SpartanNash Co (SPTN) 2008 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Spartan Stores Incorporated fiscal 2008 second quarter 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. (OPERATOR INSTRUCTIONS).

As a reminder this conference is being recorded and, ladies and gentlemen, I must remind you that comments made by management during today's call will contain forward-looking statements. These forward-looking statements discuss 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, among others, competitive pressures among food retail and distribution companies; the uncertainties inherent in implementing strategic plans and general economic and market conditions. Additional information about risk factors and the uncertainties associated with our forward-looking statements can be found in the Company's earnings announcement annual report on Form 10-K and our other filings with the SEC.

Because of these risks and uncertainties, investors should not place undue reliance on forward-looking statements. Spartan Stores disclaims any intention or obligation to update or realize any forward-looking statement.

It is about my pleasure to introduce your host, Mr. Craig Sturken, President and Chief Executive Officer for Spartan Stores Inc. Thank you, Mr. Sturken. You may now begin.

Thank you very much. Good morning, everyone, and thank you for joining our fiscal 2008 second quarter earnings conference call. With me this morning are members of our team including Executive VP and CFO, Dave Staples; Chief Operating Officer Dennis Eidson; our Executive VP of Retail Operations, Ted Adornato; and Executive VP, General Counsel, Alex DeYonker.

Our second quarter financial results continue to show substantial improvement in both sales and earnings growth, which marks our sixth and seventh consecutive quarters of net sales and operating earnings growth respectively. We made steady progress during the quarter in many of the business initiatives that are continuing to strengthen and favorably positioned Spartan Stores in a very competitive marketplace.

These initiatives include assessing and integrating the retail operations of 20 Felpausch stores, ramping up the substantial new distribution business with Martin's Super Markets and expanding supplying relationships with our existing distribution customers in southeast Michigan.

In addition, we made additional progress with our capital program related to upgrading stores from both the D&W and Felpausch acquisitions.

We are especially pleased with the performance of our core grocery stores, particularly our D&W Fresh Markets stores. During the past two quarters we completed remodels of four D&W stores and so far the sales trends have been terrific.

Additionally, today we are holding a grand opening for our recently completed 48,500-square-foot Family Fare prototype store. This store serves as a replacement for an older smaller store and will showcase many of our latest merchandising and promotional ideas. These capital investment decisions along with our strong marketing and merchandising programs, coupled with the state-of-the-art category and management practices, are continually improving our market that position at making us an even stronger market competitor.

During the quarter, we continued to make progress integrating our Felpausch retail stores. We will complete our remodeling efforts for two Felpausch stores and start one additional remodel during our third quarter. We also expect to complete a total of three additional remodels during the fourth quarter.

These store remodels will be very comprehensive and allow us to better execute our promotional and merchandising programs, as well as significantly improve the customer's shopping experience. In fact the remodel of our Eaton Rapids Felpausch store was completed last week and the first week of grand reopening sales have exceeded expectations.

The remainder of the capital program is currently being evaluated and will likely be substantially complete by the end of fiscal 2009.

As you may be aware we also announced the closing of five underperforming Pharm retail stores this quarter. These stores did not meet our performance standards, were located in markets that did not present favorable long-term growth potential, and had near-term expiring lease agreements. While closing a store is never a desired event because of its effect on our associates and the communities we serve, we are committed to continuously strengthening our Company at making the right decisions that best position us for long-term growth.

From a distribution perspective, the transition of new business from Martin's Super Markets is progressing on plan. We are very impressed with the outstanding Martin's organization and with the cooperation between our two companies. Both of our organizations rose to the challenge of successfully integrating a substantially new distribution relationship.

During the quarter we also started to realize sales volumes gains from our expanding business with distribution customers in southeast Michigan as a consequence of Farmer Jack's exit from that market. Consequently we have seen substantial volume gain from many of our core distribution customers.

