SpartanNash Co (SPTN) 2017 Q2 法說會逐字稿

Good morning, and welcome to the SpartanNash Company's Second Quarter Fiscal 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Katie Turner. Please go ahead.

Thank you. Good morning, and welcome to the SpartanNash Company's Second Quarter Fiscal 2017 Earnings Conference Call. On the call today from the company are: Dave Staples, President and Chief Executive Officer; Tom Van Hall, Interim Chief Financial Officer. By now, everyone should have access to the earnings release which went out yesterday at approximately 4:00 p.m. Eastern time. For a copy of the release, please visit SpartanNash's website at www.spartannash.com/investors. This call is being recorded, and a replay will be available on the company's website for approximately 10 days.

Before we begin, we'd like to remind everyone 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 may cause such differences include, among others, competitive pressures amongst food, retail and distribution companies; the uncertainties inherent in implementing strategic plans and integrating operations and acquired assets; and general economic and market conditions.

Additional information about the risk factors and the uncertainties associated with SpartanNash's forward-looking statements can be found in the company's second quarter earnings release, fiscal 2016 annual report on Form 10-K and in the company's other filings with the SEC. Because of these risks and uncertainties, investors should not place undue reliance on any forward-looking statements. SpartanNash disclaims any intention or obligation to update or revise any forward-looking statements. This presentation includes certain non-GAAP metrics and comparable period measures to provide investors with useful information about the company's financial performance. A reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measure and other information as required by Regulation G is included in the company's earnings release, which was issued after market close yesterday.

And it's now my pleasure to turn the call over to Dave.

Thank you, Katie. Good morning, everyone, and thank you for joining us today. The format of today's call will include my brief overview of the quarter and an update on our business. Tom will then provide additional detail on our operating and financial results before we open the call for your questions, so let's get started.

We continue to be very pleased with our distribution segment performance as we continue to deliver strong top and bottom line growth. This strong performance helped fuel our sales and earnings growth on a consolidated basis despite slower-than-anticipated contributions from the recent acquisition and challenging retail market condition.

Our second quarter consolidated net sales increased 3.7% to approximately $1.89 billion due to approximately 15% sales growth in our Food Distribution segment, thanks to contributions from our recent acquisition and continued growth from new and existing distribution customers. From a consolidated earnings perspective, we achieved adjusted EPS of $0.60, an increase of $0.02 over the prior year, primarily driven by our sales growth and supply chain efficiency. And finally, we continue to return significant capital to our shareholders, with $14 million in dividends and share repurchases in the second quarter.

Now let's take a look at our performance and strategic initiatives across our operating segments during the quarter. In our food distribution segment, we generated our sixth consecutive quarter of sales and adjusted earnings growth over the prior year. We increased sales in both new offerings and with existing and new customers, and we realized benefits from favorable margins, supply chain improvements and lower incentive compensation costs. Our ability to consistently present innovative distribution solutions to growth-orientated companies and our expanding reputation in private brands continues to provide us with opportunities to grow with existing customers and to attract new ones.

During the quarter, we continued to focus on integrating our recent acquisitions operations, in refining and expanding production in our new Fresh Kitchen facility. We began incorporating fresh-cut fruits and vegetables produced out of these facilities into our Open Acres private brand, and these value-added products are now available to both corporate-owned and independent stores serviced by our Grand Rapids and Omaha distribution centers. As we continue to ramp up our product offerings and work on securing new business, we are testing the feasibility of rolling out these freshly prepared offerings to new and existing customers through our remaining Western distribution centers by the end of the year.

Turning to our Military segment. Second quarter sales continue to be impacted by ongoing commissary sales challenges. Our private brand initiative with DeCA is progressing nicely, and we began shipping products to commissaries during the second quarter. By the end of the quarter, we had approximately 250 items in the system, and expect the number of items to increase to approximately 425 by the end of the year. With DeCA's stated target of up to 4,000 SKUs in this program, we have the potential for substantial growth over the next 2 years, which will result in a significant improvement to our financial results. As we have previously noted, our strategy with the military segment is to be the best-in-class provider for DeCA in the exchanges, while finding new opportunities for growth with both DeCA and other entities within the Military retail system.

