SpartanNash Company
Q4 2018 Earnings Call Transcript

Published: 25 Feb 2019

[Operator:]

Hello and welcome to the SpartanNash Fourth Quarter Full Year 2018 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I now would like to turn the conference over to Katie Turner. Please go ahead, ma’am.

[Katie Turner:]

Thank you. Good morning and welcome to the SpartanNash Company’s fourth quarter and fiscal 2018 earnings conference call. On the call today from the company are Dave Staples, President and Chief Executive Officer and Mark Shamber, Executive Vice President and Chief Financial Officer. By now, everyone should have access to the earnings release, which was issued yesterday at approximately 4 p.m. Eastern Time. For a copy of the earnings 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 I begin, we would 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 may 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 general economic and market conditions. Additional information about the risk factors and uncertainties associated with SpartanNash’s forward-looking statements can be found in the company’s earnings release and 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 the most comparable GAAP financial measure and other information as required by Regulation G is included in the company’s earnings release, which was issued yesterday. And now it’s now my pleasure to turn the call over to Dave.

[Dave Staples:]

Thank you, Katie. Good morning, everyone and thank you for joining us today. Our call will include my brief overview of the fourth quarter as well as an update on our business. Mark will then provide additional detail on our operating and financial results before we open the call for your questions. We remain focused on our strategic objective of becoming a growth company focused on developing a national, highly efficient distribution platform that services a diverse customer base by leveraging our complementary business units of food distribution, military distribution and retail. In December, we commenced Project One Team, a company-wide initiative with an external third-party advisor to help us identify opportunities for revenue growth while increasing our emphasis on driving greater efficiencies and reducing costs. The engagement and enthusiasm from our associates has been tremendous and together we plan to accelerate the transformation of our culture to drive substantial improvements to our business processes and results. While we are in the early stages of this project, we are focused on opportunities in all aspects of our business, including those which improve supply chain efficiency, leverage technology and improve the products and services offered to our customers. We will provide an update on our progress of this project in our first quarter call. Other strategic actions we have executed since our last call include amending our credit facility to create capacity to enable additional growth through acquisition, making strategic changes to our management team to allow us to continue the evolution of our operations in this rapidly changing environment and closing on the Martin’s acquisition. On the management front, with the retirement and announced retirement of two of our senior executives, we hired a new Chief Merchandising and Marketing Officer and Chief Information Officer. Lori Raya, our new Chief Merchandising and Marketing Officer, has held many executive positions within the Safeway organization, including Vice President of Retail Operations, Group Vice President of Strategic Initiatives as well as Divisional President of Vons Supermarkets. Her experience as a visionary leader will enable her to lead our marketing and merchandising teams to deliver innovative, consumer-focused programs for both our independent customers and our own corporate retail stores. Additionally, our new CIO, Arif Dar, has held executive IT positions at companies including SC Johnson, Maple Leaf Foods, General Motors and General Electric and has a wealth of experience in establishing cross-functional relationships throughout geographically diverse businesses and driving operating efficiencies to generate cost savings and sales growth. Arif will play a critical role in our efforts to invest in technology resources and infrastructure to become more efficient and customer focused. We are excited about having both Lori and Arif join our management team as we look to realize our company’s full potential. We will continue to make strategic investments in our senior leadership team, systems and supply chain throughout 2019. Turning to our overall results for the quarter, we are very pleased to continue to deliver sales growth driven by our Food Distribution segment. The fourth quarter represented our 11th consecutive quarter of sales growth, an accomplishment we are very proud of. This growth has come from our ability to attract new accounts and to continue to provide a strong partnership to existing accounts through offering expanding services and geographical reach. However, this positive