Ingles Markets, Incorporated (IMKTA) 2003 Q3 法說會逐字稿

Good day and welcome to the Ingles Markets Incorporated 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 Vice President, Finance , and Chief Financial Officer, Ms. Brenda Tudor. Please go ahead, ma'am..

Good morning. Welcome to Ingles Markets 2003 conference call. With me are Robert Ingle, founder of the company and Chief Executive Officer, and Tom Outlaw, Vice President of Sales and Marketing.

Statements on this call include forward-looking statements which are based on current expectations, estimates, forecasts and projections about the company's business, based on management's beliefs and assumptions. These statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21 E of the Securities and Exchange Commission act of 1934 and the Private Securities Litigation Reform Act of 1995 and are subject to the safe harbors created by such laws.

Words such aspects, anticipates, intends, plans and believes and variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve risks and uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed on this call. We do not undertake to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

For a description of forward-looking statements, you may refer to the company's public filings including the Form 10-K for the fiscal year ended September 28, 2002 and form condition, ended December 282002 and the quarter ended March 29th, 2003.

Now we'll give you a brief overview of our third quarter ended June 28, 2003, then we'll be happy to take your questions. Hopefully you've all seen our press release. If not it is available at our web site, at www.ingles-market.com.

We are happy to report a healthy increase in net sales and stable earnings for the June 2003 quarter, compared to the June 2002 quarter. Net sales for the June 2003 quarter increased 4.3% over the same quarter last year, while comparable store sales increased 2.8%. The June 2003 quarter included Easter, while in the prior year the March quarter included Easter. Excluding the effect of the timing of the Easter holiday, comparable store sales increased 2%. Net sales for the 9- month period increased 0.9% while comparable sales grew 0.4%. At June 2003 we operated 199 stores compared to 201 stores at June 2002.

Gross profit increased 1.4% for the quarter, while gross margins increased to 26% of sales in the June 2003 quarter, compared to 26.8% in the June 2002 quarter. In order to drive sales, we ran more aggressive promotions during the quarter, and were pleased with the results. The majority of the decreased gross profit as a percentage of sales was in the grocery department. Operating expenses as a percentage of sales decreased to 23.1% for the June 2003 quarter, compared to 23.3% for the June 2002 quarter, due to the increased sales volume for the quarter.

In total dollars, operating expenses increased 3.3%. The primary cause of the increase in dollars was in labor expense. As part of our strategy to drive sales, we increased labor hours at our stores to enhance customer service. Our rental income declined $0.3 million for the quarter, due primarily to the loss of income from K-Mart as a tenant in one location, and the closure of several drugstores that relocated from shopping centers to free-standing locations.

During the quarter, we had a gain of $0.9 million from a state condemnation of a portion of the real estate where we no longer operate a store. Our interest expense decreased $0.9 million for the June 2003 quarter, compared to the June 2002 quarter, due to reduction in debt from June 2002, prior to the issuance on May 29th, 2003, of a $100 million add-on to the existing eight and seven-eighths senior unsecured subordinated notes due December 2011. A portion of the proceeds from if notes was used to reduce the existing lines of credit outstanding of $22.4 million.

It is not economically feasible to reduce other debt at this time due to prepayment penalties. However, we plan to use the balance of the proceeds to fund current maturities of existing debt and capital expenditures.

Our net income for both the June 2003 and the June 2002 quarters were $3.6 million, or 16 cents per share. We have committed lines of credit totaling $145 million, all of which is unused. $120 million of the lines mature in October of 2006, while the other $25 million matures from September of 2003 through October 2004. The maturity of these lines was renegotiated in connection with the add-on to the note.

We had unencumbered property with a book value of $324 million, of which $257 million is real estate, at June 28, 2003. Capital expenditures totaled $58.1 million for the first nine months of fiscal 2003. During the first nine months, we opened four new stores, one that we own and three that are leased. We completed two major remodel expansions and three minor remodels. In addition, we purchased one shopping center where we are a tenant and closed three older stores.

We plan to open one replacement store and complete one major remodel expansion during the balance of fiscal 2003 and two major remodel expansions are expected to be completed during the first quarter of 2004.

We are very pleased with our sales growth for the quarter. We plan to continue focusing on ways to drive sales and customer satisfaction while improving profitability. Our new president is enthusiastically examining every area of our business and identifying ways to grow sales and to control costs. We will now take your questions.

