SpartanNash Co (SPTN) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen. And welcome to the Spartan Stores, Inc. third quarter fiscal 2006 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 anyone should require operator assistance during the conference please press star, zero 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 Chief Executive officer for Spartan Stores, Inc. Thank you. Mr. Sturken, you may begin.

Thank you. Good morning, everyone. And thank you for joining our fiscal 2006 third quarter earnings conference call.

With me this morning are members of our Team, including Executive VP and CFO Dave Staples, Executive VP of Marketing and Merchandising Dennis Eidson, and our Executive VP of Retail Operations Ted Adornato.

Before we begin, 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 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, the 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.

As reported, the third quarter operating earnings were 8.4 million and net earnings from continuing operations were 4.8 million. We remain very enthused about this performance because we continue to perform well despite the significant number of new super centers that have opened in our markets during the past 18 months.

Although our third quarter performance was strong it is not easily visible because of a number unusual and non-cash items recorded in operating earnings during the third quarter of this year and the third quarter of last year. These items added to a net total charge of $700,000 in this year’s third quarter and a net total benefit of $3.2 million in last year’s third quarter. If you look at our business without those items our third quarter performance on an operating basis improved relative to last year. Dave will go through more details on those items in just a moment.

Third quarter consolidated net sales increased a robust 2.8%, driven by the higher sales at our distribution segment, partially offset by lower sales in our retail segment. Higher sales to both new and existing customers and higher holiday sales related in all segments contributed to our distribution segment sales increase.

As previously mentioned, we have added a net of 11 new accounts and 34 stores to our distribution base during the past year. I will also mention that our distribution business serves some of the best performing retail grocery operators in the State of Michigan, and we are proud to have the privilege of serving them.

The lower sales in the retail segment were due primarily to the sale of our joint venture late in last year’s third quarter, the closing of two under performing pharm stores and new retail competition. These issues were partially offset by sales gains at fuel centers, higher sales at our pharm stores, and sales increases at stores not subject to new competition.

During the third quarter we continued to show solid results from our private label product initiatives. The latest initiative was the conversion of health and beauty care products to the [top care] label and conversion of our extreme value products to the [value time] label. Both of these initiatives are showing solid early results.

We also recently announced the change in our dividend policy and intend to declare a regular quarterly cash dividend of $0.05 per share beginning in the fourth quarter. The dividend policy change is indicative of the fundamental health and strength of our core business and demonstrates the confidence we have in our ongoing business strategy.

Lastly, many of you have read our recent press announcement on the signing of a purchase agreement with D&W Food Centers. This acquisition is strategically important as the D&W Stores will allow us to service new markets in West Michigan, while complementing our existing store base and markets already served. In addition, the acquisition will guarantee that consumers in our markets continue to have a choice of retail grocery store formats and have a shopping alternative to super centers.

This transaction is a significant link for both of our organizations for retail consumers in West Michigan and for the communities where we operate. We are progressing through the due diligence process, and will have more details to share with you once the transaction is complete. This initiative fulfills a major component of our strategic plan, which is to grow sales through the acquisition of retail stores in or near our existing markets.

I will provide additional detail about our business outlook following Dave’s review of the third quarter results. Dave.

Thank you, Craig. And good morning, everyone.

Consolidated net sales for the third quarter increased 2.8% to 642.3 million compared with 624.5 million in the third quarter last year due to the factors discussed by Craig. Gross margin for the third quarter declined 80 basis points to 18% compared to 18.8% in last year’s third quarter. The decline was due mainly to the 2.2 million favorable supply contract settlement recorded in last year’s third quarter and a higher percentage of consolidated sales coming from the lower margin distribution segment and retail fuel centers this year.

Distribution as a share of consolidated net sales was 58% in the third quarter compared with 55% in the same period last year. As a percent of sales third quarter operating expenses declined 30 basis points to 16.7% compared with 17% in the same period last year. This improvement was due to higher sales volumes and better fixed cost leverage in our distribution segment, the change in sales mix to a higher concentration of distribution and fuel center sales, and the continuing improvement in store labor productivity.

Total operating expenses increased to 107.4 million from 105.9 million in last year’s third quarter. This year’s third quarter included a 700,000 in pretax charges related to asset impairments and asset costs of 500,000. The write-off of banana ripening equipment of 300,000. Residual professional fees for the conclusion of our strategic review and a contract dispute settlement of 500,000. Partially offset by a favorable adjustment for the conclusion of a state tax loss of 600,000.

