SpartanNash Co (SPTN) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Spartan Stores third-quarter conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation.

It is now my pleasure to introduce our host, Mr. Craig Sturken, President and CEO. Sir, please go ahead.

Good morning, everyone, and thanks for calling into our fiscal 2004 third-quarter earnings conference call. If you don't already have a copy of the earnings release, you can call our offices at 616-878-8319 and ask for Jean Kirkbride (ph) and she will be glad to fax you a copy.

With me this morning are other members of our management team, including Executive VP and CFO Dave Staples; Executive VP of Merchandising and Marketing Dennis Eidson; Executive VP of Supply Chain John Sommavilla; and Executive VP of Operations Ted Adornato.

Before we begin discussing our quarterly financial and operational performance, I must remind you that our comments today will contain forward-looking statements. These forward-looking statements may contain plans, expectations, estimates, and projections that involve significant risks and uncertainty. Actual results may differ materially from the results discussed in these forward-looking statements. Internal and external factors that might cause such a difference include, but are not limited to -- competitive pressures among food retail and distribution companies, general economic and market conditions, and other factors described in our earnings announcements and annual reports on Form 10-K and other filings with the SEC. Spartan Stores disclaims any intention or obligation to update or revise any forward-looking statements.

I will begin by saying that we continue to make significant progress on our top priorities during the third quarter. We're very pleased to report that third-quarter consolidated sales increased 5.1 percent, representing our third consecutive quarter of sales growth. Third-quarter retail and distribution sales increased at a solid 5.9 and 4.5 percent, respectfully. Retail comparable store sales grew by an above-industry average rate of 5.7 percent in the third quarter. Our retail sales improvement occurred across all of our operating markets and at most (ph) stores, because we're starting to realize the full effect of our new marketing and merchandising practices, programs, and strategies.

Again in this quarter, we experienced considerable sales growth at our Pharm deep discount drugstores. This solid performance indicates that we are making significant progress in this intensely competitive retail grocery environment.

On a consolidated basis, we reported a quarterly operating profit of 6.1 million (ph). Operating earnings in our distribution business increased a significant 47 percent, while the operating loss in our retail business declined sharply. This improvement is a direct result of fundamental changes made in our retail operations, our cost-cutting initiatives, and our stronger focus on the overall distribution business. Our more effective retail programs are driving improvements at retail operations and are positively affecting our distribution business. Our operations have a high degree of operating leverage, so as sales improve, incremental volume produces higher profits.

During the third quarter, we achieved a major organizational milestone. On December 23rd, we completed our debt refinancing effort. The refinancing initiative has been an important priority that required considerable executive resources during the past 18 months. We are pleased to have secured new four-year asset-based credit facilities totaling $185 million and to have concluded (ph) the process. The new credit facility improves our long-run (ph) financial flexibility and stability, and has allowed us to direct all resources to our business operations. We believe that redirecting those resources will help build on our favorable financial and operational momentum.

From an operational perspective, we recently announced the consolidation of our retail grocery store vendors in an effort to streamline operations and promote more effective marketing and advertising programs. We were maintaining five retail grocery store banners and decided to consolidate them to just two. All of our grocery stores will now carry either the Family Fare supermarkets or Glen's markets names. These are the most widely recognized names among our retail stores and represent the largest number of stores we currently operate.

Lastly, we recently completed the sale of our United Wholesale Grocery company, which was the last piece of our convenience store distribution business. The proceeds of 17.4 million will be used to deleverage the balance sheet and pay off related operating liabilities and expenses.

With that introduction, I will ask Dave to give you a more detailed look at the third-quarter financial performance. I will rejoin the call later to talk more specifically about what has been driving our recent sales growth and to discuss our expectations for upcoming quarters. Dave?

Thank you, Craig, and good morning. Consolidated net sales for the third quarter increased a solid 5.1 percent to 644.1 million from 612.9 million in last year's comparable quarter. The year-over-year third-quarter sales increase was due to continuing improvements in our retail and distribution businesses. Gross margin for the third quarter increased 10 basis points to 18 percent from 17.9 percent in the third quarter last year. The gross margin improvement was due primarily to an improvement in retail gross margin rates.