In order to ask a question press the star key, followed by the digit 1 on your touch tone telephone. If you are on a speaker phone, please make sure your mute function is turned on of to allow your signal to reach our equipment. We'll go first to Jeff Dobro with Trilogy Capital. with Trilogy Capital.

Good morning, Brenda. Good job. How are you? I had a couple quickies for you. How was average count and ticket size for the quarter?

Our traffic count improved and our average ticket size remained about the same.

So the promotions really did a good job for you?

Yes, we think so.

How was the dairy business in the last quarter?

Dairy business is strong. Their sales are up, and their profitability is about flat year-over-year.

Okay. All right. That was it.

Thank you.

We'll go next to Paul Ross with ING Ghent..

Good morning, Brenda. We saw you issue $100 million dollars of fixed rate debt. And I'm curious, although I'm sure you considered it, every quarter you give us the total of unencumbered property and, a portion of which is real estate.

And I wondered what the rationale was to issue unsecured debt at the rate that it was available to you as opposed to issuing secured debt considering all of the unencumbered real estate you have. Could you have issued less costly debt had you used some of the unencumbered property?

Yes, we could issue lower cost (ph) debt. But part of the strategy in doing this -- and we kind of changed our strategy -- is we were using a lot of property to obtain financing that was quicker amortizing debt. For instance, five-year equipment loans, which used a lot of our cash flow on a monthly basis. And by doing the unsecured, the high yield debt, we are able to extend the term of that debt and be able to use more of our cash flow to fund our capital expenditures, without having to go back into the market, to constantly borrow money.

Another reason for that, especially on the real estate side, is having the real estate unencumbered, and not having a mortgager to deal with allows us flexibility when we want to expand our stores. So if we want to go in and we want to tear out a tenant and make our store bigger, we don't have to get approvals and go through a big process when we have mortgage debt out there.

Along those lines, should we expect you to increase your capital spending next fiscal year as it relates not only to remodeling but also to new stores? Given the increased flexibility that you have?

Our capital expenditures should be in line next year with where they are this year.

That's the $70 million number?

Yes, sir.

Thank you very much.

We'll go next to Brian Hunt with Wachovia Securities.

Brenda, could you quantify what the revenue numbers were for Milkco, -and also rental (ph)?

Brian, I don't of the revenues for Milkco in front of me which will be in the 10-Q which we'll be filing I think about August the 12th, I believe is the date. I don't have that in front of me. Of course the net rental income is on the income statement that is with the press release.

Gotcha. And I was wondering if you could talk about the decline in gross margin. I know you said it was all from promotion or a majority of it was from promotions. Could you tell us we should expect going forward and the type of promotions you ran in the third quarter?

I could start. I think Tom would want to add something. As I mentioned we have a in you president on board. He's really looking at ways to drive our sales and improve our profitability. And so I think we ran hotter specials during the quarter in order to increase that customer traffic, increase sales. We ran triple coupons a couple of times during the quarter, which was a very successful venture. Anything you want to add, Tom?

I'll say more buy-one-get-one-free ads.

At this point it's hard for me to say whether you can expect this going forward because I think we're trying to experiment with different things to see what works. We were pleased that our gross margin dollars increased even though as a percentage of sales they did increase. I think you can expect to see us continue with good promotional activity.

Okay. And can you say how the weather may have impacted your sales during the quarter? Was it a positive impact? Negative impact? And, maybe comment on how the sales trend is going in Q4? And how your promotional strategy may change versus Q3?

We don't feel like the weather has impacted us a whole lot. July 4th week we had some rain on the weekend. It impacted some of our tourist stores. But overall the weather has not had an impact either way.

Okay. And then how about your marketing strategy in Q4 and what the expectations may be for a gross margin change versus the year-ago period? Will you be investing a similar amount of gross margin basis points to try to achieve the sales gain?

Yes, we want to continue to promote heavily, and it's resulted in increased sales, as Brenda said. So we will promote, continue to promote heavily.

Brian Hunt Okay. And then on the SG&A line, more labor was put into the stores to add the service levels. And during this higher promotion environment, do you feel like you had a good balance on what your service levels were, or might you need more labor less labor in the stores, based on what you saw in Q3?

I don't think we'll need more labor in the stores. Basically what we wanted to do was put the labor hours back out there and see what kind of effect that we got. So that's what we're -- we're constantly monitoring. About you I don't think we'll need to put more hours out there and we'll monitor to see if we have too many.

