SpartanNash Co (SPTN) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Spartan Stores, Incorporated Third Quarter Fiscal 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If any one should require operator assistance during the conference, please press "*", "0" on your telephone keypad. As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Craig Sturken, President and CEO of Spartan Stores, Incorporated.

Thank you. Good morning everyone and thank you for calling into our fiscal 2005 third quarter earnings conference call. With me this morning are members of our team including EVP and CFO, Dave Staples; EVP of Marketing and Merchandising, Dennis Eidson; EVP of Retail Operations, Ted Adornato; and EVP of Support Services, Mark Eriks.

Before we begin, I must remind you that our comments today all contain forward-looking statements. These forward-looking statements may contain plans, expectations, estimates, and projections that involve significant risks and uncertainties. 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 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.

We are pleased to report another quarter of substantial improvements in our financial and operational performance. Operating and net earnings continue to improve significantly in the third quarter and resulted in the best third quarter performance that we have reported in the past four years. Operating earnings increased more than 87% and we reported net earnings of 4.5 million compared to a loss of 4.1 million in the last year. Year-to-date cash from operations had driven more than 160% and our balance sheet has the lowest outstanding debt levels, since, we became a profit company in August of 2000. We are very pleased with this progress.

The third quarter earnings improvement was due primarily to a number of factors gross profit margins at our Pharm stores and distribution operations, a continuing focus on cost containment, more efficient and effective use of store labor, more focused promotional strategies, and lower depreciation and interest expense. We also recorded some miscellaneous items during the quarter that has suited the earnings improvement. Dave Staples will cover these items in just a minute.

Consolidated net sales declined during the third quarter due primarily to a lower sales at our Pharm stores and in our distribution operation. There are three important points related to sales that I would like highlight. First, our core supermarket operations continue to show sales growth, during the quarter despite an intense, competitive environment that includes four new super star openings during the past calendar year. We achieved this favorable performance by improving our product mix, executing category management, by staying focused on our commitments to providing more convenient shopping services such as pharmacies and fuel. During the quarter we opened two new in store pharmacies and three fuel centers, two of which are adjacent to existing supermarkets. Although these initiatives require startup costs, our research shows they can provide significant incremental supermarket sales increases. Incidentally, consumers today expect these services. We know that these activities and continued upgrading of our facilities will allow us to continue to expand our market share relative to other conventional supermarket competitors.

Another issue related to sales. Our Pharm stores experienced a sales decline this quarter but it is important to place this into proper perspective. Last year we performed, a paint up, fix up in every store and ran very aggressive promotions which gave us significant sales increases but, we sacrificed profit margins. We also benefited from a temporary customer migration to Pharm stores as we closed or sold a large number of Food Town stores located in the same market areas. Collectively these two factors lead to very strong sales growth last year. However, as we moved back to a more balanced pricing and promotional program this year and these former Food Town shoppers migrated back to a full service grocery store format, we lost some of those sales gains. These factors along with the significant impact of the UAW mandate that we have been discussing in the past led to reported sales decline in the current year. However, our strategy for the Pharm stores is focused on both sales and profit growth and although the current year store sales declined on a two year basis, the comparable store sales are positive. More importantly the Pharm stores operating results has since significantly improved. In short we are on track with our strategy and very comfortable with the progress that we have achieved with this store banner.

Another issue related to sales is our distribution sales performance was influenced by the transition of two customers to other suppliers which we mentioned in the second quarter and the lower than anticipated initial customer response to our self distributed deli and bakery program. These two issues led to the bulk of our distribution sales declining during the quarter. I believe it is important to remember that the distribution business is significantly influenced by the timing of events. Our self distributed deli and baker program because as our self distributed deli and bakery program progresses we are confident in our ability to attract more customers and we also expect to regain a significant portion of the business that did not initially materialize.