Excluding a 47.4 million asset impairment and exit cost charge in last year's third quarter, operating expenses for the quarter declined $500,000 to 110.1 million from 110.6 million in the corresponding period last year on higher sales volumes. Operating costs declined despite higher advertising and employee severance costs associated with our third-quarter staff reduction.

Excluding last year's third-quarter asset impairment and exit charge, operating expenses as a percentage of sales fell 100 basis points to 17.1 percent compared with 18.1 percent in fiscal 2003's third quarter. Our fourth-quarter operating expense ratio should continue to compare favorably on a year-over-year basis due to the cycling of new stores, the continuing effect of our cost reduction initiatives, and our expectations for continued sales growth.

Excluding last year's asset impairment and exit cost charge, third-quarter operating earnings improved significantly to 6.1 million compared to an adjusted operating loss of 800,000 for the corresponding period last year. Third-quarter operating earnings were offset by a noncash charge of 8.8 million, or 5.7 million on an after-tax basis, for the write-off of unamortized fees related to our debt refinancing. Despite this write-off, the third-quarter net loss fell sharply to 4.1 million or 20 cents per diluted share compared with a net loss of 57.1 million or $2.87 per diluted share in the corresponding period of last year. Excluding the noncash fee write-off, we would have reported third-quarter net income of approximately 1.6 million for the current year.

Turning to our business segments -- third-quarter grocery distribution sales increased 4.5 percent to 362.2 million from 346.7 million last year. The increase was due primarily to the addition of new customers, more attractive merchandising initiatives, and additional product line sales to existing customers. The third-quarter sales increase is our third consecutive quarter of year-over-year sales growth in this segment.

Third-quarter operating income for the grocery distribution segment increased 47 percent to 7.4 million from 5.1 million last year. The improvement was due primarily to improved fixed cost leverage because of higher sales volumes and lower overhead costs. Third-quarter retail sales increased 5.9 percent to 281.9 million from last year's 266.2 million, and comparable store sales increased 5.7 percent. The sales increase represents the third consecutive quarter of comparable store sales growth and is above current industry averages.

As Craig mentioned, comparable store sales were favorable across a broad segment of our stores, with particular strength in our Pharm locations. The comparable store sales increase was due primarily to more effective marketing and merchandising program, and increased sales from three new stores opened during fiscal 2003's third quarter. Also contributing to the sales increase was the closure of competing stores in three of our northern Michigan markets and the closing of our Food Town stores, which transferred business to our Pharm locations. We expect these overall favorable sales trends to continue through the fourth quarter, despite the opening of a supercenter in our Michigan market.

Excluding the previously mentioned fiscal 2003 asset impairment and exit charge, our retail segment's third-quarter operating loss narrowed significantly to 1.3 million compared to an adjusted operating loss of 5.9 million in the same period last year. Although we experienced aggressive competition, we were able to improve our gross margin rate above the prior-year level, and we realized better operating cost leverage, both helping to improve profitability. We expect retail gross margins to remain relatively stable through the remainder of the year, excluding the potential impact of implementing a retail stock ledger (ph) system which I will cover shortly.

As Craig mentioned, we're pleased to have a new long-term debt facility in place. Completion of this refinancing has been a major focus of the management team, and we are pleased with the improved financial flexibility it will bring. We expect annual debt repayments will be approximately $10 million after giving effect to the new facility, compared to the 18.4 million reported in the second quarter of last year.

Long-term debt, including current maturities, declined 34 percent to 145.4 million at January 3, 2004, compared with 220.4 million at March 29, 2003. The completion of the United Wholesale Grocery company sale during the fourth quarter will also -- will allow us to further reduce our debt balance. We expect to record an after-tax gain from this transaction of approximately 6.6 million, or 4.3 million after-tax in the fourth quarter.

