FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-16626
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7-ELEVEN, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-1085131
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2711 NORTH HASKELL AVE., DALLAS, TEXAS 75204-2906
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code, 214/828-7011
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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. Yes X No
Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
111,543,165 shares of common stock, $.0001 par value (the
issuer's only class of common stock), were outstanding as of
September 30, 2003.
7-ELEVEN, INC.
INDEX
PAGE
NO.
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Part I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets -
December 31, 2002 and September 30, 2003 1
Condensed Consolidated Statements of Earnings -
Three Months and Nine Months Ended September 30, 2002 and 2003 2
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2002 and 2003 3
Notes to Condensed Consolidated Financial Statements 4
Report of Independent Auditors 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 23
ITEM 4. CONTROLS AND PROCEDURES 23
Part II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES 26
Exhibit (15) - Letter re Unaudited Interim Financial Information Tab 1
Exhibit 31(1) - Certification of Chief Executive Officer Required by
Section 302 of the Sarbanes-Oxley Act Tab 2
Exhibit 31(2) - Certification of Chief Financial Officer Required by
Section 302 of the Sarbanes-Oxley Act Tab 3
Exhibit 32(1) - Certification of Chief Executive Officer Required by
Section 906 of the Sarbanes-Oxley Act Tab 4
Exhibit 32(2) - Certification of Chief Financial Officer Required by
Section 906 of the Sarbanes-Oxley Act Tab 5
(i)
7-ELEVEN, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
December 31, September 30,
2002 2003
------------- -------------
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 82,423 $ 101,936
Cash for Vcom kiosks 38,342 67,517
------------- -------------
Total cash and cash equivalents 120,765 169,453
Accounts receivable 248,483 207,749
Inventories 114,091 95,425
Other current assets 140,837 157,184
------------- -------------
Total current assets 624,176 629,811
Property and equipment 2,175,360 2,347,235
Goodwill and intangible assets 140,490 140,577
Other assets 124,299 119,160
------------- -------------
Total assets $ 3,064,325 $ 3,236,783
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Trade accounts payable $ 260,978 $ 261,491
Accrued expenses and other liabilities 457,623 486,952
Long-term debt due within one year 48,609 38,716
------------- -------------
Total current liabilities 767,210 787,159
Deferred credits and other liabilities 386,995 415,515
Long-term debt 1,366,623 1,398,596
Convertible quarterly income debt securities 380,000 300,000
Commitments and contingencies
Shareholders' equity
Preferred stock, $.01 par value - -
Common stock, $.0001 par value 10 11
Additional capital 1,168,182 1,248,452
Accumulated deficit (990,107) (919,946)
Unearned compensation (1,068) (878)
Accumulated other comprehensive earnings (loss) (13,520) 7,874
------------- -------------
Total shareholders' equity 163,497 335,513
------------- -------------
Total liabilities and shareholders' equity $ 3,064,325 $ 3,236,783
============= =============
See notes to condensed consolidated financial statements.
1
7-ELEVEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
(UNAUDITED)
Three Months Nine Months
Ended September 30 Ended September 30
---------------------------- ---------------------------
2002 2003 2002 2003
------------- ------------- ------------ -------------
REVENUES
Merchandise sales (including $186,177, $228,119,
$515,443 and $641,234 in excise taxes) $ 1,979,692 $ 2,102,332 $ 5,430,833 $ 5,763,785
Gasoline sales (including $200,723, $212,752,
$568,294 and $609,770 in excise taxes) 754,332 903,529 2,031,677 2,556,872
------------- ------------- ------------ ------------
Net sales 2,734,024 3,005,861 7,462,510 8,320,657
Other income 24,246 26,172 78,741 71,164
------------- ------------- ------------ ------------
Total revenues 2,758,270 3,032,033 7,541,251 8,391,821
COSTS AND EXPENSES
Merchandise cost of goods sold 1,283,197 1,376,039 3,529,464 3,779,142
Gasoline cost of goods sold 687,739 812,789 1,847,031 2,305,810
------------- ------------- ------------ ------------
Total cost of goods sold 1,970,936 2,188,828 5,376,495 6,084,952
Franchisee gross profit expense 207,634 220,175 561,434 597,842
Operating, selling, general and administrative
expenses 514,469 546,507 1,450,766 1,525,025
Interest expense, net 16,295 19,688 48,460 52,483
------------- ------------- ------------ ------------
Total costs and expenses 2,709,334 2,975,198 7,437,155 8,260,302
------------- ------------- ------------ ------------
EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME
TAX AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 48,936 56,835 104,096 131,519
INCOME TAX EXPENSE 19,575 21,597 41,638 49,977
------------- ------------- ------------ ------------
EARNINGS FROM CONTINUING OPERATIONS BEFORE
CUMULATIVE EFFECT OF ACCOUNTING CHANGE 29,361 35,238 62,458 81,542
EARNINGS (LOSS) ON DISCONTINUED OPERATIONS (net of tax
(expense) benefit of ($60), ($568), $6,696 and $697) 90 926 (10,044) (1,137)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE (net of tax
benefit of $-, $6,550, $18,759 and $6,550) - (10,244) (28,139) (10,244)
------------- ------------- ------------ ------------
NET EARNINGS $ 29,451 $ 25,920 $ 24,275 $ 70,161
============= ============= ============ ============
NET EARNINGS PER COMMON SHARE
BASIC
Earnings from continuing operations before
cumulative effect of accounting change $ .28 $ .33 $ .60 $ .78
Earnings (loss) on discontinued operations .00 .01 (.10) (.01)
Cumulative effect of accounting change - (.10) (.27) (.10)
------------- ------------- ------------ ------------
Net earnings $ .28 $ .24 $ .23 $ .67
============= ============= ============ ============
DILUTED
Earnings from continuing operations before
cumulative effect of accounting change $ .25 $ .29 $ .55 $ .71
Earnings (loss) on discontinued operations .00 .01 (.08) (.01)
Cumulative effect of accounting change - (.08) (.22) (.08)
------------- ------------- ------------ ------------
Net earnings $ .25 $ .22 $ .25 $ .62
============= ============= ============ ============
See notes to condensed consolidated financial statements.
2
7-ELEVEN, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Nine Months
Ended September 30
------------------------------
2002 2003
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 24,275 $ 70,161
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Cumulative effect of accounting change 28,139 10,244
Depreciation and amortization of property and equipment 207,005 226,616
Other amortization 266 189
Deferred income tax expense 33,700 6,731
Noncash interest expense 916 460
Foreign currency net conversion loss 11,995 6,156
Other noncash (income) loss (1,779) 3,413
Gain on debt redemption - (10,455)
Net loss on property and equipment 9,322 297
(Increase) decrease in accounts receivable (13,703) 52,373
Decrease in inventories 8,025 18,666
Decrease (increase) in other assets 10,562 (10,322)
Increase in trade accounts payable and other liabilities 64,021 43,139
------------- -------------
Net cash provided by operating activities 382,744 417,668
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CASH FLOWS FROM INVESTING ACTIVITIES
Payments for purchase of property and equipment (303,490) (189,753)
Proceeds from sale of property and equipment 5,529 13,178
Proceeds from sale of domestic securities 2,244 1,488
Restricted cash (36,006) (12,170)
Other (167) 82
------------- -------------
Net cash used in investing activities (331,890) (187,175)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from commercial paper and revolving credit facilities 4,168,192 3,975,403
Payments under commercial paper and revolving credit facilities (4,187,505) (4,173,699)
Proceeds from issuance of long-term debt - 400,000
Principal payments under long-term debt agreements (27,693) (394,332)
(Decrease) increase in outstanding checks in excess of cash in bank (18,256) 10,733
Net proceeds from issuance of common stock 51 132
Other (939) (42)
------------- -------------
Net cash used in financing activities (66,150) (181,805)
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NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (15,296) 48,688
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 125,599 120,765
------------- -------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 110,303 $ 169,453
============= =============
RELATED DISCLOSURES FOR CASH FLOW REPORTING
Interest paid, excluding SFAS No.15 Interest $ (52,236) $ (52,508)
============= =============
Net income taxes refunded (paid) $ 2,043 $ (11,610)
============= =============
Assets obtained by entering into capital leases $ 23,685 $ 45,934
============= =============
1998 Yen loan principal and interest payments from restricted cash $ (22,790) $ (7,359)
============= =============
See notes to condensed consolidated financial statements.
