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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________to___________________
Commission file number 333-14217
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CORE-MARK INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 91-1295550
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
395 OYSTER POINT BOULEVARD, SUITE 415
SOUTH SAN FRANCISCO, CA 94080
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 589-9445
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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.
X Yes No
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At October 31, 1998, Registrant had outstanding 5,500,000 shares of
Common Stock.
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS OR INFORMATION
Certain statements contained in this quarterly report on Form 10-Q under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and elsewhere herein and in the documents incorporated
herein by reference are not statements of historical fact but are future-looking
or forward-looking statements that may constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended. Certain, but not necessarily all, of such forward-looking statements
can be identified by the use of such forward-looking terminology as the words
"believes," "expects," "may," "will," "should," or "anticipates" (or the
negative of such terms) or other variations thereon or comparable terminology,
or because they involve discussions of Core-Mark International, Inc.'s (the
"Company's") strategy. Such forward-looking statements are based upon a number
of assumptions concerning future conditions that may ultimately prove to be
inaccurate. The ability of the Company to achieve the results anticipated in
such statements is subject to various risks and uncertainties and other factors
which may cause the actual results, level of activity, performance or
achievements of the Company or the industry in which it operates to be
materially different from any future results, level of activity, performance or
achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the general state of the economy and business
conditions in the United States and Canada; adverse changes in consumer
spending; the ability of the Company to implement its business strategy,
including the ability to integrate recently acquired businesses into the
Company; the ability of the Company to obtain financing; competition; the level
of retail sales of cigarettes and other tobacco products; possible effects of
legal proceedings against manufacturers and sellers of tobacco products and the
effect of government regulations affecting such products. As a result of the
foregoing and other factors affecting the Company's business beyond the
Company's control, no assurance can be given as to future results, levels of
activity, performance or achievements and neither the Company nor any other
person assumes responsibility for the accuracy and completeness of these
statements.
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PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of December 31, 1997 and September 30, 1998. . . . . . . . . . . 3
Condensed Consolidated Statements of Income for the three and nine months ended
September 30, 1997 and 1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 1997 and 1998. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Condensed Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . 8
PART II - OTHER INFORMATION
Item 1: Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 2: Changes in Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 3: Defaults upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 4: Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . . . . 15
Item 5: Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 6: Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
</TABLE>
2
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
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<S> <C> <C>
ASSETS (UNAUDITED)
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,281 $ 12,888
Receivables:
Trade accounts, less allowance for doubtful accounts of $2,950 and
$2,790, respectively . . . . . . . . . . . . . . . . . . . . . . . . . . . 96,610 95,418
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,806 8,143
Inventories, net of LIFO allowance of $15,718 and $21,199, respectively . . . . . 103,246 96,660
Prepaid expenses and other. . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,847 6,988
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Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233,790 220,097
Property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56,633 60,023
Less accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . (28,633) (32,303)
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Net property and equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,000 27,720
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,277 7,936
Goodwill, net of accumulated amortization of $17,293 and $18,854, respectively . . . 66,513 65,002
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$ 336,580 $ 320,755
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,737 $ 50,362
Cigarette and tobacco taxes payable . . . . . . . . . . . . . . . . . . . . . . . 43,506 42,317
Income taxes payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,085 2,674
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,599 7,197
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,647 26,739
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Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 131,574 129,289
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197,012 180,482
Other accrued liabilities and deferred income taxes. . . . . . . . . . . . . . . . . 9,030 9,279
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Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337,616 319,050
Commitments and contingencies:
Shareholders' equity (deficit):
Common stock; $.01 par value; 10,000,000 shares authorized;
5,500,000 shares issued and outstanding . . . . . . . . . . . . . . . . . . . 55 55
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,121 26,121
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (22,286) (18,369)
Accumulated other comprehensive income:
Foreign currency translation adjustments. . . . . . . . . . . . . . . . . . . (2,879) (4,055)
Minimum pension liability . . . . . . . . . . . . . . . . . . . . . . . . . . (2,047) (2,047)
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Total shareholders' equity (deficit) . . . . . . . . . . . . . . . . . . . . (1,036) 1,705
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$ 336,580 $ 320,755
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</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
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1997 1998 1997 1998
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<S> <C> <C> <C> <C>
Net sales. . . . . . . . . . . . . . . . . . . . . . . . . $647,146 $657,893 $1,790,006 $1,830,164
Cost of goods sold . . . . . . . . . . . . . . . . . . . 600,106 610,325 1,656,290 1,697,485
--------- --------- ---------- ----------
Gross profit. . . . . . . . . . . . . . . . . . . . . . 47,040 47,568 133,716 132,679
Operating and administrative expenses. . . . . . . . . . . 37,765 38,830 110,696 111,880
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Operating income. . . . . . . . . . . . . . . . . . . . 9,275 8,738 23,020 20,799
Interest expense, net. . . . . . . . . . . . . . . . . . . 4,591 3,678 13,635 11,666
Debt refinancing costs . . . . . . . . . . . . . . . . . . 340 311 1,123 1,884
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Income before income taxes. . . . . . . . . . . . . . . 4,344 4,749 8,262 7,249
Income tax expense . . . . . . . . . . . . . . . . . . . . 2,068 2,183 3,635 3,332
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Net income. . . . . . . . . . . . . . . . . . . . . . . $ 2,276 $ 2,566 $ 4,627 $ 3,917
--------- --------- ---------- ----------
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</TABLE>
See Notes to Condensed Consolidated Financial Statements.