Our investment and working capital declined 43.9 percent to 48.9 million at January 3, 2004, compared with 87.2 million at the end of fiscal 2003. The lower investment was due primarily to our asset divestiture initiatives, as these businesses operated with higher net inventory investments than our remaining business units.

As you may be aware, we utilize the retail inventory method to value our inventory at the retail segment. Under the retail inventory method, inventory is stated at cost, with cost of goods sold and gross margin calculated by applying a cost ratio to the retail value of inventories. We plan on implementing a stock ledger inventory margin management system by the beginning of fiscal 2005 that will refine our ability to calculate and track gross margin and inventory balances on a weekly basis. The stock ledger will automatically capture purchase cost, retail prices, and markdowns at the transaction level, making our inventory valuation estimates more precise. It will also allow us to more actively monitor gross margins and more easily identify opportunities for gross margin improvement.

As a result of this system implementation, and depending on net (ph) existing inventory levels and inventory mix, we could record a noncash charge of up to $3 million on an after-tax basis in the (technical difficulty) quarter of fiscal 2004. We expect our favorable sales growth trend to continue during the fourth quarter. We also expect gross margins to approximate existing levels in each business segment, excluding any potential effect from the stock ledger implementation. And we look for continued year-over-year improvement in our SG&A run rate.

It's important to remember that the fourth quarter is the lowest sales volume quarter for our retail business. Because the retail segment carries a higher percentage of fixed cost, our SG&A rates will increase in the fourth quarter relative to the second and third quarters. We expect capital expenditures to approximate 12 to 14 million, and depreciation and amortization to approximate 27 million for fiscal 2004. We will provide additional guidance for fiscal 2005 during our fourth-quarter conference call.

I will now turn the call back to Craig.

Thanks, Dave. I will now share my insights about the competitive landscape, our improving sales trends, and our operational improvements.

We are very pleased to report continuing positive trends in our financial and operational performance. Our solid third-quarter performance and three consecutive quarters of sales improvements demonstrate that our business model is effective and capable of producing sales growth in this competitive environment (ph). During the first quarter of this fiscal year, we had one supercenter open in our northern Michigan retail market. This is the fifth supercenter opening in our markets over the past two years. An additional supercenter opened in our markets during the fourth quarter, and we expect two additional openings in early fiscal 2005.

Although these openings will moderate sales growth at our affected stores, we continue to expect our retail and overall sales growth to remain robust because of improved operational execution and the introduction of new merchandising retail programs at additional store locations. In short, we still have plenty of room to increase our effectiveness.

As stated during previous conference calls, we have fundamentally changed to a consumer-centric business model. This strategy has dramatically improved our marketing and merchandising practices. For example, we are now offering more and better values of the products that consumers want most. We have broadened product specials to include more national brands, and have made these specials available for longer periods. This change has produced two specific operational benefits. First, it has made store labor more efficient because we have reduced the number of display changes. Second, these specials are getting the attention of a broader segment of consumers. Consumer perceptions about our stores are changing because we are carrying more of the products that they want at better values. In addition, as sales of product categories have grown, our suppliers are providing improved marketing support which allows us to offer even more value to our consumers. Execution at store level has significantly improved as we continue to leverage our retail knowledge, expand the use a sound category management practices, and make better use of market intelligence.

From an operations standpoint, we are making much better use of retail floor space. Some of our stores have not performed merchandise resets, and have not analyzed product space allocation for more than seven years. These fundamental details of retailing are very important because they influence sales per square foot. Merchandise resets and floor space allocation are critical practices that help retailers keep pace with rapidly changing consumer buying habits. For example, there is little value in maintaining a large amount of retail space for automotive products when consumers have turned to mass auto parts retailers for these needs.

We are currently in the process of reallocating retail space to products that consumers want most. We expect to complete our initial store resets and product flow enhancements at 18 of our grocery stores by this fiscal year end and another 23 stores are scheduled for fiscal 2005. In addition, we have reset and approved the product flow at 19 of our 21 Pharm stores, with the remaining stores scheduled for fiscal 2005.