3
7-ELEVEN, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2003
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated balance sheet as of September 30,
2003, and the condensed consolidated statements of earnings for
the three-month and nine-month periods ended September 30, 2002
and 2003, and the condensed consolidated statements of cash flows
for the nine-month periods ended September 30, 2002 and 2003,
have been prepared by 7-Eleven, Inc. (the "Company") without
audit. In the opinion of management, all adjustments necessary
to present fairly the financial position at September 30, 2003,
and the results of operations and cash flows for all periods
presented have been made. Certain prior-period amounts have been
reclassified to conform to current-period presentation. The
results of operations for the interim periods are not necessarily
indicative of the operating results for the full year.
The reported results include approximately 5,800 convenience
stores that are operated or franchised in the United States and
Canada by the Company along with royalty income from worldwide 7-
Eleven area licensees. Sales and cost of goods sold of stores
operated by franchisees are consolidated with the results of
Company-operated stores in the condensed consolidated statements
of earnings. Gross profit from franchise stores is split between
the Company and its franchisees pursuant to the terms of
franchise agreements.
The condensed consolidated balance sheet as of December 31,
2002, 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 in the Company's Annual Report on Form 10-K
for the year ended December 31, 2002, include accounting policies
and additional information pertinent to an understanding of both
the December 31, 2002, balance sheet and the interim financial
statements. The information has not changed except as a result
of normal transactions in the nine months ended September 30,
2003, and as discussed in the following notes.
2. STOCK-BASED COMPENSATION
The Company adopted the interim disclosure provisions of
Statement of Financial Accounting Standards ("SFAS") No. 148,
"Accounting for Stock-Based Compensation - Transition and
Disclosure - an Amendment of FASB Statement No. 123," effective
January 1, 2003.
The fair value of each option grant under the Company's 1995
Stock Incentive Plan ("Stock Incentive Plan") is estimated on the
date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for the options
granted: expected life of five years and no dividend yields
combined with risk-free interest rates of 4.67% and 2.65% and
expected volatility of 67.54% and 64.98% for the options granted
in 2002 and 2003, respectively.
The Company has recognized no compensation expense for its
stock options as it is accounting for its Stock Incentive Plan for
employees under the provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." If
compensation expense had been determined based on the fair value
4
at the grant date for awards under this plan consistent with the
method prescribed by SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net earnings and net earnings per
common share for the three months and nine months ended September
30, 2002 and 2003, would have been reduced to the pro forma amounts
indicated in the following table (dollars in thousands, except per-
share data):
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net earnings as reported $ 29,451 $ 25,920 $ 24,275 $ 70,161
Add: stock-based compensation expense included
in reported net earnings, net of tax - 412 - 1,220
Less: Total stock-based compensation expense
determined under the fair-value-based method
for all stock-based awards, net of tax (1,176) (1,646) (3,025) (4,656)
--------- -------- -------- --------
Pro forma net earnings $ 28,275 $ 24,686 $ 21,250 $ 66,725
Net earnings per common share as reported
Basic $ .28 $ .24 $ .23 $ .67
Diluted .25 .22 .25 .62
Pro forma net earnings per common share
Basic $ .27 $ .23 $ .20 $ .63
Diluted .25 .21 .23 .59
3. COMPREHENSIVE EARNINGS
The components of comprehensive earnings of the Company for
the periods presented are as follows (in thousands):
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net earnings $ 29,451 $ 25,920 $ 24,275 $ 70,161
Other comprehensive earnings (loss)
Unrealized gains (losses) on equity
securities (net of ($240), $91, ($463)
and ($192) deferred taxes) (361) 143 (891) (217)
Reclassification adjustments for gains
included in net earnings (net of $302,
$196, $893 and $603 deferred taxes) (452) (306) (1,358) (892)
Unrealized gain (loss) related to interest
rate swap (net of ($840), $1,201,
($1,082) and $3,410 deferred taxes) (1,279) 1,524 (1,024) 4,297
Foreign currency translation adjustments (4,662) 375 (1,336) 18,206
-------- -------- -------- --------
Other comprehensive earnings (loss) (6,754) 1,736 (4,609) 21,394
-------- -------- -------- --------
Total comprehensive earnings $ 22,697 $ 27,656 $ 19,666 $ 91,555
========= ======== ======== ========
5
4. STORE CLOSINGS, ASSET IMPAIRMENT AND ASSET RETIREMENT
OBLIGATIONS
The results of operations of certain owned and leased stores
are presented as discontinued operations in accordance with the
provisions of SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The results of operations of
owned stores are presented as discontinued operations beginning
in the quarter in which management commits to a plan to close the
related store and actively markets the store. The results of
operations of a leased store are presented as discontinued
operations beginning in the quarter in which the related store
ceases operations. The results of operations include related
write-downs of stores to estimated net realizable value and
accruals for future estimated rent and other expenses in excess
of estimated sublease rental income. Amounts related to
discontinued operations of prior periods have been reclassified
to conform to discontinued operations of the current period in
the accompanying condensed consolidated statements of earnings.
The stores presented as discontinued operations had total
revenues and pretax income (loss) as follows for the periods
presented (in thousands):
Three Months Nine Months
Ended September 30 Ended September 30
------------------- -------------------
2002 2003 2002 2003
-------- -------- --------- --------
Total revenue $ 34,503 $ 1,732 $ 120,758 $ 29,770
Pretax income (loss) 150 1,494 (16,739) (1,834)
Included in the pretax income (loss) for the nine months
ended September 30, 2002, is a loss on disposal of $11.6 million
for write-downs of property and equipment to net realizable value
and anticipated future rent and other expenses in excess of
related estimated sublease income in connection with the store
closings. Included in the pretax income (loss) for the three
months and nine months ended September 30, 2003, respectively, is
a pretax gain of $5.3 million from the sale of 12 stores in
Wisconsin.
As of September 30, 2002 and 2003, assets held for sale were
$10.3 million and $10.0 million, respectively, and are included
in other current assets in the accompanying condensed
consolidated balance sheets.
As required by SFAS No. 143, "Accounting for Asset
Retirement Obligations," the Company recognizes an estimated
liability for the removal of its underground storage tanks. Upon
adoption of SFAS No. 143 in January 2002, the Company recorded a
discounted liability of $53.6 million, increased net property and
equipment by $6.7 million and recognized a one-time cumulative
effect charge of $28.1 million (net of deferred tax benefit of
$18.8 million).
5. SEJ NOTES AND RETIREMENT OF SENIOR SUBORDINATED DEBENTURES
In January 2003, the Company entered into a note purchase
agreement with Seven-Eleven Japan Co., Ltd. ("SEJ") that
authorizes the issuance and sale of up to $400 million aggregate
principal amount of Senior Subordinated Notes due January 27,
2010 ("SEJ Notes"), which were issued by the Company and
purchased by SEJ in multiple tranches. Interest on the SEJ Notes
was calculated for each tranche on its issuance date and was set
by a formula tied to the United States Treasury Rate and Japanese
government bond rates. The SEJ Notes are subordinate to all
obligations outstanding under the Company's revolving credit
facility. The Company is required to repay the SEJ Notes in
eight equal semiannual installments beginning July 2006 and
ending January 2010, and interest payments on the unpaid balance
of the SEJ Notes are required semiannually beginning January
2003.