I must also point out that the program will generate substantially higher profits for us and for our customers. In addition, one of the two accounts that recently moved to another supplier had been our customer for only a short duration and we expect to recapture three of the four lost stores during the next two quarters. I would also like to point out that our total customer attrition rate remains well below industry average. Although in total we are operating at slightly lower level than last year, our customers have solid businesses and operational expertise. Also there are additional opportunities to win new distribution accounts within our existing trade area.

Third quarter operating profits in our retail segments improved dramatically but we experienced slightly lower operating profits in the distribution segment due primarily to the sales softness and prior employee benefit cost. Retail operations continue to improve due to better operational execution at the store level, a better product mix, better promotional strategies, more efficient use of labor, more targeted pricing strategies, and our remodel and re-merchandise reset assets. All of these efforts lead to a better customer shopping experience that differentiates us from the competitor.

We also had a major success story with our Spartan brand type of label product. We recently won an award for packaging design from Private Label Buyer magazine, the recognized authoritative trade publication for private label retailing. We also had good success in the third quarter with our four private label sale and the packaging redesign continues to help raise the profile of these products. We are continuing to aggressively pursue available retail and distribution growth opportunities for these products through aggressive product and SKU expansion. With that overview I will ask Dave to give you a more detailed look at the third quarter financial performance. I will rejoin the call later and provide additional insight about our operations and outlook for the remainder of fiscal 2005. Dave.

Thank you Craig and good morning everyone. Consolidated net sales for the third quarter were 624.5 million compared with 644.1 million in the third quarter last year. The sales decline was primarily due to a decline in less profitable Pharm store and distribution sales. Gross margins for the third quarter increased 90 basis points to 18.8%, compared to 17.9% in the last year's third quarter, and was driven by a better performance in both of our operating segments.

Operating expenses for the quarter declined 2.8% but as a percentage of sales, increased 10 basis points to 17% compared with 16.9% in the third quarter last year. The dollar decline was due to better store labor productivity and lower depreciation expense, partially offset by higher employee benefit cost. As a percentage of sales the increase was due to less fixed cost leverage due to the lower sales volumes and a higher benefit cost.

Third quarter operating earnings increased 87.6% to 11.4 million from 6.1 million in last years third quarter. Net earnings also improved substantially to 4.5 million or 22 cents per diluted share compared to a net loss 4.1 million or 20 cents per diluted share in the third quarter last year. The third quarter net earnings included an after tax loss from discontinued operations of 1.3 million or 6 cents per diluted share. The third quarter loss from discounted operations relates to our withdrawal from the multi-employer pension plan, affiliated with our previously discontinued Food Town super market operations.

The third quarter also included a net after-tax benefit of 1.7 million, associated with the supply contract settlement and gain on the sale of the single store joint venture. These benefits were partially offset by a charge for unamortized loan fees related to our credit facility amount.

Last years third quarter included a non-cash after-tax charge of 5.7 million, related to the refinancing of our existing credit agreement. The current year refinancing resulted in a lower interest rate spread of a 100 basis point on LIBOR borrowings, a $45 million increase in the secured credit facility, a one year increase in the facilities term, and the repayment of the entire subordinated debt facility [which before] interest is 16%.

Turning to our business segments, third quarter retail sales were 278 million compared with 281.9 million in the same period last year and comparable store sales decreased 1.2%. Comparable store sales increased 0.9% at our supermarkets of which 0.8% was attributed to the previously disclosed change in accounting per bottle deposits. But, we are offset by a decline in Pharm comparable store sales. Our third quarter two year comparable store sales growth in the supermarkets and Pharm stores was 4.9% and 0.6% respectively. We believe the two year horizon provide the better depiction of the long-term results of our retail strategy, especially, given the multiple factors influencing trends over the past two years.