Last year’s third quarter operating expenses included 1 million in net pretax benefits related to a favorable supply contract settlement and a favorable adjustment to bad debt expense due to improved collection trends. Excluding these unusual items our third quarter total operating expenses were relatively flat on a YOY base.

Reported third quarter operating earnings including the previously mentioned non-cash and unusual items were 8.4 million compared with 11.4 million in last year’s third quarter. However, excluding the unusual items from the third quarter of both years our operating earnings would have improved.

Third quarter other income and expense included a 1.4 million pretax gain on the sale of real estate compared with a $1 million real estate gain in the third quarter last year. Last year’s third quarter also included a 600,000 pretax charge for the early extinguishment of debt.

Interest expense during the quarter despite numerous Federal reserve rate increases improved due to lower average debt levels.

Reported net earnings for the quarter including the non-cash and unusual items mentioned were 3.4 million or $0.16 per diluted share compared with 4.5 million or $0.22 per diluted share in the prior year.

Third quarter net earnings included a loss from discontinued operations of 1.4 million compared with a loss from discontinued operations of 1.3 million in the same quarter last year. The third quarter of both years was affected by non-cash pension withdrawal liability charges for previously closed stores of approximately 1.1 million per year.

Turning to our business segments, third quarter grocery distribution sales during the third quarter increased 8.2% or 375 million compared with 346.5 million in the same period last year. Third quarter distribution operating earnings increased 5.7%.

Third quarter retail sales were 267.3 million compared with 278 million in the same period last year. Total comparable store sales declined 1% representing a sequential improvement from our second quarter. Fuel sales contributed a positive 1.4% to comparable store sales during the quarter.

Of particular note was an increase of .4% in comparable store sales that are pharm stores which is the first positive sales growth at these stores in several quarters. We are still, however, experiencing the adverse sales affect of conversions to generic from branded drug. As I mentioned last quarter, this conversion lowers our sales per transaction but raises overall profitability due to higher margin rates on generic formulation.

Third quarter retail operating earnings were 1.1 million compared with 4.6 million in the same period last year. The decline was due to the non-cash and unusual items already mentioned. These items include a pretax charge of 600,000 in this year’s third quarter for exit costs associated with the closed locations and the settlement of a contract dispute. Last year’s third quarter, however, included a total benefit of 2.5 million for the favorable supply contract settlement and a 700,000 favorable bad debt adjustment due to improved collection trends.

On an adjusted basis excluding these non-cash and unusual items from both years our third quarter retail operating earnings improved on a YOY basis. We are very pleased with this financial performance because we were able to achieve it despite the nine super centers and two Cosco’s that have opened during the past 18 months in markets that directly affect our stores.

Turning to the balance sheet, long-term debt for the quarter including current maturities declined 19.3% to 76.5 million from 94.8 million as of March 26th, 2005 due to our continued strong profitability and use of a Federal income tax net operating loss carry forward that reduced cash outflows.

As of December 31st, 2005 our long-term debt to total capital ratio was .36 to 1. Upon the closing of our purchase agreement with D&W Food Centers we expect our long-term debt balance to increase as the acquisition price will be funded with available bank financing.

I will now cover our outlook for the remainder of the year. As noted in our press announcement, our upcoming fourth quarter is our lowest seasonal sales volume quarter. We expect distribution segment sales to continue to show growth compared with the year go period because of the new business we have added during the past six months and because our customers are well positioned relative to weaker competitors in Michigan.

We expect these sales gains, however, to be partially offset by the warmer than normal weather in the Northern Michigan winter resort areas and economic factors that affect discretionary consumer spending, like higher heating and gasoline costs.

In addition, approximately 3 million in Easter holiday distribution sales included in fiscal 2005’s fourth quarter will shift to the first quarter of fiscal 2007.

Turning to our Retail Division, we do not anticipate any additional super center openings during the remainder of this fiscal year and next year based on our real estate activity. We will cycle one Cosco and the remaining super center openings in fiscal 2007’s first and second quarters.

We expect fourth quarter 2006 retail sales to be challenged by the continuing strong competitive environment and the same factors that I just pointed out for our distribution operation. In addition, approximately 3 million of retail sales related to the Easter holiday that were included in last year’s fourth quarter will also shift to the first quarter of fiscal 2007.

We expect fourth quarter gross margin rates to be lower than the same quarter last year due to an increasing mix of lower margin distribution business and fuel center sales and a reduced number of new product launches in our distribution segment. The lower gross margin rate is expected to be partially offset by slightly lower operating expenses as a percentage of sales compared with last year’s fourth quarter.

