SpartanNash Co (SPTN) 2004 Q4 法說會逐字稿

Good morning, and welcome to your Spartan Stores fourth quarter earnings release and year-end earnings announcement. At this time all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Craig Sturken, President and CEO. Sir, you may begin.

Thank you. Good morning, everyone, and thank you for calling into our fiscal 2004 fourth 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 Jane Curtbright (ph), and she will be glad to fax you a copy.

With me this morning are members of our team, including executive VP and CFO, Dave Staples, Executive VP of Marketing and Merchandising, Dennis Eidson, Executive VP of Supply Chain, John Sommavilla, and our Executive VP of Retail 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 risk 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 not limited to competitive pressures among food retail and distribution companies, general economic and market conditions, and other factors described in our earnings announcement and annual report 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.

With that said, I will say that it has been a busy year for Spartan Stores and one that is best characterized by the word success. First, we were successful in reversing a trend of consecutive quarterly sales declines in fiscal 2003. In fact, we just reported our fourth consecutive quarter of an increase in comparable store sales.

Secondly, we secured new long-term debt financing that provides us with greater financial flexibility. We successfully reduced our long-term debt by more than 41 percent during fiscal 2004 by applying proceeds from noncore asset divestitures and by using improvements in our operating cash flow.

Lastly, we also made significant progress toward returning the retail operation to profitability and toward making category management a way of life throughout our organization. Even though the fourth quarter is our lowest seasonal sales volume quarter, we reported a strong 5.4 percent increase in comparable store sales and recorded our first profitable fourth quarter in three years. As you may recall, these were the top four organizational priorities established at the end of fiscal 2003, and we are very proud to have made significant progress on each one during the year.

Consolidated sales for the fourth quarter increased 4.3 percent. Total sales for the fourth quarter retail and distribution operations increased a solid 4.9 and 3.9 percent, respectively. We are reporting favorable sales growth despite increasing competition from mass retailers and other nontraditional food outlets.

I would like to place our corporate store sale performance in perspective by pointing out that we had two additional Wal-Mart Supercenters open in our markets during the fourth quarter, which brings to approximately 10 the number of Supercenters opened in our markets during the past three years. So we are very proud of our sales performance in this intensely competitive retail environment.

Our retail sales improvement occurred across all of our operating markets while our marketing and merchandising strategies are beginning to take effect. Strong sales growth at the Pharm stores continued in the fourth quarter, but we expect sales growth for these stores to temper as we move into fiscal 2005 due to industry trends related to direct mail-order prescription fulfillment.

We are growing sales profitably, as gross margin for the fourth quarter improved 20 basis points. The overall gross margin improvement was adversely affected by a $3.7 million noncash inventory adjustment to our cost of sales. This noncash charge related to implementation of a significantly enhanced inventory and margin management system that we mentioned during our last conference call.

On a consolidated basis, we reported an operating profit of $83,000, which is a significant improvement over the $6.4 million loss we reported in the fourth quarter of last year. The operating earnings included the 3.7 million noncash charge for the inventory adjustment I just mentioned. The improvement in operating earnings is a direct result of better retail and distribution execution, better fixed cost leverage and tighter cost controls.

With that overview, I will now ask Dave to give you a more detailed look at the fourth quarter financial performance. I will rejoin the call later to provide you with more insight about our operational and financial outlook for fiscal 2005. Dave?

Thank you, Craig, and good morning everyone. Consolidated net sales for the fourth quarter increased 4.3 percent, to 456.9 million from 438 million in last year's comparable quarter. The year-over-year fourth quarter sales increase was due to the continued improvement in our retail and distribution businesses.

Gross margin for the fourth quarter increased 20 basis points, to 18.3 percent from 18.1 percent in the third quarter last year. The gross margin improvement was due primarily to improved merchandising and procurement initiatives in our distribution operations. Our retail gross margin rate declined due to the inventory adjustment to cost of goods sold for the enhanced inventory and margin management system that Craig already mentioned.

Operating expenses for the quarter declined $2.4 million, or 2.8 percent, to 83.4 million from 85.8 million in the corresponding period last year. This decline occurred despite higher sales volumes, promotional costs and employee compensation and benefit costs. As a percentage of sales, operating expenses declined 140 basis points to 18.2 percent, compared with 19.6 percent in fiscal 2003's fourth quarter.