6
On January 10, 2003, the Company received $100 million from
SEJ under the note purchase agreement; the interest rate on this
tranche is stated at 3.41%. On July 9, 2003, the Company
received the remaining $300 million from SEJ under the note
purchase agreement in three equal payments of $100 million; the
interest rate on these tranches is stated at 3.01%, 3.34% and
3.71%, respectively.
In July 2003, the Company used a portion of the proceeds of
the SEJ Notes to retire $239.3 million principal amount of its 5%
First Priority Senior Subordinated Debentures due 2003, $111.4
million principal amount of its 4 1/2% Second Priority Senior
Subordinated Debentures (Series A) due 2004 and $18.5 million
principal amount of its 4% Second Priority Senior Subordinated
Debentures (Series B) due 2004. As a result of the inclusion of
SFAS No. 15, "Accounting by Debtors and Creditors for Troubled
Debt Restructuring," interest in the carrying amount of the
retired debt, the Company recognized a pretax gain of $10.5
million in the third quarter of 2003. The gain was recorded in
operating, selling, general and administrative expenses
("OSG&A").
6. OTHER RELATED PARTY TRANSACTIONS
In September 2003, the Company converted all of its
outstanding 1998 Convertible Quarterly Income Debt Securities due
2013 ("1998 QUIDS"), which were issued to Ito-Yokado Co., Ltd.
("IY") and SEJ, into approximately 6.5 million shares of 7-
Eleven, Inc. common stock (based on a per-share conversion price
of $12.3045 under the terms of the 1998 QUIDS). The principal
amount of the 1998 QUIDS was $80.0 million, and the interest rate
was 4.5%.
In May 2002, a financial-services subsidiary of SEJ made a
personal loan of 227.5 million Japanese yen (approximately $1.75
million) to one of the Company's non-employee directors. The
term of the loan, which is secured by certain shares of stock
owned by the director and bears interest at 2.6%, has been
extended from May 2003 to December 2003. As of September 30,
2003, interest expense incurred on the loan approximates $63,000.
7. ENVIRONMENTAL
In connection with its California remediation receivable,
the Company recorded a pretax charge to OSG&A of $7 million. The
California reimbursement program separates claims into four
classes: A, B, C and D. The Company's claims are in class D. As
a result of the growing backlog of Class D claims and its impact
on the Company's estimate of when it will receive funds from the
California reimbursement program, the Company recorded the $7
million charge to reflect its best estimate of the discounted
value of its California remediation receivable. The Company has
recorded the portion of the receivable that relates to
remediation activities that have already been completed at a
discount rate of approximately 5.0%.
7
8. EARNINGS PER SHARE
Computations for basic and diluted earnings per share
are presented below (in thousands, except per-share data):
Three Months Nine Months
Ended September 30 Ended September 30
--------------------- --------------------
2002 2003 2002 2003
---------- --------- --------- ---------
BASIC
Earnings from continuing operations before
cumulative effect of accounting change $ 29,361 $ 35,238 $ 62,458 $ 81,542
Earnings (loss) on discontinued operations 90 926 (10,044) (1,137)
Cumulative effect of accounting change - (10,244) (28,139) (10,244)
---------- ---------- ---------- ----------
Net earnings $ 29,451 $ 25,920 $ 24,275 $ 70,161
========== ========== ========== ==========
Weighted-average common shares outstanding 104,830 105,837 104,824 105,201
========== ========== ========== ==========
Earnings per common share from continuing operations
before cumulative effect of accounting change $ .28 $ .33 $ .60 $ .78
Earnings (loss) per common share on discontinued
operations .00 .01 (.10) (.01)
Loss per common share on cumulative effect of
accounting change - (.10) (.27) (.10)
---------- ---------- ---------- ----------
Net earnings per common share $ .28 $ .24 $ .23 $ .67
========== ========== ========== ==========
DILUTED
Earnings from continuing operations before
cumulative effect of accounting change $ 29,361 $ 35,238 $ 62,458 $ 81,542
Add interest on convertible quarterly income debt
securities, net of tax 2,608 2,594 7,823 7,983
---------- ---------- ---------- ----------
Earnings from continuing operations before cumulative
effect of accounting change plus assumed conversions $ 31,969 $ 37,832 $ 70,281 $ 89,525
Earnings (loss) on discontinued operations 90 926 (10,044) (1,137)
Cumulative effect of accounting change - (10,244) (28,139) (10,244)
---------- ---------- ---------- ----------
Net earnings plus assumed conversions $ 32,059 $ 28,514 $ 32,098 $ 78,144
========== ========== ========== ==========
Weighted-average common shares outstanding (Basic) 104,830 105,837 104,824 105,201
Add effects of assumed conversions:
Stock options, stock units, performance
share units and restricted stock (1) 140 1,728 141 997
Convertible quarterly income debt
securities (see Note 6) 20,924 20,005 20,924 20,615
---------- ---------- ---------- ----------
Weighted-average common shares outstanding plus
shares from assumed conversions (Diluted) 125,894 127,570 125,889 126,813
========== ========== ========== ==========
Earnings per common share from continuing operations
before cumulative effect of accounting change $ .25 $ .29 $ .55 $ .71
Earnings (loss) per common share on discontinued
operations .00 .01 (.08) (.01)
Loss per common share on cumulative effect of
accounting change - (.08) (.22) (.08)
---------- ---------- ---------- ----------
Net earnings per common share $ .25 $ .22 $ .25 $ .62
========== ========== ========== ==========
(1) Stock options for 6.6 million, 3.1 million, 5.2 million and 3.9 million shares of common stock
for the three-month and nine-month periods ended September 30, 2002 and 2003, respectively, have
exercise prices that are greater than the average market prices of the common shares for each
respective period. Therefore, these shares have not been included in diluted earnings-per-share
calculations.
8
9. ADOPTION OF NEW ACCOUNTING STANDARDS
In April 2003, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 149, "Amendment of SFAS No.
133 on Derivative Instruments and Hedging Activities."
SFAS No. 149 amends and clarifies accounting for
derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging
activities under SFAS No. 133. SFAS No. 149 is effective
for contracts entered into or modified after June 30,
2003, for hedging relationships designated after June 30,
2003, and to certain preexisting contracts. The Company
has adopted the provisions of SFAS No. 149 on a
prospective basis for any contracts entered into after
June 30, 2003.
In May 2003, the FASB issued SFAS No. 150,
"Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." SFAS No.
150 establishes standards for classifying and measuring as
liabilities certain financial instruments that embody
obligations of the issuer and have characteristics of both
liabilities and equity. The provisions of SFAS No. 150
are effective for all financial instruments created or
modified after May 31, 2003, and otherwise shall be
effective at the beginning of the first interim period
beginning after June 15, 2003. The Company adopted the
provisions of SFAS No. 150 as of July 1, 2003; adopting
the statement did not have a material impact on the
Company's consolidated financial statements.
FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities - an Interpretation of ARB No.
51," was issued in January 2003. The Interpretation ("FIN
46") addresses consolidation of variable interest entities
("VIEs") to which the usual condition for consolidation
described in Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," does not apply
because the VIEs have no voting interests or otherwise are
not subject to control through ownership of voting
interests. It requires existing unconsolidated VIEs to be
consolidated by their primary beneficiaries if the
entities do not effectively disperse risks among parties
involved. The provisions of FIN 46 are effective
immediately for VIEs created after January 31, 2003, and
to VIEs in which an entity obtains an interest after that
date. An entity with a variable interest in a VIE created
before February 1, 2003, will be subject to the effective-
date deferral provisions of FASB Staff Position ("FSP")
No. FIN 46-6 issued in October 2003 discussed below.