Since completing our refinancing efforts in December, our entire executive management team is more engaged in the day-to-day business operations. For example, our executive managers visited all 75 of our retail stores as a team during the month of December. This was an important exercise, because our managers now more fully understand where capital, marketing, and merchandising spending can be the most effective. Our store directors and employees understand that the performance of every store is important, and that they have our full attention and commitment to make these stores the top performers in their markets. These visits have been very valuable in creating a more cohesive effort in our retail operations. This cohesive effort is another factor that is driving our significant operational improvements.

As announced in January, we are undertaking steps to consolidate our retail store banners. This decision was based on extensive market studies, and we are going to build our retail store brand identity around the two strongest and most recognized store names. This is important because it allows us to build a stronger retail store brand with consumers through more unified and consistent advertising. We're working to bring a more consistent look, feel, and shopping experience to all of our retail grocery stores. Our customers can expect a consistency not only in appearance but in service, product quality, and in value. This action, along with better marketing and merchandising practices, will strengthen consumer loyalty and help drive sustainable sales growth. Another banner consolidation benefit is that it will lower our advertisement administrative cost and provide better returns on our advertising and marketing dollars.

As I mentioned in the opening, our retail (technical difficulty) is tripping (ph) through our distribution business. We're moving more volume and keeping tighter controls over operating cost, which is significantly improving our operating leverage. We're moving more products while improving service quality. The programs that are producing success in our retail stores are also stimulating interest from our independent customers. As we share our improved product and retail programs with our wholesale customers, it is providing direct benefits to them and stimulating incremental products and service demands for our distribution business. We will continue to work closely with our existing customers to bring them the benefits of our retail programs and the benefits of our distribution buying power. We will also continue to more aggressively and proactively pursue new distribution customers. We believe our willingness to share successful retail practices and ideas with independent operators will help them be more competitive and is an attractive distribution sales proposition.

In summary, there is considerable work to do and more opportunities to improve. The fundamental changes in our business strategy and operations are having a positive and significant influence on our improving sales and profit trends. We expect our positive sales trends to continue and profitability to improve as we maintain tight controls over operating costs (ph) and continue to realize the full benefits of previous cost-cutting initiatives. We will continue to strengthen our performance by improving our profitability and reducing debt where appropriate.

We will now open the call for your questions.

(OPERATOR INSTRUCTIONS) Chuck Cerankosky, McDonald Investments.

Good morning, guys. Can you hear me?

Yes, Chuck. Good morning.

Okay, great. When you're looking at the product mix of what you're selling -- and by the way, it was a good quarter, good to see that. When you're looking at the product mix, what is it telling you about customers' buying moods, willingness to trade up, and buy higher price points within categories?

I'd like to direct that question to Dennis Eidson.

Chuck, I don't think we're seeing a significant shift of consumers trading up with the news the economy is improving. We did see some shift in our business to fresh food departments, particularly fresh meat, which has been a driver for us and has been a focus for us as we've kind of tailored the offer to the consumer around center-of-the-plate and getting more in a back-to-basics mode. But in terms of the trade up, we have not yet seen that.

Okay. How about mix as affected by low-carb diet trends?

We're clearly seeing much interest by consumers on the low-carb products. Atkins products themselves and the low-carb introductions across virtually all the food categories are showing significant strength -- by the way, the counterbalancing weakness is coming in areas like fresh bakery, where we're struggling to keep pace with where we were a year ago.

John Evans (ph), Coker & Palmer.

Yes, can you talk a little bit what the tax rate would have been -- trying to understand that better before the charge?

Well, typically, our tax rate runs -- this is Dave Staples. Typically, our tax rate runs in the 35 percent.

Robert Goch, Miller Tabak Roberts.

I believe on your last call, you guys said you picked up about $40 million in annualized volume from new customers mostly -- I believe the eastern part of the state. And you said that you were in discussions with several potential customers at that time. Could you update us for the new annualized volume numbers, or how those discussions are ongoing, or if they are completed?