The hours that were put on the front end, the service positions to get our customers checked out quicker, and we feel like this has been a very good investment through customer satisfaction.

Okay. And then could you repeat the unencumbered real estate and also total unencumbered assets one more time for me?

Yes, total unencumbered is $324 million and $257 million of that is real estate and $67 million is equipment.

Okay. Thank you very much.

Next we'll go to Arthur Rulack (ph) With Bank of America.

Good morning, guys. Couple questions. Looking for a, just a cash balance view, sort of housekeeping balance sheet items. I think you said it was $56 million higher than normal. I wasn't exactly sure. Would normal be around $12 million or $13 million?

Yeah, normal about $15 million and the cash was $71 million.

Okay. Great. And then just looking for depreciation and amortization as well?

For the quarter, it was $13.1 million.

Okay. And then rental expense number?

$11.1 million.

Okay. Great. And a question on the rental income seemed to be a touch lower than sort of it has been. I think it was around $2 million. And it seems like it's been more like $2.3 million to $2.5 million. Is that what we should expect is more sort of a normal run rate going forward?

Yeah, I guess we're experiencing, I mentioned the one K-Mart that we had that kind of fell out into bankruptcy. And then we've had several of these drugstores that were in our shopping centers, where they've done lease buyouts and they're now in free-standing locations.

So I think we're certainly aggressively trying to replace those tenants. But I would say the run rate we are at now would be a conservative dollar amount to use. And hopefully we'll get some of that space rented and do better than that.

Have you ever sort of disclosed how much availability you have in terms of vacancy on your properties? Is that a number we can track?

I know we used to put that in our 10-K. I'll tell you the truth, I can't remember whether it's in there now or not.

Okay. Then can we talk a little bit about the labor side of the equation? Obviously you had nice revenue growth, but then it looks like obviously EBITDA margins are down, based on all the promotional activities. And you said that labor hours had increased, I guess better customer service for people in the stores.

Is there sort of an actual maybe way you can quantify that? In terms of the number of hour increases?

I can't remember what the number of hours were. I know we had a different amount of hours depending on what size store we had. But I think the overall percentage increase in labor for the quarter was about 5%.

In terms of the actual hours?

The actual dollars.

The dollars?

Uh-huh.

Is that something we should expect going forward as part of sort of this new shift in terms of changing a little bit how things are being run?

Yeah, I think so. Basically what we did when we put the hours back out there to the stores, we said we're going to give you these hours, but we expect to see improved customer service and so we're monitoring that to determine whether-- We don't want to just throw the hours out there and not get anything for it. So that's something we'll continue to monitor.

And how do you monitor that? I mean how do you determine whether you're investing in more hours, having more people staffed in the stores? What's the best way to measure customer satisfaction?

Well, there's a lot of different ways. One is customers love to communicate with you. So we hear a AI lot of feedback from our customers about the experience that they've had in the stores.

Is there an actual sort of to RM al way you guys go about doing that?

We have a service number that customers call in on. Plus people write in on our web site. And so all of those questions and comments get to the management of the company so they can see trends of what's happening.

In addition, we started a management questionnaire. So as all our field people are out in the field visiting stores, they're observing what's going on in the stores. And one of the things they're observing is customer service. So we have a questionnaire that they fill out every time they're in the store. And that comes back and we put it in a database to track what's going on in the stores.

Okay. And on the CAPEX, I know you released, saying it's going to be roughly around $70 million this year. I think in response to another analyst question you were saying it was going to be $70 million in the following year. Most of the impression of the run rate of that was going to be more in the $60 million area when you guys had done –

Actually, what we were budgeting is to have $70 million in CAPEX, net of $10 million in proceeds from the sales of real estate. So it's a net $60 million.

Net 60. Okay. Gotcha. Okay. I guess that's it for me. Thank you very much.

You're welcome.

We'll go to Sue Goodman with ABP Investments.

Brenda could you comment a bit on occupancy. I think the previous caller was asking it. But do you provide on a gross basis? And then can you provide it maybe excluding the square footage that are Ingle stores?

It's not been something that I have been provided and I don't have the data in front of me. But it's certainly something we can consider in the future.

About how many square feet, though, are accounted for by these drugstores that have moved out?

The drugstore is typically, what, 2500 square feet-- About 6,500 square feet. And I think there's six of those that have vacated since last year. And then the K-Mart would have been, what, Mr. Ingle, about 100,000? About 100,000 square feet.

