INGLES MARKETS INC 10-Q

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Ingles, a leading supermarket chain in the Southeast, operates 198 supermarkets in North Carolina (75), Georgia (65), South Carolina (35), Tennessee (21), Virginia (1) and Alabama (1). 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. Non-food products include fuel centers, pharmacies, health/beauty/cosmetic products and general merchandise, as well as quality private label items. In addition, the Company focuses on selling products to its customers through the development of certified organic products, bakery departments and prepared foods including delicatessen sections. 12 Coronavirus (COVID-19) Pandemic Impact The COVID-19 pandemic which began in March 2020 and has continued through the three months ended December 24, 2022, has impacted supermarket operations. At the onset of the COVID-19 pandemic, the Company implemented several enhanced cleaning and social distancing protocols designed to keep our customers and our associates safe and has continued to monitor and update its protocols as the pandemic has evolved. Since March 2020, the Company’s stores have experienced increased customer traffic and occasional product shortages due to supply chain issues. Recently, an extremely tight labor market has impacted the Company’s ability to attract and retain qualified store personnel, but these impacts have not materially affected our operations. Finally, as the economy recovers, inflation has reached levels not seen in decades. Inflation impacts product costs, labor costs and other goods used by the Company. At the present time, we do not know how long and to what extent the ongoing effects of the pandemic and inflation could impact our sales and financial performance. Critical Accounting Policies Critical accounting policies are those accounting policies that management believes are important to the presentation of the Company’s financial condition and results of operations, and require management’s most difficult, subjective or complex judgments, often as a result of the need to estimate the effect of matters that are inherently uncertain. Estimates are based on historical experience and other factors believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Management estimates, by their nature, involve judgments regarding future uncertainties, and actual results may therefore differ materially from these estimates. Self-Insurance 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 of $1.0 million per occurrence for workers’ compensation and for general liability, and $475,000 per covered person for medical care benefits for a policy year. Self-insurance liabilities are established based on claims filed and estimates of claims incurred but not reported. The 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 Company’s properties are self-insured for casualty losses and business interruption; however, liability coverage is maintained. At December 24, 2022 the Company’s self-insurance reserves totaled $31.1 million. This amount is inclusive of $4.1 million of expected self-insurance recoveries from excess cost insurance or other sources that are recorded as a receivable. Asset Impairments The Company accounts for the impairment of long-lived assets in accordance with FASB ASC Topic 360. 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 associates. Estimates of future cash flows and expected sales prices are judgments based upon the Company’s 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. The Company monitors the carrying value of long-lived assets for potential impairment each quarter based on whether any indicators of impairment have occurred. There were no asset impairments during the three-month period ended December 24, 2022. Vendor Allowances 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 are primarily composed of 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 applicable vendor’s products. These allowances generally relate to short term arrangements with vendors, often relating to a period of a month or less, and are negotiated on a purchase-by-purchase or transaction-by-transaction basis. Whenever practical, 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 the use of the retail method of store inventory 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 vendor consideration received is sold. Vendor allowances applied as a reduction of merchandise costs totaled $34.4 million and $31.9 million for the fiscal quarters ended December 24, 2022 and December 25, 2021, respectively. Vendor advertising allowances that represent a reimbursement of specific identifiable incremental costs of advertising the vendor’s specific products are recorded as a reduction to the related expense in the period in which the related expense is incurred. Vendor advertising allowances recorded as a 13 reduction of advertising expense totaled $2.0 million and $2.1 million for the fiscal quarters ended December 24, 2022 and December 25, 2021, respectively. Overall, v endor allowances decreased significantly at the onset of the COVID-19 pandemic as vendors reduced support for promotional activities. Vendor promotional support subsequently increased, but has not reached pre-pandemic levels. If vendor advertising allowances were substantially reduced or eliminated, the Company would likely consider other methods of advertising, as well as the volume and frequency of the Company’s product advertising, which could increase or decrease the Company’s expenditures. Similarly, the Company is not able to assess the impact of vendor advertising allowances on creating additional revenue, as such allowances do not directly generate revenue for the Company’s stores. Results of Operations Ingles operates on a 52 or 53-week fiscal year ending on the last Saturday in September. The Condensed Consolidated Statements of Income for the three-month periods ended December 24, 2022 and