SpartanNash Co (SPTN) 2011 Q3 法說會逐字稿

Greetings and welcome to the Spartan Stores, Incorporated fiscal 2011 third-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.

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 might 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 the Company's 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 revise any forward-looking statements.

It is now my pleasure to introduce your host, Mr. Dennis Eidson, President and CEO of Spartan Stores, Incorporated. Thank you, Mr. Eidson. You may begin.

Good morning from snowy Grand Rapids and thank you for joining our fiscal 2011 third-quarter earnings conference call. With me this morning are members of our team, including our CFO, Dave Staples; our Executive Vice President, Merchandising and Marketing, Alan Hartline; our Executive Vice President of Retail Operations, Ted Adornato; our Executive Vice President of Wholesale Operations, Derek Jones; and our Executive VP and General Counsel, Alex DeYonker.

I'll begin by providing a brief overview of our business progress and financial performance. And then Dave's going to give you some more specific details about the quarter's financial results, as well as our outlook for the final quarter of '11. And then I'll rejoin the call a little bit later and give some concluding remarks.

We're pleased with our overall financial performance for the third quarter of fiscal '11. The economy across our markets appears to have stabilized, but the rebounding growth is likely to come at a much slower pace than any of us would like. And that being said, we remain encouraged about the long-term prospects of our business strategy and the key markets that we serve.

For the third quarter of fiscal '11 we continued to manage the controllable aspects of our business, to report historically high levels of operating earnings and adjusted EBITDA, and, in addition, during the quarter actually generated a record level of cash from operations despite the economic challenges and our market having absorbed ten new or expanded super center openings during the past two years.

On a consolidated basis our reported operating earnings increase was due largely to a net pretax benefit that we will discuss later in the call and contributions from a larger LIFO inventory valuation credit.

Focusing on our operating segments in more detail, we continued to make solid progress in our distribution segment in the third quarter. We achieved a slight increase in net sales due to additional pharmacy program business. Improved sales and continued focus on operating efficiency led to improved operating income as well. In addition, on a year-over-year basis we reduced our FIFO inventory investment by $5.1 million. So we'll continue to work aggressively to increase sales penetration with our existing distribution customer base, seek new independent customers, enhance our value-added service offerings, and further improve the efficiency of our operations.

In the retail segment, comp store sales improved on a sequential basis for the third consecutive quarter. Operating profits were lower due mainly to the current sales environment, an unusual spike in employee healthcare costs late in the third quarter, incremental LIFO expense, increased employee incentive compensation, and higher debit/credit card fees. Our near-term business strategy will continue to focus heavily on bringing consumers excellent product value and a superior shopping experience.

In our retail segment we began rolling out our loyalty card program to our VG's Food and Pharmacy retail consumers early in the fourth quarter. We are pleased with the progress of the program, the valuable insight it brings to our marketing and merchandising efforts, and most importantly, the enhanced value that it is providing to our customers. We expect the effectiveness of the program to continue to gain even more traction as our VG's consumers realize the full extent of the value offerings provided by the card, and as we are better able to mine the data that it provides.

Another way we remain focused on enhancing our retail segment's value profile is by continuing to introduce corporate brand products. And during the quarter we introduced approximately 80 new items. These new items further enhance our strong portfolio of corporate brands and thus expanding our value offerings while giving consumers even more product choices. Just as the industry has experienced, sales penetration of our corporate brands declined slightly over the quarter due to the lapping of a very strong corporate brand performance in the third quarter of last year. I personally believe this decline in sales penetration is temporary and we remain on track to introduce up to 100 new items by fiscal year end.

In the quarter we relocated and completed the conversion of a Felpausch Food Center to a Family Fare Supermarket and remodeled two additional supermarkets. So far consumer response to the capital spend has been positive.

From a competitive standpoint, our markets remain stable, as we cycled three super center openings during the third quarter and two additional super centers opened. We do not anticipate any incremental super center openings during the remainder of this fiscal year. And as mentioned previously, our outlook for next year only includes one incremental super center opening that we expect during the first quarter.

We've made many fundamental changes and structural improvements to our operations during the past several years that have strengthened our position as a leading supermarket operator and a highly efficient, value-added distribution partner for our independent customers. And as a result of the changes, we remain confident about the strength of our market position and long-term growth as we move beyond these challenging times.

And with that overview, I'm going to turn the call over to Dave. Dave?

Thanks, Dennis, and good morning, everyone.

I'll provide you with more details about our third-quarter financial results as well as some broad financial guidance for the fourth quarter of fiscal 2011.