On October 9, 2003, the FASB issued FSP No. FIN 46-6
that defers the effective date for applying the provisions
of FIN 46 to the first interim or annual period ending
after December 15, 2003, for VIEs created before February
1, 2003, if the public entity has not issued financial
statements consolidating the VIE. FSP No. FIN 46-6 also
allows a public entity to early adopt the provisions of
FIN 46 for some or all of its VIEs. Accordingly, the
Company has elected to adopt FIN 46 for the trusts
discussed below as of July 1, 2003, but will defer
adopting FIN 46 for other potential VIEs (franchisees and
licensees) until December 31, 2003, to allow more time to
determine how FIN 46 may further affect the Company, if at
all.
The Company has included the assets, liabilities,
noncontrolling interests and results of activities of
certain trusts in its consolidated financial statements
effective July 1, 2003. The trusts, which were funded by
a group of senior lenders, were established in connection
with two lease facilities that have provided the Company
with $191.0 million in off-balance sheet financing for
constructing new stores and acquiring operating
convenience stores from unaffiliated third parties. The
9
trusts acquired land and undertook construction projects
for which the Company was the construction agent or
acquired operating convenience stores from third parties.
As a result of consolidating the trusts into the Company's
financial statements, the accompanying condensed
consolidated balance sheets include $178.1 million in
notes payable to senior lenders, $157.4 million (net of
accumulated depreciation of $16.3 million) in property and
equipment and $10.5 million of other net assets as of July
1, 2003. Consolidation of these trusts into the Company's
financial statements resulted in an after-tax, one-time
cumulative effect charge of $10.2 million (net of deferred
tax benefit of $6.6 million).
10
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Shareholders of 7-Eleven, Inc.:
We have reviewed the accompanying condensed consolidated
balance sheet of 7-Eleven, Inc. and Subsidiaries as of
September 30, 2003, and the related condensed consolidated
statements of earnings for the three-month and nine-month
periods ended September 30, 2002 and 2003, and the
condensed consolidated statements of cash flows for the
nine-month periods ended September 30, 2002 and 2003.
These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards
established by the American Institute of Certified Public
Accountants. A review of interim financial information
consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible
for financial and accounting matters. It is substantially
less in scope than an audit conducted in accordance with
generally accepted auditing standards, the objective of
which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the accompanying
condensed consolidated interim financial statements for
them to be in conformity with accounting principles
generally accepted in the United States of America.
We previously audited, in accordance with auditing
standards generally accepted in the United States of
America, the consolidated balance sheet as of December 31,
2002, and the related consolidated statements of earnings,
shareholders' equity (deficit), and cash flows for the
year then ended (not presented herein); and in our report
dated January 30, 2003, which included an explanatory
paragraph for the adoption of newly issued accounting
standards in 2001 and 2002, we expressed an unqualified
opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of
December 31, 2002, is fairly stated in all material
respects in relation to the consolidated balance sheet
from which it has been derived.
PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
October 23, 2003
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
THIS REPORT INCLUDES CERTAIN STATEMENTS THAT ARE "FORWARD-
LOOKING STATEMENTS" WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995. ANY STATEMENT IN THIS REPORT
THAT IS NOT A STATEMENT OF HISTORICAL FACT MAY BE DEEMED TO BE A
FORWARD-LOOKING STATEMENT. WE OFTEN USE THESE TYPES OF
STATEMENTS WHEN DISCUSSING OUR PLANS AND STRATEGIES, OUR
ANTICIPATION OF REVENUES FROM DESIGNATED MARKETS AND STATEMENTS
REGARDING THE DEVELOPMENT OF OUR BUSINESSES, THE MARKETS FOR OUR
SERVICES AND PRODUCTS, OUR ANTICIPATED CAPITAL EXPENDITURES,
OPERATIONS, SUPPORT SYSTEMS, CHANGES IN REGULATORY REQUIREMENTS
AND OTHER STATEMENTS CONTAINED IN THIS REPORT REGARDING MATTERS
THAT ARE NOT HISTORICAL FACTS. WHEN USED IN THIS REPORT, THE
WORDS "EXPECT," "ANTICIPATE," "INTEND," "PLAN," "BELIEVE,"
"SEEK," "ESTIMATE," AND OTHER SIMILAR EXPRESSIONS ARE GENERALLY
INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. BECAUSE THESE
FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES,
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR
IMPLIED BY THESE FORWARD-LOOKING STATEMENTS. THERE CAN BE NO
ASSURANCE THAT: (I) WE HAVE CORRECTLY MEASURED OR IDENTIFIED ALL
OF THE FACTORS AFFECTING THESE MARKETS OR THE EXTENT OF THEIR
LIKELY IMPACT; (II) THE PUBLICLY AVAILABLE INFORMATION WITH
RESPECT TO THESE FACTORS ON WHICH OUR ANALYSIS IS BASED IS
COMPLETE OR ACCURATE; (III) OUR ANALYSIS IS CORRECT OR (IV) OUR
STRATEGY, WHICH IS BASED IN PART ON THIS ANALYSIS, WILL BE
SUCCESSFUL. WE DO NOT ASSUME ANY OBLIGATION TO UPDATE OR REVISE
ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW
INFORMATION, FUTURE EVENTS OR OTHERWISE.
We are the world's largest operator, franchisor and licensor
of convenience stores and the largest convenience store chain in
North America. Our revenue principally consists of merchandise
and gasoline sales and, to a lesser extent, royalty income from
licensees. Our primary expenses consist of cost of goods sold;
operating, selling, general and administrative expense;
occupancy expense; interest expense and taxes.
We seek to meet the changing needs of convenience customers
and maintain a leadership position in the convenience store
industry by leveraging our scale, technology, people and widely
recognized brand. We continue to focus on our traditional
convenience store business as well as our growth strategy to
further our competitive advantage and improve our financial
results.
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2003,
TO THREE MONTHS ENDED SEPTEMBER 30, 2002
NET SALES
Three Months Ended
September 30
--------------------------
2002 2003
--------- ----------
Net Sales: (in millions)
Merchandise sales $ 1,979.7 $ 2,102.3
Gasoline sales 754.3 903.5
-------- --------
Total net sales $ 2,734.0 $ 3,005.8
U.S. same-store merchandise sales growth 3.2% 3.7%
Gasoline gallons sold (in millions) 524.6 552.1
Gasoline gallon sales change per store 4.4% 3.4%
Average retail price of gasoline per gallon $ 1.44 $ 1.64
12
Merchandise sales for the three months ended September 30,
2003, increased $122.6 million, or 6.2%, over the same period in
2002. U.S. same-store merchandise sales growth was 3.7% for the
three months ended September 30, 2003, on top of 3.2% for the
three months ended September 30, 2002. Key contributors to the
merchandise sales growth in 2003 were increases in the sales of
cigarettes, beverages, prepaid cards, beer and fresh food.
Gasoline sales for the three months ended September 30, 2003,
increased $149.2 million, or 19.8%, compared to the same period
in 2002. We attribute this to an increase of 20 cents per gallon
in our average retail price of gasoline in the third quarter of
2003, compared to the same quarter in 2002, as well as an increase
in gallons sold of 5.2% to 552.1 million gallons. This increase
in gallons sold translates into 3.4% growth on a per store basis.