Now, how are you accounting for these lease buyouts? Did you get lump sums and are you carrying that as an asset that you're amortizing in income?

No, when we have a lease buyout we just take that into income. But we didn't actually have any buy outs in the quarter. I think what you're seeing is as it rolled around, because they didn't just all vacate this quarter, they vacate over time.

Can you comment on your sales by region, are you seeing a more competitive marketplace in the Atlanta area and in your more hometown North Carolina area, are things a little better, what's going on there?

Well, I'll tell you, there's a lot of competitive growth in all areas. Last quarter we had WalMart in South Carolina, Georgia and Tennessee. So it's fairly widespread. So we don't see a big change in our next quarter. We've got a couple of Publix opening against us, three Publix. Possibly four. One Costco, one WalMart--and most of that is in Georgia next quarter.

I mean, if you were to disclose the comps by kind of the market territories, would we see Atlanta as, Georgia as probably the toughest comparison?

Land market is very tough. We have a AI lot of stores that are not considered the Atlanta area. We have a lot of stores in the most northern part of Georgia, Blairs (ph) view, Blueridge, and so forth. And we do extremely well there. So that kind of balances out.

How about in Tennessee, are you benefiting from the Food Lion's that were closing, that closed over there?

Yes, we are. We've got a substantial increase in sales in Tennessee.

Okay. If you were to try to back that out, can you give us some color on what comps would be across the company?

Well, the total –

You mean without the Tennessee?

Right. Without Tennessee. How much of having competitor closings in that region improved those comps that if we were to exclude those and we looked then at everything but that region, that that's kind of a one-time event?

I mean -- we don't actually track it that way. So I couldn't give you a number. If I made up one it might be wrong. But we only have, what, 19 stores in Tennessee. So it's not -- Tennessee is not by far the hugest part of our market.

Okay. I guess I was looking forward, what type of target debt levels are you getting comfortable with at this point? Looking into what your next year's CAPEX budget would be--what should we expect to see you with total debt levels?

I think right now certainly our debt level is higher than normal, because of the bonds and we did this because the opportunity was there. It was a good time to do it, certainly with the bond market you need to strike when the market is in good shape. And so we're carrying more debt than normal.

Of course we're also carrying more cash than normal. But what we would be looking at -- that's -- what we're trying to do is use that high yield money to keep us from having to borrow other money. So certainly over the next year you'll see, as we use that money, you'll see our debt return to below the $600 million mark.

Okay. Great. Thank you.

You're welcome.

We'll go next to Mary Austin with Pax World Fund.

Yeah, I was wondering if you have any underperforming stores in your mix and any plans to sell real estate from those and pay down debt?

We've closed three stores this year. So I guess like any good company, we're constantly looking at your store base, and making decisions on where is the best place to employ your capital. And we don't have immediate plans to close any more stores. But we do typically close somewhere between three and five a year.

So I would expect that trend to continue. We do have several pieces of real estate that we are marketing at the time, but I never count those until the money has been wired into the bank.

That's a good idea. And the $10 million that you mentioned, proceeds from the sale of real estate, was that for the quarter?

No, for the year.

Okay. Thanks very much.

Our next question comes from Shawn Newman (ph) with GE Asset Management.

Great quarter guys, could you give us a couple of -- as a follow on question, first of all, on asset sales, do you have any remaining asset sales pending for the rest of the year?

We are working on a couple of things for the rest of the year. But I certainly wouldn't want to step out and tell you that that's going to happen, because anything can happen when you're selling real estate.

Okay. Perfect. Then on more on an operational standpoint, could you give us an update where you see in both private label and kind of fuel center sales trends, in terms of penetration on a private label end, as well as just fuel center, how is that impacting the comps as well as margins?

Okay.

Private label sales are greatly increased. I'm not prepared to give you a number of SKUs today in dollar sales in front of me, but we have worked diligently to increase number of SKUs in private label and it is having an impact on gross margins. We're able to -- we feel that offsets the balance of having promotions by being able to put in private label products where we have better gross margins.

Then the follow-up question was just on the fuel center sales. How has that been trending?

The fuel sales are growing. We had 16 gas stations in operation right now. And the impact of the gas is on the total sales growth is less than 1%.

Thank you very much.

You're welcome.

We'll go to Mark Cooper with Benson and Associates.

Brenda, somebody earlier on the call asked about how you benchmark the progress of your customer service initiatives. It's pretty easy to benchmark the promotional side of it, because sales go up.

