Ingles Markets, Incorporated
Q4 2008 Earnings Call Transcript

Published: 1 Dec 2008

[Operator:]

(Operator Instructions) Welcome to the Ingles Markets Incorporated Fourth Quarter Conference Call. For opening remarks and introductions I’d like to turn the call over to the Chief Financial Officer, Mr. Ron Freeman.

[Ron Freeman:]

Welcome to Ingles Markets 2008 Fourth Quarter and Year End 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 Harbor as 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 performance 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 27, 2008. In accordance with the long standing company policy and in recognition of the extremely competitive nature of our industry this call will not address competitive issues or Ingle Marketing strategies other than what is included in the Form 10-K. This morning, I’ll provide you with a summary of our annual and fourth results followed by additional comments on each period. After that, we will be pleased to take your questions. Our press release issued this morning is available on our website, www.Ingles-Markets.com. Our Form 10-K will be filed later today and will be available on the website as well. For the 44th consecutive year we had record sales with this year’s increase of 13.6% resulting in sales totaling $3.24 billion. This was the first time in the company’s history sales exceeded $3 billion. Fourth quarter sales totaled $842.8 million a 13% increase compared with the fourth quarter of the prior fiscal year. For the 2008 fiscal year net income totaled $52.1 million compared with $58.6 million for fiscal year 2007. Fourth quarter fiscal year 2008 net income totaled $10.5 million compared with $14.2 million for the fourth quarter of fiscal year 2007. Predominant factors affecting comparative net income include energy costs, weather related disruptions and retail gasoline operations and higher costs related to the company’s accelerated store expansions in fiscal year 2008. Capital expenditures almost doubled to $248.8 million in fiscal 2008 compared with fiscal 2007. Our long-term focus has been and will continue to be driving top line sales through product offerings, customer satisfaction and expanded store offerings. This long-term sales and customer focus can temporarily depress operating results but we believe it is important to maintain customer loyalty during these uncertain economic times. First, our fourth quarter result, net sales increased 13.0% to $842.8 million for the quarter ended September 27, 2008, from $746.0 million for the comparable fiscal 2007 quarter. Grocery segment comparable stores sales growth rose 13% and were up 7.8% excluding gasoline sales when compared with the fourth quarter of fiscal 2007. Both average weekly customer visits and the average purchase amount increased over the comparative fourth quarters. Fourth quarter sales were substantially impacted by hurricane related gasoline shortages for most of the month of September 2008. There were few days during that month where all of our 55 fuel stations were able to sell all grades of fuel without shortage. Gross profit for the fourth quarter of fiscal 2008 totaled $191.6 million an increase of $12.1 million compared with the fourth quarter of fiscal 2007. Gross profit as a percentage of sales was 22.8% for the fourth quarter of fiscal 2008 compared with 24.1% for the fourth quarter of fiscal 2007. Excluding lower margin gasoline sales grocery segment gross profit as a percentage of sales was 26.6% for the fourth fiscal quarter of 2008 compared with 26.9% for the comparable 2007 quarter. As noted earlier hurricane influenced disruptions in retail gasoline supplies in September 2008 and the result of price volatility hurt fourth quarter 2008 gross profits. The company sold much of its gasoline at cost during the worst of the crisis and suffered reduced supply at many of its fuel stations. The company estimates fuel gross profit losses of approximately $1.5 million during that time period. Fluid dairy gross profits were lower as well reflecting a yearlong environment of cost pressures and increased competition. Total operating expenses were up $165.0 million for the fourth quarter fiscal 2008 compared with $146.3 million for the comparable 2007 quarter. The growth in operating expenses was due in part to eight stores that were opened or remodeled during the third and fourth quarters of fiscal year 2008. Bringing a large number of stores online in a short period often results in higher personnel costs and promotional expenses to ensure a successful start for new and remodeled stores. Additions of capitalized store assets also result in higher depreciation expense. Increases in these line items accounted for more than half of the dollar increase for the comparative fourth quarters. Operating expenses as a percentage of sales were 19.6% for each fourth quarter period. Net rental and other income decreased $0.4 million in the fourth quarter of fiscal 2008 compared with the 2007 fourth fiscal quarter primarily due to the lower rental income partially offset by higher sales of scrap cardboard and packaging materials. Losses from asset disposals totaled $700,000 for the fourth quarter of fiscal 2008 compared with losses of $300,000 for the fourth quarter of fiscal 2007. Interest expense totaled $12.1 million for the fourth fiscal 2008 quarter compared with $10.8 million for the same quarter last year. The company has increased its debt during fiscal year 2008 to fund capital expenditures although the new debt has generally been at lower rates than previously existing debt. Net income for the September 2008 quarter totaled $10.5 million compared with net income of $14.2 million for the September 2007 quarter. Basic and diluted earnings per share for the company’s publicly traded Class A common stock were $0.44 and $0.43 per share respectively for the September 2008 quarter compared with $0.61 and $0.57 per share respectively for the September 2007 quarter. Now I’ll go over our annual results. Net sales increased 13.6% to $3.24 billion for the fiscal year ended September 27, 2008, from $2.85 billion for the fiscal year ended