| AMCON DISTRIBUTING CO Item 1A Risk Factors |
| 15 ITEM 1A RISK FACTORS IN GENERAL - ---------- You should carefully consider the risks described below before making an investment decision |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations |
| If any of the following risks actually occurs, our business, financial condition or results of operations could be materially adversely affected |
| In that case, the trading price of our common stock could decline substantially |
| This Annual Report also contains forward-looking statements that involve risks and uncertainties |
| Our actual results could differ materially from those anticipated in the forward-looking statements as a result of a number of factors, including the risks described below and elsewhere in this Annual Report |
| RISKS AFFECTING THE WHOLESALE BUSINESS - -------------------------------------- - - the Wholesale Distribution of Cigarettes and Convenience Store Products Is Significantly Affected by Cigarette Pricing Decisions and Promotional Programs Offered by Cigarette Manufacturers |
| We receive payments from the manufacturers of the products we distribute for, allowances, discounts, volume rebates, and other merchandising incentives in connection with various incentive programs |
| These payments are a substantial benefit to us and the amount and timing of these payments are affected by changes in the programs by the manufacturers and our ability to sell specified volumes of a particular product or attaining specified levels of purchases by our customers or market share, and the duration of carrying a specified product |
| In addition, we receive discounts from states in connection with the purchase of excise stamps for cigarettes |
| If the manufacturers or states change or discontinue these programs or we are unable to maintain the volume of our sales, our results of operations and financial condition could be negatively affected |
| Over the past several years, the industry has experienced the discontinuance of promotional programs, which led to price increases by distributors, followed by manufacturers reimplementing promotional programs less than a year later |
| In the first quarter of calendar year 2005, the industry saw price increases on certain cigarette brands and in fourth quarter of calendar year 2005 more changes to promotional programs were announced for fiscal 2006 which will require all distributors to pre-pay for cigarette inventory from a certain manufacturer in order to maintain the same level of discounts |
| Based on these activities, it is difficult to predict how changes in cigarette pricing and promotional programs will impact the Company and the industry in the future |
| Increases in fuel prices are also having a negative impact on profits over the past year without any indications that they will return to past levels |
| If prices continue to rise and we are not able to pass these costs along to customers this will have a material adverse impact on our results of operations, business, cash flow and financial condition |
| 15 - - Increases in Wholesale Distribution Business Competition May Have an Adverse Effect on Our Business |
| The distribution industry is highly competitive |
| There are many similar distribution companies operating in the same geographical regions as ADC ADCapstas principal competitors are national wholesalers such as McLane Co, Inc |
| (Temple, Texas), a subsidiary of Berkshire Hathaway, Inc, and Core-Mark International (San Francisco, California) and regional wholesalers such as Eby-Brown LLP (Chicago, Illinois) and Farner-Bocken (Carroll, Iowa), along with a host of smaller grocery and tobacco wholesalers |
| Most of these competitors generally offer a wide range of products at prices comparable to ADCapstas |
| Some of our competitors, including McLane Company, Inc, the largest convenience wholesale distributor in the US, have substantial financial resources and long standing customer relationships |
| In addition, heightened competition may reduce our margins and adversely affect our business |
| If we fail to successfully respond to these competitive pressures or to implement our strategies effectively, we may lose market share and our results of operations, business, cash flow, and financial condition could suffer |
| We derive most of our revenues from the distribution of cigarettes, other tobacco products, candy, snacks, fast food, grocery products, non-alcoholic beverages, general merchandise and health and beauty care products |
| The wholesale distribution industry is characterized by a high volume of sales with relatively low profit margins |
| Our non-cigarette sales are at prices that are based on the cost of the product plus a percentage markup |
| As a result, our profit levels may be negatively impacted during periods of cost deflation for these products, even though our gross profit as a percentage of the price of goods sold may remain relatively constant |
| Gross profit on cigarette sales are generally fixed on a cents per carton basis |
| Therefore, as cigarette prices increase, gross profit generally decreases as a percent of sales |
| In addition, if the cost of the cigarettes that we purchase increases due to manufacturer price or excise tax rate increases, our inventory costs and accounts receivable could rise |