I would like to defer that question to John Sommavilla, VP of the Supply Chain.

In the third quarter, our new business acquisition -- our largest one was the (ph) Sherwood alliance that we put together. It annualized out to about $19 million. And then also in the third quarter, we picked up three other retailers -- approximately about an annualized rate of about $8.5 million.

Were any of those former Fleming (ph) customers?

No, they were not.

And could you tell me basic geographies -- the same eastern part of the state?

Eastern Michigan -- also in the third quarter, we did announce that we were entering into the Ohio market with our alliance with Sherwood. And were supplying (ph) grocery opportunity in that Ohio market, also.

Okay, thank you very much, and nice quarter.

(OPERATOR INSTRUCTIONS) Chuck Cerankosky, McDonald Investments.

Greg, can you quantify what the amount of sales at the Pharm stores picked up as a result of the Food Town closures? And Dave, can you talk a little bit about going to the stock ledger system -- what some of the nonrecurring costs might be or risks that we see -- systems foul-up just similar to what we have seen with people installing new computer systems? And I know this isn't an enterprise software system. But I just want to ask if there's anything like that at risk.

As far as that Toledo market and the Pharm business, Chuck, initially when the Food Town stores fell out, we did see some business with over to our Pharm stores -- in particular, pharmacy business, because we made a very active -- a very proactive decision to try to recruit those pharmacy customers to our Pharm stores. However, in the meantime, Kroger -- you know, we sold a lot of these stores to Kroger. Kroger has upgraded, remodeled, and reopened these stores. So there has been sort of a negative impact as of late in that respect.

In addition, Toledo is a very volatile market. There was a new Giant Eagle -- a very big, new, beautiful Giant Eagle opened up in the northwest area in Sylvania -- I think that's right -- yes, Sylvania -- which affected a handful of our stores on that section.

On the one hand, I want to tell you that we were benefited. But then I think that benefit has gone away. I think our real improvement in Toledo has been the remodel -- the paint-up, clean-up, fix-up program that we parsed was (ph) has really helped us a lot.

All right, thank you. And Dave?

Chuck, it really isn't an enterprise-wide system issue. What the stock ledger is enabling us to do -- and I know you understand how the retail method works -- it's really giving us more data at a transaction level in a more timely fashion. And it really results -- the charge more from a refinement in our estimates of what are balances would be. And if you look at our inventories consolidated on a FIFO business basis of 150 million corporatewide, it's a relatively small impact related to this.

Thank you, while I have got you, Dave and Craig, when will you be happy with the debt level? Where do you want to drive debt down to?

Well, you know, we have always talked about a target -- that would be EBITDA in the 2.5 to 3 range. We're rapidly approaching that. We feel comfortable in those ranges -- anywhere from 2.5 to 3. In a perfect world, probably like to see it get a little below that.

John Evans, Coker and Palmer.

Can you talk just as a little bit about -- I think you guys had expected to lose money this quarter. So if you just look at it from a big overview, where did you do better than you expected to? Because actually you had an operating profit, and without the debt extinguishment, you would have made about 7 or 8 cents. So can you help us understand that?

Well, I think that -- this is Craig Sturken -- I think that -- first of all, let's talk about retail. Our comp sales at retail are fairly strong. I mean, they're 5.7 comp sales -- I think would be maybe industry-leading. Consequently, we have been able to --

But is that because you're going against an easy comp? I mean, are you going against a negative 5, or --

I think, yes, that has something -- that's a very good point. We do look at calm sales on a two-year basis. That is a factor. I mean, a year ago, Spartan wasn't doing real well. And so we're doing better.

But also, we have been able to really leverage our expenses and we've done a lot of work in the expense side. If you look at the reduction of SG&A by an entire 1 percent in the quarter. That is a remarkable performance. I didn't think that we could do it as quickly as we did. And I think the organization did a great job in supporting that effort. So that had a lot to do with it.