September 29, 2007. Sales increased in every major grocery segment product category and in our fluid dairy operations. Both the average purchase amount and average weekly customer visits increased during fiscal 2008 with customer visits to our 197 stores exceeding 113 million shopping trips. Grocery segment comparable store sales excluding gasoline increased $194.3 million or 8%. A number of factors influenced sales growth many of which reflect an increasingly unstable economic environment. Trends include more at home consumption of prepared meals, increased sales of private label items and combined shopping trips. We believe we are well positioned to respond to these trends. Retail square footage increased to 10.2 million square feet at September 27, 2008, compared to 9.7 million square feet at September 29, 2007. We operated 197 stores at the end of both 2008 and 2007 so our average store size is increasing. Gross profit for the fiscal year ended September 27, 2008, increased $61.6 million or 9.0% to $747.9 million or 23.1% of sales compared with $686.2 million or 24.1% of sales for the fiscal year ended September 29, 2007. The increase in grocery segment gross profit dollars was primarily due to higher sales volume. Grocery segment gross profit margin was lower for fiscal 2008 primarily due to higher sales growth in the gasoline department which has the lowest gross margin. Excluding gasoline sales grocery segment gross profit margin increased to 26.9% for fiscal year 2008 compared to 26.7% for fiscal year 2007. Fluid dairy gross profit decreased $2.9 million in response to cost and competitive factors. Operating and administrative expenses decreased as a percentage of sales to 19.4% for the fiscal year ended September 27, 2008, compared with 19.8% for the fiscal year ended September 29, 2007. In dollars operating and administrative expenses increased $62.4 million or 11.1% to $626.4 million for the year ended September 27, 2008, from $564.0 million for the year ended September 29, 2007. Excluding gasoline which does not have significant direct operating expenses the ratio of operating expenses to sales was 22.4% for fiscal year 2008 compared with 21.9% for fiscal year 2007. In addition to the factors noted above in the fourth quarter discussion the company experienced higher distribution, energy and insurance expenses as well as increased credit and debit card processing and supply costs. Many of these cost increases were not passed through to customers in the form of higher sales prices. The company believes it is important to maintain customer loyalty and overall sales growth during the current economic conditions. Net rental and other income totaled $6.4 million for fiscal year 2008 compared with $7.4 million for fiscal year 2007 due to less available tenant space as we expand certain stores and due to a more selective process regarding complementary tenants. Offsetting some of this decline are higher income from scrap cardboard and plastic sales. Losses on asset disposals totaled $1.3 million in fiscal year 2008 primarily as a result of replacing equipment in relocated and remodeled stores. Gains on asset disposals totaled $6.9 million for fiscal year 2007 as the company sold a shopping center in which it no longer operated a store and a pre-tax gain of approximately $7.9 million. Interest expense totaled $46.9 million for the year ended September 27, 2008, compared with $46.7 million for the year ended September 29, 2007. During fiscal year 2008 the company’s financing activities provided $158.4 million in cash comprised of new borrowings totaling $189.4 million reduced by principal payments on long-term debt and dividend payments totaling $30.9 million. The additional borrowings were used primarily to finance the increased level of capital expenditures during fiscal year 2008. At September 27, 2008 the weighted average interest rate on new and refinanced borrowings was 5.4%. The company’s effective tax rate was 34.6% for fiscal year 2008 and 34.7% for fiscal year 2007. During fiscal 2007 the company settled a tax position under an initiative offered by one of the states in which it does business. As a result of this settlement income tax expense was reduced in fiscal 2007 by $3.2 million. Net income for fiscal year 2008 totaled $52.1 million compared with net income of $58.6 million for fiscal year 2007. Despite the year over year decrease fiscal year 2008 net income was the second highest in the company’s history. Basic and diluted earnings per share for the company’s publicly traded Class A common stock were $2.22 and $2.13 per share respectively for the year ended September 27, 2008, compared with $2.51 and $2.39 per share respectively for the year ended September 29, 2007. Now an update on our investing and financing activities, capital expenditures totaled $248.8 million and $127.8 million for fiscal years 2008 and 2007 respectively. During fiscal 2008 Ingles opened two new stores, closed two older stores, completed 10 replacement or remodeled stores, and purchased land parcels for future development. In 2008 CapEx and store development activities were the company’s highest in a number of years. Ingles capital expenditure plans for fiscal 2009 include 12 new replacement or remodeled stores and to add 10 fuel stations at either new or existing stores. Most of these projects are already underway with some of the expenditures included in fiscal 2008 CapEx. Given the recent pull back in credit availability we are pleased to have been able to economically fund 2008’s higher level of CapEx. Future CapEx will largely depend upon overall economic conditions and credit availability. At September 27, 2008, the company had $185 million of committed lines of credit of which $27.8 million was outstanding. We believe that these committed lines and other sources of financing are sufficient to meet planned capital expenditures and working capital requirements for the foreseeable future. At the close of another successful year we look forward to serving our customers with more stores and more products delivered with value and exceptional service. We will now take your questions.

