Ingles Markets 10-Q 2006
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended December 24, 2005
For the transition period from to .
Commission file number 0-14706.
INGLES MARKETS, INCORPORATED
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.
As of January 27, 2006, the Registrant had 12,094,737 shares of Class A Common Stock, $0.05 par value per share, outstanding and 12,363,024 shares of Class B Common Stock, $0.05 par value per share, outstanding.
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
See notes to unaudited interim financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
See notes to unaudited interim financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED)
THREE MONTHS ENDED DECEMBER 24, 2005 AND DECEMBER 25, 2004
See notes to unaudited interim financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
See notes to unaudited interim financial statements.
NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
Three Months Ended December 24, 2005 and December 25, 2004
A. BASIS OF PREPARATION
In the opinion of management, the accompanying unaudited interim financial statements contain all adjustments necessary to present fairly the Companys financial position as of December 24, 2005, and the results of operations, changes in stockholders equity and cash flows for the three months ended December 24, 2005 and December 25, 2004. The adjustments made are of a normal recurring nature. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission for Form 10-Q. It is suggested that these unaudited interim financial statements be read in conjunction with the audited financial statements and the notes thereto included in the Annual Report on Form 10-K for the year ended September 24, 2005, filed by the Company under the Securities Exchange Act of 1934 on December 8, 2005.
The results of operations for the three-month period ended December 24, 2005 are not necessarily indicative of the results to be expected for the full fiscal year.
B. ACCOUNTING FOR STOCK-BASED COMPENSATION
Prior to September 25, 2005 the Company accounted for its stock-based compensation plans under the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, (FAS 123). Under the fair value recognition provisions of FAS 123, stock-based compensation cost was measured at the grant date based on the value of the award and was recognized as expense over the vesting period. Under the transition method selected by the Company as allowed by FASB Statement No. 148, Accounting for Stock-Based Compensation Transition and Disclosure (FAS 148), the Company elected to apply the change in accounting principle using the prospective method. As no options were granted, modified or settled during the three months ended December 25, 2004, there was no stock-based employee compensation expense included in net income. The effect on net income for the quarter ended December 25, 2004 would have been approximately $15,000 if the Company had applied the fair value recognition provisions to awards granted prior to the adoption of Statement 123. This expense would not have affected the Companys reported basic and diluted earnings per share.
On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. The Company adopted Statement 123(R) as of September 25, 2005 using the modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date. Compensation cost associated with outstanding awards had no effect on earnings per share for the three months ended December 24, 2005.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Receivables are presented net of an allowance for doubtful accounts of $678,000 and $818,000 at December 24, 2005 and September 24, 2005, respectively.
D. ACCRUED EXPENSES AND CURRENT PORTION OF OTHER LONG-TERM LIABILITIES
Accrued expenses and current portion of other long-term liabilities consist of the following:
Self-insurance reserves are established for workers compensation and employee group medical and dental benefits based on claims filed and estimates of claims incurred but not reported. The Company is insured for covered costs in excess of $500,000 per occurrence for workers compensation and $250,000 per covered person for medical care benefits for a policy year. Employee insurance expense, including workers compensation and medical care benefits, net of employee contributions, totaled $6.3 million and $4.6 million for the three-month periods ended December 24, 2005 and December 25, 2004, respectively.
E. LONG-TERM DEBT
At December 24, 2005, the Company had lines of credit with five banks totaling $135 million, all of which were unused. The lines of credit mature in October and November 2006. At December 24, 2005, the Company had $16.1 million in unused letters of credit that reduced the amounts available to be drawn under its lines of credit. The letters of credit mature from January to December 2006. The lines provide the Company with various interest rate options generally at rates less than prime. The Company is not required to maintain compensating balances in connection with these lines of credit. The lines of credit contain provisions that under certain circumstances would permit lending institutions to terminate or withdraw their respective extensions of credit to the Company. Included among the triggering factors permitting the termination or withdrawal of lines of credit to the Company are certain events of default, including both monetary and non-monetary defaults, the initiation of bankruptcy or insolvency proceedings, and the failure of the Company to meet certain financial covenants designated in its respective loan documentation. The Company was in compliance with all financial covenants related to these lines of credit at December 24, 2005.
Long-term debt and lines of credit agreements contain various restrictive covenants requiring, among other things, minimum levels of net worth and maintenance of certain financial ratios. One of the covenants has the effect of restricting funds available for dividends to approximately $71.2 million, based on tangible net worth at December 24, 2005. As of December 24, 2005, the Company was in compliance with these covenants.