sales growth did not result in the bottom line we anticipated due predominantly to several discrete factors. First, characteristic of the trends within our industry, our fourth quarter 2018 profitability was impacted by higher LIFO expense associated with rising inflation rates. The additional expense reported in the quarter was above our initial expectations by approximately $0.03 of earnings per share. Second, as many of you know, there was a national romaine lettuce recall during the fourth quarter. At SpartanNash, we hold product safety and consumer health in the highest regard. We responded quickly to the general government health official mandate to remove product from our retail store shelves, from our distribution centers and from our food processing operations. We estimate this action cost us $0.01 to $0.02 per share as we had no recourse to recover losses due to our vendors ultimately not being found responsible. Finally, following the hurricanes in the late third quarter and early fourth quarter, we faced operational issues in one of our distribution centers, which experienced a significant volume of returned product related to customers who were closed or unable to receive shipments after the storm. This came at a time where the distribution center was undergoing some transition in management and was adjusting to the increased volumes associated with our growth and preparations for the holidays. The combined effect of these events resulted in a significant decline in our performance. We responded to these issues by undertaking changes to our leadership team and implementing new processes and controls to better respond to these types of circumstances in the future. These actions have allowed us to return customer service to more normalized levels. However, we still expect to run much higher than normal expense rates until we fully rebuild the management team and completely stabilize the operations by late in the first quarter. This event impacted our fourth quarter operating earnings, particularly within the Military and, to a lesser extent, the Food Distribution segments by approximately $0.06 per share. We expect the impact in the first quarter to be approximately $0.05 to $0.07 per share. Turning to our segment results, in Food Distribution, we continued our string of quarters with year-over-year sales growth. Segment net sales increased 4.7% as we continued to attract new customers while expanding business with existing ones. We continue to look for ways to grow the perimeter and center store as well as sponsor programs to partner with independent retailers to help them succeed in this intensely competitive marketplace. Included in this growth is a 4.8% increase in sales at our Caito business, which reflects new customer growth and increased sales to existing customers within our fresh distribution and Fresh Kitchen operations. As we discussed last quarter, we continue to experience industry-wide cost pressure in our supply chain and food processing operations, including increases in transportation costs, a shortage of available labor and significant price volatility in certain produce categories. These pressures have been compounded by the growth we’ve been able to generate. We will continue to focus on improving our overall supply chain efficiency and processes to address these pressures. On the food processing front, we are focused on efforts which will improve yields, rationalize our product mix and adjust pricing to reflect the significant cost increases experienced to date. We expect to begin seeing the positive effects of these efforts late in the first quarter of 2019. We are pleased to see continued growth of DeCA’s private brand program within our Military segment. We finished fiscal 2018 with over 700 private brand products in the DeCA network and will continue to collaborate with DeCA in the release of additional items in fiscal 2019. In addition, we on-boarded a significant new fresh protein program with an existing customer late in the fourth quarter. The contribution of these two programs, are expected to significantly offset the negative comparable sales experienced in the overall commissary environment. We remain focused on growing our sales pipeline as we build our relationships with the military and food manufacturers to remain the supplier of choice for their operations. Our new brand positioning initiative within the Retail segment was implemented in several stores during the fourth quarter with a more significant implementation planned in the first half of fiscal 2019. We are happy with the consumer response thus far and believe these efforts will increasingly position us to win in the current retail environment. Lastly, we are excited to have closed on the acquisition of Martin’s Super Markets. Martin’s is a very well run operation that reflects many of the brand positioning principles that we are in the process of implementing in our Family Fare banner and will be a great fit with our store base. And with that, I will now turn the call over to Mark.