Retail operating earnings improved to 4.6 million from a net loss of 1.3 million in last year’s third quarter, the operating improvement was due to a favorable supply contract settlement, more targeted promotional and pricing strategies at the Pharm stores, labor productivity improvements, and lower depreciation expense. The $2.3 million pre-tax supply contract settlement was recorded as a reduction to cost of goods sold and related to the past three years. Approximately 600,000 of the settlement applies to the fiscal 2005 and we expect this settlement to have a favorable effect on retail gross profit margin until it cycles in the third quarter of fiscal 2006.

Third quarter grocery distribution sales decreased 4.3% due primarily, to the reasons Craig has already discussed. Sales for the two former distribution accounts represented approximately 7 million out of the total of 362 million in distribution sales during the third quarter of last year and the decline in sales related to our deli bakery program amounted to approximately 8.5 million. Third quarter operating earnings in the distribution division declined to 6.9 million and were due primarily for the transition accounts, lower fixed cost leverage from a decline in sales volume, and high employee benefit cost. Turning to the balance sheet, long-term debt and investment in working capital declined for the quarter placing us in our strongest financial condition since becoming a public company in August of 2000. As of January 1, 2005, our long-term debt to total capital ratio was 0.46 to 1.

Our cash flow has continued to show a significant improvement, year-to-date cash from operations improved more than 160% to 47.8 million compared with 17.9 million in the corresponding year-to-date period last year. This improvement is a direct result of our improved profitability and continued focus on working capital management. We are revising our full year fiscal 2005 forecast to reflect a tempering of sales growth as we compare results against strong growths from last year, cycle competitive store closings, work to replace the two distribution accounts, and grow our deli bakery programs, and as we cycle additional Super Center openings.

We now expect consolidated net sales for fiscal 2005 to decline from between 0.5% to 1%, with retail comparable store sales for the year ranging from flat to an increase of 1%. Fiscal 2005's full year gross margin as a percentage of sales will be slightly higher than fiscal 2004, we expect operating expenses to be lower than last year on a dollar basis and as percentage of sales due to our productivity initiative and lower depreciation expense. However, everyone should be reminded that the upcoming fourth quarter is our lowest sales period of the fiscal year due to our approximately 30 supermarkets that operate in the resort areas of Northern Michigan. As a result we will not have the same fixed cost leverage as we did during the first three quarters and operating expenses as the percentage of sales will increase during the fourth quarter from the existing run rate. By the end of the fourth quarter we will cycle two of the four super center openings currently impacting our stores. We will also continue to realize sales pressure from the UAW mandate on prescription maintenance medications through the fourth quarter. Capital expenditures are expected to range from 22-25 million for fiscal 2005, and depreciation and amortization will be approximately 21 million. We will provide additional guidance for fiscal 2006 with the release of our fourth quarter earnings announcement. I will now turn the call back to Craig. Craig.

Thanks Dave. We are very pleased with the substantial progress made over the past two years, but believe there is additional room for growth. On the retail side we will continue improving our category management practices to bring consumers the right mix of products at competitive prices. We are continuing to introduce our more effective marketing and category management practices for the perimeter store merchandise and we will continue to expand our continued services to include more in-store pharmacies and additional fuel centers.

We expect the addition of these services to begin producing incremental sales growth directly from the service and through additional purchases of in-store merchandise. During the fourth quarter we also expect to open one additional pharmacy and remodel an existing pharmacy to include drive through service. Maintaining our correct [physical] store appearance is also very important and as such we expect to complete one major store expansion, two store remodels, and one minor store remodel during the fourth quarter. In addition, we expect to complete two more store expansions and up to 15 store remodels and or merchandise resets during the fiscal 2006.

On the distribution side we expect sales from our self distributed deli and bakery program to begin improving as we move to fiscal 2006. We are anticipating the conversion of more customers to our program as in the tourist. As I mentioned earlier, we expect to begin a large portion of the sales from one of the two accounts that lose one of the distributor earlier this fiscal year. In the coming quarters, we are going to have a challenge of more super center competition entering our markets, but we believe that the initiatives I just discussed can collectively generate enough organic growth to offset its impact. As Dave pointed out we will have fully cycle two super centers in the fourth quarter and two more during the second and third quarters of fiscal 2006.