Fourth quarter operating earnings improved significantly to 83,000, compared to 6.4 million in operating losses reported in the corresponding period last year, despite the inventory adjustment I just mentioned. Net earnings for the fourth quarter were 1.7 million, or 9 cents per diluted share, which compared to a net loss of 20.9 million, or $1.05 per diluted share in the fourth quarter last year. Included in the fourth quarter net earnings are earnings from discontinued operations of 3.2 million, or 16 cents per diluted share, which compared to a net loss from discontinued operations of 13.7 million, or 69 cents per diluted share in the fourth quarter last year. The net earnings from discontinued operations consisted primarily of a gain from the sale of our United Wholesale Grocery operation that we announced in January.

Turning to our business segments, fourth quarter grocery redistribution sales increased 3.9 percent, to 258.9 million from 249.3 million last year. The increase was due primarily to the addition of new customers and more effective merchandising and new product programs, which raised sales to existing customers. The increase in fourth quarter distribution sales is the fourth consecutive quarter of year-over-year sales growth in this business segment.

Fourth quarter operating income from the grocery redistribution segment increased significantly to 5.8 million, from 870,000 last year. The improvement was due primarily to improved merchandising procurement programs, increased fixed cost leverage on higher sales volumes and lower overhead costs resulting from our cost containment initiatives.

Fourth quarter retail sales increased 4.9 percent to 198 million from last year's 188.7 million, and comparable store sales increased 5.4 percent. The sales increase is our fourth consecutive quarter of comparable store sales growth. The comparable store sales increase was due primarily to more effective marketing and merchandising programs, our store refurbishing and reset initiatives, and continued improvements in store-level operating execution. Also contributing to the sales increase was higher customer traffic in certain of our stores due to the closing of competing supermarkets in Northern Michigan and the closing of our Food Town stores, which transferred business to select Pharm locations. As Craig mentioned, we were able to achieve this strong retail sales growth despite the opening of two additional Supercenters during the fourth quarter.

Our retail segment's operating loss, including the previously mentioned 3.7 million noncash charge, narrowed to $5.7 million compared to an operating loss of 7.3 million in the same period last year. The operating improvement was due to higher store sales volume and cost containment measures.

Turning to the balance sheet, long-term debt including current maturities declined 41.6 percent to 128.8 million at March 27, 2004, compared with 220.4 million at March 29, 2003. Our investment in working capital declined 60.7 percent to 34.2 million at March 27, 2004, compared with 87.2 million at the end of fiscal 2003. The lower working capital investment was due primarily to our divestiture of business operations that required higher net inventory investment than our core business units, and our continued focus on improving the efficiency of working capital deployed.

We expect the favorable sales growth trend to continue as we begin realizing the full potential from our improved category management practices and raise our organization's proficiency in this discipline to a higher level during fiscal 2005. We will also be concentrating on improving in-store execution, which includes remerchandising and store resets at an additional 13 of our 54 supermarkets.

As stated in our press announcement, we are forecasting fiscal 2005 consolidated net sales to improve between 1 and 3 percent and comparable store sales to range from 0.5 percent to 1.5 percent. We expect consolidated gross margin to slightly exceed fiscal 2004 levels by year-end, while operating expenses increase slightly, but at a rate slower than the anticipated sales growth. We expect both our retail and distribution operations to be profitable in fiscal 2005. Capital expenditures and depreciation and amortization will approximate 22 and 24 million, respectively.

I will now turn the call back to Craig. Craig?

Thanks, Dave. At this point, I would like to provide you with a better understanding of our fiscal 2005 business plan.

First, I would like to place our business plan into context by pointing out that the measures undertaken during the past 12 months were intended to address the most critical elements of our retail and distribution should operations. These short-term steps were necessary to reverse the negative sales trends that developed during our fiscal 2003. We successfully executed many short-term strategies that established a continuous trend of improving sales and profitability during fiscal 2004. The next phase of our plan involves a combination of short-term and long-term strategies that will continually improve our market position.

From a store operations perspective, we will expand our remerchandising and reset activity to an additional 13 grocery stores, from the 16 completed this past year. We will also implement new practices and programs at all of our supermarkets in fiscal 2005 to better manage the in-store experience for our customers.

Shrink control is another area of our business where we have considerable room to improve particularly at our Pharm deep discount drugstores. With our enhanced inventory and margin management system and the increased accountability that it brings, we will implement new shrink control practices that we believe will reduce our shrink rates as fiscal 2005 progresses.