But it seems like over the last several years, just looking at the quarterly numbers, you know the gross margin and the SG&A leverage seem to work in opposite directions. And that your SG&A leverage seems to go down when your gross margins are going up. So they tend to eat away at each other. And I'm just curious how you look at that from a management point of view, what do you think is happening?

Well, I think strategy changes for one thing. I guess if you look back with our history, really our gross margin growth has been fairly constant over time. And so this is a change in what we're doing. And I think a lot of that comes from having a new president and somebody looking at things in a new way, especially since he came from the field out there at Ingle stores and saw things that he felt needed to be done.

So the gross margin trend is certainly different than what we have been experiencing and I think what we're trying to do is run the promotional activity and do some things, but at the same time, which I think this part hasn't shown as much, is we're looking at ways to improve that gross margin without hurting our sales.

For example, we recently brought eggs into our warehouse, whereas before we were having eggs direct store delivered. So what we were able to do was bringing the eggs into our warehouse so we would have a lower cost basis on it. We were also able to lower the cost at the store level to drive sales. So I think a lot of factors have to come together and those are the kinds of things that we're looking at.

And I think on the SG&A side, I would like to say that we've made a lot of improvements in a lot of line items on SG&A. But labor is certainly the largest part of your SG&A. And the strategy with the labor was certainly intentional to try to drive the sales, which I think another benchmark is that the sales did improve and I think customer service is something that we all believe is one of the best ways to drive sales and differentiate yourself.

I would agree with that. I guess just going back for the last three and a half years, if I just look at the operating margin, taking out everything else, it seems to be in a general trend of decline, which -- I'm not a grocery store operator, obviously, and you have the details there -- but it just seems like that what's driving the sales is being more than eaten up by the SG&A side of the business.

And I think one thing that I didn't hear, I was a little disappointed, is that the measuring of customer satisfaction tended to be or sounded like it's primarily an in-bound type of thing not something that you proactively go out and survey the customers or solicit what is happening in the stores, like secret shopper, that sort of thing. Any panel discussions. Do you do that sort of thing.?

Yeah, we've done secret shoppers in the past. We're not doing that now. But it is something that we're looking at. And we've also done recently, focus groups where we have Ingles customers in one group and then people who shop at other stores in another group. We're not present, but then we can observe the comments that the customers make about us and about our service. So we are going back into the customer for those kinds of things.

Mark, part of adding hours came as a result of a focus group we had done recently. This was done in western North Carolina. Our customers seemed to be very satisfied with our sales and promotions and our store conditions, so forth, that we did have some feedback on the service end. So part of the results was to add hours on the front end.

Well, thank you.

Thank you.

Once again, it's star one to ask a question. We'll go next to Jeff Kobalaris with Salomon Brothers.

Good morning. I wanted to ask about-- You said you ran hotter specials and triple coupons and buy ones get ones, how has the competition responded to this?

It's been a very competitive market. And we've seen our competitors run a lot of buy ones get one frees. And so far the promotions we've done with triple coupons has been fairly unique. We haven't seen anybody follow suit on that.

There's some other high feature items that we've done on key items such as milk and bread that have been effective also, that our competition has, they have followed some of those prices.

Okay. Do you have a feeling that this could be escalating the competition in the competitive environment right now?

I guess grocery people are always paranoid--we always feel like it's a highly competitive situation, and it's relentless and never ends. So we're constantly thinking and trying to think of new ways to give our customers value about hurting our bottom line too much.

All right. And can you, I may have missed this. Can you comment on the number of competitive openings year-to-date? And what your outlook is for the near term?

I don't have the year-to-date in front of me. We had about six new competitors last quarter, the quarter we just completed. Let's see, four of those, WalMart Supercenters, two of them were Publix stores.

And when you say they're competitive opening, how far are these Supercenters away from your stores?

That can vary greatly. But we consider it a competitor if it's within 10 miles. So normally just looking at the list, it was anywhere from, oh, 3 to 10 miles.

Okay. And how many of your 199 stores now compete with the WalMart Supercenters?

About 45 stores.

Okay. All right. Thank you.

At this time we have no further questions in the queue. I'd like to turn the call over to Ms. Tudor for closing remarks.

We thank you for your time and interest. We look forward to keeping you updated in the future. Have a good day.

This conclude today's conference call. We thank you for your participation. You may disconnect your line at this time.