We do expect, however, an additional 5 super centers to open in our market during fiscal 2006. It is important to understand that the 5 super centers are expected to open in our next fiscal year are not likely to have the same sales effect as [reported] this year. The reason is that two of them represent conversions of existing discount stores with super centers and all 5 of these trade areas already include a super center alternative. All of the openings are also taking place in markets that will affect only of own stores and at least one other conventional competitor. It is important to know that we have this kind of activity in our run rate and we continue to show positive super market comp sales despite this activity. We believe that the growth in our super center opening will tamper following fiscal 2006 and that we will benefit from the improved competitive landscape as retail competitors exit the market. Our key near-term enhancement opportunities remain on an improving category management practices and reducing our product cost, increasing our private label penetration, increasing sales penetration with existing distribution customers, and improving perimeter department sale. We will also be pursuing growth opportunities through new store construction to fill an existing market gaps and the expansion of it to existing stores to better serve customer needs. To date, fiscal 2005 has been a great success and we look forward to extending that success into the future. We will now open the call for your questions.

Ladies and gentlemen, at this time we will be conducting a question-and-answer session. If you would like to ask a question, please press "*", "1" on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press "*", "2" if you will like to remove your question from the queue. For participants using speaker equipment it may be necessary to pick up your handset before pressing the "*" key. One moment please, while we poll for questions.

Our first question comes from Chuck Cerankosky with Key McDonald. Please state your question.

Good morning gentleman, good quarter.

Good morning, Chuck. How are you?

I am okay. Craig, firstly I want to ask about is, you know, you made a lot of margin progress year-to-date, could you take a look at the fiscal '06 and talk about what part of the margin improvement is sustainable both at the growth line and in controlling operating expenses? And then I have got another question.

Chuck that would be, I think some form of guidance and I would prefer to differ to our fourth quarter conference call before I would answer that question.

Which was Craig, you meant to figure it this way what aspects of the progress in the current fiscal year are due to better execution, better systems within the company, you know, apart from the competitive environment?

Well, Chuck, a significant part of our margin improvement really comes through the efforts that we have in category management, through the entire process of a certain rationalization or promotion activity and more effective pricing strategy. So, I really feel that this is now inner base, inner run rate, and a major portion of our margin improvements is -- will stick to our ribs and I would think that this will be part of our go forward results.

What's the ability to look at some of your wholesale customers as acquisition opportunities, is that picking up or even some competitors out there as a way to expense their base and can you talk about any net new stores you plan on building?

Let me just make a note, Chuck, our retailers are all having a good year themselves and we of course are always there as an excess strategy for them if in fact they feel that they want to get over the business through retirement, etcetera and these opportunities exist, however, it’s -- we don’t see anything on the near horizon that’s going to change the landscape for us. I think it’s just continued business as usual at least on a near-term, maybe at the end of the fourth quarter we will be able to comment further on that. The other question you asked is about new stores, we actually now have in the pipeline three new Greenfield locations that we feel are going to work for us but, you know, with the slow fast as we are here and that of winter construction is the minimums at best, as a matter of fact its minus 4 degrees here, this morning and there is not a lot of activity. So, it's just a slow process, but we now are moving forward with our capital plan as we had described in the past conference calls.

Do you have any idea when those are open? Are those fiscal '06 openings or more likely in fiscal '07?

I mean, we would be very fortunate if they were fourth quarter events for fiscal '06, but we think right now that we can only, like, we are sure that they will happen clearly in our fiscal year '07.

Thank you.

And Chuck, I really wish that these things would happen fast, we all want them to happen faster. We are prepared to operate them today, but the process is just very slow.

Thank you.

Thank you. Our next question comes from Mark Cooper with Wells Capital, please state your question.