GROSS PROFIT
Three Months Ended
September 30
--------------------------
2002 2003
-------- ---------
Gross Profit (in millions)
Merchandise gross profit $ 696.5 $ 726.3
Gasoline gross profit 66.6 90.7
-------- --------
Total gross profit $ 763.1 $ 817.0
Merchandise gross profit margin 35.18% 34.55%
Merchandise gross profit growth per store 5.8% 2.5%
Gasoline gross profit margin cents per gallon 12.7 16.4
Gasoline gross profit change per store (13.0)% 33.8%
Merchandise gross profit for the three months ended September
30, 2003, increased $29.8 million, or 4.3%, over the same period
in 2002 as a result of higher sales. Gross profit margin
declined 63 basis points to 34.55% for the third quarter of 2003
from 35.18% for the same period in 2002. Changes in product mix
positively impacted merchandise sales and gross profit dollars,
but resulted in a lower merchandise margin during the quarter.
The changing product mix affects merchandise margins as we sell
more items that contribute to gross profit dollars but
negatively impact gross profit margin, such as cigarette
cartons, prepaid phones and phone cards. The impact on
merchandise margin was partially offset by a continuation of the
favorable trend from managing cost of goods and shortages.
Gasoline gross profit for the three months ended September 30,
2003, increased $24.1 million, or 36.3%, to $90.7 million.
Expressed as cents per gallon, our gasoline margin was 16.4
cents in the third quarter of 2003 compared to 12.7 cents in the
third quarter of 2002. Declining wholesale costs midway through
the third quarter, followed by generally stable retail pricing,
contributed to the higher gasoline profit.
OTHER INCOME
Other income for the three months ended September 30, 2003,
was $26.2 million, an increase of $2.0 million, or 7.9%, from
$24.2 million for the same period in 2002. Our royalty income
from our area licensees was $13.8 million for the three months
ended September 30, 2003, compared to $17.8 million for the same
period in 2002, a $4.0 million decrease. As we anticipated,
because of a reduction in the Seven-Eleven Japan ("SEJ")
licensing royalty rate, our royalties from SEJ declined by $5.1
million compared to the same period in 2002. This decrease was
partially offset by an increase in Vcom placement fee income as
a result of the installation of additional kiosks compared to
the prior-year quarter. See "Liquidity and Capital Resources."
13
FRANCHISEE GROSS PROFIT EXPENSE
Franchisee gross profit expense for the three months ended
September 30, 2003, was $220.2 million, an increase of $12.6
million, or 6.0%, from $207.6 million for the same period in 2002.
The increase is due to higher gross profit, which resulted from
increased sales at franchised stores as well as an increase in the
number of stores operated by franchisees.
OPERATING, SELLING, GENERAL AND ADMINISTRATIVE EXPENSE (OSG&A)
The primary components of OSG&A are store expenses, occupancy
(including depreciation) and corporate expenses. OSG&A for the
three months ended September 30, 2003, was $546.5 million, an
increase of $32.0 million, or 6.2%, from $514.5 million for the
same period in 2002. The primary drivers of the increase were
higher occupancy expenses, compensation and other benefits,
environmental costs and credit card processing fees partially
offset by a gain due to the redemption of the senior subordinated
debentures.
The ratio of OSG&A to revenues decreased to 18.0% for the
third quarter of 2003 from 18.7% for the third quarter of 2002.
Included in OSG&A for the three months ended September 30, 2003
was a $9.9 million currency conversion loss, a $7.0 million
charge related to the California remediation receivable balance,
and a $10.5 million gain due to the redemption of the senior
subordinated debentures. Included in OSG&A for the same period
of 2002 was an $835,000 currency conversion gain. See "Liquidity
and Capital Resources."
INTEREST EXPENSE, NET
Net interest expense for the three months ended September 30,
2003, was $19.7 million, an increase of $3.4 million, or 20.8%
from $16.3 million for the same period in 2002. The increase is
primarily due to new borrowings of senior subordinated debt and
the consolidation of debt in accordance with Financial Accounting
Standards Board ("FASB") Interpretation No. 46, "Consolidation of
Variable Interest Entities - an Interpretation of ARB No. 51,"
("FIN 46"). See "Liquidity and Capital Resources" and "Other
Issues -Adoption of New Accounting Standards."
INCOME TAX EXPENSE
Income tax expense for the three months ended September 30,
2003, was $21.6 million compared to $19.6 million for the same
period in 2002. Our effective tax rate was 38.0% for the third
quarter of 2003, compared to 40.0% for the third quarter of 2002.
EARNINGS FROM CONTINUING OPERATIONS
For the three months ended September 30, 2003, our earnings
from continuing operations were $35.2 million ($0.29 per diluted
share), compared to $29.4 million ($0.25 per diluted share) for
the same period in 2002.
DISCONTINUED OPERATIONS
Discontinued operations for the three months ended September
30, 2003, resulted in a gain of $926,000 (net of $568,000 tax
expense) compared to a gain of $90,000 (net of $60,000 tax
expense) for the same period in 2002. These stores had total
revenues of $1.7 million and $34.5 million and
14
pretax earnings of $1.5 million and $150,000 for the three
months ended September 30, 2003 and 2002, respectively.
Included in the September 30, 2003 pretax gain is a gain on
disposal of $5.3 million from the sale of 12 non-strategic stores
in Wisconsin.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Effective July 1, 2003, we adopted FIN 46, which resulted in a
one-time charge of $10.2 million, net of deferred tax benefit,
related to the cumulative effect of the accounting change
resulting from the consolidation of two trusts that provided us
with off-balance sheet financing. See "Other Issues - Adoption
of New Accounting Standards."
NET EARNINGS
Net earnings for the three months ended September 30, 2003,
were $25.9 million ($0.22 per diluted share), compared to $29.5
million ($0.25 per diluted share) for the same period in 2002.
SEASONALITY
Weather conditions can have a significant impact on our sales,
as buying patterns have shown that our customers increase their
transactions and also purchase higher profit margin products when
weather conditions are favorable. Consequently, our results are
seasonal, and we typically earn more during the warmer second and
third quarters.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2003,
TO NINE MONTHS ENDED SEPTEMBER 30, 2002
NET SALES
Nine Months Ended
September 30
--------------------------
2002 2003
--------- ---------
Net Sales: (in millions)
Merchandise sales $ 5,430.8 $ 5,763.8
Gasoline sales 2,031.7 2,556.9
-------- --------
Total net sales $ 7,462.5 $ 8,320.7
U.S. same-store merchandise sales growth 3.1% 3.4%
Gasoline gallons sold (in millions) 1,487.1 1,588.4
Gasoline gallon sales change per store 3.6% 4.1%
Average retail price of gasoline per gallon $ 1.37 $ 1.61
Merchandise sales for the nine months ended September 30,
2003, increased $333.0 million, or 6.1%, over the same period in
2002. U.S. same-store merchandise sales growth was 3.4% for the
nine months ended September 30, 2003, on top of 3.1% for the nine
months ended September 30, 2002. Key contributors to the
merchandise sales growth in 2003 were increases in the sales of
cigarettes, prepaid cards, beer, beverages and fresh food.
Gasoline sales for the nine months ended September 30, 2003,
increased $525.2 million, or 25.9%, compared to the same period in
2002. We attribute this increase to an increase of 24 cents per
gallon in our average retail price of gasoline in the first nine
months of 2003, compared to the same period in 2002, as well as an
increase of 6.8% in gallons sold to 1,588.4 million gallons. This
increase in gallons sold equates to a 4.1% growth in gallons sold
per store.