The Company paid cash dividends of $0.165 for each share of Class A Common Stock and $0.15 for each share of Class B Common Stock on October 18, 2005 to stockholders of record on October 6, 2005.
G. CALCULATON OF EARNINGS PER COMMON SHARE
The Company has two classes of common stock: Class A which is publicly traded, and Class B, which has no public market. The Class B Common Stock has restrictions on transfer; however, each share is convertible into one share of Class A Common Stock at any time. Each share of Class A Common Stock has one vote per share and each share of Class B Common Stock has ten votes per share. Each share of Class A Common Stock is entitled to receive cash dividends equal to 110% of any cash dividend on Class B Common Stock.
The Company has determined that, under Emerging Issues Task Force (EITF) Issue 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share, the two-class method of computing earnings per share is required. Prior periods have been restated to reflect this change.
The two-class method of computing basic earnings per share for each period reflects the cash dividends paid per share for each class of stock, plus the amount of allocated undistributed earnings per share computed using the participation percentage which reflects the dividend rights of each class of stock. Diluted earnings per share is calculated assuming the exercise of dilutive stock options outstanding and the conversion of all shares of Class B Common Stock to shares of Class A Common Stock on a share-for-share basis. The tables below reconcile the numerators and denominators of basic and diluted earnings per share for current and restated periods.
The restated per share amounts for the second, third and fourth quarters of fiscal 2005 and the fiscal year ended September 24, 2005 are based on the following amounts:
H. LINES OF BUSINESS
The Company operates three lines of business: retail grocery sales, shopping center rentals, and a fluid dairy processing plant. All of the Companys operations are domestic. Information about the Companys operations by lines of business (in thousands) is as follows:
Revenue from shopping center rentals is reported on the rental income, net line of the income statements. The other revenues comprise the net sales reported.
For the three months ended December 24, 2005 and December 25, 2004, the fluid dairy segment had $12.3 million and $11.4 million, respectively, in sales to the grocery sales segment. These sales have been eliminated in consolidation and are excluded from the amounts in the table above.
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Ingles, a leading supermarket chain in the Southeast, operates 197 supermarkets in Georgia (76), North Carolina (63), South Carolina (35), Tennessee (20), Virginia (2) and Alabama (1). The Company locates its supermarkets primarily in suburban areas, small towns and rural communities. Ingles supermarkets offer customers a wide variety of nationally advertised food products, including grocery, meat and dairy products, produce, frozen foods and other perishables and non-food products, including health and beauty care products and general merchandise, as well as quality private label items. In addition, the Company focuses on selling high-growth, high-margin products to its customers through the development of book sections, media centers, floral departments, bakery departments and prepared foods, including delicatessen sections. During fiscal 2000, the Company began adding fuel centers and pharmacies at select store locations. As of December 24, 2005, the Company operated 41 in-store pharmacies and 28 fuel centers.
Ingles also operates two other lines of business, fluid dairy processing and shopping center rentals. The fluid dairy processing segment sells approximately 31% of its products to the retail grocery segment and approximately 69% of its products to third parties. Real estate ownership (including the shopping center rental segment) is an important component of the Companys operations, providing both operational and economic benefit.
Critical Accounting Policies
Critical accounting policies are those accounting policies that management believes are important to the portrayal of Ingles financial condition and results of operations, and require managements most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
The Company is self-insured for workers compensation and group medical and dental benefits. Risks and uncertainties are associated with self-insurance; however, the Company has limited its exposure by maintaining excess liability coverage. Self-insurance reserves are established based on claims filed and estimates of claims incurred but not reported. These estimates are based on data provided by the respective claims administrators. These estimates can fluctuate if historical trends are not predictive of the future. The majority of the Companys properties are self-insured for casualty losses and business interruption; however, liability coverage is maintained.
The Company accounts for the impairment of long-lived assets annually unless events and changes in circumstances indicate that additional testing is necessary. The Company accounts for the impairment in accordance with Statement of Financial Accounting Standards No. 144. For assets to be held and used, the Company tests for impairment using undiscounted cash flows and calculates the amount of impairment using discounted cash flows. For assets held for sale, impairment is recognized based on the excess of remaining book value over expected recovery value. The recovery value is the fair value as determined by independent quotes or expected sales prices developed by internal specialists. Estimates of future cash flows and expected sales prices are judgments based upon the Companys experience and knowledge of local operations and cash flows that are projected for several years into the future. These estimates can fluctuate significantly due to changes in real estate market conditions, the economic environment, capital spending decisions and inflation.