[Operator:]

(Operator Instructions) Your first question comes from Ellen Itskovitz – Lord Abbett

[Ellen Itskovitz:]

When you’re doing a lot of your renovations, etc. you said that a lot of that went into your SG&A did some put some of it in PP&E? I’m curious how much of it is expensed versus capitalized.

[Ron Freeman:]

Typically the personnel costs that you incur for additional training and for having additional staff on hand during a store opening will go to SG&A expense. What’s capitalized typically is going to be certainly the construction costs and the equipment that goes in there. Personnel and promotional costs go directly to SG&A.

[Ellen Itskovitz:]

The SG&A was really just the personnel costs associated with it?

[Ron Freeman:]

And the additional promotional expenses, everything that it takes to get a successful store opening.

[Operator:]

Your next question comes from Bryan Hunt – Wachovia

[Bryan Hunt:]

I was wondering if you could discuss your revolver maturities and your LC facility. I believe your LC facility matures at the end of this calendar and your revolvers mature in 2010 is that correct?

[Ron Freeman:]

It’s a little bit off. The details on that are going to be in the 10-K that we file later today. Right now everything we have is committed through this time next year, through the end of 2009 and we have maturities coming up in late 2009 and 2010.

[Bryan Hunt:]

Could you give us an idea of what your CapEx plan is for next year? You’ve given us an idea of what you’re going to spend and a chunk of that fell in 2008 but could you frame the dollars for us?

[Ron Freeman:]

Fiscal 2008 we expect to be somewhere between $140 and $160 million.

[Bryan Hunt:]

With that level of CapEx do you feel like you’ll be able to pay down your revolver balances by the end of next year?

[Ron Freeman:]

Yes.

[Bryan Hunt:]

When I look at your CapEx numbers the $140 to $160 million is there anything in there for distribution center expansion? I know you guys bought some land for that is there any planned CapEx on expanding the DC next year?

[Ron Freeman:]

We don’t go into the details of our CapEx plans other than to talk about the number of store openings we anticipate having in the coming year.