4
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
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1997 1998
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<S> <C> <C>
CASH PROVIDED BY OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,627 $ 3,917
Adjustments to reconcile net income to
net cash provided by operating activities:
LIFO expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,535 5,481
Amortization of goodwill. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,552 1,561
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . 4,172 4,686
Amortization of debt refinancing fees . . . . . . . . . . . . . . . . . . . . . . 1,123 1,884
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227 (245)
Other adjustments for non-cash and non-operating activities . . . . . . . . . . . 350 261
Changes in operating assets and liabilities, net of acquisitions. . . . . . . . . 15,159 3,241
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Net cash provided by operating activities. . . . . . . . . . . . . . . . . . . . . . 30,745 20,786
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INVESTING ACTIVITIES:
Net assets of acquired businesses . . . . . . . . . . . . . . . . . . . . . . . . (21,361) --
Additions to property and equipment . . . . . . . . . . . . . . . . . . . . . . . (8,547) (3,932)
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Net cash used in investing activities. . . . . . . . . . . . . . . . . . . . . . . . (29,908) (3,932)
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FINANCING ACTIVITIES:
Net payments under revolving credit agreement . . . . . . . . . . . . . . . . . . (15,347) (88,530)
Net proceeds from securitization of trade accounts receivable (see Note 6). . . . -- 72,000
Debt refinancing fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (1,541)
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Net cash used in financing activities. . . . . . . . . . . . . . . . . . . . . . . . (15,347) (18,071)
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Effects of changes in foreign exchange rates . . . . . . . . . . . . . . . . . . . . (164) (1,176)
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Decrease in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (14,674) (2,393)
Cash, beginning of period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,769 15,281
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CASH, END OF PERIOD. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 11,095 $ 12,888
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SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments during the period for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15,645 $ 13,588
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,779 2,019
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of September 30, 1998, the
condensed consolidated statements of income for the three-month and nine-month
periods ended September 30, 1997 and 1998, and the condensed consolidated
statements of cash flows for the nine-month periods ended September 30, 1997 and
1998, have been prepared by Core-Mark International, Inc. (the "Company"). In
the opinion of management, all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of the Company
at September 30, 1998 (subject to year-end adjustments) with respect to the
interim financial statements, and of the results of its operations and cash
flows for the interim periods then ended, have been included. The results of
operations for the interim periods are not necessarily indicative of the
operating results for the full year.
The condensed consolidated balance sheet as of December 31, 1997, is
derived from the audited financial statements but does not include all fiscal
year-end disclosures required by generally accepted accounting principles. The
notes accompanying the consolidated financial statements of the Company included
in the Company's Annual Report on Form 10-K for the year ended December 31, 1997
("1997 Form 10-K") include a description of the Company's significant accounting
policies and additional information pertinent to an understanding of both the
December 31, 1997 balance sheet and the interim financial statements included
herein.
2. INVENTORIES
The condensed consolidated financial statements have been prepared using
the LIFO method of accounting for inventories. The use of the LIFO method
resulted in an increase in cost of goods sold and a corresponding decrease in
inventories of $2.5 million and $1.4 million for the three months ended
September 30, 1997 and 1998, respectively, and $3.5 million and $5.5 million for
the nine months ended September 30, 1997 and 1998, respectively. Interim LIFO
calculations are based on management's estimates of year-end inventory levels
and inflation rates for the year.
3. EXCISE TAXES
State and provincial excise taxes paid by the Company on cigarettes were
$136.5 million and $123.4 million for the three months ended September 30, 1997
and 1998, respectively, and $379.9 million and $352.0 million for the nine
months ended September 30, 1997 and 1998, respectively. These amounts are
included in net sales and cost of goods sold for the periods indicated.
4. ACQUISITION OF THE SOSNICK COMPANIES
On February 3, 1997, the Company consummated a transaction, pursuant to a
Purchase Agreement dated January 31, 1997, to acquire certain assets and the
business of two related companies, Melvin Sosnick Company and Capital Cigar
Company (collectively "Sosnick" or the "Sosnick Companies"), a wholesale
distributor to the convenience retail market in northern California and northern
Nevada. Sosnick operated in the same geographic marketplace as the Company and
provided similar products and services.
The Company's net sales for the nine-month period ended September 30, 1997
would have been $1,805 million if the acquisition had occurred as of January 1,
1997. The Company's net sales for the three-month period ended September 30,
1997 includes Sosnick sales for the entire period. The impact of the acquisition
on net income would not have been material for the nine-month period ended
September 30, 1997.
6
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5. NEW ACCOUNTING PRONOUNCEMENT
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement
requires that all items recognized under accounting standards as components of
comprehensive earnings be reported in an annual financial statement that is
displayed with the same prominence as other annual financial statements. This
Statement also requires that an entity classify items of other comprehensive
earnings by their nature in an annual financial statement. Other comprehensive
loss represents foreign currency translation adjustments made during the
respective periods. Comprehensive income will be presented in the Company's
annual financial statements and prior periods will be reclassified, as required.