To that end, we recently entered into an agreement to obtain additional commissary distribution business from a DeCA provider exiting their operations in the Southwest. The newly secured business, together with the incremental volume from the DeCA private brand program, is anticipated to reverse the sales trend on an annualized basis, bringing us back to positive sales and earnings on a year-over-year basis for the second half of the year.

In the Retail segment, despite continued challenging conditions, we were able to maintain our overall comparable sales rate trend for the -- from the prior quarters. While we don't expect the environment to improve significantly over the next couple of quarters, we are intently focused on improving our trends and have many efforts under way to make this happen. We are committed to providing a great shopping experience for our customers and continue to pursue various ways to provide quality products in a convenient and affordable manner.

Near the end of the quarter, we launched Fast Lane, our new online ordering and curbside pick-up service. The Fast Lane service is now offered at 11 stores in Michigan, and is expected to be rolled out to up to 50 stores by the end of the year. We're excited about the benefits of Fast Lane and an improved website experience offers our customers as well as providing a service that is right on track with the consumer's expectations for convenience. We continue to make targeted capital investments in our store base by converting certain stores into Family Fare banner and remodeling others. During the quarter, we completed 1 major remodel in Michigan, and 1 remodel and banner conversion to Family Fare in Minnesota and have been pleased with their performance to date.

We continue to enhance our private brand programs for both independent customers and corporate-owned stores. In the second quarter, we announced the launch of the Our Family brand into the Michigan region. This brand will replace our Spartan brand and will provide us with a system-wide national brand equivalent or better quality program, providing a larger variety of product offerings at a lower cost to our customers and will allow us to streamline our supply chain. 30 retailers in Michigan already depend on the Our Family brand and have proudly offered its products to their customers for years. We're excited to expand the brand and introduce it throughout our distribution network.

Additionally, we continue to expand the Open Acres fresh private brand offering and, as mentioned earlier, have begun to incorporate our own fresh-cut fruits and vegetables into the brand. We also continue to enhance our expanded Living Well offering, which includes the natural and organic Full Circle private brand line and a significant number of new SKUs across organic produce and healthier specialty items. We have expanded significant efforts to build an industry-leading private brand, and after recent wins such as the DeCA private brand worldwide program, are now being contacted by new companies to potentially help them drive sales through our wide variety of private brand offerings. We embrace the opportunity to help both existing and potential customers to meet their growth goals.

For the second quarter, private brand unit penetration in our retail operations was 21.5%, up 30 basis points from the prior year quarter, whereas the national average was flat to slightly negative during the same time period. We ended the quarter with approximately 4,800 unique private brand items as we continue to enhance our assortment. Through these initiatives, we believe we are well positioned against the market backdrop and we'll continue to evolve our merchandising efforts and customer personalization initiatives to deliver an even better experience for our customers.

Before I end my comments here, I would like to note how pleased we are to have had Tom Van Hall back at SpartanNash as our interim CFO. Tom has spent close to 15 years in key financial leadership roles at our company prior to his retirement and has extensive knowledge of our operations and the industry and has been able to step right in where he left off.

Also, as announced yesterday, Mark Shamber will be joining the company as our new CFO effective September 11, 2017. Mark previously served as the CFO for United Natural Foods, and following his departure from UNFI at the end of 2015, has been working as an independent consultant and serving as the Vice Chairman, Board of Directors of Day Kimball Healthcare. We look forward to Mark joining the team and believe his background and expertise in the natural and organic space, serving independent grocers and national chains, and overall M&A prowess will lead to continued success for both Mark and SpartanNash.

We thank Tom for his continued contributions and are grateful he will remain onboard to assist Mark with this transition. And with that, I will now turn the call over to Tom. Tom?