December 25, 2021 both include 13 weeks of operations. Comparable store sales are defined as sales by retail stores in operation for five full fiscal quarters. Sales from replacement stores, major remodels and the addition of fuel stations to existing stores are included in the comparable store sales calculation from the date thereof. A replacement store is a newly-opened store that replaces an existing nearby store that has closed. A major remodel entails substantial remodeling of an existing store and includes additional retail square footage. For the three-month period ended December 24, 2022, comparable store sales included 197 stores. For the three-month period ended December 25, 2021, comparable store sales included 196 stores. The following table sets forth, for the periods indicated, selected financial information as a percentage of net sales. For information regarding the business’ segments, see Note K “Segment Information” to the Condensed Consolidated Financial Statements. Three Months Ended December 24, December 25, 2022 2021 Net sales 100.0 % 100.0 % Gross profit 24.9 % 25.2 % Operating and administrative expenses 18.5 % 18.7 % Income from operations 6.4 % 6.5 % Other income, net 0.1 % 0.1 % Interest expense 0.4 % 0.4 % Income tax expense 1.5 % 1.4 % Net income 4.6 % 4.8 % Three Months Ended December 24, 2022 Compared to the Three Months Ended December 25, 2021 Net income for the first quarter of fiscal 2023 totaled $69.4 million, compared with net income of $66.2 million for the first quarter of fiscal 2022. Retail grocery sales increased due to continued consumer trends seen since the beginning of the COVID-19 pandemic, as well as the effects of inflation. Corresponding operating expenses did not increase as much as sales, resulting in higher pre-tax income. Net Sales. Net sales increased by $101.8 million, or 7.3%, to $1.5 billion for the three months ended December 24, 2022 compared with $1.4 billion for the three months ended December 25, 2021. Excluding fuel sales, total grocery comparable store sales increased 7.3% over the comparative fiscal quarter. Ingles operated 198 stores at both December 24, 2022 and December 25, 2021. Inflation in the prices of food and fuel has also positively impacted the dollar amount of sales. Changes in retail grocery sales for the quarter ended December 24, 2022 are summarized as follows (in thousands): Total retail sales for the three months ended December 25, 2021 $ 1,348,261 Comparable store sales increase (including fuel) 86,427 Impact of stores opened in fiscal 2021 354 Impact of stores closed in fiscal 2021 (330) Other 162 Total retail sales for the three months ended December 24, 2022 $ 1,434,874 Gross Profit. Gross profit for the three-month period ended December 24, 2022 totaled $371.2 million, an increase of $20.7 million, or 5.9%, compared with gross profit of $350.5 million for the three-month period ended December 25, 2021. Gross profit as a percentage of sales was 24.9% and 25.2% for the three months ended December 24, 2022 and December 25, 2021, respectively. The decrease in gross profit as a percentage of sales resulted primarily from inflation and raw material shortages, which have increased the cost of products. Retail segment gross profit, excluding fuel decreased 84 basis points for the quarter ended December 24, 2022, as compared with the quarter ended December 25, 2021. 14 Operating and Administrative Expenses. Operating and administrative expenses increased $16.1 million, or 6.2%, to $276.2 million for the three months ended December 24, 2022, as compared to $260.1 million for the three months ended December 25, 2021. As a percentage of sales, operating and administrative expenses were 18.5% and 18.7% for the December 2022 and December 2021 quarters, respectively. Excluding fuel sales and associated fuel operating expenses (primarily payroll), operating expenses were 21.0% of sales for the first fiscal quarter of fiscal 2023 compared with 21.5% for the first fiscal quarter of 2022. A breakdown of the major changes in operating and administrative expenses is as follows: Increase Increase (decrease) (decrease) as a % of in millions sales Salaries and wages $ 13.0 0.87 % Insurance $ (2.9) (0.19) % Repairs and maintenance $ 2.7 0.18 % Store supplies $ 1.8 0.12 % Bank charges $ 1.3 0.09 % Salaries and wages increased in dollars due to increased competition in the labor market in the Company’s market area. Insurance expense decreased due to lower claims under the Company’s self-insurance programs. Repairs and maintenance increased due to wear and tear of equipment due to increased sales volume, increased costs of parts and refrigeration. Store supplies, which include customer packaging containers, increased as a result of increased sales and market costs of certain supplies and supply chain issues for certain raw materials. Bank charges increased due to increased sales and a greater portion of sales settled with credit/debit cards instead of cash or check. Other Income. Other income totaled $1.4 million for the three months ended December 24, 2022 compared with $1.6 million for the three months ended December 25, 2021. Interest Expense. Interest expense totaled $5.3 million for the three-month period ended December 24, 2022 compared with $5.4 million for the three-month period ended December 25, 2021. Total debt at December 24, 2022 was $564.5 million compared with $586.1 million at December 25, 2021. Income Taxes. Income tax expense totaled $22.5 million for the three months ended December 24, 2022, reflecting an effective tax rate of 24.5% of pretax income. Income tax expense totaled $20.4 million for the three months ended December 25, 2021, reflecting an effective tax rate of 23.6% of pretax income. Net Income. Net income totaled $69.4 million for the three-month period ended December 24, 2022 compared with $66.2 million for the three-month period ended December 25, 2021. Basic and diluted