The Company's total comprehensive income was as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
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1997 1998 1997 1998
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<S> <C> <C> <C> <C>
Net income. . . . . . . . . . . $2,276 $2,566 $4,627 $3,917
Other comprehensive loss. . . . (297) (866) (627) (1,176)
---------- ---------- ---------- ----------
Total comprehensive income. . . $1,979 $1,700 $4,000 $2,741
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</TABLE>
6. ASSET SECURITIZATION
On April 1, 1998, the Company entered into a transaction to securitize its
U.S. trade accounts receivable portfolio ("Accounts Receivable Facility"). In
connection with this transaction, the Company formed a wholly-owned special
purpose, bankruptcy-remote subsidiary (the "Special Purpose Company" or "SPC"),
to which the U.S. trade accounts receivable originated by the Company are sold
or contributed, without recourse, pursuant to a receivables sale agreement. The
receivables have been assigned, with a call option by the SPC, to a trust formed
pursuant to a pooling agreement. On April 1, 1998, the SPC issued two classes of
term certificates with an aggregate principal value of $55 million, and variable
certificates of up to $30 million representing fractional undivided interests in
the receivables and the proceeds thereof.
On a daily basis, collections related to sold receivables are administered
by the Company acting as servicer, pursuant to a servicing agreement. Pursuant
to supplements to the pooling agreement, certificate holders' accrued interest
expense and other securitization expenses are reserved out of daily collections,
before such remaining collections are returned to the Company by the SPC to pay
for the SPC's purchase of newly originated receivables from the Company. The
revolving period of the securitization expires in January 2003, or earlier if an
early amortization event, as defined in the pooling agreement, occurs. The
interest rate on the fixed term certificates is 0.28% (Class A) and 0.65% (Class
B) above the Eurodollar Rate which was 5.38% as of September 30, 1998. The
interest rate on the variable certificates is 0.50% above the commercial paper
rate (as defined in the securitization agreement), which was 5.25% as of
September 30, 1998.
In connection with the securitization of accounts receivable, the Company
amended its Revolving Credit Facility. The amendment reduced the available
credit facility from $175 million to $120 million, reduced its interest rates
from 1.5% to 1.0% above the Prime Rate, and from 2.5% to 2.0% above the
Eurodollar Rate, as defined in the amendment, and extended the maturity through
April, 2003. As a result of this modification, the Company wrote off $0.9
million of unamortized refinancing costs relating to the Revolving Credit
Facility in the second quarter of 1998.
The net result of the (i) securitization of the Company's U.S. trade
accounts receivable portfolio and (ii) the modification of the Revolving Credit
Facility was to lower the Company's cost of borrowings, and to increase its
variable-rate borrowing capacity from $175 million to $205 million. The Company
incurred approximately $1.6 million for legal, professional and other costs
related to the transactions described above. These costs were capitalized and
classified as other assets and are being amortized over the term of these
transactions.
7
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with Management's
Discussion and Analysis included in the Company's 1997 Form 10-K.
GENERAL
The Company is one of the largest broad-line, full-service wholesale
distributors of packaged consumer products to the convenience retail industry in
western North America. The products distributed by the Company include
cigarettes, food products such as candy, fast food, snacks, groceries and
non-alcoholic beverages, and non-food products such as film, batteries and other
sundries, health and beauty care products and tobacco products other than
cigarettes. In the nine-month period ended September 30, 1998, approximately
67%, 23% and 10% of the Company's net sales were derived from cigarettes, food
products and non-food products, respectively.
TOBACCO INDUSTRY BUSINESS ENVIRONMENT
Manufacturers and distributors of cigarettes and other tobacco products in
the United States are currently facing a number of significant issues that
affect the business environment in which they operate including proposed
additional governmental regulation (see Part II, Item 1. "Legal Proceedings -
Regulatory Matters"); actual and proposed excise tax increases (see "Impact of
Tobacco Taxes"); increased litigation involving health and other effects of
cigarette smoking and other uses of tobacco (see Part II, Item 1. "Legal
Proceedings - Legal Matters"); and proposed legislative action to resolve
certain regulatory and litigation issues affecting the U.S. tobacco industry
described below.
In June 1997, a so called "national settlement" of many of these issues was
proposed (referred to herein as the "Proposed Settlement") following
negotiations among major U.S. tobacco manufacturers, state attorneys general,
representatives of the public health community and attorneys representing
plaintiffs in certain smoking and health litigation. The Proposed Settlement can
be implemented only by federal legislation. In April 1998, the Senate Commerce
Committee overwhelmingly approved a Bill sponsored by Senator McCain (the
"McCain Bill"), which would have replaced the Proposed Settlement. The McCain
Bill would have substantially changed the Proposed Settlement by, among other
things, enacting substantial increases to federal excise taxes on tobacco
products without affording the tobacco manufacturers and other industry
participants protection from private litigation, which is a significant aspect
of the Proposed Settlement. In June 1998, the bill sponsored by Senator McCain
failed to pass the Senate.