Thank you, Dave, for the kind words, and good morning, everyone. Retirement has been everything I expected, except for getting a cold. But I'm pleased to be back reenergized and interacting with a great SpartanNash team. And I look forward to continuing to help through this transition till Mark is settled into his new role.

I'd like to begin with some highlights of our second quarter results and then review our guidance for fiscal 2017. In terms of overall operating performance, we had a good quarter. We grew adjusted EBITDA by $3.3 million or 5.6% over the prior year quarter and delivered adjusted EPS of $0.60, which exceeded the prior year despite the challenging environment we're encountering.

Turning now to our operating segments. In food distribution, sales were up $121.3 million or 14.8% due to contributions of our recent acquisition and organic sales growth of 1.9% as we continue to leverage our network and provide value-added services to our customers. As Dave mentioned, results from the recent acquisition have been slower than anticipated for 3 major reasons. Our distribution center consolidation and efficiency efforts taken following the expected customer losses as a result of the acquisition are under way and gaining traction but are not yet fully implemented. While we have finished construction of the new Fresh Kitchen facility and the rollout of limited production has begun, the facility is still testing and refining processes and incurring startup challenges as one would expect in this completely new endeavor.

Lastly, the timing of implementing new manufacturing system rollouts was delayed and we're implementing a new system to be up and running late this year or early Q1 next year. That being said, we remain confident about what the addition of fresh-cut fruits and vegetables as well as the ability to produce fresh protein meal alternatives into our value-added product offerings and future results. We continue to be pleased with how these offerings align our company with where consumer tastes are trending and how they contribute to us being even more strongly differentiated in the fresh parameter.

While we saw inflation through distribution of around 30 basis points in the second quarter, an improvement from 171 basis points of deflation in the previous quarter, we're still seeing deflation in certain categories such dairy and produce. And looking forward, we currently expect to see only modest overall inflation in the second half of the year.

From an earnings perspective, second quarter adjusted operating earnings for food distribution increased 19.5% to $25.8 million due to organic sales growth, supply chain optimization efforts and lower incentive compensation costs. In our Military segment, sales were $471.1 million versus $505.4 million in the previous year, driven by overall sales declines at the DeCA-operated commissaries we serve. Adjusted second quarter operating earnings for Military were $2.5 million compared to $2.2 million last year due to favorable margin and operating expenses, which more than offset the impact of lower sales. Our team remains focused on operating efficiencies, and we're pleased with our efforts here. These efforts, combined with the private brand program and our recently obtained business in the Southwest, are expected to return sales and profit positive on a year-over-year basis in the last half of the year.

In our retail segment, net sales were $482 million versus $501.8 million in the same period last year, with $11.6 million of the net sales decline driven by the close or -- with the sale or closure of retail stores, along with the decrease in comparable store sales of 1.8%, which despite the challenging retail environment, was in line with past quarter results. In connection with our continued store rationalization program and to drive new distribution business, we sold 2 stores during the quarter and another store at the beginning of the third quarter to new food distribution customers. We now have a store base of 150 corporate-owned retail stores compared to 160 stores in the prior year quarter.

Second quarter adjusted operating earnings for retail were $13.1 million compared to $15.5 million in the prior year, reflecting the difficult sales environment and incremental margin investment in the fresh departments. From an operating cash flow perspective, on a consolidated basis, we generated $38.4 million in the first half of 2017 compared to $57.2 million last year. The decrease is primarily due to changes in working capital position and include higher accounts receivable balances at Military as certain customers were dealing with system conversion issues and payments were temporarily delayed.

For the second quarter, we also paid quarterly cash -- a quarterly cash dividend of $0.165 per share and repurchased 300,000 shares of stock at $7.9 million. Our total net long-term borrowings increased $230.8 million to $637.5 million at the end of the quarter compared to $406.7 million at the end of 2016, largely the result of funding the recent acquisition but also the timing of working capital payments. Our net long-term debt to adjusted EBITDA ratio was 2.7x. We remain committed to our long-term target of 2x, and excluding any further M&A activity, continue to expect this ratio to improve as we grow sales, improve operating efficiencies and pay down debt from free cash flow.