Consolidated net sales for the 16-week third quarter were $782.3 million compared with $786.9 million in the year-ago quarter. The slight decline related primarily to lower supermarket sales, substantially offset by higher fuel center and distribution sales. Distribution and fuel center sales represented slightly over 44% and 5%, respectively, of consolidated net sales compared with 44% and 4%, respectively, in last year's third quarter.

The consolidated gross margin rate for the third quarter increased 10 basis points to 21.1% from 21.0% in last year's quarter. The increase was driven by improved margin contributions from our supermarkets and fuel centers and the benefit of a $700,000 increase in the LIFO inventory valuation credit due to improvements in our warehouse operations. The gross margin rate improvement was, however, partially offset by a slightly higher mix of lower margin distribution and fuel center sales.

Third-quarter operating expenses were $148.2 million, or 18.9% of sales compared with $151.8 million, or 19.3% of sales in the same period last year. The adjusted operating expense to sales ratio was 19.3% in the third quarter of fiscal 2011, excluding a noncash $2.4 million net pretax benefit related to lease terminations and the freezing of our employee cash balance pension plan, net of asset impairment charges. We were pleased to be able to effectively maintain our expense leverage despite the existing sales environment, as store labor productivity improvements, cost containment initiatives, and distribution efficiency gains offset higher healthcare expense, debit/credit card fees, and employee incentive compensation costs.

Reported third-quarter operating earnings were $16.6 million compared with $13.7 million last year. Excluding the previously mentioned noncash items in this year's third quarter and the $700,000 of asset impairment charge in last year's third quarter, adjusted operating earnings for the third quarter were $14.2 million compared with $14.4 million in the year-ago period.

Adjusted EBITDA for the period was 3.3% of net sales, which was the same as the third quarter last year.

Reported third-quarter earnings from continuing operations increased 42% to $7.5 million, or $0.33 per diluted share, from $5.3 million, or $0.23 per diluted share, in the year-ago quarter. Adjusted earnings from continuing operations were $6.0 million, or $0.26 per diluted share, compared with $5.7 million, or $0.25 per diluted share, in the year-ago quarter.

Let me take a moment to provide some additional color around the $2.4 million net pretax benefit. We restructured our retirement benefits in a manner that we believe provides a strong benefit for our associates and a more predictable and sustainable program for the Company. The benefit plan changes included freezing our cash balance pension plan, reinstituting the matching employer contribution for the 401k plan, and adding a profit sharing component to the 401k plan. These actions resulted in a curtailment gain being recognized of approximately $4.0 million.

Additionally, as the result of the termination of three leases, the Company was able to shorten the existing liabilities associated with those leases and recognized income of $5.9 million. The asset impairment charge included in the net pretax benefit totaled $7.5 million. As you are aware, assessing assets is a recurring process for any retailer, and some of the adjustments made in the industry by our peers have been quite significant. This adjustment represents a noncash charge to set the asset base for a handful or so of stores to the cash flow generated by these locations.

Turning to our operating segments, third-quarter distribution net sales increased approximately 1% to $346.9 million from $343.6 million last year. Sales improvement was due to stronger pharmacy program sales. Reported distribution operating earnings for the quarter were $15.4 million compared with $11.7 million in last year's quarter. On an adjusted basis, which excludes the segment's portion of the previously mentioned noncash items totaling $2.2 million, operating earnings improved 12.7% to $13.2 million. The adjusted earnings improvement was due primarily to a $1.0 million increase in the LIFO inventory valuation credit and operating efficiency and expense leverage gains, which were partially offset by higher healthcare costs and employee incentive compensation expense.

Third-quarter retail sales were $435.4 million compared with $443.4 million in the same period last year. We are pleased with the continued improvement in our comparable store sales. And although we reported a 4.4% decline excluding fuel centers, the third-quarter results are an improvement relative to the second quarter and represent the third consecutive quarter of improvement. Additionally, our two-year comparable store sales on a same-store basis stabilized from the second to third quarter.

During the quarter we experienced a modest level of cost inflation at the distribution level, as well as at the retail level, which occurred mostly in the perishable departments. We believe that competitive store openings and the cannibalization effect from new and reopened stores impacted sales by approximately 100 basis points, offsetting the inflationary impact.