| To the extent that product cost increases are not passed on to our customers due to their resistance to higher prices, our profit margins and earnings could be negatively impacted |
| The consumable goods distribution industry is sensitive to national and regional economic conditions |
| Inflation, fuel costs and other factors affecting consumer confidence may negatively impact our sales |
| Our operating results are also sensitive to, and may be adversely affected by, other factors, including difficulties with the collectibility of accounts receivable, competitive price pressures, severe weather conditions and unexpected increases in fuel or other transportation-related costs |
| - - Our Sales Volume Is Largely Dependent upon the Distribution of Cigarette Products, Sales of Which Are Declining |
| The distribution of cigarettes is currently a significant portion of our business |
| For the year ended September 30, 2005, approximately 72prca of our revenues came from the distribution of cigarettes |
| During the same period, approximately 32prca of our gross profit was generated from cigarettes |
| Due to increases in the prices of cigarettes, restrictions on advertising and promotions by cigarette manufacturers, increases in cigarette regulation and excise taxes, health concerns, increased pressure from anti-tobacco groups and other factors, the US cigarette market has generally been declining, 16 and is expected to continue to decline |
| Notwithstanding the general decline in consumption, we have benefitted from a shift of cigarette sales to convenience stores |
| - - Legislation and Other Matters Are Negatively Affecting the Cigarette and Tobacco Industry |
| The tobacco industry is subject to a wide range of laws and regulations regarding the advertising, sale, taxation and use of tobacco products imposed by local, state, federal and foreign governments |
| Various state and provincial governments have adopted or are considering legislation and regulations restricting displays and advertising of tobacco products, establishing fire safety standards for cigarettes, raising the minimum age to possess or purchase tobacco products, requiring the disclosure of ingredients used in the manufacture of tobacco products, imposing restrictions on public smoking, restricting the sale of tobacco products directly to consumers or other unlicensed recipients over the Internet, and other tobacco product regulation |
| Other states may adopt similar legislation and initiate similar lawsuits |
| In addition, cigarettes are subject to substantial excise taxes in the United States |
| Significant increases in cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted within the United States |
| These tax increases are likely to continue to have an adverse impact on sales of cigarettes due to lower consumption levels or sales outside of legitimate channels |
| - - In the United States, We Purchase Cigarettes from Manufacturers Covered by the Industryapstas Master Settlement Agreement, Which Results in Our Facing Increased Financial Risks |
| In June 1994, the Mississippi attorney general brought an action against various tobacco industry members |
| This action was brought on behalf of the state to recover state funds paid for health-care, medical and other assistance to state citizens suffering from diseases and conditions allegedly related to tobacco use |
| Most other states, through their attorneys general or other state agencies, sued the major US cigarette manufacturers based on similar theories |
| The cigarette manufacturer defendants settled the first four of these cases scheduled for trial Mississippi, Florida, Texas and Minnesota by separate agreements between each state and those manufacturers in each case |
| In November 1998, the major US tobacco product manufacturers entered into the master settlement agreement with the other 46 states, the District of Columbia, Puerto Rico, Guam, the United States Virgin Islands, American Samoa and the Northern Marianas to settle asserted and unasserted health care cost recovery and other claims |
| The master settlement agreement and the other state settlement agreements: settled all health-care cost recovery actions brought by, or on behalf of, the settling jurisdictions; released the major US cigarette manufacturers from various additional present and potential future claims relating to past conduct arising out of the use, sale, distribution, manufacture, development, advertising, marketing or health effects of, the exposure to, or research, statements or warnings about, tobacco products; settled all monetary claims relating to future conduct arising out of the use of, or exposure to, tobacco products that have been manufactured in the ordinary course of business; imposed a stream of future payment obligations on major US cigarette manufacturers; and placed significant restrictions on their ability to market and sell cigarettes |
| 17 The payments required under the master settlement agreement result in the products sold by the participating manufacturers to be priced at higher levels than non-master settlement agreement manufacturers |
| In order to limit our potential tobacco related liabilities, we do not purchase cigarettes from non-master settlement agreement manufacturers for sale in master settlement agreement states |
