INGLES MARKETS INC 10-K

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Ingles is a leading supermarket chain in the Southeast United States and operates a total of 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. The Company offers quality private label items in most of its departments. 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. As of September 30, 2023, the Company operated 114 in-store pharmacies and 108 fuel stations. Ingles also operates a fluid dairy and earns shopping center rentals. Critical Accounting Policies and Estimates Critical accounting policies are those accounting policies that management believes are important to the presentation of Ingles’ 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, general liability, 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 $1,000,000 per occurrence for workers’ compensation and for general liability, and $500,000 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 which is then applied to appropriate actuarial methods. 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. The Company’s self-insurance reserves totaled $32.9 million and $31.0 million for employee group insurance, workers’ compensation insurance and general liability insurance at September 30, 2023 and September 24, 2022, respectively. These amounts were inclusive of expected recoveries from excess cost insurance or other sources that are recorded as receivables of $4.3 million at September 30, 2023 and $4.0 million at September 24, 2022. Asset Impairments The Company accounts for the impairment of long-lived assets in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 360. Asset groups are primarily comprised of our individual store and shopping center properties. 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, net of costs to sell. 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 16 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. 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 one 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 reduction of item cost in inventory and recognized in merchandise costs when the item is sold. Due to the use of the retail method for 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 $128.9 million, $110.6 million and $116.3 million for the fiscal years ended September 30, 2023, September 24, 2022, and September 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 that the related expense is incurred. Vendor advertising allowances recorded as a reduction of advertising expense totaled $8.5 million, $7.1 million, and $8.1 million for the fiscal years ended September 30, 2023, September 24, 2022, and September 25, 2021, respectively. 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 Fiscal Year Ingles operates on a 52- or 53-week fiscal year ending on the last Saturday in September. The consolidated statements of income for the fiscal year ended September 30, 2023 had 53 weeks. The consolidated statements of income for fiscal years September 24, 2022, and September 25, 2021 each consisted of 52 weeks of operations. Comparable Store Sales Comparable store sales are defined as sales by grocery stores in operation for five full fiscal quarters. The Company has an ongoing renovation and expansion plan to modernize the appearance and layout of its existing stores. 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 of completion of the replacement, remodel or addition. A replacement store is a newly opened store that replaces an existing nearby store that is closed. A major remodel entails substantial remodeling of an existing store and may include additional retail square footage. Comparable store sales for the fiscal year ended September 30, 2023, included 198 stores and, for the fiscal year ended September 24, 2022, comparable store sales included 197 stores. The following table sets forth, for the periods indicated, selected financial information as a percentage of net sales. Fiscal Year Ended September 2023 2022 2021 Net sales 100.0% 100.0% 100.0% Gross profit 23.8 24.9 26.1 Operating and administrative expenses 18.9 18.3 19.3 Gain from sale or disposal of assets 0.1 — 0.2 Income from operations 5.0 6.6 7.0 Other income, net 0.2 — 0.1 Interest expense 0.4 0.4 0.5 Income before income taxes 4.8 6.4 6.6 Income tax expense 1.2 1.6 1.6 Net income 3.6 4.8 5.0 17 Fiscal Year Ended September 30, 2023 Compared to the Fiscal Year Ended September 24, 2022 Net income for the fiscal year ended September 30, 2023 was $210.8 million, compared with net income of $272.8 million for the fiscal year ended September 24, 2022. Comparisons of fiscal year 2023 to fiscal year 2022 are affected by the difference in the number of weeks in each year. Fiscal year 2023 had 53 weeks and fiscal year 2022 had 52 weeks. Net income as a percentage of sales was 3.6% for fiscal year 2023 compared with 4.8% for fiscal year 2022. Inflation in the cost of goods and increases in operating expenses due to the competition in the labor market contributed to this decrease. Net Sales . Net sales for the fiscal year ended September 30, 2023 totaled $5.89 billion, compared with $5.68 billion for the fiscal year ended September 24, 2022. In fiscal years with 53 weeks, such as 2023, management analyzes comparable stores sales for the 53 weeks of the year with the corresponding 52 calendar weeks of the