Reported third-quarter retail segment operating earnings were $1.2 million compared with $1.9 million in the same period last year. The change in operating earnings was due to the lower sales volumes, an unusually high spike in employee healthcare costs that occurred late in the third quarter, higher employee incentive compensation expense and debit and credit card fees. Incremental LIFO expense and the additional expense and grand reopening costs associated with the relocation and remodeling of retail stores during the quarter also contributed to the change. These cost increases were partially offset by improved margins in our fuel business, better store labor productivity, and lower net restructuring and asset impairment costs.

We continue to generate strong cash flow and our balance sheet improved during the quarter. On a year-to-date basis cash from operating activities improved 14.9% to a record $62.5 million. As of January 1st, 2011, net long-term debt including current maturities and capital lease obligations, net of cash and cash equivalents, decreased $46.8 million to $149.8 million from the balance at the end of last year's third quarter. Our net long-term-debt-to-capital ratio at the end of the quarter was 0.34 to 1.00 and the net debt-to-EBITDA ratio, based on trailing 12-month EBITDA was 1.48 to 1.00.

Currently we also have approximately $120 million of availability under our existing credit facility.

I will now provide some broad forward-looking guidance. We believe that business conditions, while stabilized, will remain challenging during the remainder of the fiscal year and into fiscal 2012. We expect to continue to experience a modest level of product cost and retail price inflation, particularly in the perishable product categories.

On the competitive front, as previously mentioned, we are not anticipating any material level of new competitive store openings in our markets during fiscal 2012. Also as noted, we are currently expanding our loyalty card program to our VG's retail stores and expect to incur an additional $500,000 of expenses related to the initiative during the fourth quarter.

As a result of our Yes loyalty card launch, capital initiatives, and the status of the Michigan economy, we expect retail comparable store sales for the fourth quarter, excluding fuel centers, to improve relative to the third-quarter results, with distribution sales approximating the year-ago levels. From an earnings perspective, we anticipate that the fourth quarter will approximate last year's fourth-quarter performance.

Capital investment in fiscal 2011 will range from approximately $34.0 million to $35.0 million. We expect depreciation and amortization for the fiscal year to be approximately $35.0 million to $36.0 million, with total interest expense of approximately $15.0 million to $15.5 million.

I will now turn the call back to Dennis for his closing remarks. Dennis?

Thanks, Dave.

In closing, during the remainder of the year our priorities will continue to focus on improving sales growth in both the distribution and the retail segments, enhancing the value proposition, and achieving additional efficiencies while managing all of the controllable aspects of our business.

Improving economic measures, including the upward revision to the GDP growth forecast for calendar 2011, the relatively stable unemployment rate, and the rebound of the US auto industry bode well for our markets. We believe that these conditions will lead to a slowly improving retail climate. We will continue to seek prudent growth opportunities in our existing markets or adjacent states through new customer development or acquisitions, and are fortunate to have a strong and experienced management team, along with motivated associates, that will enable us to achieve these priorities over the long term.

And with that, we'll now open the call for your questions.

Thank you, sir. (Operator instructions.) Scott Mushkin; Jefferies & Co.

I guess what I wanted to understand a little bit -- it's good news that the two-year stack is now I guess flattish. But I was wondering if we look at it, besides the economy turning around, what can you guys do to drive better sales going forward?

And then my other question actually is kind of a housekeeping issue, is what was the traffic in the quarter? Thanks.

You know, Scott, I think that's an ongoing challenge for us. As we look at the marketplace, what can we do? You know, we're not just victims of the economy. Our job is to improve the results despite what might be a tough economic environment. And I think we've done some things that have moved the needle. This launch of the loyalty card at VG's has gotten off to a very, very good start. And that's an example. I would tell you that the private label initiative, where we're going to present another 100 new items to the consumer in the quarter is another example of that. We are a high/low promotional retailer and we take great pride in that promotional program that we put on the street week in and week out. And I wouldn't tell you that we win every single week, but we win the vast majority of the weeks. And trying to find promotions that are relevant to the consumer. And we've done some relatively unique things that have driven some results for us. And we're going to continue to do that. So I think that would be the way I would answer the sales driver question.

In terms of your traffic question, the improvement from Q2 to Q3 was obviously not dramatic. But as you look at that, we got a little bit of improvement in traffic and a little bit of improvement in SPT. And that's what it counted for on the trend rate for the benefit. But -- well, let me just go forward a little bit on what we are seeing now, despite, as I look out the window, about 16 inches of snow. We see that the comps in Q1 are improving. And I would say the pace of improvement from 3 to 4 is significantly better than the pace of improvement we saw from 2 to 3. So we're somewhat heartened by that, but still pretty cautious. I mean, it is a difficult consumer to try and figure out. But we are feeling a bit better.