Turning now to our guidance. Based on our current expectations regarding the integration of our acquisition and the continuation of the current retail environment for the second half of the year, we're refining our previously issued fiscal 2017 guidance. We expect adjusted earnings per share from continuing operations to be approximately $2.18 to $2.28 and reported earnings from continuing operations to be approximately $1.83 to $1.90 per diluted share. For the third quarter of fiscal 2017, we anticipate earnings to be flat to slightly ahead of the prior year as continued strong performance in distribution operations will be partially offset by slower-than-anticipated contributions from the recent acquisition and the effects of the retail marketplace.

We continue to see progress integrating the recently acquired operations, have begun limited production at the Fresh Kitchen facility and remain confident about the ultimate growth potential and long-term vision for this business and its ready-to-eat categories. We now expect the transaction to be accretive in the second year as we get the required systems in place over the last half of this year, adjust fully to the existing volume levels in produce distribution, and attract additional volume into our Fresh Kitchen operations.

To address the retail landscape, we're continuing to invest in our store base, personalized marketing initiatives, customer convenience and experience through efforts such as Fast Lane and newer solutions, and the launch of the Our Family brand into the Michigan region. For the Military segment, the recently secured new business, together with increasing contributions from the DeCA private brand program, are expected to return military sales and earnings to positive versus the prior year by the fourth quarter and for the second half of the fiscal year.

As already mentioned, we continue to expect an easing of deflationary pressures with modest food inflation in the second half of the year. Accordingly, depending on the variability associated with inflation by commodity and its related impact on LIFO, we do not expect the deflation-related LIFO benefit of $0.07 per diluted share realized last year to repeat in the fourth quarter of fiscal 2017.

Lastly, due to changes in the timing of capital projects and several emerging long-term growth opportunities materializing more quickly than anticipated, we now expect capital expenditures for fiscal 2017 to be in the range of $75 million to $78 million, depreciation and amortization to be $83 million to $85 million, and total interest expense to be in the range of $23 million to $25 million.

Now I'll turn the call back to Dave for his closing remarks. Dave?

Thank you, Tom. In conclusion, we are committed to both top line and earnings growth. As we look to the back half of 2017, we believe our experienced team and sound strategic plan, focused sales-building initiatives and productivity gains will help us overcome the challenges impacting the industry.

We believe that our expertise as both a food wholesaler and a retailer makes us a better operator, as we are uniquely positioned to anticipate and understand our food distribution and retail customer needs and deliver best-in-class solutions and experiences to them. We have positive momentum in our food distribution business as we continue to integrate our acquisition and expand our product offering in highly desired new categories. Onboard new military and food distribution business, we'll provide innovative solutions to growth-orientated companies.

While still in the early stages, we believe that our recent acquisition, our DeCA private brand program, and the new business obtained in the Southwest will deliver the anticipated long-term benefits expected. These initiatives are a few of the many opportunities that we have to drive sustainable long-term growth, and we remain confident in our ability to execute and deliver our expected results.

With that, I'd like to turn the call back to our operator, Brandon, and open it up for questions. Brandon?

(Operator Instructions) Our first question comes from Chris Mandeville with Jefferies.

Can we just start off with the updated guidance? In terms of the revision here, can you speak to the primary drivers to the guide down? And then when it comes to some of the metrics provided, why is D&A going up roughly $3 million, while CapEx -- or excuse me, D&A is going down $3 million, while CapEx is being ramped up about $5 million?