previous year plus one additional week. On this basis, retail grocery comparable store sales excluding fuel increased 4.0% for fiscal 2023 compared with 2022. The number of transactions (excluding fuel) increased 2.9% while the average transaction size (excluding fuel) increased by 0.9%. Comparing fiscal 2023 with 2022, fuel gallons sold decreased 0.4% and per gallon fuel prices decreased 10.2%. Sales by product category for the fiscal years ended September 30, 2023 and September 24, 2022 were as follows: Fiscal Year Ended September (dollars in thousands) 2023 2022 Grocery $ 2,062,416 $ 1,940,414 Non-foods 1,326,907 1,204,443 Perishables 1,482,089 1,445,042 Fuel 792,524 885,801 Total retail grocery $ 5,663,936 $ 5,475,700 The “Grocery” category includes grocery, dairy and frozen foods. The “Non-foods” category includes alcoholic beverages, tobacco, pharmacy, and health/beauty/cosmetic products. The “Perishables” category includes meat, produce, deli and bakery. Changes in retail grocery sales for the fiscal year ended September 30, 2023 are summarized as follows (in thousands): Total retail grocery sales for the fiscal year ended September 24, 2022 $ 5,475,700 Comparable store sales increase 75,615 Effect of 53rd week 106,715 Sales growth from stores opened fiscal 2023 3,099 Other 2,807 Total retail grocery sales for the fiscal year ended September 30, 2023 $ 5,663,936 Increased sales for fiscal year 2023 were due to comparable store sales through enhanced loyalty programs and special offers, as well as the additional 53 rd week in fiscal year 2023. Gross Profit. Gross profit for the fiscal year ended September 30, 2023 decreased $10.9 million, or 0.77%, to $1.40 billion compared with $1.42 billion for the fiscal year ended September 24, 2022. As a percentage of sales, gross profit totaled 23.8% for the fiscal year ended September 30, 2023 as compared to 24.9% for the fiscal year ended September 24, 2022. Retail grocery gross profit as a percentage of total sales (excluding fuel) decreased 182 basis points in fiscal year 2023 compared with fiscal year 2022. The gross margin decrease was primarily due to inflation and supply chain factors that impacted prices and mix of products sold. In addition to the direct product cost, the cost of goods sold line item for the grocery segment includes inbound freight charges, which generally increased in fiscal year 2023 as compared to fiscal year 2022, and increased costs related to the Company’s distribution network, including the impact of higher diesel prices. Operating and Administrative Expenses. Operating and administrative expenses increased $75.2 million, or 7.2%, to $1.1 billion for the fiscal year ended September 30, 2023, from $1.0 billion for the fiscal year ended September 24, 2022. As a percentage of sales, operating and administrative expenses were 18.9% and 18.3% for fiscal years 2023 and 2022, respectively. Excluding fuel, which does not have significant direct operating expenses, the ratio of operating expenses to sales was 21.7% for fiscal year 2023 compared with 21.5% for fiscal year 2022. 18 A breakdown of the major increases and (decreases) in operating and administrative expenses is as follows. Increase Increase (decrease) (decrease) as a % of (in millions) sales Salaries and wages $ 55.2 0.94 % Repairs and maintenance $ 11.6 0.20 % Advertising and promotion $ (6.3) (0.11) % Store supplies $ 5.7 0.10 % Salaries and wages increased due to increased competition in the labor market in the Company’s market area, in addition to the extra week of expense for the 53 rd week. Repairs and maintenance increased due to higher refrigerant costs and the cost of other supply items, as well as increased wear and tear on equipment to accommodate sales volume, in addition to the extra week of expense for the 53 rd week. Advertising and promotion costs decreased due to absorbing some of the activity in-house and moving towards lower-cost types of advertising. Store supplies, which include customer packaging containers, increased as a result of increased sales, market costs of certain supplies, and supply chain issues for certain raw materials, in addition to the extra week of expense for the 53 rd week. Gain from Sale or Disposal of Assets. Gains on sale or disposal of assets totaled $2.8 million for fiscal year 2023 and $1.4 million for fiscal year 2022. Other Income, Net. Other income, net totaled $8.3 million and $5.8 million for the fiscal years ended September 30, 2023 and September 24, 2022, respectively. Other income consists primarily of interest earned and sales of waste paper and packaging. Interest Expense. Interest expense totaled $22.1 million for the fiscal year ended September 30, 2023 and $21.5 million for the fiscal year ended September 24, 2022. Total debt was $550.2 million at the end of fiscal year 2023 compared with $571.9 million at the end of fiscal year 2022. Income Taxes. Income tax expense totaled $67.7 million for fiscal year 2023, reflecting an effective tax rate of 24.3%. This compares with an income tax expense totaling $88.5 million and an effective tax rate of 24.5% for fiscal year 2022. Net Income. Net income totaled $210.8 million for the fiscal year ended September 30, 2023 compared with net income of $272.8 million for the fiscal year ended September 24, 2022. Basic and diluted earnings per share