In addition, our distribution business is very robust. We have been able to generate additional and incremental distribution business in an organic way to with our own customers. One of the things that I mentioned is that we have -- many of our distribution customers are supporting the merchandising and marketing concepts that we are deploying in our own stores. So we're seeing a really integrated kind of program where we -- we'll run, say, a two-day sale, and we'll find that we have as many as 200 stores on the program. And that's a real improvement and real benefit to us.

Got you -- one other follow-up question -- can you talk a little bit -- I mean, we're already into February. Can you talk what you've seen? Have your comps continued to be pretty strong in January so far?

Well, our comps last period were -- continued to be very strong. Yes.

Okay. And then can you just help us with the seasonality? December, you mentioned, you usually lose money because of kind of the seasonality you have. Can you help us understand kind of the March quarter? And then, maybe the June quarter?

Well, you know, we're very much dependent -- particularly in our own stores -- on the seasonality of Michigan in general. Everybody knows that Michigan in summertime is a wonderful place to be, because the sun shines and the sky is blue. So we do a lot of business in the summer. In the winter, it snows a lot. And we got a lot of snow this year. And so we are being benefited in our northern Michigan stores with the ski and snowmobile business that probably is a little bit stronger than a year ago. So that is helping us. But as we trail out of the winter and before we really hit school close in (ph) the summer, we have these -- sort of the doldrums of March and April. So our P&L is definitely affected by that swing.

And then lastly, you mentioned you've done a great job on cost. Is there still more opportunity in costs?

I tell my people every day there is.

Robert Goch, Miller Tabak Roberts.

Yes, I was wondering if you could lay out through 2004 where you see where Myers (ph) and Wal-Mart supercenters coming and in what geographies?

And secondly, just on the issue that was addressed before, could you just quantify at all -- the months of March and April on a sales basis? Are they generally 10 percent, 5 percent less than the rest of the year? Or some feel for that seasonality impact? Thank you.

Dave wants to touch the -- handle the seasonality thing.

Robert, I will give you sort of a generality in our retail business if you were to think about weekly sales. If you use like -- first-quarter average weekly sales as your base, you'll see anywhere from say a 7.5 to 9 percent lift on those weekly sales in the summer months for retail. You'll see it relatively flattish in the third quarter. And in the fourth quarter, you'll see the retail sales decline from a first-quarter base anywhere probably from, you know, 4, 4.5, 5.5 percent. That's sort of been the typical history to give you a flavor for sort of how the weekly sales ebb and flow if you want to kind of just try to bake that into your head.

You can't use our trends as much on distribution as you see the increases we've had. So I mean our distribution base continues to increase. But they don't -- it doesn't have nearly the seasonality. So if that helps you at all with your model --?

It does. Thank you very much. And on the openings?

On the other part of your question -- what is going on with Wal-Mart and Myer (ph) -- Wal-Mart just opened a new store in West Branch, which is somewhere in the middle of the state on the I-75 corridor -- where we had a very good store. So we are affected by that. They're going to open a store in Gaylord, where we have a very good store. And we will be affected by that. But one of the things that we've been able to do is sort of craft a strategy where we are surviving this because we are the surviving conventional retailer after all the dust settles. And I could point -- if you had a map of Michigan, if you think of Cheboygan, which is way up in the northern part in the lower peninsula where -- we were there with a very good store. Wal-Mart enlarged their conventional store to a supercenter. They hurt us badly. But a competitor closed, and we are right back to where we started in that community. And that same situation has played through in Petoskey and in Cadillac, where we just seem to be able to survive these things because we work hard, and maybe we're a little bit better than the competition in these small towns.

(OPERATOR INSTRUCTIONS) At this time, there appear to be no further questions. And I'd like to turn the floor back over to management for any closing remarks.

Well, it looks like there's no more questions. And we will conclude. On behalf of myself and the team here at Spartan stores, we thank you for listening to our comments. And we look forward to discussing our fourth-quarter and year-end results with you during the next conference call. Thank you.

Thank you, and thank you, callers. This does conclude today's conference. You may disconnect your lines at this time, and have a pleasant day.