Sure. Yes, let me take that with you, Chris. In the overall guidance, I'd say the predominant driver is the integration of the acquisition not being where we anticipated for the reasons we discussed. That has the bigger impact. As we initially moved into that, we thought we would be somewhat further ahead and realizing more of the benefit from the kitchen and some of the other integration activities, and we're just not. But as Tom alluded to, we do expect that back on track and to have a real positive year again next year and really see where we're going. So I would say that would be the majority of the answer. Also, certainly, the existing retail environment is a little bit of it as well. So those would be the 2 key factors in the guidance change. From the explanation of the capital, if you look at the capital, what's going to happen there is we just -- I think we've done a great job of aligning ourselves with companies that are making things happen and going places in the industry. And when you do that, sometimes things happen more quickly than originally anticipated because you are aligning yourself with people thinking ahead and making one step further and thinking one step further and faster than anybody else. And so part of what helped us be successful is our ability to be nimble and work with them. In this instance, 2 really great opportunities are going to present themselves. We will spend the capital this year quicker than we'd originally anticipated, won't have any depreciation with that spend as it happens in the back half. And the benefits don't really begin to incur till the following year. So that's one reason you're not seeing an increase in depreciation because of the increased spend. From the overall decrease in depreciation, it's always such a hard thing to estimate because you're putting forth your capital expenditure plan and obviously maybe even depreciate it. Things change, some projects get accelerated; some get pushed back. And depending on the type of projects there over the course of the year, they can affect your depreciation rate. So it's as simple as that from the depreciation side. It's just how the capital project is mix out.

Okay. And then as you mentioned, in retail, it sounds like the competitive environment has gotten a little bit more intense lately. Can you just maybe help us understand how much of this is related to new store openings opening up against you, versus just the existing boxes simply getting more aggressive? And if willing, is there one specific region seeing greater challenges? Or can you at least maybe give us a sense of what tactics are being used and what categories your competition is primarily focusing on?

Sure. As you look at the market, I think, in general, I think you see a fairly consistent and competitive impact as far as new store openings. That's been, I think, moving between that 15 to 30 basis point impact. And I don't think you're seeing any significant change in that type of an impact. So competition is a reality in retail and, as we all know, it's always never going away. And so I think we can continue to see a consistent impact from the store openings. And I will say, where I would see the overall environment getting a little tougher is really if you see the retail entrants into the market and the response that's sparking from an Aldi and then a Walmart and then bring the Kroger and other players in, and so I think you're seeing some price -- an increased price competition in various markets. Again, nothing we've never seen before. This is a fairly common event in retail and different events happen in different periods of time. And it's nothing we've not experienced before, and I don't think it's anything we won't experience again. And I believe the team is just doing a wonderful job in a number of areas to take that type of battle on. This -- our Fast Lane program, I think as we roll that out, we're going to be very pleased with how that works. It's so early right now. I don't have a lot of long history. It's been under a month that we had our first store out. But we're seeing great things like as the person comes back in their third and fourth times, their purchases keep going up substantially. And they get into that $110 to $120 range by that fourth visit. We're seeing 65% to 70% of the sales being new business, whether that be new customers or incremental purchases from existing customers. So we believe that's going to be a strong tool for us to combat what's going on, and a number of these other competitors won't offer that type of service. And we continue to expand that private brand, and so we're expanding the value offering into that fresh perimeter more so than we've ever done before. And that, I believe, combats a number of these types of new competitors and that they don't have that reputation in fresh. And our overall private brand offering, when you get into the Living Well and the extensive nature of that, I believe, is more substantial than a lot of these price competitors. So we don't ever intend to be the lowest-priced retailer. That's not who we are. We offer a lot more than price. We intend to be the best value retailer. And so we'll combine these uniquenesses with a very, very fair price to be the best. And so I think that's how we're combating it and that's how we see the industry shaping up.

Okay. And just to clarify, so you're of the view that some of your competition are maybe being a little bit proactive in advance of a Lidl, who isn't necessarily in the market that you're servicing right now?

Yes. And that's a fair point, because they're not in the market. But I think they're just -- there's sort of that fight for the low end. And I think you see everybody fine-tuning their game in that space based on what they see happening.

Okay. And then last one for me on the distribution side. So you did see a modest sequential slowdown in organic growth. But how should we think about the back half of the year? Is there any net new business you can speak to? Or should we just simply expect maybe that any type of greater growth versus Q2 is going to be predicated upon inflation than maybe just the continued ramp of Fresh Kitchen?

