always had a fairly high debt profile. And we're well within the bounds of that on the way the company has operated for a number of years.

[Andrew Berg:]

Okay. But is there a target leverage level where you say I don't want let leverage get above X, X is too high for us, or are we just driving this for top line growth at the expense of leveraging at the balance sheet?

[Ron Freeman:]

Our focus is top line growth.

[Andrew Berg:]

Okay. Thank you.

[Ron Freeman:]

Thank you.

[Operator:]

We'll take our next question from Emily Shanks with Lehman Brothers.

[Emily Shanks:]

Good morning and thank you for taking the question. I have a question around the disclosure in the Q and specifically on the lines of credit that mature between October of '08 to November 2010. Can you please let us know what the dollar amount is that's maturing specifically in October 2008, or has that been pre-funded by this new commercial mortgage?

[Ron Freeman:]

I'm not sure I understood the second part of your question. But I believe there is a table in the 10-Q that outlines those maturities. We have a mix of one-year lines and three-year lines and I do not know, sitting right here at the table, what the mix is right now. But I believe there is a table in the 10-Q that has what amount of those credit lines mature in one year and what amount mature in three years.

[Emily Shanks:]

Okay, I think we may have missed it. We'll take a look. How are you planning on refinancing that maturity that is coming in October of 2008?

[Ron Freeman:]

We have been working with the line banks that we have for a number of years. And we have never had any problems with renewing those lines of credit. And I don't anticipate any this year.

[Emily Shanks:]

Are those lines backed by the real estate?

[Ron Freeman:]

No, those are unsecured lines.

[Emily Shanks:]

Okay. And specifically there, you mentioned a number of trigger events but are generally typically events of defaults or covenant breaches. But, do the credit lines, are they uncommitted in any way, meaning that if the bank's see any material adverse change to the business, is it at the bank's option to walk away from those lines?

[Ron Freeman:]

Those are committed lines and as long as we stay within our covenants, we have got the availability.

[Emily Shanks:]

Super, okay. And then moving more to the operations, can you comment at all about what type of rate of inflation you're seeing right now, particularly on the grocery sales?

[Ron Freeman:]

I think our experience has been pretty similar to what the experience has been nationwide. And the data that we're seeing is from the U.S. Bureau of Labor Statistics is for the three months ended this March, food and beverage inflation was 5.1% and it has been 4.4% for the last 12 months. And I believe the rate of food and beverage inflation for the December quarter was like 2.3%. So it has been ramping up pretty good.

[Emily Shanks:]

Okay, great. And then if I could just one final question. Just looking at accounts payable, days outstanding, it looks like they came down quarter-over-quarter and year-over-year. Are you seeing any change in your relations with your vendors on any of the term?

[Ron Freeman:]

No, not really.

[Emily Shanks:]

Okay, thank you.

[Ron Freeman:]

You're welcome.

[Operator:]

(Operator instructions) We will take a follow-up from Bryan Hunt with Wachovia.

[Bryan Hunt:]

According to the Q, you spent money on your dairy this year. Could you talk about, one, the size of the spending and, two, what exactly you are doing at the dairy?

[Ron Freeman:]

There were some land adjacent to the existing facility that we purchased. And there are no current capacity issues at the dairy. But, when land becomes available that is adjacent to where you are and it is at a good price, you buy it. And you plan for the future. But, there is nothing imminent out there that would make sense to discuss right now.

[Bryan Hunt:]

So there is no capacity issues there either?

[Ron Freeman:]

No, not at all.

[Bryan Hunt:]

And then, looking at your CapEx number, we have had the pendulum swing completely in your favor, you're obviously doing a lot of unique things with regards to data mining and your advantage card, rolling out fuel centers and you've had a great run. If the pendulum were to swing the other way and the markets were to become very competitive and margins were to tighten up, where could you dial CapEx down to, if you didn't have to grow the business, what is the maintenance CapEx number at Ingles?

[Ron Freeman:]

Bryan, first of all, it is always competitive. So we're glad we're doing well right now, but we never take the competitive environment for granted. Again, we don't necessarily have a maintenance CapEx number. I can't stress enough, we focus on top line growth and we very strongly believe that you have to keep your stores top-notch, up to date, modern and the best in their market. And we don't want to change that.

[Bryan Hunt:]

Okay. Do you feel like there is any of your competitors that are going down the same path that you are going down competitively, and spending aggressively and trying to develop stores in your market? Do you feel strong competitive pressures because with 9% plus traffic growth, it would appear that you are taking substantial share?

[Ron Freeman:]

Bryan, I know you're tired of hearing me say this, but our policy is we don't comment on the activities of our competitors. We focus on what we do and continue to try to do it better all the time.

[Bryan Hunt:]

All right. Thank you very much.

[Ron Freeman:]

You're welcome, Bryan.

[Operator:]

We'll take a follow-up from Andrew Berg with Post Advisory Group.

[Andrew Berg:]

Well, I asked that question [ph]. Thanks.

[Operator:]

And it appears we have no further questions at this time. I now turn the call back over to Mr. Freeman for any additional or closing remarks.

[Ron Freeman:]

Thank you for joining us today and we enjoy sharing the numbers with you and look forward to seeing you in our stores. Have a great day everyone. Thank you.

[Operator:]

That does conclude today's presentation. We thank you for your participation and you may now disconnect.