We expect fourth quarter’s earnings from continuing operations to be lower than last year’s due to the sales factors and margin and operating expense trends I mentioned earlier and because of the favorable conclusion of an IRS tax audit that reduced our Federal tax provision by 1.3 million in last year’s fourth quarter.

Annual capital expenditures are anticipated to range from 25 to 28 million with interest and depreciation expense of approximately 7.5 to 8 million and 20 to 21 million, respectively.

I will now turn the call back to Craig.

Thanks, Dave.

As we mentioned during our last conference call, our goal as an organization is to becoming larger, more profitable, and a more competitive company with a dominant market share among conventional supermarket operators in our markets.

As such, we will continue to aggressively pursue sales and profit growth by executing internal growth strategies that include improving category management, keeping our stores in good physical condition, expanding certain existing stores, and strategically leveraging convenience by adding more fuel centers and pharmacies.

We will continue to aggressively pursue new distribution customers and seek to expand sales with our existing and loyal customer base through increased purchase concentration.

Our most immediate priority, however, will be to complete our due diligence in the acquisition process with D&W Food Centers. We are extremely enthused about this transaction because it meets our strict criteria of acquiring only retail stores that have a strong potential to enhance the long-term value of our Company.

Upon completion of the acquisition we will work diligently to integrate the two operations. As you may be aware D&W Food Centers had been a valued full line customer up until five years ago. As a result, we have a good understanding of their operating markets and we both subscribe to a fundamental consumer centric business strategy.

In addition, this acquisition is a strong complement to our existing stores and provides us with some intriguing growth opportunities. For example, with our Spartan private label products we have an opportunity to re-introduce one of the most widely recognized private label brands in Michigan to the D&W customer base.

Through this acquisition we also gain access to market areas not presently served by one of our corporate stores or in some instances not even a Spartan affiliate. The acquisition will also allow us to change our near-term expectations for new store construction. In past communications we stated that we expected to construct two to four new stores annually. Because this acquisition provides us with many additional store locations we are not likely to construct [two] of those stores in this upcoming fiscal year. However, we do expect to continue our remodel program, relocate certain existing stores, and build new stores in future years.

Finally, with the majority of the D&W stores located within a 20 to 30-mile radius of our distribution center we believe there will be significant cost and procurement synergies available to us. As a normal course of business we will continue to prudently evaluate those business strategies that have the potential to improve long-term shareholder value, and we believe that this latest transaction is certainly one of them.

As stated during our last call but worth repeating, we believe that the majority of super center openings in markets where we own stores have already occurred. That does not mean that additional openings will not take place but the pace of these store openings has subsided for the remainder of this year and next fiscal year.

We will continue to stay squarely focused on our strategies designed around customer convenience. During the third quarter we opened two additional payroll centers and completed seven store remodels or re-merchandise resets, while beginning a significant store remodel and expansion that will be completed in the fourth quarter.

Today our store base is in significantly better condition than when we began our program two-and-a-half years ago. At the end of this fiscal year we will have substantially completed the investment in our existing store base.

Although integrating the D&W acquisition will be a priority, it will not be tracked in the basic blocking and tackling at our distribution operation and at our existing retail stores. We will continue to implement our perimeter store merchandising, private label, and retail store marketing positioning initiatives. Early indications are that our market positioning initiatives are producing the favorable results that we were expecting. These initiatives include new store signage, new service offerings, customer service enhancements, and advertising campaigns designed around healthy living habits and wellness.

On the distribution side, we will continue to aggressively seek new customers and increase our sales penetration with our existing customers. As many of you know, business conditions in our markets continue to rapidly evolve, and many of our distribution customers are very well positioned to capitalize on available opportunities. Consequently, significant growth opportunities in our distribution operations continue to exist.

In summary, we remain optimistic about our future growth opportunities and are firmly committed to the long-term success of Spartan Stores.

We will now open the call for your questions.

[CALLER INSTRUCTIONS.]

Our first question comes from [Blane Marter] with Globe Partners.

Hi, guys. Do you currently distribute to D&W now?

Not really, as a matter of fact, in the transition we are beginning to supply them with some of our private label product because they are running out of the private label brand that Super Value had been shipping to them, but it’s a diminimous amount.

Okay. And when does that Super Value contract expire?

Well, it’s not like their contract expires. It’s that they are exiting their relationship with Super Value, and we don’t know under what terms that exit is, but we will take over full distribution of their stores when the transaction is completed in late March.