Lastly, we are continuing to continuously striving to improve our operational efficiencies. Currently we are evaluating a number of initiatives that will help improve our distribution network and sustain our competitive advantage.

With that overview, I'll turn the call over to Dave Staples for a detailed review of our second quarter financial results. I will rejoin the call following Dave's comments to provide you with an update of our business outlook. Dave.

Thank you, Craig, and good morning, everyone.

Consolidated net sales for the second quarter reached a six-year high, increasing 13.5% to $627.1 million from $552.6 million in last year's second quarter. The increase was due to higher sales in both of our business segments.

Gross margin for the quarter increased 60 points to 20.6% compared to 20% in the second quarter last year. The improvement was due mainly to an increase in the sales mix of higher margin retail sales and an improvement in retail gross margin rates, partially offset by a volume increase in lower margin fuel and pharmacy sales.

As a percentage of sales, second quarter operating expenses increased to 17.4% from 16.8% in the same period last year, reflecting the higher retail operating cost structure due to the recent acquisitions and a 1.3 -- and $1.3 million of favorable insurance related items that reduced last year's operating expenses.

Startup costs attribute to the Felpausch acquisitions amounted to approximately $0.3 million in the second quarter.

Second quarter operating earnings increased 11.9% to $20.1 million from $17.9 million in the same period last year. The improvement was the result of strong overall sales growth as improved gross margin rates were offset by startup costs for our new business activities and the $1.3 million favorable insurance reserve adjustment in last year's second quarter.

Second quarter earnings from continuing operations before the non-cash charge related to the Michigan tax law change increased 19.6% to $11.5 million or $0.53 per diluted share from $9.6 million or $0.45 per diluted share in the same period last year. Earnings benefited from lower interest expense due to the private placement of convertible senior notes and the amendment to our credit facility that took place in the first quarter. The earnings benefit was, however, partly offset by the borrowings associated with the Felpausch acquisition and the higher networking capital requirements due to higher sales volume.

As described in our press announcement, the non-cash charge relates to a new Michigan state income tax law that was originally enacted in one form and then subsequently changed to correct the deficiency in the new tax code that would have had adverse financial consequences to businesses operating in the state. The timing of the two legislative actions fell between our fiscal 2008 second and third quarters, requiring us to record the non-cash charge in this quarter only to record an equal credit in our fiscal 2008 third quarter which has already been recorded.

Consequently the income taxes line of our financial statement increased by $2.7 million this quarter but will decrease by $2.7 million in the upcoming third quarter. This transaction is strictly a non-cash accounting entry between two reporting periods that will have no effect on our annual net earning. As a matter of fact, we are not even subject to the new tax rules until January 1st of 2008.

The other substantially issue related to the tax law change is that in the fourth quarter of this year and in subsequent period, the Michigan Business Tax will be classified as an income tax. Beginning in the fourth quarter all provisions related to the tax will be included in income taxes and our financial statements rather than the past classification as Selling, General and Administrative expense.

Net earnings for the quarter before the non-cash state income tax charge rose to $11.9 million or $0.55 per diluted share, compared with $9.3 million or $0.44 per diluted share last year. Including the non-cash charge, reported net earnings were $9.1 million or $0.42 per diluted share.

Turning to our business segment, second quarter distribution sales increased 4.4% to $293.8 million from $281.5 million in the same period last year. The sales improvement was due to new distribution customers and expanding sales to our core customers, particularly in southeast Michigan. This gain was partially offset by the elimination of sales to be acquired Felpausch stores as these sales are now reflected in our retail division.

Distribution operating earnings improved 4.8% to $8.1 million from $7.8 million in the same period last year, marking our highest second quarter operating earnings level in six years. The improvement was due to higher sales volumes and network efficiency improvements, partially offset by last year's favorable insurance reserve adjustment of $0.5 million.