| The benefits of the master settlement agreement do not apply to sales of cigarettes manufactured by non-master settlement agreement manufacturers |
| - - In the United States, We Purchase Cigarettes from Manufacturers Covered by the Industryapstas Master Settlement Agreement, Which Results in Competition from Lower Priced Sales of Cigarettes Produced by Manufacturers Who Do Not Participate in the Master Settlement Agreement |
| Competition among cigarette manufacturers for cigarette sales is primarily based on brand positioning, price, product attributes, consumer loyalty, promotions, advertising and retail presence |
| Cigarette brands produced by the major manufacturers generally require competitive pricing, substantial marketing support, retail programs and other financial incentives to maintain or improve a brandapstas market position |
| Increased selling prices and higher cigarette taxes have resulted in the growth of deep-discount brands |
| Deep-discount brands are brands manufactured by companies that are not original participants to the master settlement agreement, and accordingly, do not have cost structures burdened with master settlement agreement related payments to the same extent as the original participating manufacturers |
| Historically, major manufacturers have had a competitive advantage in the United States because of significant cigarette marketing restrictions and the scale of investment required to compete made gaining consumer awareness and trial of new brands difficult |
| However, since the master settlement agreement was signed in November 1998, the category of deep-discount brands manufactured by smaller manufacturers or supplied by importers has grown substantially |
| As a result of purchasing premium and discount cigarettes for sale in master settlement agreement states exclusively from manufacturers that are parties to the master settlement agreement, we are adversely impacted by sales of brands from non-master settlement agreement manufacturers and deep-discount brand growth |
| We believe that small manufacturers, not subject to the master settlement agreement, of deep-discount brands have steadily increased their combined market share of cigarette sales |
| The premium and discount cigarettes subject to the master settlement agreement that we sell have been negatively impacted by widening price gaps in the prices between those brands and the deep-discount brands for the past several years |
| The growth in market share of the deep-discount brands since the master settlement agreement was signed in 1998 has had an adverse impact on the volume of the cigarettes that we sell |
| As a result, our operations and financial condition may be negatively impacted as sales volumes of premium cigarettes erode |
| - - We Also Face Competition from Illicit and Other Low Priced Sales of Cigarettes |
| We also face competition from the diversion into the United States market of cigarettes intended for sale outside the United States, the sale of counterfeit cigarettes by third parties, the sale of cigarettes in non-taxable jurisdictions, inter-state and international smuggling of cigarettes, increased imports of foreign low priced brands, the sale of cigarettes by third parties over the Internet and by other means designed to 18 avoid collection of applicable taxes |
| The competitive environment has been characterized by a continued influx of cheap products that challenge sales of higher priced and taxed cigarettes manufactured by parties to the master settlement agreement |
| Increased sales of counterfeit cigarettes, sales by third parties over the Internet, or sales by means to avoid the collection of applicable taxes, could have an adverse effect on our cash flow, results of operations and financial condition |
| In connection with the master settlement agreement, we are indemnified by the tobacco product manufacturers from which we purchase cigarettes and other tobacco products for liabilities arising from our sale of the tobacco products that they supply to us |
| To date, litigation challenging the validity of the master settlement agreement, including claims that the master settlement agreement violates antitrust laws, has not been successful |
| However, if such litigation were to be successful and the master settlement agreement is invalidated, we could be subject to substantial litigation due to our sales of cigarettes and other tobacco products, and we may not be indemnified for such costs by the tobacco product manufacturers in the future |
| In addition, even if we continue to be indemnified by cigarette manufacturers that are parties to the master settlement agreement, future litigation awards against such cigarette manufacturers and us could be so large as to eliminate the ability of the manufacturers to satisfy their indemnification obligations |
| Our results of operations and financial condition could be negatively impacted due to increased litigation costs and potential adverse rulings against us |
| Cigarettes and tobacco products are subject to substantial excise taxes in the United States |
| Significant increases in cigarette-related taxes and/or fees have been proposed or enacted and are likely to continue to be proposed or enacted within the United States |