No. I think we would expect our organic growth to improve in the back half. The rates would be even better as we do have some new business coming onboard. The Central Grocers event, we were the only one I think of the 3 or 4 or 5 people who competed for accounts there that don't have a facility in the market yet we're still able to secure $20 million to $40 million. I think that's a big win for us, and I think that speaks to the type of reputation we're beginning to build. When you can go into a market where every one of your competitors has a facility either in the state or right on the border of that market and still win a nice chunk of business, that just speaks a lot to our new business team and the wonderful job they do out there connecting with existing and incremental customers. In addition, we're working with some really great retailers and we're experiencing phenomenal growth with them, and we think that will continue to go. And so we're just really optimistic about so many of those type of things we have going as well as, as I've mentioned a little bit in the call, inquiries we get in this type of brand arena and what can we do to help other retailers and whether they're customers of ours or not, supplement a program or help them think of how they could create a program and how we can potentially become involved with that. So we just have a lot of very, very positive things going on in that distribution world. And you go to Military and you rethink about what we have going on there in the positive direction and the effort our teams are putting forth to integrate this substantial amount of business between private brands and the new business out West, it's just the testament to the quality of our team and really the resourcefulness and the innovativeness of our associates in our distribution businesses. And it's just -- it's really a pleasure and you're really proud to be a part when you see these things take place. So I think on a number of fronts, we have a lot of really great things going on. And then as you added, as we get this kitchen rolling and when we get more business being put through that, that just does nothing but help us going forward.

Our next question comes from Scott Mushkin with Wolfe Research.

Congratulations on snagging Mark. He's a really good CFO. So the -- a couple of questions. First of all, distribution business continues to perform well. But I wanted to talk about, like, there's been a lot of news lately and some market news in Progressive Grocer of just how some of these regional chains, smaller regional chains and more mom-and-pop operations are really starting to struggle with competitive environments. And I was wondering, as you view your distribution business and your customer base there, how you view the current environment vis-a-vis kind of how they are doing net of wins, net of acquisitions. But just how is your base customer doing and what can you do to help them?

Well, I think our base customer is a built up of people who are -- if you think of the trends in the industry, right, people want to shop local. People want smaller stores. And when I say small, I don't -- I'm not trying to imply like tiny stores. I'm talking more like that 20,000- to 40,000-square-foot supermarket. They want that local. They want smaller size. They want convenience. They want to know they're helping their community thrive. And that's exactly what our customers are, right? Our customers predominantly are those 2- to 3- to 20-store operators, and they are their community, right? And they're people who have survived the onslaught of Walmart. I think, if I replay the tape back to 2000, our independent customers were off the map as Walmart rolled out throughout the country and independent food retailing was done, and that didn't happen. Our customers continue to thrive and continue to do well. And we just got a lot of great customers. So in some of the challenges that will be out there, I think everyone will feel a little pressure. But I think we've got a great base and I think we've got some really savvy retailers. And I think they'll work through it. When you take the Internet challenge, you have to remember, our customer base in a lot of their stores are more suburban and rural. And so they're not really in the sweet spot of the Internet challenge. And as you look at the new entrants into the market and some of the other things that are going on, and that's not necessarily a more rural-suburban strategy right off the bat either, and it's certainly not initially in the markets we serve. I mean, it's tangentially in some of the markets we serve, but the bulk of the markets are not being impacted right of out of the bat by the new entrants. So I think we're well-positioned. I think our customers are well-positioned. And what we can do to help them, we can do a lot of things. And we are doing a lot of things. I think we have really worked hard on our promotional and value-orientated offerings and programs. And we work with a number of customers to put a whole program throughout their store trying to accentuate the positive value they offer and what a good opportunity they are to shoppers as other players given their breadth of products as well as the value. This private brand program we're developing and are continuing to develop and the level that we've taken that gives them a really strong tool to have people come their way. Our new product offerings and the fresh direction we're taking help them differentiate their perimeter there -- perimeter of their store better than a lot of these new entrants. And I think we do these things better than a lot of other people out there. So I think we've done a lot to help our customers see what they are, but, certainly, their innovation and their entrepreneurial mindsets are really what have allowed them to succeed.