Second quarter retail sales increased 22.9% to $333.2 million from $271.1 million in the same period last year. The sales improvement was due to the addition of our Felpausch stores and solid sales performances across all of our retail supermarket banners. Comparable store sales, excluding fuel, rose 2.8% as a result of our newly remodeled stores, the opening of additional fuel centers and higher prescription sales from the acquired pharmacies.

Second quarter retail operating earnings increased 17.4% to $11.9 million from $10.2 million in the same period last year. This is the highest level of retail operating earnings that we have reached since becoming a public company in August of 2000. The improvement was driven by higher store sales volumes in our acquisitions partially offset by the $0.8 million non-recurring insurance reserve adjustment in last year's second quarter.

I will now cover our outlook for the second half of fiscal 2008.

We expect comparable retail store sales to increase in the low single digits in the second half of our fiscal year and the acquired Felpausch stores to add approximately $85 million to our consolidated sales for the fiscal year. On the distribution side we expect to continue to generate incremental revenue from the new Martin's business and from the Farmer Jack store closures in the Detroit area through our fiscal year end. We experienced some of the business benefits of this business ramp up during the second quarter and expect additional benefits through year end as our customers continue to open the former Farmer Jack stores they acquired.

We expect the additional business from our Martin's relationship to the modestly accretive to earnings in fiscal 2008 because of the startup costs associated with this new business. We expect to incur startup costs as a result of the Felpausch acquisition of between $1.5 and $2 million for the store repositioning, remodeling and employee training during the remainder of this year.

The remainder of our Felpausch capital spending program is now expected to extend through our fiscal 2009 year, resulting in additional store remodels and promotional programs during that time period. We will provide more guidance on the capital program timing as we finalize our budget plans during the remainder of the fiscal year.

Capital expenditures for fiscal 2008 are expected to range from $40 million to $45 million including the anticipated remodel activity of the Felpausch retail stores. Depreciation and amortization expense to range from $23 to $26 million and interest expense should be approximately $12 million.

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

Thanks Dave.

We are very pleased to report consistent and continuing revenue and earnings growth and to be making consumable considerable progress executing our strategic business plan. We continue to gain ground on our competitors, solidify our market position, and gradually nurture sustainable long-term competitive advantage by differentiating our retail offerings by maintaining consistent and high service levels.

We are building one of the best retail grocery store franchises in our markets and are expanding our best-in-class distribution network to new markets.

During the remainder of the year, we will continue to upgrade select Felpausch stores, bringing them up to the high-performance standards that we expect. This will include additional store remodels, banner transitions, new marketing and merchandising programs and store layout changes. We will also finalize our plans for the remainder of the Felpausch stores. While we still have much more work left, we remain very optimistic about the potential of the stores as they are an excellent complement to our existing store base.

In addition we are working on fiscal 2009's capital plan for the remainder of our stores which will include several significant remodels and one or two store relocations. We will provide more details about these plans as next year's operating plans finalize.

Our distribution division, we have finished most of the heavy lifting associated with assimilating the Martin's business and expect the benefits of this expanded supplier relationship to continue to the end of the fiscal year. In addition, we have additional business to bring on with customers in the Detroit area which will also contribute to our continuing distribution sales growth.

We have identified areas in our warehouse network that will allow us to continue to improve our operating efficiencies and capacity. And we are currently working very hard to realize these benefits.

We will continue to look for expansion and consolidation opportunities for both our distribution and retail divisions in contiguous Midwestern states, as well as the current markets that we serve.

Considering our strong year-to-date financial performance in light of the competitive environment and economic climate in our markets, we are increasingly confident about our long-term business prospects. As we move forward, we will continue executing the growth phase of our business strategy while further strengthening our business fundamentals and competitive market position. We firmly believe that significant and sustainable growth opportunities remain before us.

We will now open the call for your suggestions.

(OPERATOR INSTRUCTIONS). [Bakley] Smith with Bank of America.

Congratulations on a great quarter. Just really I have two macro questions. First one would be how are you seeing the climate up there in Michigan? It's been a topic of discussion, jobs, etc.