Good morning and thank you. This gross margin, I don’t know what you call it but the $2.3 million, what is the nature of the change in your inventory that -- would let you put a reserve back or profits back into gross profits from three years ago?

Mark, this is Dave Staples, let me walk you through this. It's not a reversal of the reserve. As you know, you are in a long contract for certain commodities and other types of items that you purchased, they are typically dependent on a formula basis to compute the actual cost, but what happens at times, if there is a lot of moving parts in that certain product that you are buying, there can be cost changes that accumulate over time, in essence what it is, it was a review of some costing issues associated with a contract and it was in absence of settlement that reimbursed the company for income over charges in absence of cost.

And is it in next year in 2006, fiscal 2006, that mean that the gross margin that we see for the full year of 2005, you say that it should be better but that seems like a pretty big pickup?

Yes, when we talk about better obviously, you have to take in to consideration one time thing. If you listen to how we discuss that 600,000 of that 2.3 million would have pertained to the first half of this year, rest of it was from the previous years, so I think you would have to factor that in to your analysis.

Okay.

Just like you have to, looking at last year factor in that charge we took at the end of last year, right.

Right.

But, it will provide better cost of goods for us especially in the first half until we cycle the catch up.

Alright. Thank you.

Yes.

Just a reminder if you would like to ask a question at this time please press "*", "1" on your telephone keypad. Our next question comes from Blaine Modder (phonetic) with Lowe Partners (phonetic). Please state your question.

Hi guys, just a few numbers, technical questions, and few strategic questions for later. The gain that you took on the JV that was third year, your other line?

Yes.

Okay, and then you flushed up the sales, I mean there was a small amount of sales in the quarter, but in the fourth quarter what can I assume for sales for that operations, can you just?

They way were about 20 million annually.

Okay, so you just price it seasonally in the fourth quarter on the 20 million, I will come up with some numbers?

Yes, they are not nearly as seasonal. You know, it’s a fairly consistent business. Obviously, the third quarter has an extra period in it but, and you know, you always get a little less with the holidays but yeah, it's pretty straight forward.

Okay. And is that part of the reason for the reduction in sales guidance or is it really just other things?

No, that's part of the reason certainly but it is other thing as well.

Okay. So you say it is almost a 20 million or 15 million or whatever head wins for next year in the retail side?

Right.

Okay. And then when you actually receive the cash and reduced the debt from what I saw you had some on the balance sheet looks like after [inaudible] for sale, when you actually get that cash?

I am sorry for the joint venture that we sold we've received all that already. In addition to that we have another, what we call non-operating assets and we typically talked about between $10 million and $15 million, we expect we can realize overtime as we are able to look with it over that, but that's kind of an ongoing process for us.

Okay, great. And Dave, remind me why the depreciation moves around every quarter like it does?

Well, a large part of it if you look at the historical, I guess founding of our retail group it was based on roughly five acquisitions. Those five acquisitions now are between five and six years old and so a lot of the assets, you know, your original set up acquisition assets are amortizing. In addition, as you followed our CAPEX you will notice that this year we are spending more CAPEX than we spent last year. So, you know, there is timing of when your spent happens which is increasing as well as timing of the different acquisition as to when depreciation is falling off. So net, net we have a much less depreciation as you can see.

Okay. Just a couple of more, do you have any more in terms of network obligations. I think you said that was it for the discontinued operations, what about just in general in terms of your obligations network [ph] plans?

Okay. These multi-employer.

Yes.

We really, you know, at this point experienced those because there was a separation liability. We closed those stores a number years ago now. At that time the indications were that the plans were fully funded however there were some changes in their actuarial computation within the last year that we were notified of just recently that caused that liability. We don't think that there is anything else out there like that at this time, I mean that is doing well. Our union plans are multi employer. So…

Okay and are you going to make your contribution for pensions this year in the fourth quarter?