for Class A Common Stock were $11.35 and $11.10, respectively, for the fiscal year ended September 30, 2023 compared with $14.69 and $14.36, respectively, for the fiscal year ended September 24, 2022. Basic and diluted earnings per share for Class B Common Stock were each $10.32 for the fiscal year ended September 30, 2023 compared with $13.35 of basic and diluted earnings per share for the fiscal year ended September 24, 2022. Fiscal Year Ended September 24, 2022 Compared to the Fiscal Year Ended September 25, 2021 See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Ingles Annual Report on Form 10-K for the year ended September 24, 2022, filed with the SEC on November 23, 2022, for a discussion of the year ended September 24, 2022 as compared to September 25, 2021. Liquidity and Capital Resources Capital Expenditures The Company believes that a key to its ability to continue to increase sales and develop a loyal customer base is providing conveniently located, clean and modern stores which provide customers with good service and an increasingly diverse selection of competitively priced products. As such, the Company has invested and plans to continue to invest significant amounts of capital toward the modernization of its store base. The Company’s modernization program includes the opening of new stores, the completion of major remodels and expansion of selected existing stores, and the relocation of selected existing stores to larger, more convenient locations. Capital expenditures totaled $173.6 million and $119.6 million for fiscal years 2023 and 2022, respectively, with the increase driven primarily by the purchase of new sites and land parcels. Major capital expenditures included the following: 2023 2022 New stores 0 0 Store sites/land parcels purchased 15 6 New fuel stations added 1 0 19 Capital expenditures include upgrading and replacing store equipment, technology investments, those related to the Company’s distribution operation and its milk processing plant, and expenditures for stores to open in subsequent fiscal years. Ingles’ capital expenditure plans for fiscal year 2024 include investments of approximately $120 to $170 million. The Company currently plans to dedicate the majority of its fiscal 2024 capital expenditures to continued improvement of its store base, 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 net 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 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, major store remodels/expansions, and build-out of tenant space under the long-term leases. 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. In general, the Company finances its capital expenditures to the extent possible from cash on hand and cash flow from operations. Additional financing sources for capital expenditures could include borrowings under the Company’s $150 million of committed line of credit (described below), other borrowings that could be collateralized by unencumbered real property and equipment with a net book value of approximately $1.2 billion, and the public debt or equity markets. The Company has used each of these to finance past capital expenditures and expects to have them available in the future. 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. Construction commitments at September 30, 2023 totaled $3.0 million. Liquidity The Company generated $266.4 million of cash from operations in fiscal 2023 compared with $339.5 million for fiscal year 2022. The decrease resulted primarily from a $61.9 million decrease in net income for fiscal year 2023 compared with fiscal 2022. Cash used by investing activities for fiscal year 2023 totaled $170.1 million compared with $112.0 million for fiscal year 2022. The Company’s most significant investing activity is capital expenditures, which increased in fiscal year 2023 as compared to fiscal year 2022. The Company’s cash used by net financing activities totaled $35.0 million and $30.6 million for fiscal years 2023 and 2022, respectively. The U.S. Dollar LIBOR panel ceased following June 30, 2023, and the Company’s debt agreements and interest rate swaps that utilized LIBOR discontinued the use of LIBOR and adopted the Secured Overnight Financing Rate (“SOFR”). In June 2021, the Company issued at par $350.0 million aggregate principal amount of 4.00% senior notes due 2031 (the “2031 Notes”) and used a portion of the proceeds to redeem the remaining outstanding $295.0 million principal amount of the Company’s 5.75% senior notes due. The Company has a $150.0 million unsecured senior 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 SOFR. The Line allows the Company to issue up to $10.0 million in letters of credit, of which none were issued at September 30, 2023. The Company is not required to maintain compensating balances in connection with the Line. At September 30, 2023, the Company had no borrowings outstanding under the Line. In December 2010, the Company completed the funding of $99.7 million of Recovery Zone Facility 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, such financial institutions hold the Bonds until December 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 aggregate principal amount of the Bonds was $54.4 million at September 30, 2023. The Company may redeem the Bonds without penalty or premium at any time prior to December 