[Bryan Hunt:]

If I look at your same store sales growth in Q4 could you talk about pharmacy did you experience growth in that department as well?

[Ron Freeman:]

We don’t provide detail on pharmacy that’s included in the category with non-perishables. If it’s not in the 10-K we really can’t discuss it on the call.

[Bryan Hunt:]

Could you talk about general department were sales up across all departments in Q4?

[Ron Freeman:]

Yes.

[Bryan Hunt:]

On your new stores and your remodels are those hitting your sales targets do you feel like you hit your ROI hurdles?

[Ron Freeman:]

We don’t go into individual store performance. We’re pleased with the store openings we had in 2008. We’re excited with the ones we have in progress for 2009 but we’re not able to go into individual store performance.

[Bryan Hunt:]

Of the 12 new openings and replacements are there any geographic concentration on those stores, are they most North Carolina, South Carolina or are you doing some openings in Georgia?

[Ron Freeman:]

Of the 12 fell six in Georgia, four in North Carolina, and two in South Carolina. It’s spread out pretty well.

[Bryan Hunt:]

With regards to the sales performance are there any differentials between those particular states or are you seeing pretty much general lifts across all geographies.

[Ron Freeman:]

We look at it across all geographic lines. We really don’t distinguish one market from the next in that way.

[Bryan Hunt:]

If I look at your sales gains what percent of your sales are to customers with an Advantage card versus customers without a card?

[Ron Freeman:]

I’m not sure we have that detailed number in the K. The percentage is a little bigger this year than it was last. We continue to be very pleased with the Advantage card program.

[Bryan Hunt:]

With regard to private label, you mentioned it in your comments that you’d gained sales year over year on private label. Could you talk about what your mix and maybe what your goal is and whether you’re introducing any new private label products this year?

[Ron Freeman:]

We have new private label products coming on all the time and they are literally in every department in the store now. I think it’s been an industry wide trend this year given the economy that a lot of people have been purchasing more private label items. We’re no exception to that.

[Bryan Hunt:]

If you look at the 16 shopping centers the company does not occupy are you actively selling any of those locations?

[Ron Freeman:]

We hear things all the time. If the right offer comes around then we may do something.

[Bryan Hunt:]

Are any of those locations in the Georgia market or are they in the North Carolina, South Carolina areas?

[Ron Freeman:]

I don’t have the detail in front of me. I can only assume that they pretty much mirror the company’s geographic presence.

[Operator:]

Your next question comes from Todd Duvick - Banc of America

[Todd Duvick:]

With respect to capital expenditures I appreciate the guidance and I wanted to know if you can tell us if you expect capital expenditures to be paid out of the cash flow this year to be free cash flow positive or break even?

[Ron Freeman:]

I hesitate to go into much detail on the breakdown between internally provided and externally provided. I think the important take away here is we have a lot of revolver availability and we have a lot of unencumbered properties. We’ve had even in the tight credit environment relative ease in financing what we needed to this year and we don’t really see that changing for us in ’09.

[Todd Duvick:]

Shifting to the income statement, it seems if you take a look at your comparable store sales growth over the last three years excluding gasoline it seems like you’re defying gravity as compared to your competition. Do you expect comparable store sales to continue at the pace you’ve set over the past few years or can you provide us any color on what you’re looking for going forward?

[Ron Freeman:]

We don’t provide guidance on future sales. Really the CapEx level is about the only thing we provide future guidance on. We’re top line oriented, that’s where it all starts with us, and that’s what we’re going to continue to focus on. A lot can depend upon what happens in the general economy over the next 12 months. I’d hate to put a number out there.

[Todd Duvick:]

Can you comment generally if you take a look at the underlying agricultural commodities obviously we’re seeing a lot of prices come down there and there’s speculation out there that that may ultimately impact the prices that packaged food companies are going to be able to charge going forward. How do you think that this environment is going to affect your ability to grow sales, comparable store sales going forward? Have you seen any impact on same store sales so far in the first quarter?