I appreciate the answer. And just one follow-up, a clarification. Are they comping positive in aggregate, your distribution customers? And (inaudible)

Yes. I mean, I think if you look at our core distribution, we said our organic growth was 2%. So, I mean, I think our business is positive on an organic basis in an aggregate quarter.

Okay. And then just wanted to comment and I'll yield. Scale. I mean, how do you feel about the scale of the company? And then I'll yield.

Well, I mean, I think we have a really nicely put together operation. I mean, think about what we've done. Our distribution business now is about a $4 billion business with strength -- a lot of strength on the perimeter. I mean, our produce operation is approaching $700 million. Our meat program is $0.5 billion. We've really provided value, and then we vertically have integrated that with 150 retail stores. And so I think that really provides a strong position from which we work with our vendor partners to go to market and provide value to the consumer and value to our customers. I think in the military side, we are the gold standard. There is nobody who offers the military system what we offer them. From a frequency of delivery, a variety of products, a simplicity of billing, an ease of working with, I think we provide tremendous value there. And so I think as we activate the remainder of our strategy, right, which is to continue to grow the business and to make strategic moves whether it be in the core or continue in the adjacencies to expand even our strength in this perimeter. I think the company is just incredibly well-positioned to do what it needs to on a long-term basis to drive value.

Our next question comes from Ryan Gilligan with Barclays.

I want to follow-up on these 2 emerging growth opportunities you referred to. Can you talk about what kind of projects they are and what type of customer you're working with?

Yes, without naming too many specifics, because this stuff is still pretty competitive. But we, in the kitchen operation, have just been, like I said, pleased with the type of opportunities we're seeing out there. Now we have to execute upon those opportunities. But one of those opportunities is really an exciting move into what we think is a really hot space and a space that is right on trend with where the world is going and it's going to take us some incremental packaging, some new types of packaging equipment to work on that opportunity with a significant customer. I don't really want to go into any more detail on that on the customer. The other opportunity, we do some things very uniquely in the space that have provided us with a substantial competitive advantage and it's allowed us to really service some customers very uniquely and very -- more efficiently than anybody else can. And because of growth opportunities to use this kind of process that we have, we really need to put automation into another facility to allow us to continue to grow in that area as well as service our customers' grow. And so part of us being a national chain that can serve our customers where they go, both of these fall into that area. And so both of -- in the automation world, right, new equipment automate packaging and new equipment allow us to continue new technology to continue to have -- really to have some state-of-the-art processes.

That makes sense. And then I guess just in the working capital issue you called out with the military customers, has that reversed already?

Yes, that is -- that was just a temporary situation. We were undergoing some system conversions and some payments were slowed for a period of time. They were right at our quarter end. Our vendors are (inaudible)

Got it. And then, the new business in the Southwest, did that start completely at the beginning of the third quarter? Or does that ramp over time?

It'll start actually this week, so it's sort of the middle-ish of the third quarter.

Got it. And then just lastly on what the potential is for the private label program over time. You mentioned getting the 4,000 SKUs. That's obviously a great opportunity. But can you give us a sense for what the net opportunity is and some -- I'm guessing you already supplied some of those SKUs that will be replaced?