Closed Store Accrual
For properties closed prior to December 31, 2002 that were under long-term lease agreements, the present value of any remaining liability under the lease, discounted using risk-free rates and net of expected sublease recovery, is recognized as a liability and expensed. For all store closures subsequent to the adoption of Statement of Financial Accounting Standards No. 146, effective December 31, 2002, the liability is recognized and expensed based on the difference between the present value of any remaining liability under the lease and the present value of the estimated market rate at which the Company expects to be able to sublease the properties. The Companys estimates of market rates are based on its experience, knowledge and typical third-party advice or market data. If the real estate and leasing markets change, sublease recovery could vary significantly from the recoveries originally assumed, resulting in a material change in the Companys recorded liability.
The Company receives funds for a variety of merchandising activities from the many vendors whose products the Company buys for resale in its stores. These incentives and allowances include volume or purchase based incentives, advertising allowances, slotting fees, and promotional discounts. The purpose of these incentives and allowances is generally to help defray the costs incurred by the Company for stocking, advertising, promoting and selling the vendors products. Whenever possible, vendor discounts and allowances that relate to buying and merchandising activities are recorded as a component of item cost in inventory and recognized in
merchandise costs when the item is sold. Due to system constraints and the nature of certain allowances, it is sometimes not practicable to apply allowances to the item cost of inventory. In those instances, the allowances are applied as a reduction of merchandise costs using a rational and systematic methodology, which results in the recognition of these incentives when the inventory related to the initial purchase is sold. Amounts that represent a reimbursement of specific identifiable incremental costs, such as advertising, are recorded as a reduction to the related expense in the period that the related expense is incurred.
Despite the Companys belief that its tax positions are consistent with applicable tax laws, the Company believes that certain positions are likely to be challenged by taxing authorities. Settlement of any challenge can result in no change, a complete disallowance, or some partial adjustment reached through negotiations or litigation. Significant judgment is required in evaluating the Companys tax contingencies. The Companys contingencies are adjusted in light of changing facts and circumstances, such as the progress of its tax audits as well as evolving case law. Income tax expense includes the impact of contingency provisions and changes to contingencies that the Company considers appropriate. Unfavorable settlement of any particular issue would require use of cash. Favorable resolution would be recognized as a reduction to income tax expense at the time of resolution.
Results of Operations
Ingles operates on a 52 or 53-week fiscal year ending on the last Saturday in September. The unaudited condensed consolidated statements of income for the three-month periods ended December 24, 2005 and December 25, 2004 both include 13 weeks of operations. Comparable store sales are defined as sales by grocery stores in operation for the entire duration of the previous and current fiscal periods. Replacement stores and major and minor remodels are included in the comparable store sales calculation. A replacement store is a new store that is opened to replace an existing nearby store that is closed. A major remodel entails substantial remodeling of an existing store and may include additional retail square footage. A minor remodel includes repainting, remodeling and updating the lighting and equipment throughout an existing store. For the three-month periods ended December 24, 2005 and December 25, 2004, comparable store sales include 193 and 194 stores, respectively.
The following table sets forth, for the periods indicated, selected financial information as a percentage of net sales. For information regarding the various segments of the business, see Note H Lines of Business to the Unaudited Consolidated Financial Statements.
Three Months Ended December 24, 2005 Compared to the Three Months Ended December 25, 2004
Net income for the first quarter of fiscal 2006 totaled $7.8 million, 53.4% higher than net income of $5.1 million earned for the first quarter of fiscal 2005. Total and comparable store sales increases were strong and gross profit dollar growth exceeded expense growth.
Net Sales. Net sales increased 11.5% to $623.4 million for the three months ended December 24, 2005 from $559.3 million for the three months ended December 25, 2004. Ingles operated 197 stores at December 24, 2005 and at December 25, 2004. Retail square footage was approximately 9.5 million at December 24, 2005 and 9.3 million at December 25, 2004. Comparable store sales grew $51.6 million or 9.8% in the first quarter of fiscal 2006 compared to the first quarter of fiscal 2005. Sales improved in all major departments, with the largest dollar increases in the grocery and gasoline departments. The largest percentage sales increases were in the gasoline and pharmacy departments.