We will also be launching our first comprehensive strategic marketing and merchandising program. It will be a synchronized campaign designed to strengthen our retail store brand identity by focusing on a true neighborhood market concept. It will include well coordinated and integrated consumer awareness advertising campaigns, stronger product promotions and more effective pricing strategies.

As we have stated in the past, category management is a critical function in grocery retailing. Improving this function was one of our four organizational priorities set at the end of fiscal '03. Although we made significant progress in improving this business discipline, we still have work to do as we push these practices and understanding throughout our business units.

During fiscal '04, we identified key retail product categories that comprised up to 50 percent of our sales volume and began implementing category management disciplines. Improvements from the category management initiatives just began to materialize in the second half of fiscal '04. We still have to work through and implement the new practices and procedures for the bulk of these categories, and expect to have the practices in place for all categories by fiscal '05.

Another area of growth opportunity is our private-label program. I firmly believe that this is one of the most valuable and untapped assets that we own. Our Spartan brand private-label is one of the strongest and most widely recognized private consumer labels in the state of Michigan. We recognize the unrealized potential in this asset, and will be aggressively and proactively managing our private-label program in '05. The quality of our private-label product is outstanding and we are moving to match the high product quality with better product labeling, a more attractive product appearance and stronger marketing practices. We are also working on the procurement end of our private-label program to improve our buying practices. We expect these initiatives to boost private-label product sales and to improve overall profitability in both our retail and distribution businesses. To help ensure we achieve our private-label program objectives, we have recently joined forces with Damon (ph) Worldwide and Topco, two companies widely recognized as best-in-class for private-label marketing and procurement.

From a distribution perspective, we have continued to partner with our customers in order to jointly address the challenges that exist in today's retail environment. We firmly believe that by developing and expanding our value-added strategy, we will secure new distribution customers and increase our sales penetration with existing customers.

We will focus on distribution efficiency by further leveraging our buying power, improving our buying practices, and implementing what is known in our industry as a slow-moving warehouse. We expect to have this resource functional by the second half of fiscal '05.

During fiscal '05, we will also be working to improve the profitability of our Pharm stores. Although sales growth has been exceptionally strong, the stores are not currently meeting our profit objectives. We just recently appointed a skilled executive to lead our store operations in our Pharm retail division, and expect these stores' results to improve over the course of fiscal '05.

From a competitive perspective, we had two Wal-Mart Supercenters open during the fourth quarter of '04, and we are expecting the opening of an additional Wal-Mart and an additional Meyer during the second half of fiscal 2005.

Our sales performance during fiscal '04 demonstrates that we are capable of generating overall positive sales growth despite Supercenter openings. We believe that our improvement initiatives will generate additional performance improvements at all of our retail stores. Additionally, we are confident we can coexist with Supercenters and continue to grow our market share at the expense of other supermarket operators.

In summary, there is still considerable work to do and more opportunities to improve our sales growth, our profitability and our operational execution. We expect to improve our fiscal 2005 financial performance above the levels we achieved in '04 and look forward to a promising year ahead. We encourage you to follow our progress throughout fiscal 2005.

We will now open the call for your questions

(OPERATOR INSTRUCTIONS). Chuck Cerankosky, KeyBank Capital.

In looking at the fiscal '05 outlook, I've got a couple of questions. For you, Dave, can you talk to us about how the balance sheet might look, especially in terms of cash flow generation and repaid debt, including cash coming from working capital management? Which we calculate generated about $75 million of cash last year which looks like a pretty good performance. Can that get better or does anticipated sales growth sort of stop that progress? And Craig, in looking at -- you talked about some of the Supercenter competition, but A&P certainly seems like a troubled company in that, call it the Toledo to Detroit corridor. What opportunities do you see as a result of their slowdown there? Are there possible stores that your wholesale operations or wholesale customers might acquire? Could you acquire some of those stores and operate them corporately, and does it help out the Pharm profit picture?

We'll let Dave go first while I think about my answer.

Chuck, from a balance sheet perspective, and as you know, a lot of the productivity improvements we made last year were through rationalizing underperforming businesses that had a much greater working capital demand, so we were able to free up a lot of cash that way. As we look forward, our debt amortization, in our mind, will be approximating the $10 million range. So we would expect debt levels to decline in the $10 million range, assuming we don't have any acquisition or roll-up of any kind of stores or anything like that. From an overall remaining of working capital improvements in our balance sheet, I don't see anything dramatic like we've had in the past. I think we have our asset load to a pretty good level at this point, and I think we're doing a pretty good job leveraging that. We continue to look to have small improvements in turn and efficiencies, but nothing on the magnitude of what you have seen in the past. One thing, too, let me just correct. I think I -- in comp sales guidance here on the call I think I mentioned 0.5 point to 1.5, and I should have said flat to 0.5. So I just want to make sure I don't confuse anybody from our previous announcement.