15
GROSS PROFIT
Nine Months Ended
September 30
--------------------------
2002 2003
------ -------
Gross Profit (in millions)
Merchandise gross profit $ 1,901.4 $ 1,984.6
Gasoline gross profit 184.6 251.1
--------- ---------
Total gross profit $ 2,086.0 $ 2,235.7
Merchandise gross profit margin 35.01% 34.43%
Merchandise gross profit growth per store 5.4% 2.4%
Gasoline gross profit margin cents per gallon 12.4 15.8
Gasoline gross profit change per store (8.0)% 32.5%
Merchandise gross profit for the nine months ended September
30, 2003, increased $83.2 million, or 4.4%, over the same
period in 2002 as a result of higher sales. Gross profit
margin declined 58 basis points to 34.43% for the nine months
ended September 30, 2003 from 35.01% for the same period in
2002. The decrease in overall gross profit margin is
attributable to our strategy of maximizing gross profit
dollars. The changing product mix affects merchandise margins
as we sell more items that contribute to gross profit dollars
but negatively impact gross profit margin, such as cigarette
cartons, prepaid phones and phone cards. The impact from
product assortment changes was partially offset by the
continued emphasis on managing cost of goods.
Gasoline gross profit for the nine months ended September
30, 2003, increased $66.5 million, or 36.0%, to $251.1 million.
Expressed as cents per gallon, our gasoline margin was 15.8
cents in the nine-month period ended September 30, 2003,
compared to 12.4 cents for the same period in 2002. Although
wholesale costs were greater in the nine-month period ended
September 30, 2003, than in the same period a year ago, retail
prices were much higher than in the prior-year period,
contributing to the increase in profit margin.
OTHER INCOME
Other income for the nine months ended September 30, 2003,
was $71.2 million, a decrease of $7.5 million, or 9.6%, from
$78.7 million for the same period in 2002. Our royalty income
from our area licensees was $38.4 million for the nine months
ended September 30, 2003, compared to $59.5 million for the
same period in 2002. Of this decrease, $24.0 million was
primarily due to the previously anticipated reduction in the
SEJ licensing royalty rate. The decrease in the licensing
royalties was partially offset by an increase in franchise fees
and an increase in Vcom placement fee income as a result of the
installation of additional kiosks over the prior-year nine-
month period. See "Liquidity and Capital Resources."
FRANCHISEE GROSS PROFIT EXPENSE
Franchisee gross profit expense for the nine months ended
September 30, 2003, was $597.8 million, an increase of $36.4
million, or 6.5%, from $561.4 million for the same period in
2002. The increase is due to higher per-store gross profit,
which resulted from increased sales at franchised stores as well
as an increase in the number of stores operated by franchisees.
OPERATING, SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE
(OSG&A)
The primary components of OSG&A are store expenses, occupancy
(including depreciation) and corporate expenses. OSG&A for the
nine months ended September 30, 2003, was $1,525.0 million, an
increase of $74.2 million, or 5.1%, from $1,450.8 million for
the same period in 2002. The primary drivers of the increase
16
were higher occupancy expenses, compensation and other benefits,
environmental costs and credit card processing fees partially
offset by a gain due to the redemption of the senior subordinated
debentures.
The ratio of OSG&A to revenues decreased to 18.2% for the nine
months ended September 30, 2003 from 19.2% for the same period in
2002. Included in OSG&A for the nine months ended September 30,
2003 was a $10.5 million gain due to the redemption of the senior
subordinated debentures, a $3.6 million gain related to life
insurance proceeds, a $7.0 million dollar charge related to the
California remediation receivable balance, a $6.2 million currency
conversion loss and $0.8 million charge related to severance
expenses. Included in OSG&A for the same period of 2002 was a
$6.9 million charge related to severance and other expenses and a
$12.0 million currency conversion loss. See "Liquidity and Capital
Resources."
INTEREST EXPENSE, NET
Net interest expense for the nine months ended September 30,
2003, was $52.5 million, an increase of $4.0 million, or 8.3%,
from $48.5 million for the same period in 2002. The increase is
primarily due to new borrowings of senior subordinated debt and
the consolidation of debt in accordance with FIN 46. See
"Liquidity and Capital Resources."
In accordance with SFAS No. 15, "Accounting by Debtors and
Creditors for Troubled Debt Restructuring," our debentures were
recorded at an amount equal to the undiscounted cash payments of
both principal and interest, and we did not recognize interest
expense on our debentures in our condensed consolidated statement
of earnings. Accordingly, until the debentures were retired in
July 2003, we charged the cash interest payments against the
recorded amount of the debentures.
INCOME TAX EXPENSE
Income tax expense for the nine months ended September 30,
2003, was $50.0 million compared to $41.6 million for the same
period in 2002. Our effective tax rate was 38.0% for the nine
months ended September 30, 2003 compared to 40.0% for the nine
months ended September 30, 2002.
EARNINGS FROM CONTINUING OPERATIONS
For the nine months ended September 30, 2003, our earnings
from continuing operations before cumulative effect of accounting
change were $81.5 million ($0.71 per diluted share), compared to
$62.5 million ($0.55 per diluted share) for the same period in
2002.
DISCONTINUED OPERATIONS
Discontinued operations for the nine months ended September
30, 2003, resulted in a loss of $1.1 million (net of $697,000
tax benefit) compared to a loss of $10.0 million (net of $6.7
million tax benefit) for the same period in 2002. These stores
had total revenues of $29.8 million and $120.8 million and
pretax losses of $1.8 million and $16.7 million for then nine
months ended September 30, 2003 and 2002, respectively. The
pretax loss for the nine months ended September 30, 2003,
includes a gain of $5.3 million from the sale of 12 non-strategic
stores in Wisconsin. The pretax loss for the nine months ended
September 30, 2002, includes a loss on disposal of $11.6 million.
The loss on disposal represents write-downs of property and
equipment to net realizable value and anticipated future rent and
other expenses in excess of related estimated sublease income in
connection with the store closings.
17
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Effective July 1, 2003, we adopted FIN 46, which resulted in a
one-time charge of $10.2 million, net of deferred tax benefit,
related to the cumulative effect of the accounting change
resulting from the consolidation of two trusts that provided us
with off balance sheet financing. See "Other Issues - Adoption
of New Accounting Standards."
On January 1, 2002, we adopted SFAS No. 143, "Accounting for
Asset Retirement Obligations," which resulted in a one-time
charge of $28.1 million, net of deferred tax benefit, related to
the cumulative effect of the accounting change which relates to
the accounting for costs associated with future removal of
underground gasoline storage tanks.
NET EARNINGS (LOSS)
Net earnings for the nine months ended September 30, 2003, were
$70.2 million ($0.62 per diluted share), compared to a net
earnings of $24.3 million ($0.25 per diluted share) for the same
period in 2002.
LIQUIDITY AND CAPITAL RESOURCES
We obtain the majority of our working capital from these
sources:
* Cash flows generated from our operating activities;
* A $650 million commercial paper facility, guaranteed by
Ito-Yokado Co., Ltd.;
* Borrowings of up to $200 million under our revolving
credit facility.
We believe that operating activities, available working capital
sources and additional borrowings will provide sufficient
liquidity in 2003 to fund our operating costs, capital
expenditures and debt service. In addition, we intend to continue
accessing the leasing market to finance our new stores and certain
equipment.
We expect capital expenditures for 2003, excluding lease
commitments, will be between $315 million and $335 million. Our
new capital lease commitments for the first nine months of 2003
were $45.9 million compared to $23.7 million for the same period
in 2002. For the nine months ended September 30, 2003, our
capital expenditures and capital lease commitments were primarily
related to developing new stores, replacing store equipment and
information technology. We opened 54 stores in the first nine
months of 2003 and expect to open approximately 100 stores during
the full year 2003.