| These tax increases are expected to continue to have an adverse impact on sales of cigarettes due to lower consumption levels and a shift in sales from the premium to the non-premium or discount cigarette segments or to sales outside of legitimate channels |
| If these excise taxes are substantially increased, it could have a negative impact on our liquidity |
| Accordingly, we may be required to obtain additional debt financing, which we may not be able to obtain on satisfactory terms or at all |
| Our inability to prepay the excise taxes may prevent or delay our purchase of cigarettes and other tobacco products, which could materially adversely affect our ability to supply our customers |
| If we cannot pass along to our customers increases in our cost of goods sold which we experience when manufacturers or taxing authorities increase prices or taxes or reduce or eliminate discounts, rebates, allowances and other incentive programs, our profit margins could erode |
| Our industry is characterized by a high volume of sales with relatively low profit margins |
| 19 If we cannot pass along cost increases to our customers due to resistance to higher prices, our relatively narrow profit margins and earnings could be negatively affected |
| - - We Are Dependent on the Convenience Store Industry for Our Revenues, and Our Results of Operations and Financial Condition Would Suffer If There Is an Overall Decline in the Convenience Store Industry |
| The majority of our sales are made under purchase orders and short-term contracts with convenience stores which inherently involve significant risks |
| These risks include the uncertainty of general economic conditions in the convenience store industry, credit exposure from our customers and termination of customer relationships without notice, consolidation of our customer base, and consumer movement toward purchasing from club stores |
| Any of these factors could negatively affect the convenience store industry which would negatively affect our results of operations and financial condition |
| In the retail health food business, our primary competitors currently include national natural foods supermarkets, such as Whole Foods and Wild Oats, conventional and specialty supermarkets, other regional natural foods stores, small specialty stores and restaurants |
| These businesses compete with us in one or more product categories |
| Whole Foods Market and Wild Oats, continue to expand their geographic markets by opening stores in new markets |
| In addition, conventional supermarkets and mass market outlets are also increasing their emphasis on the sale of natural products |
| In addition, some traditional and specialty supermarkets are expanding more aggressively in marketing a range of natural foods, thereby competing directly with us for products, customers and locations |
| These strategies have contributed to the saturation of health food retail stores in some markets |
| This has increased competition in the health food sector and has had a restraining impact on same store sales increases in some markets and a slight reduction in same store sales in other markets |
| Further, some of these potential competitors may have greater financial or marketing resources than we do and may be able to devote greater resources to sourcing, promoting and selling their products |
| Increased competition may have an adverse effect on our results of operations, business, cash flow and financial condition as the result of lower sales, lower gross profits and/or greater operating costs such as marketing |
| Our continued growth depends on our ability to open or acquire new retail health food stores in existing and new markets and to operate these stores successfully |
| Our expansion strategy is dependent on finding suitable locations, and we face intense competition from other retailers for such sites |
| We also need to be able to open new stores timely and operate them successfully |
| In addition, our success is dependant on our ability to hire, train and integrate new qualified team members |
| Management continues to 20 closely review all store locations for opportunities to close or relocate marginally performing stores, remodel and expand performing stores and identify locations for additional stores |
| Our success is dependant on our ability to adapt our distribution, management information and other operating systems to adequately supply products to new stores at competitive prices so that we can operate the stores in a successful and profitable manner |
| If we are not able to find and open new store locations and to close poor performing stores this will have a material adverse impact on our results of operations, business, cash flow and financial condition |
| Our comparable store sales in the future could fluctuate or be lower than our historical average for many reasons including new and acquired stores entering into the comparable store base, the opening of new stores that cannibalize store sales in existing markets, increased competition, price changes in response to competitive factors, possible supply shortages, and cycling against above-average sales results in the prior year |
| Results of operations and financial condition may be materially impacted by fluctuations in our comparable store sales as it becomes more difficult to leverage expenses at a lower level of sales |