17, 2029. In September 2017, the Company refinanced approximately $60 million of secured borrowing obligations with a SOFR-based amortizing floating rate loan secured by real estate, which matures in October 2027. The Company has an interest rate swap agreement for a current notional amount of $24.5 million at a fixed rate of 3.962%. Under this agreement, the Company pays monthly the fixed rate of 3.962% and receives the one-month SOFR plus 1.75%. The interest rate swap effectively hedges floating rate debt in the same 20 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 $0.5 million and mature October 1, 2027. In December 2019, the Company closed a $155 million SOFR-based amortizing floating rate loan secured by real estate, which matures in January 2030. The Company has an interest rate swap agreement for a current notional amount of $124.6 million at a fixed rate of 2.998%. Under this agreement, the Company pays monthly the fixed rate of 2.998% and receives the one-month SOFR plus 1.60%. 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 is 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 2031 Notes indenture in the event of default under any one instrument. The Bonds and the Line contain provisions that under certain circumstances would permit the acceleration of the indebtedness under such instruments or would otherwise 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 Bonds and 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 September 30, 2023, the Company was in compliance with these covenants. Under the most restrictive of these covenants, the Company would have been permitted to incur approximately $1.8 billion of additional borrowings (including borrowings under the Line) as of September 30, 2023. 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 cash balances, the existing 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 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 Company’s results of operations and financial condition will be different from that described in this Annual Report on Form 10-K based on a number of intangible factors. These factors may include, among others, resurgence of the COVID-19 pandemic virus, 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 above and elsewhere under “Item 1A. Risk Factors.” 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 Annual Report on Form 10-K. Quarterly Cash Dividends Since December 27, 1993, the Company has paid regular quarterly cash dividends of $0.165 per share on its Class A Common Stock and $0.15 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. Certain of the Company’s long-term debt agreements contain various restrictive covenants requiring, among other things, minimum levels of net worth and maintenance of certain financial ratios. These covenants have the effect of restricting certain types of transactions, including the payment of cash dividends generally and in excess of current quarterly per share amounts. New Accounting Pronouncements For new accounting pronouncements, see Note 1 to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Outlook and Trends in the Company’s Markets The COVID-19 pandemic that began in March 2020 substantially impacted supermarket operations during fiscal years 2020, 2021 and 2022. While the effects of the pandemic on the Company have eased considerably over the fiscal year ended September 30, 2023, some effects have continued through the year ended September 30, 2023, and we do not know how long and to what extent COVID-19 will impact our markets in fiscal year 2024. 21 The Company continually assesses and modifies its business model to meet the changing needs and expectations of its customers. In connection with this review, the Company assesses the trends present in the markets in which it competes. Generally, it is difficult to predict whether a trend will continue for a period of time and it is possible that new trends will develop which will affect an existing trend. The Company believes that the following trends are likely to continue for at least the next fiscal year:  The supermarket industry will remain highly competitive and will be characterized by industry consolidation, fragmented food retail platforms, and continued competition from super centers and other non-supermarket operators.  Traditional supermarket products will be acquired by customers in new and diverse ways, including online ordering, home delivery and pre-picked for customer pickup.  Economic conditions will continue to affect customer behavior. Economic conditions may affect purchasing patterns with regard to meal replacement items, private label purchases, promotions and product variety.  The Company and its customers will continue to become more environmentally aware, evidenced by the Company’s increased recycled waste paper and pallets and customers’ increased usage of reusable shopping bags.  Volatile petroleum costs will impact utility and distribution costs, plastic supplies cost and may change customer shopping and dining behavior.  Retail fuel costs and retail prices will continue to be volatile, affecting the Company’s fuel sales and gross margin. The Company plans to continue to focus on balancing sales growth and gross margin maintenance (excluding the effect of fuel sales) and will carefully monitor its product mix and customer trends.