Yes, and so that's the real -- the difficulty there is when you get into that question. But let me just try to frame it the best I can, and I'm using generalizations so don't hold me to the penny on this. But if you look at the Military business at DeCA, they are about a $5 billion retailer. And if you think of the things that we -- that private brand really can, as they're structured today, be a part of from our perspective, the universe is probably in that $3 billion world of what could be private brand. And so if you think of how they evolved to their target of 4,000 SKUs, assuming they can make that, which we believe they can if they continue to put the effort they are into it, the national penetration on average for private brand in that area of product would be 20%, 22%. And so you're probably looking at a $600 million to $650 million opportunity if it was 100% incremental. Now I think 2 things are going to happen as a result of this. There will be some level of cannibalization of national brands. But DeCA today already was selling a lot of packer labels and other kind of labels, so that really shouldn't impact the national brand. So I don't think it will be as much as people may have been concerned about. Secondly, I think the last of this offer has cost the DeCA system sales and it's cost some sales, I believe, in 2 ways. I believe because of the prevalence of Walmarts and Krogers and Safeways off base and because of the number of people who have moved off base over the years, this private brand is being consumed. They are buying private brand. Our DeCA consumers today are going to these channels and buying private brand because of the value. That is going to be purely incremental when they come back to DeCA, because the DeCA offering is a great offering and it's a good value, and so they should be able to pick up incremental sales of people who were buying private brand elsewhere. And secondly, I believe that there are probably some patrons who maybe had not shopped the commissary or weren't shopping very frequent. Now they have another reason to come back and do their full shop there or a new shop. So I think as DeCA continues to develop their program and roll it out, and we're really privileged to be able to serve them while they do that. There's just a lot of opportunity there between incremental sales, between more sales to existing customers. And yes, there's probably some amount of cannibalization. I just -- I can't tell you what that will be because if -- with the packer label, they had, which were quite a few, that minimizes that impact. Now don't tell Kathy I said -- I don't want -- because she's still trying to change that in her budget. I want her budget out. So don't -- I don't want her to sandbag on cannibalization and stuff like that.

(Operator Instructions) Our next question comes from Shane Higgins with Deutsche Bank.

I saw that you sold 2 of your stores to some new food distribution customer. Is this something -- I know you guys have done some of this in the past, but are you guys looking to maybe place more of your own stores with some of your distribution customers? And can you just kind of talk about what some of the benefits of making that move and whether or not it's something you guys would consider maybe accelerating going forward?

Yes, Shane. As we've talked about before, part of our strategy is to continue to put forth an outstanding retail operation. And we're committed to retail and retail, as you all know, I think is a strong reason for why we are as successful we are in distribution because we walk in the shoes of the retailer. We know what they experience and, thus, we are able to I think offer a solution that others don't to help them succeed. With that said, we're also -- we're committed to having a right store base, a store base that fits our expectations. And that's an evolving thing. And sometimes, stores are in markets that aren't exactly ones that make sense for us. And sometimes the physical store isn't exactly what makes sense for us. Yes, it makes tremendous sense for either a potential new distribution customer that we could attract with that location or our existing customer base that wants to grow. And so this is really, I think, about commitment to retail and a commitment to our customers and future customers that we want the stores where they will be the most successful. And so we expect to be in retail ongoing and we expect to be good at it and great at it. And we expect to continue to evolve with the way that world -- the world is trending to be a very -- a great retailer. But that being said, where we have stores that could be better served by either a new customer or an existing customer so that they can make them great operations, we'll place them there. And so we strategically done that forever, and I think we'll continue to strategically do that where it makes sense based on our store base.

Got it, got it. And that makes sense. And I know you guys obviously are looking at stores each as an individual and based on the prospects, whether or not it's worth keeping those -- some of those stores open. Do you guys anticipate closing some additional stores over the next year or 2 as you evaluate your portfolio and lease expirations?

Yes, I think we've said that. I think at the merger, we said there was a -- there were a number of stores that we were either going to try to relocate or as they either weren't cash positive any longer or the lease expired and they just did not fit our portfolio if there wasn't another home for them, we'll do that. And so yes, I think as any retailer does, that's just part of the business. We want to make sure our base is what we wanted, not just what we have.

This concludes our question-and-answer session. I'd like to turn the conference back over to Dave Staples for any closing remarks.

Thank you, Brandon, and thank, all of you, for participating today. We look forward to speaking with you again over the course of the next quarter and on our next conference call. Thanks, everybody.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.