Yeah, we made ours in December so we don't have another one in the fourth quarter.

Okay. Oh, I am sorry, I am confusing calendar with your fiscal so, yeah, December you paid was it a million bucks or something?

800,000.

800,000. Okay and then just finally the credit facility amendment. Just to remind me the new terms again under [inaudible] and does this give you more flexibility as far as buying back your stock and paying your dividends?

It was very favorable, the amendment. You are new I believe following are plan but if you went back to what we did last year that obviously was significant. This amendment this year really improved our situation even more. It added 45 million to our secured facility of total potential availability. It increased our media availability up to $25 million, it allowed us to totally repay our $16 million -- $15 million supplemental unsecured facility which was varying interest at roughly 16%. It has brought about a 100 basis point reduction in our LIBOR spread and has lengthened the term by one year and that really is exactly the same bank members taking a bigger piece so, I mean, results is very, very positive.

Okay. The first, your flexibility to buyback stock or pay dividends?

Well, I think, our policy on dividend as we have stated before that at this point we believe that the capital -- the cash that we are generating is better spend on improving our store base and growing our operations so, in the short-term anyway that isn’t part of our strategy. From a stock buyback perspective there are requirements in that deal that they have done it, you know, those are limited under certain circumstances.

Alright. Thanks guys. I will follow up with you later. Thank a lot.

Yeah. Thank you.

Thanks. Your next question comes from Chuck Cerankosky with Key McDonald. Please state your question.

When you are looking at some of these news ventures like the drag through GAAPs and the – excuse me, drag through pharmacy and increased GAAP, are you past the experimental stage, do you really want to ramp that up?

I will tell you, our experience thus far is very favorable Chuck. We are somewhat delighted with most of the results that we have seen, not every venture has been totally successful but, you know, but still it might be too soon to tell but the early indications are that we will want to go further with this initiative.

And both of them?

Yeah. I will clearly, you know, we have been watching our competitors that say that with the progress in the [miners] of the world, particularly, with the refuel centers we have been watching them for some time and we wanted to know more about it and we got into it and now we know why they are so mature in that area.

You have any capability to stay to in-store promotions, royalty cards, anything like that, yet or are your systems caught up with it?

Yes. That was all part of this initiative. We actually had to slow down a little bit so that the IT guys could catch up with, but we really -- we have I would consider state-of-the-art, best in class technology as far as supporting the customer with the electronic promotions. So, as a matter of fact if you ever get a chance to come up here and see what we have done, you would be quite impressed.

I [will plan it by] the time I get there.

But Chuck, you don’t want to be minus 4 degrees when you come.

Dave, looking at this recovery from the vendor, can you talk about who this supplier was or what type of product, and is that a cash settlement?

It's a cash settlement. We prefer not to get into those other specifics, Chuck. I mean we received the money which settles and we actually extended and re-up the contract with that same supplier. So we still believe in that supplier and we are happy with them, we would rather not go into those other areas.

Cash is good.

Cash is always good.

Thank you.

Thank you, our next question comes from Blaine Modder (phonetic) with Lowe Partners (phonetic).

Yeah, I actually in a public form, just have a comment for the other analyst on the call that covers your company. Now EE had a 10 cent number for the quarter and I would just recommend that this analyst seriously review his numbers, in light of the strong performance, I mean you quite came up with 2 x, two times his estimates, and I would think that he should just review your guidance that you gave for the rest of the year and perhaps do his clients more of a service and put and publish more accurate EPS numbers for this company. Thanks a lot.

Mr. Sturken there are no further question at this time I will now turn the conference back over to you to conclude.

Well, thank you very much. On behalf of Dave Staples, Dennis Eidson, Ted Adornato, Mark Eriks, and myself, I just want to thank everybody for calling in today and we are delighted with our performance and we look forward to talking to you at the end of the fourth quarter. Thank you.

Thank you, this concludes today's conference. Thank you all for your participation.