Well first of all, it is cold and rainy which is the way it always is. But the job climate? Well let's face it. Southeast Michigan, Detroit market that's so reliant on the auto industry, they have issues. In western Michigan, however, we see things as much more stable and as the environment here segues from a manufacturing marketplace to one of service and health, we see the the employment situation probably improving.

And then in terms of inflation, you haven't talked about the food inflation as far as I noted. I didn't note anything if you did talk about it. How are you handling dairy, etc., some of the problems that other folks have been talking about?

You can't ever deny that there is such a thing as food inflation. We feel that we are maintaining pace with food inflation. We don't see it affecting our earnings. Food inflation has been around for many, many years and we deal with it on an everyday, every period basis.

Thanks. Again congratulations on a great quarter.

Karen Short. Friedman Billings Ramsey.

Couple of questions. Just wondering -- well. Follow up with another macro. Just wondering if you can maybe give a little color on what you are seeing from the consumer? You know are you seeing some trading down? Are you seeing I guess also just some changes in the competitive environment? Has it gotten worse? Craig, I think at the beginning of the call you alluded to the fact that it was a very competitive marketplace. So what I mean is, has it always been competitive? Has it gotten -- has it changed?

It's -- you know. More of the same from a competitive standpoint. You know we really are faced with two of the toughest retailers in the United States, being (inaudible) and Wal-Mart. They are not going to go away. We have learned to deal with it and live with it and we will march on.

Your question about the consumer, what's going on? Nothing to report out of the ordinary except that our private label program continues to be very, very strong. We've just come off our fall private label sale and it was fantastic. It was just a terrific program for us and we think that it serves the needs and maybe the desires of the customers today.

That's great. Then I just wanted to follow up on the Farmer Jack stores. I think you guys were -- you maybe got eight, eight-ish of the Farmer Jack stores were bought by your customers. I just was wondering if you could give some color on how many actually had reopened in the second quarter? Clarify if that eight is actually the right number?

The total number of stores that our retailers will have opened is 14, and we were hoping for 15 but we got 14. Currently nine of those stores are operating. So embedded in our numbers is the benefit of those nine stores and we have five more to go.

Also just on your comps a little bit. Can you talk a little bit about traffic versus baskets? Then also I guess wondering if it was volume-based or was it largely food inflation-related?

Well, actually, this is the count -- the sales for transaction versus customer count has more or less flattened out. We were having difficulty with customer count and we might be just slightly negative. Less than -- I'm sorry, customer count is slightly positive, around 1%. Sales (inaudible) transaction is slightly negative around 1%. It's really not much.

And what about -- so volumes slightly down?

You mean tonnage?

Well, volume at the store, at the retail level.

We're very flat.

Chuck Cerankosky. FTN Midwest Research.

Great quarter. If we are looking at the [tag flying], Dave, can you give us an update on the NOLs ex carryforwards?

Say that again, Chuck. I'm sorry.

Yes. Just focusing on the tag flying to start, can you give us an update on what you have left with the NOLs tags carryforwards?

We are pretty much through that at the end of the second quarter at this point. So there's always good news and bad news. Right? The good news is we keep performing better than we ever anticipate. I guess the bad news is we use up the NOLs faster.

Understand. Craig, comment on pharmacy trends. How's that been going for you? What's your script count growing at?

Well, script count first of all are affected by the transition to multiple week or multiple month scripts that are being written by the insurance companies and by doctors. In other words I used to get 30-day supply and now I get a 90-day supply. So that really affects and that happens to everybody. Everybody is going through that. So that really is affecting the script count.

The other thing that is going on is generics. Generics has really changed the [ring] value of prescriptions and you -- everybody has seen the incredible numbers of the difference in the ring value of a prescription that is generic. So that all adds up to a lot of pressure on the topline sales of our pharmacy business, which we are experiencing just like everybody else.

