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 March 31, 1999
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
============
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
============
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
At April 30, 1999, 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, 1998
and March 31, 1999........................... ..................... 3
Condensed Consolidated Statements of Income for the three
months ended March 31, 1998 and 1999............. ................. 4
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 1998 and 1999.......................... 5
Notes to Condensed Consolidated Financial Statements................ 6
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations............... ....................................... 8
Item 3: Quantitative and Qualitative Disclosures About Market
Risk................................................................ 12
PART II - OTHER INFORMATION
Item 1: Legal Proceedings.................................................. 13
Item 2: Changes in Securities and Use of Proceeds.......................... 14
Item 3: Defaults Upon Senior Securities.................................... 14
Item 4: Submission of Matters to a Vote of Security Holders................ 14
Item 5: Other Information.................................................. 14
Item 6: Exhibits and Reports on Form 8-K.................................... 14
Signature .............................................................. 15
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(In Thousands of Dollars)
<TABLE>
<CAPTION>
December 31, March 31,
1998 1999
--------- ---------
Assets (Unaudited)
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Current assets:
Cash .................................................................. $ 24,586 $ 18,843
Receivables:
Trade accounts, less allowance for doubtful accounts of $2,761 and
$2,670, respectively ......................................... 103,412 100,082
Other ............................................................. 12,578 8,161
Inventories, net of LIFO allowance of $34,332 and $34,432, respectively 112,481 82,046
Prepaid expenses and other ............................................ 6,576 5,864
--------- ---------
Total current assets .............................................. 259,633 214,996
Property and equipment ..................................................... 61,332 61,375
Less accumulated depreciation ......................................... (33,283) (33,857)
--------- ---------
Net property and equipment ............................................ 28,049 27,518
Other assets ............................................................... 7,227 6,747
Goodwill, net of accumulated amortization of $19,375 and $19,896,
respectively .......................................................... 64,481 63,960
--------- ---------
$ 359,390 $ 313,221
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Trade accounts payable ................................................ $ 48,867 $ 49,814
Cigarette and tobacco taxes payable ................................... 45,073 53,515
Income taxes payable .................................................. 2,698 3,984
Deferred income taxes ................................................. 6,992 6,941
Other accrued liabilities ............................................. 34,514 30,880
--------- ---------
Total current liabilities ......................................... 138,144 145,134
Long-term debt ............................................................. 208,124 151,999
Other accrued liabilities and deferred income taxes ........................ 9,260 9,557
--------- ---------
Total liabilities ..................................................... 355,528 306,690
Commitments and contingencies:
Shareholders' equity:
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 ................................................... (15,077) (12,765)
Accumulated other comprehensive loss:
Foreign currency translation adjustments .......................... (4,225) (3,868)
Minimum pension liability adjustment .............................. (3,012) (3,012)
--------- ---------
Total shareholders' equity ........................................ 3,862 6,531
--------- ---------
$359,390 $313,221
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(In Thousands of Dollars)
(Unaudited)
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<CAPTION>
Three Months
Ended March 31,
------------------------------
1998 1999
----------- -----------
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Net sales ..................................... $ 563,220 $ 629,452
Cost of goods sold ............................ 522,533 583,882
--------- ---------
Gross profit ............................. 40,687 45,570
Operating and administrative expenses ......... 36,037 37,871
--------- ---------
Operating income ......................... 4,650 7,699
Interest expense, net ......................... 4,296 3,395
Amortization of debt refinancing costs ........ 374 318
--------- ---------
Income (loss) before income taxes ....... (20) 3,986
Income tax expense (benefit) .................. (9) 1,674
--------- ---------
Net income (loss) ........................ $ (11) $ 2,312
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
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CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(In Thousands of Dollars)
(Unaudited)
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<CAPTION>
Three Months
Ended March 31,
----------------------------------------
1998 1999
------------- -------------
CASH PROVIDED BY OPERATING ACTIVITIES:
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Net income (loss)...................................................................$ (11) $ 2,312
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
LIFO expense................................................................... 800 100
Amortization of goodwill....................................................... 520 521
Depreciation and amortization.................................................. 1,573 1,550
Amortization of debt refinancing fees.......................................... 374 318
Deferred income taxes.......................................................... 13 317
Other adjustments for non-cash and non-operating activities.................... (125) 53
Changes in operating assets and liabilities ................................... 28,532 45,929
------------- -------------
Net cash provided by operating activities .......................................... 31,676 51,100
------------- -------------
INVESTING ACTIVITIES:
Additions to property and equipment ........................................... (1,402) (971)
------------- -------------
Net cash used in investing activities .............................................. (1,402) (971)
------------- -------------
FINANCING ACTIVITIES:
Net borrowings under accounts receivable securitization ....................... - 3,000
Net payments under revolving credit agreement ................................. (32,194) (59,125)
------------- -------------
Net cash used in financing activities .............................................. (32,194) (56,125)
------------- -------------
Effects of changes in foreign exchange rates........................................ 403 253
------------- -------------
Decrease in cash ................................................................... (1,517) (5,743)
Cash, beginning of period .......................................................... 15,281 24,586
------------- -------------
CASH, END OF PERIOD................................................................. $ 13,764 $ 18,843
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash payments (refunds) during the period for:
Interest ...................................................................... $6,243 $5,534
Income taxes .................................................................. (1,712) 63
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
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Notes to Condensed Consolidated Financial Statements
Three Months Ended March 31, 1999
(Unaudited)
1. Basis of Presentation
The condensed consolidated balance sheet as of March 31, 1999 and the
condensed consolidated statements of income and of cash flows for the
three-month periods ended March 31, 1998 and 1999, 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 March 31, 1999 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, 1998, is
derived from the audited financial statements but does not include all
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, 1998
("1998 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, 1998 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 $800,000 and $100,000 for the three months ended March 31, 1998
and 1999, 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
$112.2 million and $128.8 million for the three months ended March 31, 1998 and
1999, respectively. These amounts are included in net sales and cost of goods
sold for the periods indicated.
4. Comprehensive Income
The Company's total comprehensive income was $463,000 and $2,669,000 for
the three months ended March 31, 1998 and 1999 respectively, which included
other comprehensive income related to foreign currency translation adjustments.
5. Segment Information
Management has determined that the only reportable segment of the Company
is its wholesale distribution segment, based on the level at which executive
management reviews the results of operations in order to make decisions
regarding performance assessment and resource allocation. There has been no
change in the segment reported or the basis of measurement of segment profit or
loss from that which was reported in the Company's 1998 Form 10-K. Wholesale
distribution segment information for the three-month periods ended March 31 is
set forth below (dollars in thousands):
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1998 1999
---- ----
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Net sales from external customers............................. $563,220 $629,452
Segment pre-tax operating income (1).......................... 2,053 4,884
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(1) Represents operating income, including allocated interest
expense, but excluding amortization of goodwill and debt
refinancing costs, and income taxes.
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5. Segment Information (Cont.)
Segment assets as of December 31,1998 and March 31, 1999 are set forth
below (dollars in thousands):
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1998 1999
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Segment Assets .......................................................... $341,583 $302,401
A reconciliation of the segment information reported above to the
consolidated financial statements is as follows (dollars in thousands):
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INCOME (LOSS) BEFORE INCOME TAXES
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1998 1999
---- ----
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Segment information .......................................... $ 2,053 $ 4,884
Less: Goodwill and other unallocated amortization ............ 654 562
Interest expense: unallocated and other............... 1,045 18
Amortization of debt refinancing costs ............... 374 318
------- -------
Consolidated total............................................ $ (20) $ 3,986
======= =======
INTEREST EXPENSE
1998 1999
---- ----
Segment information........................................... $ 3,251 $ 3,377
Add: Unallocated and other.................................... 1,045 18
------- -------
Consolidated total............................................ $ 4,296 $ 3,395
======= =======
ASSETS
1998 1999
---- ----
Segment Information .......................................... $341,583 $302,401
Add: Corporate and other ..................................... 17,807 10,820
------- -------
Consolidated total ........................................... $359,390 $313,221
======= =======
</TABLE>
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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 and the discussion under the heading "Legal Proceeding -
Regulatory and Legislative Matters" included in the Company's 1998 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 quarter ended March 31, 1999, approximately 69%, 21% 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 are
currently facing a number of significant issues that affect the business
environment in which they operate including proposed additional governmental
regulation; actual and proposed excise tax increases (see "Impact of Tobacco
Taxes" below); increased litigation involving health and other effects of
cigarette smoking and other uses of tobacco; and potential litigation by the
U.S. Department of Justice to recover federal Medicare costs allegedly connected
to smoking.
In August 1996, the United States Food and Drug Administration (the "FDA")
determined that it had jurisdiction over cigarettes and smokeless tobacco
products and issued regulations restricting the sale, distribution and
advertising of cigarette and smokeless tobacco products, especially to minors.