| There is no assurance that quality natural and organic products including dietary supplements, fresh and processed foods and vitamins will be available to meet our future needs |
| If conventional supermarkets increase their natural and organic product offerings or if new laws require the reformulation of certain products to meet tougher standards, the supply of these products may be constrained |
| Any significant disruption in the supply of quality natural and organic products could have a material impact on our overall sales and cost of goods |
| We believe our stores more heavily emphasize perishable products than conventional supermarket stores |
| The Companyapstas emphasis on perishable products may result in significant product inventory losses in the event of extended power outages, natural disasters or other catastrophic occurrences |
| The bottled water market is highly competitive, with numerous participants selling products often perceived as generic by consumers |
| The principal bases of competition in the industry are brand recognition, price, water source for bottled water products, and packaging |
| Price competition has become more pronounced as the industry has matured |
| The Company seeks to develop recognition for its brands by differentiating its products from more recognized products in the brand category |
| The Hawaiian Springs brands of water are unique because of their water source |
| HNWC is the only producer of natural spring water from Hawaii |
| If we are not able to differentiate the product and brand 21 from bottlers purified municipal water, we will not be able to increase our prices and this will have a materially adverse effect on our results of operation, business, cash flow and financial condition in the beverage businesses |
| The acquisition of existing stores, the opening of new retail stores, and the development of new production and distribution facilities requires significant amounts of capital |
| In the past, our growth has been funded primarily through proceeds from bank debt, private placements of equity and debt and internally generated cash flow |
| In addition, restrictive covenants that may be imposed by our lenders may restrict our ability to fund our growth |
| Our revolving credit facility imposes restrictions on us that could increase our vulnerability to general adverse economic and industry conditions by limiting our flexibility in planning for and reacting to changes in our business and industry |
| Specifically, these restrictions limit our ability, among other things, to: incur additional indebtedness, pay dividends and make distributions, issue stock of subsidiaries, make investments, repurchase stock, create liens, enter into transactions with affiliates, merge or consolidate, or transfer and sell our assets |
| - - Failure to Meet Restrictive Covenants in Our Revolving Credit Facility Could Result in Acceleration of the Facility and We May not be Able to Find Alternative Financing |
| Under our revolving credit facility, we are required to meet certain financial ratios and tests |
| Our ability to comply with these covenants may be affected by factors beyond our control |
| If we breach any of these covenants or restrictions, it could result in an event of default under our revolving credit facility, which would permit our lenders to declare all amounts outstanding thereunder to be immediately due and payable, and our lenders under our revolving credit facility could terminate their commitments to make further extensions of credit under our revolving credit facility |
| - - During Our First and Second Fiscal Quarters We Generally Experience Reduced Sales of Our Products Due to Seasonality of Our Business, Our quarterly operating results could fluctuate for many reasons, including seasonality of our business, losses from beverage segment, variations in the mix of product sales, price changes in response to competitive factors, increases in store operating costs, possible supply shortages, extreme weather-related disruptions, and potential uninsured casualty losses or other losses |
| Sales in the wholesale distribution and beverage segments are somewhat seasonal by nature and tend to be higher in warm weather months, which generally fall within the Companyapstas third and fourth fiscal quarters |
| 22 In addition, our quarterly operating results may fluctuate significantly as the result of the timing of new retail store openings, the timing of acquisitions, the range of operating results generated from newly opened retail stores and changes in estimates associated with the disposal of discontinued operations |
| Quarter-to-quarter comparisons of results of operations and financial condition have been and may be materially impacted by the timing of new retail store openings |
| Our results of operations and financial condition may be sensitive to changes in overall economic conditions that impact consumer spending, including discretionary spending |
| Future economic conditions affecting disposable consumer income such as employment levels, business conditions, interest rates and tax rates could reduce consumer spending or cause consumers to shift their spending to our competitors |
| A general reduction in the level of discretionary spending or shifts in consumer discretionary spending to our competitors could adversely affect our growth and profitability |