earnings per share for Class A Common Stock were $3.73 and $3.65, respectively, for the December 2022 quarter, compared to $3.57 and $3.48, respectively, for the December 2021 quarter. Basic and diluted earnings per share for Class B Common Stock were each $3.40 for the December 2022 quarter compared with $3.24 for the December 2021 quarter. Liquidity and Capital Resources Capital Expenditures Capital expenditures totaled $59.3 million for the three-month period ended December 24, 2022. The Company’s capital expenditures include the construction of new stores, the expansion and remodeling of existing stores, the acquisition of sites, new technology, and upgrades of the Company’s transportation fleet and facilities. The Company’s capital expenditure plans for fiscal 2023 currently include investments of approximately $120 to $140 million. At this time the Company does not anticipate that the continually evolving COVID-19 environment will have an adverse impact on its long-term capital expenditure plans. The Company currently plans to dedicate the majority of its fiscal 2023 capital expenditures to continued improvement of its store base and continued investment in one store expected to open in fiscal 2023, as well as technology improvements, upgrading and replacing existing store, warehouse and transportation equipment and improvements to the Company’s milk processing plant. The Company currently expects that its annual capital expenditures will be in the range of approximately $100 to $160 million going forward in order to maintain a modern store base. Among other things, planned expenditures for any given future fiscal year will be 15 affected by the availability of financing, which can affect both the number of projects pursued at any given time and the cost of those projects. The number of projects may also fluctuate due to the varying costs of the types of projects pursued including new stores and major remodel/expansions. 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. Liquidity The Company generated $57.3 million net cash from operations for the December 2022 three-month period compared with $95.0 million for the December 2021 three-month period. The decrease was primarily attributable to higher working capital needs . Cash used by investing activities for the three-month periods ended December 24, 2022 and December 25, 2021 totaled $58.2 million and $131.1 million, respectively. Excess cash of approximately $110 million was invested in short-term financial instruments in the prior year offset by higher capital expenditures through the first quarter of fiscal 2023. Cash used by financing activities totaled $10.7 million for the three-month period ended December 24, 2022, compared with $6.5 million for the three-month period ended December 25, 2021. During the quarter ended December 24, 2022, the Company repaid $4.2 million of mortgage debt. In June 2021, the Company issued $350.0 million aggregate principal amount of senior notes due 2031 (the “Notes”). The Notes bear an interest rate of 4.00% per annum and were issued at par. The Company has a $150.0 million line of credit (the “Line”) that matures in June 2026. The Line provides the Company with various interest rate options based on the prime rate, the Federal Funds Rate, or LIBOR. The Line allows the Company to issue up to $10.0 million in letters of credit, of which none were issued at December 24, 2022. The Company is not required to maintain compensating balances in connection with the Line. At December 24, 2022, the Company had no borrowings outstanding under the Line. In December 2010, the Company completed the funding of $99.7 million of Bonds (the “Bonds”) for the construction of new warehouse and distribution space adjacent to its existing space in Buncombe County, North Carolina (the “Project”). The final maturity date of the Bonds is January 1, 2036. Under a Continuing Covenant and Collateral Agency Agreement (the “Covenant Agreement”) between certain financial institutions and the Company, the financial institutions would hold the Bonds until December 17, 2029, subject to certain events. Mandatory redemption of the Bonds by the Company in the annual amount of $4.5 million began on January 1, 2014. The outstanding balance of the Bonds is $59.0 million as of December 24, 2022. The Company may redeem the Bonds without penalty or premium at any time prior to December 17, 2029. The Covenant Agreement was amended during the three months ended December 25, 2021 to extend the holding period from September 2026 to December 2029 and reduce the interest rate on the Bonds. In September 2017, the Company refinanced approximately $60 million secured borrowing obligations with a LIBOR-based amortizing floating rate loan secured by real estate maturing in October 2027. The Company has an interest rate swap agreement for a current notional amount of $29.0 million at a fixed rate of 3.92%. Under this agreement, the Company pays monthly the fixed rate of 3.92% and receives the one-month LIBOR plus 1.65%. The interest rate swap effectively hedges floating rate debt in the same amount as the current notional amount of the interest rate swap. Both the floating rate debt and the interest rate swap have monthly principal amortization of $0.5 million and mature October 1, 2027. In December 2019, the Company closed a $155 million LIBOR-based amortizing floating rate loan secured by real estate maturing in January 2030. The Company has an interest rate swap agreement for a current notional amount of $130.5 million at a fixed rate of 2.95%. Under this agreement, the Company pays monthly the fixed rate of 2.95% and receives the one-month LIBOR plus 1.50%. The interest rate swap effectively hedges floating rate debt in the same amount as the current notional amount of the interest swap. Both the floating rate debt and the interest rate swap have monthly principal amortization of $0.65 million and mature in fiscal