The major U.S. cigarette manufacturers disclosed in a report dated October
8, 1997 to a U.S. Senate task force that, if the Proposed Settlement were
enacted in its then current form, among other things, prices of cigarettes would
increase significantly and cigarette consumption would decline, although it is
not possible to forecast, with any degree of confidence, the magnitude of the
decline in consumption. Although the Company cannot predict whether federal
legislation reflecting the Proposed Settlement will be enacted or if other
legislation, similar to the McCain Bill, would be enacted, the Company believes
that any form of federal legislation will cause significant increases in the
prices of cigarettes. In addition, although no new federal legislation has been
enacted or any type of national settlement agreed to, the U.S. cigarette
manufacturers have continued to settle lawsuits individually, and have been
raising the wholesale prices of cigarettes to fund the cost of such
settlements. Finally, press reports have indicated that several of the major
tobacco companies are engaged in settlement discussions with the attorneys
general of various states regarding the lawsuits brought on behalf of these
states that seek reimbursement of costs incurred in treating Medicare and
other patients suffering from illnesses allegedly caused by cigarette and
tobacco smoking. Settlement of these lawsuits could involve payment of
substantial amounts by the tobacco companies which they likely would seek to
recover through significant increases in wholesale cigarette prices.
The Company believes that significant increases in the prices of
cigarettes would negatively affect the Company's business of distributing
tobacco products by decreasing the volume of sales of tobacco products and as
a result of the impact of increases in cigarette prices on its working
capital (see "Liquidity and Capital Resources"). The Company does not believe
it is able to quantify the impact that the Proposed Settlement or other
future legislation or governmental regulation affecting cigarettes and other
tobacco products will have on future sales of cigarettes and other tobacco
products. However, based upon various industry estimates of wholesale price
increases which would result from different settlement scenarios, the
Company's debt levels and interest expense would significantly increase.
Depending upon the ultimate level of actual wholesale price increases, or if
the terms or amount of state and provincial excise taxes were adversely
changed, or if the volume of cigarettes sold by the
8
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Company significantly declined as a result of higher prices, or taxes, or
both, the Company may be required to seek additional financing in order to
meet such higher working capital requirements.
The Company's business strategy has included and continues to include
increasing sales of higher margin, non-tobacco products, a strategy which is
intended to lessen the impact of potential future declines in unit sales and
profitability of its tobacco distribution business.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
NET SALES. Net sales for the three months ended September 30, 1998 were
$657.9 million, an increase of $10.7 million or 1.7% from the comparable period
in 1997.
Net sales of cigarettes for the three months ended September 30, 1998
were $437.1 million, an increase of $7.0 million or 1.6% from the comparable
period in 1997. The Company's total cigarette unit sales for the three months
ended September 30, 1998 were 23.1 million cartons, a decrease of 1.6 million
cartons or 6.5% from the comparable period in 1997. The increase in net sales
of cigarettes was principally due to increases in manufacturers' list prices
that were passed along to the Company's customers. The decrease in carton
sales occurred primarily in California, and was principally due to increased
price competition. The California market, which is generally the most price
competitive market in which the Company operates, has been significantly
affected by sales of cigarettes originally intended for export, but which are
reintroduced into the domestic market (known in the industry as "grey market"
cigarettes). Although "grey market" cigarettes are produced by the major
tobacco companies, because the product is intended for export only,
traditional wholesalers, like the Company, are prohibited from acquiring and
selling these products by the manufacturers who produce them. These "grey
market" cigarettes sell for substantially less than cigarettes intended for
domestic sale, and the Company has lost volume because of these products. On
August 12, 1998, the California Legislature passed a law prohibiting the sale
and distribution of these export cigarettes. However, the Company is unable
to predict what effect this new legislation will have on the sale of "grey
market" cigarettes in the state of California.
Net sales of food and non-food products for the three months ended
September 30, 1998 were $220.8 million, an increase of $3.7 million or 1.7% from
the comparable period in 1997. The increase occurred primarily in grocery sales,
which increased $5.9 million or 33.5%, retail beverage sales, which increased
$3.8 million or 16.0%, and fast food sales, which increased $2.0 million or
7.8%. The increases were partially offset by decreases in confection sales of
$8.7 million, or 12.8%, which resulted from the loss of one customer whose
purchases were heavily oriented towards confection products, and decreases in
other tobacco sales of $2.4 million or 6.2%.
GROSS PROFIT. Gross profit for the three months ended September 30,
1998 was $47.6 million, an increase of $0.5 million from the comparable
period in 1997. The increase was primarily due to sales increases in both the
cigarette and the food and non-food categories. The gross profit margin for
the three months ended September 30, 1998 decreased slightly, to 7.23% of net
sales, as compared to 7.27% of net sales for the comparable period in 1997.
The decrease in overall gross profit margin was primarily due to the fact
that, while both cigarette gross profit margin, as well as gross profit per
carton, increased during the third quarter of 1998, as compared to the
comparable 1997 period, gross profit margins on net sales of food and
non-food products declined slightly. For the three months ended September 30,
1998, the Company recognized LIFO expense of $1.4 million, compared to $2.5
million in the comparable period in 1997. The decrease in LIFO expense for
the three months ended September 30, 1998, was primarily due to smaller
cigarette price increases as compared to the same period for 1997.