Chuck, as far as the answer about the A&P Farmer Jack scenario, and it's a very complex issue that A&P is faced with there, and I'll just give you a couple of points. First of all, we have excellent penetration in the Detroit trade area with existing food distribution customers. We have a bunch of great people in that area that know the market very well and that do very well. As a matter of fact, this past year a couple of our customers picked up some closed Farmer Jack stores which were added to our distribution network. So that we see as an opportunity, if in fact A&P were to, like, slip any further. So we see wholesale distribution business being enhanced if that were to happen.

The other thing is we know the trade area. Both Dennis and myself came from the Detroit area. We know the market very well. We know the Farmer Jack system very well. We know that competition in the trade area. So we would be perfectly positioned to assume any opportunities that might exist, providing it is a reasonable thing for us. And so we'll have to see how that happens and we'll play it by ear. The other thing, as you know, we have distribution facilities in place there. Our warehouse in Plymouth has additional capacity, and we think that we can deal with any additional volume that might come up in the Detroit area, or for that matter in the Toledo area, that we have capacity and we can handle it. So we'll see how it works out there, but at this point in time it would only be conjecture as to what ultimately will happen.

Do you see -- another flip side is do you worry about Kroger getting increasingly aggressive in that market as A&P slips, as farmer Jack slips?

My experience with Kroger is that they are profit-focused opportunists. And you know, as Farmer Jack slips, it's going to fall right into Kroger's hands. I would not see Kroger becoming more aggressive; I would see Kroger enjoying the bottom-line benefit of any volume that slipped there way.

(OPERATOR INSTRUCTIONS). A follow-up question from Chuck Cerankosky.

Craig and Dave, I think I heard you say expect both reported operating segments to generate an operating profit in fiscal '05. How do you see that phasing throughout the quarter? And again, I'm thinking that the operating loss for retail is much better or much less than it appears because of that inventory charge, so sort of looking like a $2.1 million loss for the entire year. And do you see retail showing a sharp improvement and being profitable all year, or do you see it more of a slow ramp through the year with, say, losses early on and then second half profitability offsetting that?

Chuck, first of all, you read it right. And I applaud you for being able to see the thing the way it really is. We have made a lot of progress in retail. The fact is that we have generated a lot of respect, and I'm proud of both our competitors and our suppliers with the progress that we have made. The category management effort that we put in place is, I think, a superior effort, and we are getting a lot of credit for holding to our commitment in the category management area. The kind of progress that we are making in retail -- we see fiscal year '05 where retail will grow at a faster rate than our food distribution, as far as what it means to us on a profit basis. The first quarter is never really a great quarter, because we are seasonally affected by what happens in Northern Michigan. So it would be -- I would be cautioned to say that we're going to jump out of the gun in the first quarter and have a phenomenal quarter, but the fact is that we have very high hopes as to where we are and where we are going in retail. We feel very good about it. The fact is that we feel good about both sides of the house, that we have nothing looming in our horizon that we that we see as being a negative factor. The only thing we see is just better opportunities for us, but we are taking a conservative approach as far as our outlook, because Wal-Mart and Meyer -- we still have those guys and they are a factor. We have developed a strategic plan to work around the Wal-Mart and Meyer and Supercenter programs, but we feel very good about where we are today.

Dave, on that inventory charge, what exactly is that writing down?

As you look at what we implemented, Chuck, we implemented a system that, in our mind, is a significant enhancement to the measurement and reporting systems that we had in place. And so basically what it has done is it has refined our ability to estimate our margins and our on-hand inventory of quantity. And so it is actually adjustment to our inventory balance.

Okay. That's all it is. So completely noncash as reported and going forward.

Correct.

(OPERATOR INSTRUCTIONS). Sir, there appear to be no further questions at this time.

Thank you. Considering the fact that there are no more questions, we'll conclude this call. On behalf of Dave Staples, Dennis Eidson, John Sommavilla, Ted Adornato, and everyone else at the Spartan team, I thank you for listening to our comments. We look forward to discussing our '05 first quarter results during our next conference call. And again, thank you very much.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.