year 2030. The fair market value of the interest rate swaps are measured quarterly with adjustments recorded in other comprehensive income. The Company’s long-term debt agreements generally have cross-default provisions which could result in the acceleration of payments due under the Company’s Line, Bonds and Notes indenture in the event of default under any one instrument. The Company’s long-term debt agreements generally 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 the Line 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 documents. As of December 24, 2022, the Company was in compliance with these 16 covenants. Under the most restrictive of these covenants, the Company would have been permitted to incur approximately $2.3 billion of additional borrowings (including borrowings under the Line) as of December 24, 2022. The Company’s principal sources of liquidity are expected to be cash flow from operations, borrowings under the Line and long-term debt financing. The Company believes, based on its current results of operations and financial condition, that its financial resources, including the Line, short- and long-term financing expected to be available to it 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 is 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 Company’s results of operations and financial condition will be different from that described in this Quarterly Report on Form 10-Q based on a number of factors. These factors may include, among others, increased competition, changing regional and national economic conditions, adverse climatic conditions affecting food production and delivery, changing demographics, and the ongoing impact of the COVID-19 pandemic, 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 Quarterly Report on Form 10-Q. 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, the Notes, the Bonds, the Line, and other debt agreements contain provisions that, based on certain financial parameters, restrict the ability of the Company to pay additional cash dividends in excess of current quarterly per share amounts. Further, the Company is prevented from declaring dividends at any time that it is in default under the indenture governing the Notes. Seasonality Grocery sales are subject to a slight seasonal variance due to both holiday related sales and sales in areas where seasonal homes are located. Sales are traditionally higher in the Company’s first fiscal quarter due to the inclusion of sales related to Thanksgiving and Christmas. Unless Easter falls within the quarter, the Company’s second fiscal quarter traditionally has the lowest sales of the year predominantly due to lower occupancy of seasonal homes. In the third and fourth quarters, sales are usually positively affected by the return of customers to seasonal homes in our market area. Impact of Inflation As the economy continues to recover from the initial impact of the COVID-19 pandemic, inflation has recently reached levels not experienced in decades. Food and energy costs have increased, reflecting a tight labor market and supply chain/transportation disruptions. The following table from the United States Bureau of Labor Statistics lists annualized changes in the Consumer Price Index that could have an effect on the Company’s operations. One of the Company’s significant costs is labor, which increases with general inflation. Inflation or deflation in energy costs affects the Company’s fuel sales, distribution expenses and plastic supply costs. During the past twelve months, inflation has reached its highest level in a number of years, impacting food costs, transportation costs, and labor costs. Twelve Months Ended December 2022 All items 6.5 % Food at home 11.8 % Energy 8.3 % Forward Looking Statements This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. The words “expect”, “anticipate”, “intend”, “plan”, “likely”, “goal”, “believe”, “seek”, “will”, “may”, “would”, “should” 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 Company’s current judgment regarding the direction of 17 the Company’s business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested or described by such forward-looking statements. 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 Company’s control. Some of these assumptions inevitably will not materialize, and unanticipated events will occur which will affect the Company’s results. Some important factors (but not necessarily all factors) that affect the Company’s revenues, financial position, growth strategies, 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 the potential continued impact of the COVID-19 pandemic on our business and economic conditions generally in the Company’s operating area; the Company’s ability to successfully implement its expansion and operating strategies and to manage rapid expansion; pricing pressures and other competitive factors; reduction in per gallon retail fuel prices; the maturation of new and expanded stores; the Company’s 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; disruptions in the efficient distribution of food products; changes in accounting policies, standards, guidelines or principles as may be adopted by regulatory agencies as well as the Financial Accounting Standards Board; and those factors contained under the heading “Risk Factors” in Item 1A of Part I of our most recent Annual Report on Form 10-K for the year ended September 24, 2022, filed by the Company under the Securities Exchange Act of 1934, on November 23, 2022 . Consequently, actual events affecting the Company and the impact of such events on the Company’s operations may vary significantly from those described in this Quarterly Report on Form 10-Q or contemplated or implied by statements in this Quarterly Report on Form 10-Q. The Company does not undertake and specifically denies any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments, except to the extent required by applicable law.