I appreciate that. That was great color. Appreciate it.

Karen Short; BMO Capital Markets.

Just a couple questions in terms of inflation and what you're seeing with price increases. I guess can you maybe give a little bit of color on how the consumer's responding to price increases? Or is it a little too early to tell?

And then I guess following on that, maybe can you just talk a little bit about what you think you're going to see from the vendors in terms of the initial phases of the price increases? Will they be supporting some of the price increases or -- maybe just a little color on that in general?

You know, we're right -- you're asking us again to look a little bit in a crystal ball with the second part of the question. I'm reading the same things you are about input costs. And in some of those areas the commodities are pretty significantly up. I think we have to remember that commodity input costs is just a percentage of the cost of the goods as they come to us through the distribution channel. And I guess we're continuing to expect that the overall inflation, despite the input costs, is only going to be 2.5% or so, somewhere 2 to 3%. That doesn't seem like too big of a bite for us to have to take. And, trust me, we fight back on all of them, but some of them we're going to have to accept. So I think that's probably what the pace looks like. I saw this week -- I think it was Colgate came out and said they were going kind of 1 to 2%. So I think they're going to vary by manufacturer.

As we've had some that we've had to pass on it seems like they've gone pretty well. Historically, fresh proteins, meat and produce have always been, I think, a little easier for the consumer to digest. And those are the ones that we've had more recently where beef, pork, even some of the produce. Bananas we just had an increase. The market went up on bananas. And it's pretty interesting, because that's an item, as you all know, is one of the highest velocity items in a supermarket. And the retails did go up.

So I'm, again, maybe cautious here, but I think we're going to be okay on being able to pass them through.

Okay, thanks. And then, I guess a housekeeping -- how did gas margins impact the quarter?

Gas margins performed similarly to last quarter's. They were a help of $0.02 to the quarter. I think that is the number. Dave, help me if I'm not right.

No, that's right.

That we had last quarter. Cents per gallon was, I think, $0.066 favorable on the margin this year in Q3 versus last year. Our comp gallons were up about 1.8% in the quarter for fuel. So fuel continues to be a tool that we like and has been able to help us move the needle.

And you know, Karen, I just -- on the inflation and I think you're aware, we've talked about it before, going back to that. Remember on the distribution segment when we do get those cost increases, they're an immediate pass-through, so we're able to get the incremental sales benefit of that at the time they come through and there is no lag.

Well, actually, just following on that then, I was going to ask about what you're seeing, volumes, I guess, in distribution. I mean, I understand it is a direct pass-through, but is there a volume impact or is it, again, too soon to really know?

It's too soon for me to tell you because of inflation what the effect is on volume. I would say to you that -- and as you saw by the top-line numbers, we were pretty happy with being able to at least break positive on the distribution sales line in the quarter and that business. I'll tell you what, our distribution customers have proven to be very resilient despite an economic environment that has been very difficult. And we're really heartened that we've been able to manage through the top line in kind of a flattish fashion.

Okay. And then maybe can you just talk a little bit about what was really going on with the healthcare cost increase in retail?

Dave, do you want to (inaudible) question?

Yes. Well, Karen, as we went through the quarter we had been trending right on plan pretty much and in the last two weeks particularly had a dramatic spike in healthcare costs. And when I say dramatic, probably $1.3 million or $1.4 million over our expectations, $1.0 million of which hit in the retail segment. And so that was very unexpected and very out of line with anything we've seen ever, as a matter of fact. We've never -- we always get a spike in those weeks, but we've never seen a spike like this.

And so as we've looked at the last four weeks since year end, it seems to have come back into its normal run rate. So it feels to us at this point -- and we won't know for sure until we get to the end of the quarter and have a few more weeks under our belt -- it just seems like it was an unusually high spike as a result of an unusual number of claims over a $50,000 mark. And so we just seem to have had a higher than normal level of high-level claims. And it was really out of line. And it appears to be coming back into line as we move through this quarter. But that was an impact of $1.0 million, roughly, in retail and probably around $300,000 in distribution.

Okay. And then maybe just some color or comments on, I guess, both the competitive environment -- I know you just briefly commented, but -- and then also the acquisition environment?

Yes. On the competitive environment, I would say we're all challenged for top line here in our geography. It's very competitive. It's always been very competitive. I think it will remain very competitive. The population in Michigan is -- shrank a bit. And so there are less people here to consume products and we're all fighting for our fair share of the pie. So I think rational competition, but tough.