Net sales to outside parties for the Companys milk processing subsidiary increased $1.0 million or 3.9% in the December 2005 quarter compared to the December 2004 quarter. The sales increase is primarily attributable to an increase in gallons sold and, to a lesser extent, increased raw milk costs in the December 2005 quarter compared to the December 2004 quarter. Raw milk cost increases are passed on to the subsidiarys customers in the pricing of milk products.
Sales for the first quarter of fiscal 2006 were bolstered by successful holiday promotions in November and December. The Company expects more moderate sales growth for the rest of fiscal year 2006 and will emphasize growth in higher margin areas such as deli, bakery and other perishable departments. The Company expects the maturation of new and expanded stores that enhance one-stop shopping and convenience-oriented products will also drive sales growth.
Gross Profit. Gross profit for the three-month period ended December 24, 2005, increased $11.6 million or 8.2% to $153.6 million, or 24.6% of sales, compared to $142.0 million, or 25.4% of sales, for the three-month period ended December 25, 2004. Gross profit dollars increased due to the increased sales volume. Gross profit as a percentage of sales decreased due to larger sales growth in lower margin departments and holiday-related pricing incentives.
Gross profit for the Companys milk processing subsidiary decreased $0.4 million or 8.3% for the December 2005 quarter compared to the December 2004 quarter due primarily to higher cream prices in the December 2004 quarter compared to the December 2005 quarter. Excess cream is produced in the processing of milk and is sold in bulk to producers of ice cream and cheese. The sale of the excess cream is a reduction to cost of goods sold. Increased plastic packaging costs and post-hurricane sales of lower margin bottled water also contributed to lower gross profits.
In addition to direct product cost, the cost of goods sold line item for the grocery segment includes inbound freight charges. Purchasing and receiving costs, inspection costs, warehousing costs, internal transfer costs, and other costs of the Companys distribution network are included in operating and administrative expenses. The milk processing segment is a manufacturing process. Therefore, all of the costs mentioned above incurred by the milk processing segment are included in cost of sales.
The Companys gross margins may not be comparable to those of other retailers, since some retailers include all of the costs related to their distribution network in cost of goods sold and others, like the Company, exclude a portion of the costs from gross profit, including the costs instead in operating and administrative expenses.
Operating and Administrative Expenses. Operating and administrative expenses increased $7.8 million or 6.3% to $130.5 million for the three months ended December 24, 2005, from $122.7 million for the three months ended December 25, 2004. As a percentage of sales, operating and administrative expenses were 20.9% and 21.9% for the three months ended December 24, 2005 and December 25, 2004, respectively. A variety of factors contributed to the dollar increase.
The major increases (decreases) in operating and administrative expenses were as follows:
Salaries and wages increased in dollars due to the addition of labor hours required for the increased sales volume, but decreased as a percentage of sales due to the allocation of management salaries over higher sales dollars and sales growth in less labor-intensive departments.
Insurance expense increased due to higher employee group insurance and workers compensation costs. The Company is self-insured for workers compensation and employee group medical and dental benefits.
Utility and fuel expenses increased due to increases in market energy prices.
Store supplies increased due to upgraded packing used in perishables departments and the higher cost of plastic used in bags and wrapping materials.
Bank charges rose primarily due to increased fees for processing debit and credit cards. The increase is a result of both increased usage of cards and increased transaction fees related to the usage.
Rent expense decreased due to lower net expenses for leased facilities in which the Company no longer operates a store.
Rental Income, Net. Rental income, net of $1.3 million decreased $0.2 million, or 12.6% for the December 2005 quarter compared to the December 2004 quarter as a result of higher operating costs.
Other Income, Net. Other income, net increased $0.3 million to $0.7 million for the three-month period ended December 24, 2005 from $0.4 million for the three-month period ended December 25, 2004. The increase is principally due to land compensation settlements with state or local governments.
Interest Expense. Interest expense decreased $0.7 million for the three-month period ended December 24, 2005 to $12.3 million from $13.0 million for the three-month period ended December 25, 2004. Total debt at December 2005 was $564.3 million compared to $595.2 million at December 2004.
Income Taxes. Income tax expense as a percentage of pre-tax income increased to 39.2% in the December 2005 quarter compared to 37.6% in the December 2004 quarter primarily due to increased state income taxes.