Okay. That’s great. And then can you at least give us a sense are their margins at, below, or above your current retail margins?

Our initial look at it is that their gross margins are higher, but I think that is primarily related to retail price structure.

Okay. They’re a higher priced operation?

That’s correct.

Okay. And will you be adding any gas stations to these stores?

Actually, we see a couple of opportunities. Not significant, but we see two or three opportunities among the 20 stores that are involved.

Okay. And then you mentioned that the CapEx or the store development would slow as a result of the deal, so where do you see a CapEx budget come in? It seems like you’re running a little light versus your projection for this year, and then where do you see it coming in next year?

Dave?

Yes, Blane, what we’re looking at because remember you also then put 20 stores into the mix, right? So, we haven’t really disclosed our outlook for next year but we’ve disclosed where we are this year. We’ll probably run somewhat higher than that next year because we have our capital for the integration of those stores, as well. So, you know, I would stay with our outlooks in that low 30s, probably.

Okay. Thanks.

At least in the short term.

Right. Thanks.

Our next question is from Chuck Cerankosky with McDonald.

Good morning, everyone. Good quarter.

Good morning, Chuck.

First question. [Bill Keller] is here with me, but we each have a couple of questions. Looking at the possibility of higher energy costs, impacting the business, Craig, did you see any of that in the third quarter and did it affect the holiday sales mix?

Yes. To answer the first part of your question, yes, there is an increase. I think everybody at retail that operates stores is seeing that. We didn’t really feel any impact at Christmas because we really, we thought we had a great Christmas season. So, you know, it’s not like that impaired our Christmas volume. Well, the impact that we saw was in our own energy costs in the business that we operate.

Okay. Can you quantify that at all? What it was YOY?

Well, say probably $1 million or so, Chuck.

Lastly, of increased diesel and heating costs, that kind of thing?

Between your electric, your natural gas, more electric and natural gas. Fuel we have a surcharge that we work through. So, certainly fuel costs were up, but we covered that. I’m was talking mostly in the utility area.

Okay. All right. And, okay, so you don’t think the sales mix was affected in the fourth quarter or in the third quarter. Why, Craig, do you think it’ll show-up in the fourth quarter then?

Well, you know, it’s sort of a catch-up affect, you know. Increased fuel charges for a consumer, okay, let’s just talk about the average consumer, you know, the first couple of months that they get a big bill they can sort of digest it. But as time goes on I think it starts to wear, you know, have a wear factor.

Okay. Switching to D&W, Craig, can you put any parameters around what you think that’ll contribute to fiscal ’07 earnings?

I can’t disclose that at this time, Chuck. I mean we certainly would like to be able to do that, but we really haven’t done enough work to be in a position to disclose that on a public basis.

Okay. And how about other chains to acquire, including some of your own customers? What’s the outlook on that? And then I realize you want to digest D&W but can you talk to that subject at all?

I can’t be specific, but all I can tell you is that the outlook is very encouraging. We have, of course, done a lot of work with our retailers. Told them that we are their exit strategy if, in fact, they feel that they want to exit the business. So, we – because of those good relationships we have we think…

[Audio difficulty.]

…the interest and depreciation forecast [inaudible]?

Yes, the interest is 7.5 to 8, and the depreciation is 20 to 21.

And then on the inventories that were mentioned in the release the incremental pharmacy and fuel is that just due to adding more pharmacies and fuel stations?

Right.

Thanks.

[CALLER INSTRUCTIONS.]

Our next question is from Karen Short with Fulcrum.

Hi, guys.

Good morning.

Hi. A couple of questions for you. Just in your prepared remarks and your press release, Craig, you said that the fourth quarter would be I guess somewhat lower, to quote you, than levels in the corresponding quarter last year. Can you just clarify what you consider your earnings to be last year? Or when you make that statement are you including or excluding the tax benefit?

It would be excluding that.

Excluding the tax benefit, so on an earnings basis looking at $0.19 is kind of what I have?

You’d have to adjust the 1.3 million out.

Right, okay. And then the second question is do you guys have the divisional EBITDA handy?

The segment?

Segment EBITDA.

Karen, I can give you like some of the depreciation, if you’d like, and you can go there.

Sure.

You know, if you look at our depreciation this year and if you break-out our number for the quarter between retail and distribution, retail was about 3.5 million in depreciation and distribution was about 2.4 million in depreciation.

And what about the [SPB] and the LIFO?

If you – LIFO was relatively flat, I believe about 100,000 or so would be the LIFO number.