OPERATING AND ADMINISTRATIVE EXPENSES. Operating and administrative
expenses for the three months ended September 30, 1998 were $38.8 million, an
increase of $1.1 million or 2.8% from the comparable period in 1997. Operating
expenses increased to 5.9% of net sales for the three months ended September 30,
1998 as compared to 5.8% for the comparable period in 1997.
OPERATING INCOME. As a result of the foregoing factors, operating income
for the three months ended September 30, 1998 was $8.7 million, a decrease of
$0.5 million or 5.8% compared to the comparable period in 1997. As a percentage
of net sales, operating income for the three months ended September 30, 1998 was
1.3%, as compared to 1.4% for the comparable period in 1997.
9
<PAGE>
NET INTEREST EXPENSE. Net interest expense for the three months ended
September 30, 1998 was $3.7 million, a decrease of $0.9 million or 19.9% from
the comparable period in 1997. The net decrease resulted from a decrease in the
Company's borrowing rates as a result of the asset securitization and a decrease
in average debt levels.
DEBT REFINANCING COSTS. Debt refinancing costs were $0.3 million for the
three months ended September 30, 1998 and September 30, 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
NET SALES. Net sales for the nine months ended September 30, 1998 were
$1,830.2 million, an increase of $40.2 million or 2.2% over the comparable
period in 1997. Net sales of cigarettes and food and non-food products both
increased in 1998 compared to 1997.
Net sales of cigarettes for the nine months ended September 30, 1998 were
$1,220.3 million, an increase of $26.1 million or 2.2% over the comparable
period in 1997. The increase in net sales of cigarettes was principally due to
increases in manufacturers' list prices that were passed along to the Company's
customers. The Company's total cigarette unit sales for the nine months ended
September 30, 1998 were 66.0 million cartons, a decrease of 3.4 million cartons,
or 4.9% from the comparable period in 1997. Substantially all of this decline
occurred in the second and third quarters, and was principally due to increased
price competition in California, primarily the result of the "grey market"
activity as explained above in connection with the three months ended
September 30, 1998.
Net sales of food and non-food products for the nine months ended
September 30, 1998 were $609.9 million, an increase of $14.1 million or 2.4%
over the comparable period in 1997. The increase occurred primarily in fast
food sales, which increased $7.8 million or 11.5%, grocery sales, which
increased $7.1 million or 14.1%, and snack sales, which increased $5.3
million or 12.9%. These increases were partially offset by decreases in
confection sales of $12.2 million or 6.4%, which resulted from the loss of
one customer whose purchases were heavily oriented towards confection
products, and other tobacco product sales of $2.5 million or 2.3%.
GROSS PROFIT. Gross profit for the nine months ended September 30, 1998
was $132.7 million, a decrease of $1.0 million from the comparable period in
1997. The gross profit margin for the nine months ended September 30, 1998
decreased to 7.25% of net sales as compared to 7.47% of net sales for the
comparable period in 1997. The decrease in gross profit margin was primarily
due to the fact that, while the dollar amount of cigarette gross profit per
unit increased during this period, the Company's overall cigarette prices per
unit increased at a faster rate, due to significant increases in
manufacturers' list prices. Gross profit margins earned on net sales of food
and non-food products declined slightly. For the nine months ended September
30, 1998, the Company recognized LIFO expense of $5.5 million compared to
$3.5 million for the comparable period in 1997. The increase in LIFO expense
was due to inflation in the cigarette category, and was offset by gains
resulting from increases in manufacturers' list prices.
OPERATING AND ADMINISTRATIVE EXPENSES. Operating and administrative
expenses for the nine months ended September 30, 1998 were $111.9 million, an
increase of $1.2 million or 1.1% over the comparable period in 1997. However,
such expenses for the nine months ended September 30, 1998 decreased to 6.1% of
net sales as compared to 6.2% for the comparable period in 1997. The higher
expenses as a percent of net sales in the 1997 period reflect approximately $2.4
million (0.1% of 1997 net sales) of one-time duplicative facility costs as a
result of the Sosnick acquisition.
OPERATING INCOME. As a result of the foregoing factors, operating income
for the nine months ended September 30, 1998 was $20.8 million, a decrease of
$2.2 million or 9.7% compared to the comparable period in 1997. As a percentage
of net sales, operating income for the nine months ended September 30, 1998 was
1.1%, as compared to 1.3% for the comparable period in 1997.
NET INTEREST EXPENSE. Net interest expense for the nine months ended
September 30, 1998 was $11.7 million, a decrease of $2.0 million or 14.4% from
the comparable period in 1997. The net decrease resulted primarily from a
decrease in the Company's borrowing rates as a result of the asset
securitization and a decrease in average debt levels.
DEBT REFINANCING COSTS. Debt refinancing costs for the nine months ended
September 30, 1998 were $1.9 million, an increase of $0.8 million or 67.8% over
the comparable period in 1997. This increase resulted primarily from a one-time
write off of unamortized costs relating to the modification of the Revolving
Credit Facility (see Note 6 - Asset Securitization).
10
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements arise primarily from the funding of
its working capital needs, capital expenditure programs and debt service
requirements with respect to its credit facilities. The Company has no mandatory
reductions of principal on its Revolving Credit Facility, its Accounts
Receivable Facility or its $75 million Senior Subordinated Notes prior to their
final maturities in 2003. The Company historically has financed its operations
through internally generated funds and borrowings under its credit facilities.