Net Income. Net income increased 53.4% or $2.7 million to $7.8 million for the three-month period ended December 24, 2005 compared to $5.1 million for the three-month period ended December 25, 2004. Net income, as a percentage of sales, was 1.2% and 0.9% for the December 2005 quarter and the December 2004 quarter, respectively. The increase in net income is primarily attributable to the increase in sales and gross profit, partially offset by increased operating expenses. Basic and diluted earnings per share for Class A Common Stock were $0.33 and $0.32, respectively, for the December 2005 quarter compared to $0.22 and $0.21, respectively, for the December 2004 quarter. Basic and diluted earnings per share for Class B Common Stock were $0.30 for the December 2005 quarter compared to $0.20 for the December 2004 quarter.
Liquidity and Capital Resources
The Company believes that a key to its ability to continue to develop a loyal customer base is providing conveniently located, clean and modern stores which provide customers with good service and a broad selection of competitively priced products. As such, the Company has invested and will continue to invest significant amounts of capital toward the modernization of its store base. The Companys modernization program includes the opening of new stores, the completion of major remodels and expansion of selected existing stores, the relocation of selected existing stores to larger, more convenient locations and the completion of minor remodeling of its remaining existing stores.
Capital expenditures totaled $30.2 million for the three-month period ended December 24, 2005, including the replacement of one new store and the purchase of three future store sites. Capital expenditures also included the costs of upgrading and replacing store equipment, technology investments, capital expenditures related to the Companys distribution operation and its milk processing plant, and expenditures for stores to open later in fiscal 2006 and in fiscal 2007.
Ingles capital expenditure plans for all of fiscal 2006 include investments of approximately $75 million. For the balance of fiscal 2006, the Company plans to open four new or replacement stores, all of which will be owned, add approximately three new fuel stations and purchase store sites for future expansion. Expenditures will also include investments in stores expected to open in fiscal 2007 as well as technology improvements, upgrading and replacing existing store equipment and warehouse and transportation equipment and improvements to the Companys milk processing plant.
The Company expects that its net annual capital expenditures will remain in the range of approximately $65 to $75 million going forward in order to maintain a modern store base. The number of projects pursued during each fiscal year could decline to some degree as the Company increases the average size of stores being built. The number of projects may also fluctuate due to the varying costs of the types of projects pursued including new stores, major remodel/expansions or minor remodels. The Company makes decisions on the allocation of capital expenditure dollars based on many factors including the competitive environment, other Company capital initiatives and its financial condition.
The Company does not generally enter into commitments for capital expenditures other than on a store-by-store basis at the time it begins construction on a new store or begins a major or minor remodeling project. The Company generally engages in major remodeling and new store development on not more than three or four locations at a time. Construction commitments at December 24, 2005 totaled $11.7 million.
The Company generated net cash from operations of $15.9 million in the December 2005 quarter compared to $2.1 million in the December 2004 quarter. Both inventory and accounts payable-trade increased by $10.4 million and $13.4 million, respectively, in the December 2005 quarter due to normal inventory growth to accommodate higher Christmas holiday sales.
Cash used in investing activities for the December 2005 quarter totaled $29.8 million comprised primarily of $30.2 million of capital expenditures during the period, partially offset by $0.4 million of proceeds from the sale of assets.
Cash used in financing activities during the December 2005 quarter totaled $8.8 million. Principal payments on long-term debt were $5.1 million and dividend payments were $3.8 million.
At December 24, 2005, the Company had committed lines of credit with five banks totaling $135 million. No amounts were borrowed under the lines of credit at December 24, 2005; however unused letters of credit totaling $16.1 million reduced the amount available to be drawn under these lines to $118.9 million at December 24, 2005. The lines of credit mature in October and November 2006. The
lines provide the Company with various interest rate options generally at rates less than prime. The Company is not required to maintain compensating balances in connection with these lines of credit. The Company was in compliance with all financial covenants related to these lines of credit at December 24, 2005.
At December 24, 2005, the Company had $349.8 million principal amount of senior unsubordinated notes (the Notes) outstanding to mature in December 2011. The indenture governing the Notes contains certain restrictive covenants relating to, among other things, the issuance of indebtedness and the payment of dividends. The Company was in compliance with all financial covenants related to the Notes at December 24, 2005.