Dave, I want to be sure I understand in the retail segment, in the second quarter, you had about $300,000 of expense related to assimulating Felpausch and by that I mean the integration, training, etc. factors?

Correct.

Okay. Is that -- was that below or above plan? Are you happy with that number you indicated for the second half of the year, we are going to see $1.5 million to $2 million so it is going to pick up. And are we still looking I think at a number of 4 to 5 total?

Yes. By the time you get through next year because, really, you know a large percentage of that after the first quarter relates to your re grand opening expense, your promotion as well as you've relaid out the store. There's some training that goes with that, but mostly are resets. So mostly it has to do with the remodel activity or coin sync with that.

So as we pushed out a few remodels out of the second quarter into the third and then the fourth and then as this plan moves through next year, we will still stay relatively on track for that number. It's just spread out over somewhat of a longer time frame.

But it is $4 million to $5 million total?

Yes. It will still be in that ballpark.

When do you think you'll be done with that?

We think we will be late next year because in a couple of markets I think we will really put some nice touches on those markets. So it will go through the end of next year. It could trickle into the following year depending on timing with what -- and what we do with a couple of stores. But we expect to be substantially complete by the end of next year.

Then I guess we should when thinking about what kind of operating margin to apply to your retail segment it could drift up a little this year, but maybe a little more pressure next year because more expenses being pushed into fiscal '09?

Yes. You will be a little off right because if we end up 4 to 5 we are going to be -- we were 500 in Q1 -- $500,000, $300,000 then the $1.5 million to $2 million. We actually should be half or better this year. So you'll probably spend about the same or a little less next year, actually.

Right, if you take the $800,000 year-to-date plus the $1.5 million to $2 million puts you at $2.3 million to $2.8 million and we are talking $4 million to $5 million, you've got the bulk of -- a little more than half of it probably behind you this year. So it shouldn't put more pressure on.

Well, the other thing is there's a benefit for this investment. You know we will do better in those stores where we have made the investment this year and that is part of an offset for future investment.

(OPERATOR INSTRUCTIONS). Perry Caicco. CIBC World Markets.

I know it's very early on Felpausch, but I wonder what you've learned about the Felpausch customer base, you know, how they've responded to specific parts of your program? Is there any sort of change or new thinking in how you see that store base unfolding specific to banners and format changes?

One of the things that we mentioned earlier in our presentation, the -- we chose one store (inaudible) as a test to be sure that we had our formula right in making the change and in Eaton Rapids, Michigan, (inaudible) about an isolated store, doesn't affect any other markets. We are just overwhelmed with the response on the part of the consumer. We had it right plus. The conversion through the Family Fare banner which is what we did there.

It had no negative impact on the customer because you know we always worry about, does the banner change, is it a good thing or a bad thing. The banner change was great. What we did in the way of modifying the store's format really has turned out to be great. So we are very very pleased with that and we expect to see that kind of response going forward.

You know, these people -- what we're going to get is a more loyal customer out of the deal because we are in a better spot to fulfill all of their shopping needs with the changes that we are making.

And is that -- has that early success altered your thinking in terms of being more aggressive with the Family Fare banner? Or on the asset base?

Well, that's a good question. I mean what it -- you are not the first person to ask this question. You look at this and say, gee, should we speed up the entire investment process? And frankly we are considering how we are going to look at that.

The one thing that is very important though is that we don't disrupt what is going on in the balance of our business. It's very tempting to look at Felpausch and say, my goodness, let's marshal all the troops, put them all over there. But you know we have this other part of our business that is very important. What's going on with the Farmer Jack stores, what's going on with Martin's.

So we are -- I hear what you are saying. I heard it from someone else and it's tempting and we will let you know when we -- if we change our schedule.

That's fair. I wonder what's driving your improved margin rates in the retail segment, considering you are battling some pretty heavy cost inflation and some pretty heavy retail price action by Wal-Mart. I guess I'm assuming the private-label in perishables are part of that?