In January 2003, we entered into a note purchase agreement
with SEJ that authorizes the issuance and sale of up to $400
million aggregate principal amount of Senior Subordinated Notes
due January 27, 2010 ("SEJ Notes"), which we issued and SEJ
purchased in multiple tranches. Interest on the SEJ Notes was
calculated for each tranche on its issuance date and was set by a
formula tied to the United States Treasury Rate and Japanese
government bond rates. The SEJ Notes are subordinate to all
obligations outstanding under our revolving credit facility. On
January 10, 2003, we received $100 million from SEJ under the
note purchase agreement; the interest rate on this tranche is
3.41%. On July 9, 2003, we received the remaining $300 million
from SEJ under the note purchase agreement in three equal
payments of $100 million; the interest rate on these tranches is
3.01%, 3.34%, and 3.71% respectively.
In July 2003, we used a portion of the proceeds of the SEJ
Notes to retire $239.3 million principal amount of our 5% First
Priority Senior Subordinated Debentures due 2003, $111.4 million
18
principal amount of our 4 1/2% Second Priority Senior
Subordinated Debentures (Series A) due 2004 and $18.5 million
principal amount of our 4% Second Priority Senior Subordinate
Debentures (Series B) due 2004. As a result of including the
SFAS No. 15 interest in the carrying amount of the retired debt,
we recognized a pretax gain of $10.5 million in which was
recorded in OSG&A.
During the period the senior subordinated debentures were
outstanding, (see -"Comparison of Nine Months Ended September
30, 2003 to Nine Months Ended September 30, 2002-Interest
Expense, Net"), we did not recognize interest expense. Because
we recognize interest on the SEJ Notes, we expect an increase in
our interest expense of approximately $8 million for 2003 and
approximately $14 million annually beginning in 2004.
In September 2003, we converted all of the outstanding 1998
Convertible Quarterly Income Debt Securities due 2013 ("1998
QUIDS"), which were issued to Ito-Yokado Co., Ltd. and SEJ, into
approximately 6.5 million shares of 7-Eleven common stock. The
principal amount of the 1998 QUIDS was $80.0 million, and the
interest rate was 4.5%. As a result of the conversion, which
was mandatory under the terms of the 1998 QUIDS, our annual
interest expense will decrease by $3.6 million.
VCOM
We announced plans in the third quarter of 2002 to expand our
rollout of Vcom to 1,000 stores, adding to our original Vcom
pilot program in Texas and Florida. As of September 30, 2003,
this expanded rollout was complete. We funded the $55 million
capital investment needed for the Vcom rollout primarily through
a capital lease program. We estimate that we will need up to
$110 million by year-end to fund check-cashing and ATM
transaction disbursements to consumers. We are funding this
requirement through our commercial paper program.
In exchange for our granting strategic partners exclusive
rights to offer their services or products on our Vcom kiosks,
the partners will pay us placement fees, a percentage of the
transaction fees and, in certain circumstances, expense
reimbursement. Placement fee commitments for the 1,000 units
total approximately $150 million.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash provided by operating activities for the nine months
ended September 30, 2003, was $417.7 million compared to $382.7
million for the nine months ended September 30, 2002. We
attribute this increase to changes in working capital items,
primarily as a result of the timing of receipt of vendor
allowances and other receivables, the timing of payment of
merchandise and gasoline payables, the timing of funding for
money orders, decreases in employee benefits payables and
decreases in inventories.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used in investing activities for the nine months
ended September 30, 2003, was $187.2 million, a decrease of
$144.7 million, or 43.6%, from $331.9 million for the nine
months ended September 30, 2002. The primary driver of the
decrease was a $113.7 million decrease in capital expenditures
to $189.8 million for the nine months ended September 30, 2003,
from $303.5 million for the same period in 2002.
19
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash used in financing activities was $181.8 million for
the nine months ended September 30, 2003, an increase of $115.6
million from $66.2 million for the nine months ended September
30, 2002. The $400 million in proceeds from issuance of long-
term debt in 2003 resulted from the borrowings under the SEJ
Notes. As of September 30, 2003, long-term debt repayments were
$394.3 million compared to $27.7 million during the same period
in 2002. Included in the 2003 repayments was $369.2 million
related to the redemption of the senior subordinated debentures.
Net payments under commercial paper and revolving credit
facilities for the nine months ended September 30, 2003, totaled
$198.3 million, compared to net payments of $19.3 million for
the same period in 2002.
OTHER ISSUES
NEW FRANCHISE AGREEMENT
We have approximately 3,300 franchised stores. Of that
number, approximately 35% are subject to franchise agreements
that expire on December 31, 2003. We are continuing to develop
a new franchise agreement to replace the expiring agreements and
to offer to our other franchisees.
A committee of our franchisees will evaluate the economic
impact of the new agreement on our franchisees according to a
procedure set forth in a 1998 court-approved settlement
agreement. This procedure provides for extension of the
existing franchise agreements until all the steps in the
procedure have been completed.
We do not anticipate that the terms of the new agreement will
have a material adverse impact on our franchisees or us.
EXPANSION IN CHINA
There are currently approximately 485 7-Eleven stores in Hong
Kong and approximately 150 7-Eleven stores in the south China
province of Guangdong operated by subsidiaries of Dairy Farm
International Ltd. pursuant to a licensing arrangement.
We have been pursuing the possibility of entering into a
licensing arrangement for the greater Beijing market area with a
joint venture formed by Seven-Eleven Japan, President Chain
Store Corporation and two Chinese participants. President Chain
Store Corporation is our current licensee in Taiwan, where it
operates approximately 3,400 stores, and Seven-Eleven Japan is
our current licensee in Japan, where it operates approximately
10,000 7-Eleven stores. We have focused on the possibility of
negotiating a licensing arrangement with Seven-Eleven Japan and
President Chain Store Corporation because of their financial
strength, business experience in China and proven ability to
develop and operate 7-Eleven stores.
Because Seven-Eleven Japan, together with Ito-Yokado Co.,
Ltd., owns approximately 74% of our common stock, our Board of
Directors has appointed a Special Committee of three directors,
none of whom is affiliated with Seven-Eleven Japan, Ito-Yokado
or any of the proposed joint venture partners, to review and
consider the proposed licensing arrangement for approval.
During the third quarter of 2003, the Special Committee
approved the essential financial terms for the joint venture.
In addition, the Committee authorized us to proceed to negotiate
an area license agreement, which the Committee will then review
and consider for final approval.
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The members of the joint venture are in the process of
seeking the final approval of the Beijing government for the
formation of the joint venture. After the joint venture
receives that approval, we expect the negotiations regarding the
area license agreement to accelerate.
ENVIRONMENTAL
At September 30, 2003, our estimated undiscounted
liability for our environmental costs related to remedial
action at existing and previously operated gasoline storage
sites and other operating and non-operating properties where
releases of regulated substances have been detected was $37.8
million. We anticipate that substantially all of the future
remediation costs for detected releases of regulated substances
at remediation sites of which we are aware, as of September 30,
2003, will be incurred within the next five to six years. The
estimated liability could change within the near future for
several reasons, including (i) revisions to or the creation of
governmental requirements, (ii) existing remediation projects
become fully defined, resulting in revised estimates of the
cost to finish the projects and (iii) unplanned future failures
of underground gasoline storage tank systems.
Under state reimbursement programs, we are eligible to be
reimbursed for a portion of remediation costs previously
incurred. At September 30, 2003, we had recorded a net
receivable of $51.4 million for the estimated state
reimbursements, of which $27.0 million relates to remediation
costs incurred in the State of California. In assessing the
probability of state reimbursements, we take into consideration
each state's fund balance, revenue sources, existing claim
backlog, historical payments and claim ranking. As a result of
these assessments, the recorded receivable amounts at
September 30, 2003, are net of allowances of $11.0 million. The
estimated future state reimbursement amounts could change within
the near future as governmental requirements and state
reimbursement programs continue to be revised or extended.