Okay. And you do an add-back for the Michigan tax, or no?

Yes, we add-back Michigan tax. It’s pretty diminimous in the quarter, so I…

Yes, that’s…

So, that’s not going to be much of a factor for this quarter.

Okay. And, also, just to clarify the favorable tax audit, where did you allocate that, again?

Well, the tax audit wouldn’t show-up in either of your operating divisions because we ended operating earnings, so that’s just in your Federal income tax.

For Michigan?

Part of Michigan’s this year’s. That was in your distribution, in our distribution [footprint].

Okay. And then just I guess looking forward, you know, obviously there’s been a lot of noise on what’s been happening with the Medicare transition. Just wondering if you could talk about it a little bit. I know, you know, the pharm stores just turned positive this quarter, but did you, are you seeing so far a negative impact on – well, I guess it would be a negative impact on margins more than sales, but maybe could you just talk a little bit about it?

You’re talking about what? On the Medicare?

Well, just I mean you’ve got – there’s been so much press about what’s been going on with, you know, seniors not being able to fill their prescriptions. You know, long phone – being on hold with, you know, the different HMOs, to try to sort out coverage and things like that. So, I just wanted to see if you guys could talk about it a little bit?

Karen, I would think at this time it’s really too soon to tell what the impact is going to be. You know, we are encouraged with the margin benefit from generics. It’s, you know, as we explained there is a sales [hurt] but the offsetting margin benefit is a pleasant thing to experience. So, at this point in time we are not experiencing any significant impact.

Okay.

I know it’s been discussed that what’s going on with Walgreen’s and all of those guys, and some people took down their earnings because of that. But at this point in time we haven’t seen anything.

Okay. And then, just a last question for clarification, in retail the third quarter of this year is the last time you have FICO, the past YOY comparisons with the sale of the joint venture and the closure of the pharm…

Sale of the joint venture, yes. Closure of the pharms, no. Closure of the pharms were right at the beginning of this current year.

So you saw the 4.2 million?

Right.

Or whatever the number is for the fourth quarter is lower.

But the joint venture is cycle.

Cycle, okay.

Let me correct my LIFO number. I was giving you a period number. If you want LIFO it’s about 200 for the quarter in the retail group and about 300 in the distribution group.

It’s 500 for the quarter, the LIFO expense.

300 in distribution, 200 in retail?

Yes.

Okay. Great. Thanks a lot, guys.

Okay. Thank you.

Our next question is from [Louis Shapelvita] with Ryan Beck.

How are you doing? I have two questions for you. The first one is are there still any Jewel Food Stores in your marketplaces? And, if so, how do you see the Super Value buy to affect your markets?

No, there are not any Jewel Stores in the State of Michigan. They divested those stores about seven or eight years ago. So, we do not compete with Jewel in any way.

All right. Thank you. The other question is if you can just go over a little bit the competitive landscape since those nine super stores and the two Cosco’s opened as far as where do you stand in those markets? And then have any of the smaller players exited those markets since those super stores opened?

We haven’t seen any exit being recent, but we do see a significant softening in sales on the part of our competition. We expect to see something happen within the next six to 12 months. It’s – we’ve – our strategy has always been that our competition is that other conventional retailer, so we are focused on being the surviving conventional and we feel pretty good about where we are at this point in time.

And those markets where the nine super centers opened, are you the top conventional supermarket?

In just about every location, yes.

Thank you.

Our next question is a follow-up from Karen Short with Fulcrum.

Hi. I just wanted to ask on the D&W stores are you – do you have the ability to put fuel centers in some of those stores, all of those stores? And I guess the same question would go with pharmacies?

To answer the fuel center, we think there’s two or three locations that a fuel center is a very natural thing and will work very well for us. We haven’t been terribly focused on that part of the due diligence process, but we know that there are two or three that we will want to go forward within the first couple of years.

On the pharmacy business, just about every one of their stores currently has a pharmacy but the pharmacy is a third-party relationship with the D&W stores, so we are not buying the pharmacies in this transaction. However, the pharmacy does operate in the store and you get the residual benefit of having a pharmacy with your store.

Okay. So, you are keeping all of those pharmacies in your store?

Yes, that’s our current plans.

Okay. Great. Thanks.

Mr. Sturken, I’m showing no further questions at this time.

Well, at this time, on behalf of Spartan Stores and all of our great associates I’d like to thank everyone for dialing in, and we look forward to talking to you at the end of the fourth quarter. Thank you.

This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time. 1