The acquisition environment -- as you know, we've been opportunistic there. And I think the environment has probably maybe ripened the opportunity that something can develop from an acquisition from an acquisition perspective. But those are so lumpy in when they come and, again, I think we're been relatively conservative in making prudent acquisitions. And we're certainly not going to make an acquisition for the sake of making an acquisition. We've got to -- it's got to feel right. It's got to fit for us strategically. We've got to believe that it's going to deliver long-term profitable growth. And so as we have our little checklist of criteria, when we get enough checkmarks in the boxes, we'll go.

Great. Thanks a lot.

(Operator instructions.) Chuck Cerankosky; Northcoast Research.

I wanted to go back and ask Dennis if you could talk about Christmas a little bit. Where was the customer's head at in terms of what they were buying in your stores, the way they were spending money, trading up, versus a year ago, if any at all?

You know, Chuck, we didn't have the kind of Christmas I had hoped we would have, say that. It wasn't awful. I mean, it manifested in our numbers for the quarter. You see the constant retail. But it was a little tougher. I don't know if I can tell you specifically about the buying behavior at Christmas, but let me -- if I look at the customer and some of the trends we see in what they're buying today, we still have D&W is our best performing brand as more of that upscale consumer continues to be -- seeming more confident in themselves.

If we look at what's going on in the quarter in terms of what sold in the marketplace, wine up was up in the whole market. It was up for us. That seems a big of an indicator to me. If you look at our private label business, where we have kind of like three tiers, where we have Spartan, which is the benchmark brand. And then we have the low end Valu Time entry level, and then the natural organic brands. What's happened in the quarter is the mix has shifted. We had a decline in the mix from Valu Time. It was the lowest performing on a relative basis. Organics was the best. Actually we were flat and we had been running negative. And the core Spartan brand was right there in the middle.

So when you look at that it tells me the upscale consumer's feeling good. Maybe all consumers are feeling just a little bit better, trading up a little bit. And that seems to be what the momentum is feeling like in our first quarter as well.

But you would have hoped for a little bit better Christmas than you got, it sounds like.

Yes, I would have.

Okay. On the loyalty card, Dennis, what's the pace to bring that into the Family Fare and the D&W stores and why didn't you move there [now]? And what are some things you need to do on the analytic side to harvest the info from the data? Is it a learning curve thing or do you have to spend some money on software and hardware?

Well, we're doing the latter. We are spending some money on software and hardware. And I would say we're being a little bit cautious on how we introduce the card. We did it at Glen's and we said it was a test and we learned a lot there. And I would tell you that the launch at VG's has benefited from our learnings at Glen's. And to the extent we deploy that in any other markets I think we will also benefit from what we learned at VG's.

But we put some different bells and whistles on the program when we launched it at VG's. It is a points-based program, Chuck, and we changed the way we awarded points half way through the Glen's test. And we used that methodology at VG's and it seems to have been very effective at the launch. We've also been able to determine more effective clubs that seem to resonate with the consumer. At VG's there's -- as an example we have a baby club and we also have a milk club, which has been extremely attractive to the consumer and has allowed us to play in the milk pricing game with a little bit of a different twist. So we like that.

On balance I think the marketplace here in Southwest Michigan will likely see the card, but I don't know that it would help our competitive posture for us to give you a date on that.

I understand. If you were to look at your super center competition, which is quite formidable, how would you categorize -- or characterize their collective comps?

Boy, I really -- it would be a guess. You know, Chuck, I think -- well, I mentioned earlier in the last decade Michigan was the only state to lose population in the Union. So that's kind of -- is a base line. I think everybody's struggling. How do you sell product to people who aren't here? I think we're all challenged. I don't know whether it would do me any good to tell you what I think their comps are. I think they're all difficult and we're all fighting really hard to try and satisfy the consumer.

I like the fact that as we compete against not only Walmart as a super center and some of the limited assortment guys, that we have promotion as a plank in our strategic platform that gives us another arrow in the quiver, if you will, to try and attract, satisfy and excite that consumer. And I think we've got the right strategy there. And I think we are relatively effective with it and I think we can get a lot better. And I think we have been getting better in that regard.

Thank you very much.

Thank you. Ladies and gentlemen, we have no further questions at this time so I'd like to turn the floor back to management for any closing comments.

Okay. Well, thanks. If there are no further questions, we'll conclude the call. And on behalf of Dave and everybody on the Spartan team, I want to thank everybody for joining the call. And we look forward to discussing our fourth-quarter and full-year results with you during the next conference call. Thanks.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.