The FDA regulations are significant not only because of their substance, but
also because the FDA has determined that it has jurisdiction over cigarettes and
smokeless tobacco as "combination products having both a drug component,
including nicotine, and device components." The regulations regulate such
products as "devices". In April 1997 the U.S. District Court for the Middle
District of North Carolina held that the FDA could impose restrictions on access
and labeling of tobacco products, but did not have authority to restrict the
promotion and advertisement of such products. The court stayed implementation of
the FDA regulations except for those establishing a federal minimum age of 18
for the sale of tobacco products and requiring proof of age for anyone under the
age of 27. On August 14, 1998, however, the United States Court of Appeals for
the Fourth Circuit reversed the decision of the District Court, finding that the
FDA lacked statutory authority to regulate tobacco products altogether. The
FDA's petitions for rehearing and rehearing en banc by the Fourth Circuit were
denied, but, on April 26, 1999 the Supreme Court granted certiorari to review
the decision of the Court of Appeals. A date for arguments on the case has not
yet been set.
In June 1997, a so called "national settlement" of many of these issues was
proposed 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 national
settlement required implementation by federal legislation, however, and such
legislation was considered but not passed by the Congress in 1998. Similar
federal legislation has not been introduced to date in 1999.
In light of failure of the national settlement legislation, in November
1998 the four largest U.S. cigarette manufacturers and the attorneys general of
46 states, five territories, and the District of Columbia agreed to a settlement
of approximately $400 billion for public health-care costs allegedly connected
to smoking. The settlement - which takes effect in each settling jurisdiction
when the courts in each such jurisdiction enter a final consent decree and any
appeals of such decree are disposed of or become time-barred - allows for
payment of the agreed sum by the cigarette manufacturers over 25 years, settles
the state and territory health-care claims against the tobacco industry and
imposes a number of new marketing, advertising, sales and other restrictions on
tobacco products. As a direct result of this settlement, the major cigarette
manufacturers raised the wholesale price of cigarettes by $4.50 per carton,
effective November 24, 1998, bringing the total per-carton price increase in the
United States in 1998 to $6.35.
Included in the terms of the settlement are conditions that tobacco
companies participating in the settlement may not: target youth in the
advertising, promotion or marketing of tobacco products; use tobacco brand names
to sponsor concerts, athletics events or other events in which a significant
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percentage of the audience is under 18 years of age; advertise products in
conspicuous places outdoors (such as billboards) or on transit vehicles;
merchandise a tobacco brand name through the marketing, distribution or sale of
apparel or other merchandise; provide free samples of tobacco products in any
area except on adults-only facility; distribute or sell cigarettes in pack sizes
of less than 20; or lobby state legislatures on certain anti-tobacco initatives
(such as limitations on youth access to vending machines). Many of these
provisions took effect in November 1998; most of the remaining provisions will
take effect by April 23, 1999. The Company is unable to assess the effects that
this agreement will have on the sale of the Company's products; there can be no
assurance that these new restrictions will not result in a material reduction of
the consumption of tobacco products in the United States and thus will have not
a material adverse effect on the Company's business and financial position.
In early 1999, the President of the United States requested the Department
of Justice to review whether the United States can recover various expenditures
for medical costs incurred by smokers or former smokers which were paid or
reimbursed by the federal government. To date, the Justice Department has not
taken any action to do so, but there can be no assurance that the federal
government will not commence litigation against the tobacco manufacturers or as
to the outcome of any such litigation.
Effective January 1, 1999, the State of California increased the state
excise tax on cigarettes by $5.00 per carton. California is the Company's
largest market, representing approximately 37% of carton sales during the three
months ended March 31, 1999.
The Company believes that price and tax increases of the magnitude recently
experienced will have a negative impact on overall industry unit sales and will
negatively affect the Company's sales of tobacco products. The Company does not
believe that it is able to quantify the impact of these higher prices and taxes
on future sales of cigarettes and other tobacco products. Manufacturer price
increases will also increase the Company's debt and interest expense levels. The
Company believes that it has adequate financing arrangements in place at the
present time to finance the additional working capital requirements of the most
recent manufacturer price increases. However, depending upon future levels of
manufacturer price increases, or if the terms or amounts of state and provincial
excise taxes were adversely changed, the Company may be required to seek
additional financing in order to meet future higher working capital
requirements.