The Companys principal sources of liquidity are expected to be cash flow from operations, borrowings under its lines of credit and long-term financing. As of December 24, 2005, the Company had unencumbered real property and equipment with a net book value of approximately $436.2 million. The Company believes, based on its current results of operations and financial condition, that its financial resources, including existing bank lines of credit, short- and long-term financing expected to be available to it, including renewals of lines of credit upon expiration, and internally generated funds, will be sufficient to meet planned capital expenditures and working capital requirements for the foreseeable future, including any debt service requirements of additional borrowings. However, there can be no assurance that any such sources of financing will be available to the Company when needed on acceptable terms, or at all.
It is possible that, in the future, the Companys results of operations and financial condition will be different from that described in this report based on a number of intangible factors. These factors may include, among others, increased competition, changing regional and national economic conditions, adverse climatic conditions affecting food production and delivery and changing demographics as well as the additional factors discussed below under Forward Looking Statements. It is also possible, for such reasons, that the results of operations from the new, expanded, remodeled and/or replacement stores will not meet or exceed the results of operations from existing stores that are described in this report.
Contractual Obligations and Commercial Commitments
There have been no material changes in contractual obligations and commercial commitments subsequent to September 24, 2005.
Off Balance Sheet Arrangements
The Company is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Companys financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.
Quarterly Cash Dividends
Since December 27, 1993, the Company has paid regular quarterly cash dividends of $0.165 (sixteen and one-half cents) per share on its Class A Common Stock and $0.15 (fifteen cents) per share on its Class B Common Stock for an annual rate of $0.66 and $0.60 per share, respectively.
The Company expects to continue paying regular cash dividends on a quarterly basis. However, the Board of Directors periodically reconsiders the declaration of dividends. The Company pays these dividends at the discretion of the Board of Directors and the continuation of these payments, the amount of such dividends, and the form in which the dividends are paid (cash or stock) depends upon the results of operations, the financial condition of the Company and other factors which the Board of Directors deems relevant. In addition, certain loan agreements containing provisions outlining minimum tangible net worth requirements restrict the ability of the Company to pay additional dividends to approximately $71.2 million based on tangible net worth at December 24, 2005. Further, the Company is prevented from declaring dividends at any time that it is in default under the indenture governing the Notes. In addition, the terms of the indenture may restrict the ability of the Company to pay additional dividends based on certain financial parameters.
Sales in the grocery segment of the Companys business are subject to a slight seasonal variance due to holiday related sales and due to sales in areas where seasonal homes are located. Sales are traditionally higher in the Companys first fiscal quarter due to the inclusion of sales related to Thanksgiving and Christmas. The Companys second fiscal quarter traditionally has the lowest sales of the year. In the third and fourth quarter, sales are affected by the return of customers to seasonal homes in our market area. The fluid dairy segment of the Companys business has slight seasonal variation to the extent of its sales into the grocery industry. The Companys real estate segment is not subject to seasonal variations.
Impact of Inflation
Inflation in food prices during the December 2005 quarter was higher than the overall increase in the Consumer Price Index, but was lower than the overall increase in the Consumer Price Index during fiscal 2005. One of the Companys significant costs is labor, which increases with inflation. Inflation in energy costs was higher than the overall increase in the Consumer Price Index for the twelve months ended December 2005. Higher energy costs affect both the Companys gasoline sales and distribution expenses.
Securities and Exchange Commission Investigation
In May 2005, the Securities and Exchange Commission (the SEC) issued a formal order of private investigation in the name of the Company following the previously disclosed informal inquiry. In January 2006 the SEC issued a Wells Notice indicating the staff of the SEC intends to recommend that the Commission bring a civil enforcement action against the Company. See Part II Item 1. Legal Proceedings.
This Quarterly Report contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. The words expect, anticipate, intend, plan, believe, seek and similar expressions are intended to identify forward-looking statements. While these forward-looking statements and the related assumptions are made in good faith and reflect the Companys current judgment regarding the direction of the Companys business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested herein. Such statements are based upon a number of assumptions and estimates which are inherently subject to significant risks and uncertainties many of which are beyond the Companys control. Some of these assumptions inevitably will not materialize, and unanticipated events will occur which will affect the Companys results. Some important factors (but not necessarily all factors) that affect the Companys revenues, growth strategies, future profitability and operating results, or that otherwise could cause actual results to differ materially from those expressed in or implied by any forward-looking statement, include business and economic conditions generally in the Companys operating area; the Companys ability to successfully implement its expansion and operating strategies and to manage rapid expansion; pricing pressures and other competitive factors; the Companys ability to reduce costs and achieve improvements in operating results; the availability and terms of financing; increases in labor and utility costs; success or failure in the ownership and development of real estate; changes in the laws and government regulations applicable to the Company; the ultimate resolution of the SECs investigation of the Company; and changes in accounting policies, standards, guidelines or principles as may be adopted by regulatory agencies as well as the Financial Accounting Standards Board.