[Ron Freeman:]

We really can’t talk about the first quarter since we’re not there yet. Even though we’ve had some costs coming down it take a while for the affect of that to flow all the way through purchasing and distribution and retail sales channels. Even though commodity prices come down there’s an awful lot of other factors that go into that. Distribution costs have been very difficult this year for everyone given the volatile gas prices so I don’t think you can just point to commodity cost activities and say this is the direction that retail grocery sales are going to go.

[Todd Duvick:]

With respect to that going into next year obviously distribution the headwinds in terms of the fuel costs for distributing your own products are going to be more favorable. What would you expect for margins going forward? It looks like in the current quarter the sales of gasoline really impacted your margins. Can you talk about how gasoline you would expect it to affect the margins of the products you sell in addition to the margins because of lower delivery costs?

[Ron Freeman:]

That’s too many factors I think to balance and try to speculate on to say this is where your margin number is going to come out. Again, our focus, while we certainly care about margin, our focus is on top line sales and being competitive. Beyond that I don’t know. What do you think?

[Operator:]

Your next question comes from Emily Shanks – Barclays Capital

[Emily Shanks:]

Could you let us know what the amount of outstanding letters of credit were at year-end?

[Ron Freeman:]

Yes, $23.9 million.

[Emily Shanks:]

I had a quick balance sheet question, it looks like fiscal year ’07 in the press release was restated on the cash and cash equivalent line to a lower number and then there was the equal offset in the other current liabilities line item versus what was in the 10-K. To what is this difference attributable?

[Ron Freeman:]

That is a reclassification of outstanding checks.

[Emily Shanks:]

What type of outstanding checks?

[Ron Freeman:]

Checks that we’ve written that haven’t cleared the bank yet.

[Emily Shanks:]

Checks that you’re paying what, your vendors?

[Ron Freeman:]

Yes, vendors, anyone that we would pay. You’re right, it’s strictly a re-class between cash and accounts payable, and we’ve made it comparable for all years presented.

[Operator:]

Your next question comes from Bryan Hunt – Wachovia

[Bryan Hunt:]

I was wondering if you could talk about your store expansion. Are all the planned store openings in current geographies for 2009 or are you moving into any new markets?

[Ron Freeman:]

They’re in current geographies.

[Bryan Hunt:]

You opened a few convenience stores over the last couple of years how have those performed relative to expectations? Are there any plans for 2009 to open any additional?

[Ron Freeman:]

The c-stores are a small part of our operation and we don’t discuss them individually.

[Bryan Hunt:]

Could you talk about where your RP basket is? Relative to cash with the stock down there’s definitely opportunity to buy the stock back or potentially raise the dividend considering the size where I think your RP basket is. Could you talk about what your priorities are for cash whether its buy back stock, raise the dividend or pay down debt for 2009.

[Ron Freeman:]

Our first priority is to continue to take care of our stores, we will do that. Beyond that we’ll see how the economy turns out and what happens with interest rates and credit availability and all the other factors that can affect our cash.

[Bryan Hunt:]

Could you give us an idea where the RP basket underneath the notes currently?

[Ron Freeman:]

I think its somewhere in the $30 million range, that’s not a number we calculate everyday because it doesn’t affect our day-to-day operations.

[Operator:]

Your next question comes from Rob Magnuson – Goldman Sachs

[Rob Magnuson:]

Can you give me depreciation and amortization for the fiscal year?

[Ron Freeman:]

Yes, that’s in the press release so that’s already out there on the web. Depreciation and amortization expense was $69.1 million for fiscal 2008 and $60.9 million for fiscal 2007.

[Rob Magnuson:]

In terms of attendance from your shopping mall locations have you noticed any increase in delinquencies or increased push back in terms of renegotiations with any of the tenants?

[Ron Freeman:]

No we haven’t.

[Operator:]

With no other questions in the queue I’d like to turn the call back to Mr. Freeman for any additional or closing comments.

[Ron Freeman:]

Thank you all for joining us today. We wish all of our customers, employees, and shareholders a happy and safe holiday season. Thank you very much.

[Operator:]

That does conclude today’s call again thank you for your participation have a good day.