Over the past decade, various state and local governments have imposed
significant regulatory restrictions on tobacco products, including sampling and
advertising bans or restrictions, packaging regulations and prohibitions on
smoking in restaurants, office buildings and public places. With a limited
number of exceptions, the state Medicaid litigation settlement prohibits the
participating tobacco manufactureres from challenging any restriction relating
to tobacco control enacted prior to June 1, 1998. Additional state and local
legislative and regulatory actions are being considered and are likely to be
promulgated in the future. 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'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.
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
NET SALES. Net sales for the three months ended March 31, 1999 were $629.5
million, an increase of $66.2 million or 11.8% over the same period in 1998. The
increase in net sales was primarily due to an increase in net sales of
cigarettes, as well as increased sales of food and non-food products in 1999
compared to 1998.
Net sales of cigarettes for the three months ended March 31, 1999 were
$435.3 million, an increase of $60.2 million or 16.0% over the same period in
1998. The increase in net sales of cigarettes was principally due to increases
in manufacturers' list prices as well as the $5.00 per carton increase in
California state excise taxes which became effective January 1, 1999, all of
which have been passed on to the Company's customers in the form of higher
prices. The Company's total cigarette unit sales for the three months ended
March 31, 1999 were 17.8 million cartons, a decrease of 3.3 million cartons or
15.6% from the same period of 1998. Cigarette carton sales in the U.S. declined
by 3.2 million cartons or 17.9% compared to the same period in 1998. The
decrease in the Company's carton sales occurred primarily in California, and was
due to a number of factors. Consumers in California purchased large quantities
of cigarettes in December 1998, in advance of the increase in state excise taxes
which became effective January 1, 1999. This hurt the Company's sales of
cigarettes in the first three months of 1999. Additionally, the competition from
so called "grey market" cigarettes continued to be intense in California. Grey
market cigarettes are cigarettes produced by the major tobacco companies, and
intended for export only, but which are reintroduced into the domestic market by
unauthorized distributors at prices substantially lower then domestic
cigarettes. For the three months ended March 31, 1999, cigarette carton sales in
the United States, outside of California, were substantially the same in 1999 as
in the comparable period of 1998.
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Net sales of food and non-food products for the three months ended March
31, 1999 were $194.1 million, an increase of $6.0 million or 3.2% over the same
period in 1998.
GROSS PROFIT. Gross profit for the three months ended March 31, 1999 was
$45.6 million, an increase of $4.9 million or 12.0% over the same period in
1998. The increase was primarily due to sales increases in both the cigarette
and food and non-food categories. The gross profit margin for the three months
ended March 31, 1999 increased slightly to 7.24% of net sales as compared to
7.22% of net sales for the comparable period in 1998. Both cigarette and food
and non-food categories experienced slight increases in gross profit margin. For
the three months ended March 31, 1999, the Company recognized LIFO expense of
$0.1 million compared to $0.8 million for comparable period in 1998. The
decrease in LIFO expense for the three months ended March 31, 1999, was
primarily the result of a cigarette price increase that occurred during the
three months ended March 31, 1998, whereas no such increase occurred in 1999.
OPERATING AND ADMINISTRATIVE EXPENSES. Operating and administrative
expenses for the three months ended March 31, 1999 were $37.9 million, an
increase of $1.8 million or 5.1% over the same period in 1998. However, such
expenses for the three months ended March 31, 1999 decreased to 6.0% of net
sales as compared to 6.4% for the same period in 1998. The decline in operating
expenses as a percent of net sales is primarily due to the increased net sales
resulting from cigarette price increases which occurred primarily in the last
quarter of 1998.
OPERATING INCOME. As a result of the foregoing factors, operating income
for the three months ended March 31, 1999 was $7.7 million, an increase of $3.0
million or 65.6% compared to the same period in 1998. As a percentage of net
sales, operating income for the three months ended March 31, 1999 was 1.2%, as
compared to 0.8% for the same period in 1998.
NET INTEREST EXPENSE. Net interest expense for the three months ended March
31, 1999 was $3.4 million, a decrease of $0.9 million or 21.0% compared to 1998.
The net decrease resulted from a decrease in the Company's average debt levels
and a decline in the average borrowing rate as a result of the implementation of
the accounts receivable securitization program, which was effective April 1,
1998.
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 has historically financed its operations
through internally generated funds and borrowings under its credit facilities.
In November 1998, the four largest U.S. cigarette manufacturers and the
state attorneys general of 46 states agreed to a multi-billion dollar settlement
over public health costs connected to smoking (see "Tobacco Industry Business
Environment"). As a direct result of this settlement, the cigarette
manufacturers raised the wholesale price of cigarettes by $4.50 per carton,
effective November 24, 1998, in order to cover initial costs of the settlement.