Significant increases in the cost of cigarettes would occur if legislation
were approved to enact the Proposed Settlement, or if future legislation similar
to the McCain Bill were enacted. Based upon various industry estimates of
wholesale price increases which would result from different settlement
scenarios, the Company's required working capital would increase significantly.
Depending upon the ultimate level of actual wholesale price increases, or if the
terms or amount of state and provincial excise taxes were adversely changed, or
if the volume of cigarettes sold by the Company significantly declined as a
result of higher prices or taxes, or both, the Company could be required to seek
additional financing in order to meet such higher working capital requirements.
Any significant increase in debt would also increase the Company's interest
expense.
The Company's debt obligations totaled $180.5 million at September 30,
1998, a decrease of $16.5 million from $197.0 million at December 31, 1997. The
net decrease in outstanding debt is primarily due to decreased borrowings needed
to finance working capital funding requirements. Debt requirements are
generally the highest at December 31, when the Company historically carries
higher inventory.
The Company's principal sources of liquidity are net cash provided by
operating activities and its credit facilities. At year end, the Company
typically carries higher inventories which are then liquidated in future
periods. Therefore, net cash provided by operating activities is typically lower
at the end of any fiscal year compared to interim periods. However, at
September 30, 1998, the Company's inventory levels were higher than the same
period last year due to higher cigarette inventories, resulting in a decrease
in cash provided by operating activities for the nine months ended September 30,
1998, as compared to the same period in 1997.
The Company made capital expenditures of $4.0 million for the nine
months ended September 30, 1998. For the remainder of 1998, the Company
estimates it will spend approximately $2 to $3 million for capital requirements,
principally consisting of warehouse facilities and other equipment. These
expenditures are expected to be funded out of net cash provided by operating
activities and the Company's credit facilities.
On April 1, 1998, the Company entered into a transaction to securitize its
U.S. trade accounts receivable portfolio ("Accounts Receivable Facility"). In
connection with this transaction, the Company formed a wholly-owned special
purpose, bankruptcy-remote subsidiary (the "Special Purpose Company" or "SPC"),
to which the U.S. trade accounts receivable originated by the Company are sold
or contributed, without recourse, pursuant to a receivables sale agreement. The
receivables have been assigned, with a call option by the SPC, to a trust formed
pursuant to a pooling agreement; the SPC issued two classes of term certificates
with an aggregate principal value of $55 million, and variable certificates of
up to $30 million representing fractional undivided interests in the receivables
and the proceeds thereof. The revolving period of the securitization expires in
January 2003, or earlier if an early amortization event, as defined in the
pooling agreement, occurs. The interest rate on the fixed term certificates is
0.28% (Class A) and 0.65% (Class B) above the Eurodollar Rate, which was 5.38%
as of September 30, 1998. The interest rate on the variable certificates is
0.50% above the commercial paper rate (as defined in the securitization
agreement), which was 5.25% as of September 30, 1998.
In connection with the securitization of accounts receivable, the Company
amended its Revolving Credit Facility. The amendment reduced the available
credit facility from $175 million to $120 million, reduced its interest rates
from 1.5% to 1.0% above the Prime Rate, and from 2.5% to 2.0% above the
Eurodollar Rate, as defined in the amendment, and extended the maturity through
April 2003. As a result of this modification, the Company wrote off $0.9 million
of unamortized refinancing costs relating to the Revolving Credit Facility in
the second quarter of 1998. Effective October 1, 1998, the Company's interest
rates on the Revolving Credit Facility were further reduced from 1.0% to 0.75%
above the Prime Rate, and from 2.0% to 1.75% above the Eurodollar rate, as
defined in the amendment.
The net result of the (i) securitization of the Company's U.S. trade
accounts receivable portfolio and (ii) the modification of the Revolving Credit
Facility was to lower the Company's cost of borrowings, and to increase its
variable-rate borrowing capacity from $175 million to $205 million.
11
<PAGE>
IMPACT OF YEAR 2000 COMPLIANCE ISSUES
The Company is reliant upon various information technology and
non-information technology systems that the Company is currently in the process
of assessing and modifying or converting to be year 2000 compliant. Year 2000
compliance indicates that computer software, hardware and embedded processors
are able to correctly process the year 2000 date parameter. The systems being
assessed for year 2000 compliance include the Company's computer programs,
certain building infrastructure components (including, elevators, alarm systems
and certain HVAC systems), certain data collection and transmission devices and
the systems of customers, vendors and other constituents with whom the Company
has material relationships that could have an impact on the Company's
operations. Non-compliance could result in a disruption of the business, which
could have a material impact on the Company's results of operations, financial
position and/or cash flows.
The most reasonable and likely result of non-compliance would be the
Company's inability to utilize its computer systems to process daily
transactions, which could result in increased operating costs and delayed
shipments to customers, and as a result, the possible monetary losses from
cancelled future business and lawsuits for breach of contract with these
customers. The Company is currently in the process of developing contingency
plans for various business disruptions, which will include procedures to
mitigate the effect of year 2000 non-compliance issues. The contingency plans
will include procedures for manual processing of daily transactions in the event
of an inability to use the Company's computer systems, as well as procedures for
transmitting and receiving data from third parties with non-compliant systems.