Yes. I want to give that to Dennis Eidson.

You are exactly right. Craig touched on the private label a little bit earlier in the call. But private-label has really been the driver for us. As you know, the profitability is significantly better than on the branded side and we treat our private-label as really a strategic plank to our whole go-to-market offer. And it's paying great dividends.

As a matter of fact on both sides of the house, we actually just got done with the fall (inaudible) where we ran TV on Spartan brand product across the state of Michigan and northern Indiana in markets where we don't even have corporate stores, supporting our independent customers which as far as we know is pretty unique from a wholesaler perspective.

So -- that's fine. Then just one more question if I could, Craig, and see, I guess with the sort of weak southeast Michigan economy and I guess with Wal-Mart's heavy promotional programs, I wonder does that change the environment for acquisitions among the independent base in the region?

Not that I can tell. Honestly our retailers are doing very well. You know, again, if we -- let's just take the private label story. If we increase the penetration of private label in the retail customers that we supply, their profitability is enhanced also. So there is no extraordinary pressure on the retailers from a profit standpoint to say, well, now is the time to get out. It's probably just the opposite.

But the likelihood of our continuing to march down the road of acquiring retailers that we supply is always there. And in our -- we are their exit strategy, and as time goes on, it becomes attractive for them and we will be there to work with them.

Is it possible that the retailers that are not in your system are more likely acquisition candidates at this point?

I would love to be able to tell it you that. Yes. You may have to ask somebody else on another conference call, but sure. Yes. We -- that's a big part of our strategy.

Karen Short. Friedman Billings Ramsey.

I just wanted to ask a question on the operating margin side and distribution. Craig do you -- kind of alluded and touched briefly on some initiatives that you are working on to improve operating performance. Can you maybe elaborate a little bit on that and maybe see if you can direct some color on what the margin expanse and opportunity is?

Really, what we are looking at in our district, as we grow our distribution business, we are looking for efficiencies. Systems and technology are there for us to implement; and, frankly, we have been so focused on growing the business and bringing (inaudible) onboard this year, we haven't made any major changes there. But there's a lot of opportunities for us to incorporate both technology and maybe expertise from other people, such as consultants, that know -- know how there is a better way to do it.

We feel that there's -- there is upside. We know that there is upside for us on the efficiency standpoint. We benchmark our Company against everybody else and we realize that there are tremendous upsides for us. As well as we are doing, as much progress as we have made, we know that there is upside.

So would it -- I mean it is kind of fair to say it's a multiyear type of an initiative?

Yes. As a matter fact I think it's probably a continual initiative.

Great. Thanks a lot.

Chuck Cerankosky with FTN Midwest Research.

Wonder if you can elaborate on that same subject, relative to the outlook and the distribution business presented in the press release? You're talking about some fourth quarter benefits as a result of some improvement initiatives there and I was wondering if you could expand on what was briefly mentioned in the press release?

One of the things that we are doing -- and Dave just reminded me, okay, is that we are reflowing and reracking them, a major part of our grocery distribution center here in Grand Rapids.

As you know we've added many SKUs in order to take care of Martin's. We've added many SKUs to take care of our retailers on the southeast side that have taken over these Farmer Jack stores that had a mix of products that was different and unique. And we've just sort of plopped that stuff into our business.

Now we are going through the process of reracking and reflowing our distribution centers so that we can put this product where it belongs. And that will have a big impact on the efficiency of our -- and the travel time of the people in our distribution center. And that will be ongoing throughout the fourth quarter and into next year. So the benefits will accrue over time.

Is there a way to put a basis point improvement target on that?

I don't think that our supply chain guy would ever let me do that.

Mr. Sturken, there are no further questions at this time.

I would like to thank everybody for being part of our second quarter conference call. We look forward to our third quarter conference call down the road. Thank you.

This concludes today's conference. Thank you for your participation.