While we cannot be certain of the timing of our receipt of
state reimbursement funds, based on our experience we expect to
receive the majority of state reimbursement funds within one to
three years after our payment of eligible remediation expenses.
This time period assumes that the state administrative
procedures for processing such reimbursements have been fully
developed.
The exception to our assumption regarding the timing of
when we will receive state reimbursement funds is in
California. The California reimbursement program separates
claims into four classes: A, B, C and D. Our claims are in
class D. As a result of the growing backlog of class D claims
and its impact on our estimate of when we will receive funds
from the California reimbursement program, we recorded a pretax
charge to OSG&A of $7 million in the third quarter of 2003 to
reflect our best estimate of the discounted value of our
California remediation receivable. We have recorded the
portion of the receivable that relates to remediation activities
that have already been completed at a discount rate of
approximately 5.0%. Thus, in addition to the allowance
discussed above, the recorded receivable amount is also net of a
discount of $19.6 million, which reflects the change in
estimated timing of reimbursements of our California claims.
Any revisions to our estimated future remediation
expenditures and related state reimbursement amounts could have
a material impact on our operations and financial position.
ADOPTION OF NEW ACCOUNTING STANDARDS
In April 2003, the Financial Accounting Standards Board
("FASB") issued SFAS No. 149, "Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149
amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified
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after June 30, 2003, for hedging relationships designated after
June 30, 2003, and to certain preexisting contracts. We have
adopted the provisions of SFAS No. 149 on a prospective basis
for any contracts entered into after June 30, 2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity." SFAS No. 150 establishes standards for
classifying and measuring as liabilities certain financial
instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. The provisions
of SFAS No. 150 are effective for all financial instruments
created or modified after May 31, 2003, and otherwise shall be
effective at the beginning of the first interim period beginning
after June 15, 2003. We adopted the provisions of SFAS No. 150
as of July 1, 2003; adopting the statement did not have a
material impact on our consolidated financial statements.
FIN 46 was issued in January 2003. The Interpretation
addresses consolidation of variable interest entities ("VIEs") to
which the usual condition for consolidation described in
Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," does not apply because the VIEs have no voting
interests or otherwise are not subject to control through
ownership of voting interests. It requires existing
unconsolidated VIEs to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks
among parties involved. The provisions of FIN 46 are effective
immediately for VIEs created after January 31, 2003, and to VIEs
in which an entity obtains an interest after that date. An
entity with a variable interest in a VIE created before February
1, 2003, will be subject to the effective-date deferral
provisions of the FASB Staff Position ("FSP") No. FIN 46-6
issued in October 2003, discussed below.
On October 9, 2003, the FASB issued FSP No. FIN 46-6 that
defers the effective date for applying the provisions of FIN 46
to the first interim or annual period ending after December 15,
2003, for VIEs created before February 1, 2003, if the public
entity has not issued financial statements consolidating the VIE.
FSP No. FIN 46-6 also allows a public entity to early adopt the
provisions of FIN 46 for some or all of its VIEs. Accordingly,
we have elected to adopt FIN 46 for the trusts discussed below as
of July 1, 2003, but will defer adopting FIN 46 for other
potential VIEs (franchisees and licensees) until December 31,
2003, to allow more time to determine how FIN 46 may further
affect us, if at all.
We have included the assets, liabilities, noncontrolling
interests, and results of activities of certain trusts in our
consolidated financial statements effective July 1, 2003. The
trusts, which were funded by a group of senior lenders, were
established in connection with two lease facilities that have
provided us with $191.0 million in off-balance sheet financing
for constructing new stores and acquiring operating convenience
stores from unaffiliated third parties. The trusts acquired
land and undertook construction projects for which we were the
construction agent or acquired operating convenience stores from
third parties. As a result of consolidating the trusts into our
financial statements, the accompanying condensed consolidated
balance sheets include $178.1 million in notes payable to senior
lenders, $157.4 million (net of accumulated depreciation of
$16.3 million) in property and equipment and $10.5 million of
other net assets.
Consolidation of these trusts into our financial statements
resulted in an after-tax, one-time cumulative effect charge of
$10.2 million (net of deferred tax benefit of $6.6 million), as
well as an after-tax charge on earnings from continuing
operations of $1.4 million in the third quarter of 2003. On an
annual basis, we expect the after-tax impact on earnings from
continuing operations to be a charge of approximately $6 million.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET
RISK
See "Management's Discussion and Analysis of Financial
Condition and Results of Operations," above.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a system of controls and procedures designed to
provide reasonable assurance as to the reliability of the
financial statements and other disclosures included in this
report, as well as to safeguard assets from unauthorized use or
disposition. Within 90 days prior to the filing of this report,
our Chief Executive Officer and Chief Financial Officer have
evaluated the effectiveness of the design and operation of our
disclosure controls and procedures with the assistance and
participation of other members of management.
Based upon that evaluation, our Chief Executive Officer and
Chief Financial Officer concluded that:
* Our disclosure controls and procedures are effective for
gathering, analyzing and disclosing the information we are
required to disclose in the reports we file under the
Securities Exchange Act of 1934 within the time periods
specified in the SEC's rules and forms; and
* There has been no change in our internal control over
financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal
control over financial reporting.
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PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We have been advised that we are the subject of an
investigation by the District Attorney's Office of San Joaquin
County, California, for allegedly violating the California Health
& Safety Code by failing to obtain permits to replace certain
monitoring systems for underground storage tanks at seven stores.
The allegations are based primarily on the alleged failure of our
contractor to comply with these permitting requirements.
Subsequently, the District Attorney for San Joaquin County
obtained the cooperation of two additional counties, and the
investigation was expanded to include issues of operational
store-level compliance with environmental regulations.
We have learned that the district attorneys in these three
counties have been authorized by the Attorney General of
California to conduct a statewide investigation and enforcement
action covering alleged violations at our gasoline locations in
California.
In October 2003, we received a written demand to resolve
all of these alleged violations. The demand includes injunctive
provisions, restitution relief, civil penalties and legal and
investigative costs.
We are cooperating with authorities and continuing to
evaluate this matter as additional information is gathered.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
1. Exhibit 15 - Letter re Unaudited Interim
Financial Information. Letter of
PricewaterhouseCoopers LLP.
2. Exhibit 31(1) - Certification by Chief Executive
Officer
Required by Section 302 of the Sarbanes-Oxley
Act of 2002.
3. Exhibit 31(2) - Certification by Chief Financial
Officer
Required by Section 302 of the Sarbanes-Oxley
Act of 2002.
4. Exhibit 32(1) - Certification by Chief Executive
Officer
Required by Section 906 of the Sarbanes-Oxley
Act of 2002.
5. Exhibit 32(2) - Certification by Chief Financial
Officer
Required by Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) 8-K Reports:
DATE OF REPORT DESCRIPTION
-------------------- --------------------------
July 31, 2003 Furnished copy of press release
issued on July 31, 2003,
announcing the Company's earnings
for the second quarter of 2003
September 18, 2003 Furnished copy of press release
issued on September 18, 2003,
announcing the mandatory conversion
of the Convertible Quarterly Income
Debt Securities Due 2013 in the
principal amount of $80 million.
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SIGNATURES
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.
7-ELEVEN, INC.
(Registrant)
Date: November 7, 2003 /s/ James W. Keyes
--------------------------------
(Officer)
James W. Keyes
President and Chief Executive Officer
Date: November 7, 2003 /s/ Edward W. Moneypenny
--------------------------------
(Principal Financial Officer)
Edward W. Moneypenny
Senior Vice President and
Chief Financial Officer
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