This manufacturer price increase resulted in an increase in inventories and
trade accounts receivable for the Company, and correspondingly higher debt and
interest levels. The Company believes that it will be able to adequately finance
the corresponding increase in working capital requirements relating to its
existing business under its current credit facilities. At current levels of
business activity, the Company has substantial excess borrowing capacity under
its current credit facilities. However, if manufacturers' price increases or
federal excise tax increases (over and above currently enacted increases)
continued to sharply escalate, or if payment terms for state and provincial
taxes were adversely changed, the Company might be required to seek additional
financing in order to meet such higher working capital requirements.
The Company's debt obligations totaled $152.0 million at March 31, 1999, a
decrease of $56.1 million or 27.0% from $208.1 million at December 31, 1998. 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.
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The Company made capital expenditures of $1.0 million in the first quarter
of 1999. For the remainder of 1999, the Company estimates it will spend
approximately $6 to $7 million for capital requirements, principally consisting
of warehouse and other equipment.
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 the first quarter of 1999, such taxes on cigarettes
represented approximately 26% of cigarette net sales in the U.S. and 46% in
Canada. In general, such taxes have been increasing, and many states and
Canadian provinces are currently weighing proposals for higher excise taxes on
cigarettes and other tobacco products.
Effective January 1, 1999, the State of California increased excise taxes
on cigarettes by $5.00 per carton as well as increased taxes on cigars and other
tobacco products.
Under current law, almost all state and Canandian 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 and provinces
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. The federal excise tax is scheduled to increase 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 will 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 legislative resolution of various issues affecting the U.S. tobacco
industry discussed above or to finance unrelated federal spending.
Impact of Year 2000 Compliance Issues
In accordance with the safe harbor provisions of the Private Securities Act
of 1995, the Company notes that certain statements contained in the following
discussion concerning year 2000 compliance issues are forward-looking in nature
and are subject to many risks and uncertainties. These forward-looking
statements include such matters as the Company's projected state of readiness,
the Company's projected cost of remediation, the expected date of completion of
each phase and the expected completion date of contingency plans. Such
statements also constitute "year 2000 readiness disclosure" within the meaning
of the year 2000 Information and Readiness Disclosure Act.
The Company relies 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
canceled 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 alternate 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.
-11-
<PAGE>
The assessment phase of the Company's systems was complete as of March 31,
1999. The Company has completed modification or conversion and testing of
approximately 95% of the Company's systems as of March 31, 1999. The Company
presently believes that the modification or conversion of existing systems will
be completed in the second 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 June 30, 1999 and was
approximately 95% complete as of March 31, 1999. 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 44%
of the fiscal 1999 information technology department budgeted expenses 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 $1.1 million of costs as of March 31, 1999 which were
comprised of $1 million for assessment and $1.0 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.
New Accounting Standards
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 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 March 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company believes there has been no material change in its exposure to
market risk from that discussed in the Company's 1998 Consolidated Financial
Statements.
-12-
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
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 manufactures 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. The
Company was dismissed from this suit on January 6, 1999.
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), now part of a coordinated proceeding pending in the Superior Court
for San Diego County, against the principal tobacco manufacturers, the Company
and other distributors and retailers of tobacco products. The compliant seeks,
inter alia, compensatory and punitive damages, restition for monies expended by
the Trust for health care of its members who have used tobacco products, and
forms of injuctive relief.
From April 1998 through the date of this filing, the Company was named as a
defendant in 24 additional similar actions brought by various union health and
welfare trusts, coordinated into a single proceeding now pending in the Superior
Court for San Diego County, 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 November 1998, the Company was served with a
summons and complaint in an action brought by the Pechanga Band of Luiseno
Mission Indians, which is now part of the coordinated proceedings involved in
the union health and welfare trust cases noted above. In May 1999 this complaint
was ammended and the name of the case is now U Tu Utu Gwaitu Paiute Tribe, et.
al.. The complaint seeks, inter alia, compensatory and punitive damages,
restitution for monies expended by the tribe for health care of its members who
have used tobacco products, and forms of injunctive relief.
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.
-13-
<PAGE>
Item 2: Changes in Securities and Use of Proceeds
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:
None.
-14-
<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 May 12, 1999.
CORE-MARK INTERNATIONAL, INC.
By /s/ Leo F. Korman
-----------------------------------
Leo F. Korman, Senior Vice President and
Chief Financial Officer
-15-
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