The assessment phase of the Company's systems is complete as of September
30, 1998. The Company has completed modification or conversion and testing of
approximately 80% of the Company's systems as of September 30, 1998. The Company
presently believes that the modification or conversion of existing systems will
be completed in the first quarter of 1999.
The Company has initiated formal communications with customers, vendors and
other constituents with whom the Company has material relationships, to
determine the extent to which the Company is vulnerable to those third parties'
failure to become year 2000 compliant. The Company presently believes that the
third party assessment process will be completed by March 31, 1999 and is
approximately 30% complete as of September 30, 1998. However, there can be no
assurance that the systems of other companies will be modified or converted on
time, which could have an adverse effect on the Company's operations.
The Company has utilized and will continue to utilize internal resources to
modify or convert and test for year 2000 compliance. The estimated total cost
for the assessment, modification or converting and testing of the Company's
systems is approximately $1.1 million. These costs represent approximately 42%
of the total fiscal 1998 information technology budget and are comprised of $0.1
million for assessment and $1.0 million for software modification or conversion.
As a result of the year 2000 compliance effort, the Company believes that no
information technology projects have been deferred that will have a material
impact on the Company's operations. All of the costs related to year 2000
compliance have been expensed as incurred, and have been and are expected to be
funded through operating cash flows. The Company has incurred approximately
$0.95 million of costs as of September 30, 1998 which were comprised of $0.1
million for assessment and $0.85 million for software modification or
conversion.
The costs associated with year 2000 compliance are based on management's
estimates, which were derived using numerous assumptions of future events,
including the cost and continued availability of certain resources, and other
factors. However, there can be no assurance that these estimates will be
achieved and actual results could differ materially from those anticipated.
IMPACT OF TOBACCO TAXES
State and Canadian provincial tobacco taxes represent a significant
portion of the Company's net sales and cost of goods sold attributable to
cigarettes and other tobacco products. In general, such taxes have been
increasing, and several states and Canadian provinces are currently weighing
proposals for higher excise taxes on cigarettes and other tobacco products.
In November 1998, Proposition 10 was passed in the California general
election. This proposition, which is effective January 1, 1999, will increase
California state excise taxes on cigarettes by $5.00 per carton, as well as
increase taxes on cigars and other tobacco products.
12
<PAGE>
Under current law, almost all state and Canadian provincial taxes are
payable by the Company under credit terms which, on the average, exceed the
credit terms the Company has approved for its customers to pay for products
which include such taxes. This practice has benefited the Company's cash flow.
If the Company were required to pay such taxes at the time such obligation was
incurred without the benefit of credit terms, the Company would incur a
substantial permanent increase in its working capital requirements and might be
required to seek additional financing in order to meet such higher working
capital requirements. Consistent with industry practices, the Company has
secured a bond to guarantee its tax obligations to those states requiring such a
surety (a majority of states in the Company's operating areas).
The U.S. federal excise tax on cigarettes is currently $2.40 per carton of
cigarettes. In August 1997, legislation was enacted that will raise the federal
excise tax by $1.00 per carton of cigarettes starting in the year 2000 and by an
additional $.50 per carton of cigarettes in 2002. Unlike the state and
provincial taxes described above, U.S. federal excise taxes on cigarettes are
paid by the cigarette manufacturers and passed through to the Company as a
component of the cost of cigarettes. Such increases in U.S. federal taxes
increase the Company's working capital requirements by increasing the balances
of its inventories and accounts receivable. The President as well as various
members of Congress have suggested additional excise taxes on cigarette and
tobacco products, either as part of the Proposed Settlement discussed above or
to finance unrelated federal spending. Depending upon the ultimate level of any
increase in federal excise taxes, the Company may be required to seek additional
financing in order to meet its higher working capital requirements.
NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about
Segments of an Enterprise and Related Information." SFAS 131 changes the way
companies report segment information and requires segments to be determined and
reported based on how management measures performance and makes decisions about
allocating resources. SFAS 131 is effective for financial statements issued for
periods beginning after December 15, 1997, and will first be reflected in the
Company's financial statements for the year ended December 31, 1998.
In 1998, the FASB issued Statement of Financial Accounting Standards No.
132, "Employers' Disclosures about Pensions and Other Postretirement Benefits."
This Statement revises employers' disclosures about pension and other
postretirement benefit plans. It does not change the measurement or recognition
of those plans. This Statement standardizes the disclosure requirements for
pensions and other postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis, and eliminates certain
disclosures. Restatement of disclosures for earlier periods is required. This
Statement is effective for the Company's financial statements for the year ended
December 31, 1998.
In 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which standardizes the accounting for
derivatives, requiring recognition as either assets or liabilities on the
balance sheet and measurement at fair value. The Company plans to adopt this
statement for fiscal 1999. The Company has not yet determined the effect
adoption of this statement will have on the Company's consolidated financial
position, results of operations or cash flows.
In 1998, the American Institute of Certified Public Accountants issued
Statement of Opinion ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This SOP provides guidance on
accounting for the costs of computer software developed or obtained for internal
use. This SOP requires that entities capitalize certain internal-use software
costs once certain criteria are met. Currently, the Company generally expenses
the costs of developing or obtaining internal-use software as incurred. The
Company is currently evaluating SOP 98-1, but does not expect it to have a
material impact on its consolidated financial statements. This SOP is effective
for the Company's financial statements for the year ended December 31, 1999.