Consequently, actual events affecting the Company and the impact of such events on the Companys operations may vary significantly from those described in this report or contemplated or implied by statements in this report.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market interest rates subsequent to September 24, 2005.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and pursuant to the regulations of the Securities and Exchange Commission. Disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act, include controls and procedures designed to ensure the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Companys management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that the Companys system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.
As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with participation of its management including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of December 24, 2005, the end of the period covered by this report. In making this evaluation, it considered matters previously identified and disclosed in connection with the filing of its Form 10-K for fiscal 2005. After consideration of the matters discussed above, the Company has concluded that its controls and procedures were not effective in all respects as of the end of the period covered by this report.
The Company disclosed in its Form 10-K for fiscal 2005 the following material weaknesses identified by management.
Segregation of Duties
Management identified two different areas where the lack of appropriate segregation of duties constituted a material weakness.
Information Technology General Controls
During previous fiscal years, the Company attempted to implement additional controls and procedures designed to ensure vendor income was recorded completely, accurately and timely. The changes were not sufficient to correct all weaknesses in the design of such controls. As such, the controls and procedures for vendor income are not sufficient to ensure that all vendor income is properly recorded. In addition, there has been a lack of compliance with these procedures by certain Company associates.
(b) Changes in Internal Control over Financial Reporting
Subsequent to the filing of the Companys Form 10-K for fiscal 2005, management has undertaken the following remediation efforts:
Item 1. LEGAL PROCEEDINGS
As was initially disclosed in December 2004, during 2004, the SEC initiated an informal inquiry regarding the accounting for a vendor contract the Company entered into in 2002. Through the inquiry, the SEC requested certain documentation regarding that vendor contract, other vendor contracts entered into from 2002 through 2004, and related information and documents regarding the Companys accounting for vendor allowances. The Audit Committee of Ingles Board of Directors conducted an internal review, with assistance of independent counsel, of the accounting issues arising out of the inquiry and related accounting issues regarding vendor contracts. As a result, the Company restated its financial statements for fiscal years 2002 and 2003 and the first three quarters of fiscal 2004. In May 2005, the SEC issued a formal order of private investigation in the name of the Company.
On January 10, 2006, the Company received a Wells Notice from the staff of the SEC indicating the staff intends to recommend that the SEC bring a civil enforcement action against the Company, which may include injunctive relief and civil penalty, related to certain vendor contracts entered into in 2002 and 2003 and internal control accounting issues that have been the subject of the previously disclosed formal investigation. The notice provides the Company the opportunity to respond formally to the SEC before the staff makes a final recommendation to the SEC. The Company is not currently able to predict the outcome of the SEC investigation.
Shareholder Derivative Claim
On June 15, 2005, a purported shareholder of the Company filed a shareholder derivative suit on behalf of the Company against certain current and former individual members of the Companys Board of Directors and against the Company as a nominal defendant in the U.S. District Court for the Western District of North Carolina. The suit alleges that the defendant Directors breached their fiduciary duties by failing to implement appropriate internal controls. The suit seeks from the Directors damages in an unspecified
amount allegedly sustained by the Company, as well as disgorgement by certain Directors to the Company of salaries and bonuses received by those Directors between 2002 and 2005. The Companys Board of Directors appointed an independent committee, which retained independent counsel, to review the suit and evaluate whether maintenance of the derivative proceeding was in the best interest of the Company. After an investigation, the independent committee concluded that the maintenance of the derivative proceeding was not in the best interest of the Company. On October 10, 2005, the Company filed a motion to dismiss the derivative proceeding. No amount is currently recorded as the outcome of the case is not known and any potential loss is not estimable.
Various legal proceedings and claims arising in the ordinary course of business are pending against the Company. In the opinion of management, the ultimate liability, if any, from all pending legal proceedings and claims would not materially affect the Companys financial position or the results of its operations.
Item 6. EXHIBITS
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused the report to be signed on its behalf by the undersigned thereunto duly authorized.