Earlier application is encouraged in fiscal years for which annual financial
statements have not been issued.
13
<PAGE>
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
REGULATORY MATTERS
The tobacco industry is currently subject to significant regulatory
restrictions, such as the requirement that product packages display warning
labels, a prohibition on television and radio advertising and the establishment
of a federal minimum age of 18 for the sale of tobacco products with proof of
age for anyone under the age of 27. The status of U.S. Food and Drug
Administration (the "FDA") regulation is described in more detail in the
Company's 1997 Annual Report on Form 10-K. While neither the FDA regulations nor
the pending legislation would impose restrictions on the sale of cigarettes and
smokeless tobacco products to adults, there can be no assurance such
restrictions will not be proposed in the future or that any such proposed
legislation or regulations would not result in a material reduction of the
consumption of tobacco products in the United States or would not have a
material adverse effect on the Company's business and financial position.
Over the past decade, various state and local governments have imposed or
are considering future significant regulatory restrictions on tobacco products
which are more fully described in the Company's 1997 Annual Report on Form 10-K.
The Company is unable to assess the future effects that these various proposals
may have on the sale of the Company's products.
The Company is subject to various federal, state and local environmental,
health and safety laws and regulations. Generally, these laws impose limitations
on the discharge of pollutants and the presence of hazardous substances in the
workplace and establish standards for vehicle and employee safety and for the
handling of solid and hazardous wastes. These laws include the Resource
Conservation and Recovery Act, the Comprehensive Environmental Response,
Compensation and Liability Act, the Clean Air Act, the Hazardous Materials
Transportation Act and the Occupational Safety and Health Act. Future
developments, such as stricter environmental or employee health and safety laws
and regulations thereunder, could affect the Company's operations. The Company
does not currently anticipate that the cost of its compliance with or of any
foreseeable liabilities under environmental and employee health and safety laws
and regulations will have a material adverse affect on its business and
financial condition.
LEGAL MATTERS
As previously reported, in May 1996, the Court of Appeals for the Fifth
Circuit decertified a federal class action purportedly brought on behalf of all
cigarette smokers in the United States. Following the decertification, lawyers
for the class brought state class action lawsuits in a number of states, with
the objective of filing such lawsuits in all fifty states, the District of
Columbia and Puerto Rico. Several of these state lawsuits name cigarette
distributors as defendants.
As previously reported, in October 1996, a subsidiary of the Company was
named as a defendant in a class action lawsuit filed in state court in New
Mexico. The other defendants include the principal U.S. tobacco manufacturers as
well as other distributors. The case is brought on behalf of a putative class of
smokers who reside in New Mexico, each of whom is allegedly nicotine dependent.
The suit seeks, on behalf of the class, compensatory damages, punitive damages
and equitable relief, including medical monitoring of the class members.
As previously reported, in January 1998, the Company was served with a
summons and First Amended Complaint in an action brought by Operating Engineers
Local 12 Health and Welfare Trust (on behalf of itself and all others similarly
situated), in the United States District Court for the Central District of
California, against the principal tobacco manufacturers, the Company and other
distributors and retailers of tobacco products. The complaint seeks, inter alia,
compensatory and punitive damages, restitution for monies expended by the Trust
for health care of its members who have used tobacco products, and forms of
injunctive relief.
14
<PAGE>
From April 1998 through October 1998, the Company was named as a defendant
in 23 similar actions brought by various union health and welfare trusts, filed
in state courts of several counties in Northern California against major tobacco
manufacturers as well as other distributors. The complaints seek, inter alia,
compensatory and punitive damages, restitution for monies expended by the trusts
for health care of its members who have used tobacco products, and forms of
injunctive relief.
As previously reported, in May 1998, a division of the Company was named a
defendant and served in an individual tobacco litigation complaint filed in a
state court in Broward County, Florida. The other defendants include the
principal U.S. tobacco manufacturers as well as other distributors/retailers.
The case is brought on behalf of two individuals, residents of Florida, who have
purchased cigarette products distributed by the Company, and alleges, among
other things, the plaintiffs have suffered personal injuries and economic losses
from the use of such cigarettes. The suit seeks, on behalf of the plaintiffs,
compensatory damages and punitive damages.
The Company does not believe that these actions will have a material
adverse effect on the Company's financial condition. The Company has been
indemnified with respect to certain claims alleged in each of the above actions.
In addition, the Company is a party to other lawsuits incurred in the
ordinary course of its business. The Company believes it is adequately insured
with respect to such lawsuits or that such lawsuits will not result in losses
material to its consolidated financial position or results of operations.
ITEM 2: CHANGES IN SECURITIES
Not applicable
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5: OTHER INFORMATION
Not applicable
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
During the third quarter of 1998, the Company filed no reports on
Form 8-K.
15
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of South San Francisco,
California, on November 13, 1998.
CORE-MARK INTERNATIONAL, INC.
By:
----------------------------------------
Leo F. Korman, Senior Vice President and
Chief Financial Officer
16
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