[Mark Shamber:]

Thanks, Dave and good morning to everyone who’s joining us on the conference call and listening via the webcast. Net sales for the fourth quarter of fiscal 2018 increased to $1.90 billion, an increase of $11.3 million, or approximately 1% over 2017’s fourth quarter sales of $1.89 billion. Adjusted EPS for the fourth quarter of fiscal 2018 came in at $0.32 per diluted share, which compares to adjusted EPS of $0.41 per diluted share in fiscal 2017’s fourth quarter. I would like to note that both our GAAP and adjusted diluted EPS include an estimated $0.10 per diluted share impact in the quarter associated with the combination of operational issues at one of our distribution centers, the effects of inflation on LIFO expense and the industry-wide romaine lettuce recall. On a GAAP basis, the company recognized a loss of $0.39 per diluted share in the quarter compared to earnings of $0.94 per share in the fourth quarter of fiscal 2017. Shifting to our business segments, net sales in Food Distribution increased by $43 million, or 4.7%, to $954.4 million in the fourth quarter of fiscal 2018, primarily due to sales growth from new and existing customer programs. Inflation accelerated 72 basis points in Food Distribution during the quarter, an increase of 70 basis points from Q3 when inflation was nearly flat, coming in at 2 basis points. In the fourth quarter, reported operating losses for Food Distribution totaled $14.3 million, largely driven by the non-cash charge taken related to a customer experiencing solvency issues, higher LIFO expense, the impact of expenses associated with the industry-wide recall of romaine lettuce and the warehouse operational issues noted earlier. Adjusted operating income totaled $17.9 million in the quarter versus the prior year’s fourth quarter adjusted operating income of $18.8 million. Fourth quarter adjusted operating earnings in the current year exclude $32.2 million in adjustments primarily related to the non-cash charge. And adjusted operating earnings in the prior year quarter exclude $4.5 million of pretax charges primarily related to Fresh Kitchen startup costs and expenses associated with tax planning strategies. Military net sales of $513.3 million in the fourth quarter decreased by $10.7 million, or 2%, compared to $524 million of revenues in the prior year fourth quarter. The decrease is primarily due to lower comparable sales at DeCA-operated locations partially offset by incremental volume from new business with an existing customer and incremental volume under DeCA’s private brand program. Military had a reported loss of $0.5 million in the fourth quarter compared to earnings of $2.5 million in the fourth quarter of fiscal 2017 primarily due to the higher LIFO expense and warehouse operational issues noted earlier in the call. On an adjusted basis, military’s operating loss was $0.4 million for the fourth quarter of fiscal 2018 compared to operating income of $3.1 million in 2017’s fourth quarter. Finally, our retail net sales came in at $429.1 million for the quarter compared to $450 million in the fourth quarter last year. Approximately $12 million of the sales decline was related to the closure of stores and fuel centers, with the balance driven by a decrease in comparable store sales of 1.9%, which was partly due to the New Year’s holiday sales shift and unfavorable weather as compared to the prior year. We finished the fourth quarter with 139 stores and increased this count to 160 stores following the acquisition of Martin’s. Retail reported GAAP operating income of $2.9 million for the fourth quarter of 2018 compared to income of $2 million in the prior year’s fourth quarter. The increase was primarily attributable to lower asset impairment charges and expenses related to tax planning strategies; lower healthcare, incentive and other administrative costs; and the favorable impact of closing underperforming stores. Partially offsetting these items were higher DIR fees paid to pharmacy benefit managers, higher LIFO expense as well as acquisition expenses related to the Martin’s acquisition. As noted in previous calls, we continue to see pressure from the increase in DIR fees in the pharmacy, which was a primary factor in pharmacy margin being unfavorable by $1.3 million compared to the prior year. This impact is consistent with our expectations provided on the Q3 earnings call, although slightly higher. We expect to continue to see a similar impact of pharmacy DIR fees into 2019, with the largest known year-over-year impact in the first quarter of fiscal 2019 as we cycle 2018’s increases, which we cycle the once – excuse me. Once we have cycled the increases from 2018, we expect that DIR fees will still be a significant expense for the remainder of fiscal 2019; however, they will be at a more normal run-rate following the first quarter impact. Fourth quarter adjusted operating earnings in retail amounted to $4.8 million compared to $6.2 million in 2017’s fourth quarter. Interest expense increased $1.4 million in the fourth quarter of fiscal 2018 to $7.7 million due to higher interest rates compared to the same period last year. In fiscal 2018, we generated consolidated operating cash flows of $171.7 million compared to $52.8 million during fiscal 2017. The higher operating cash flows were generated by lower working capital requirements, particularly improvements in inventory and accounts receivable compared to the prior year. We generated $10.2 million of free cash in the fourth quarter and $100.2 million in fiscal 2018 compared to a use of cash of $34.3 million in the fourth quarter of fiscal 2017 and $18.1 million in fiscal 2017. During fiscal 2018, we returned $45.9 million to shareholders, including $25.9 million in the form of cash dividends. Additionally, we repurchased approximately 952,000 shares of our common stock for $20 million, all during the first quarter, at an average price of $21.01 per share while reducing our long-term debt balance by over 6%. Our total net long-term debt decreased by $54.8 million to end the year at $679.5 million compared to $734.3 million at the end of fiscal 2017. Our net long-term debt to adjusted EBITDA ratio was 3.2

[Dave Staples:]

Thank you, Mark. In fiscal 2019, we expect the operating environment to remain challenging. However, we will continue to take decisive actions to move our company forward. We will continue to make progress positioning our supply chain operations to manage our current and future growth. We will focus on strategic additions to our senior management team and will continue to build technology resources and infrastructure to improve our efficiency and provide a better experience to our customers in each business unit. We will commence execution of the opportunities identified as Project One Team as we work to continue our growth and seek opportunities to capitalize on new business made available by disruption in the industry while improving profitability. We will successfully complete the integration of Martin’s Super Markets into our retail operation and look to continue the success this retail chain has experienced during its history. We are eager to take on these challenges in the coming year as we work towards realizing the company’s long-term strategic objectives. With that, I’d like to turn the call back over to the operator and then open it up for any of your questions.

[Operator:]

Yes, thank you. [Operator Instructions] And this morning’s first question comes from Christopher Mandeville with Jefferies.

[Christopher Mandeville:]

Hey, good morning, guys.

[Dave Staples:]

Hey, Chris, we are having some real serious distortion.

[Operator:]

Yes. Mr. Mandeville, your line is almost un-hearable, so I’d recommend dialing back in again. And the next question comes from Kelly Bania from BMO Capital.

[Kelly Bania:]

Hi, good morning. Thanks for taking my questions. First just on Food Distribution, so low to mid single-digit top line outlook there, can you just maybe walk us through how conservative that is or what you are expecting in terms of core same-store sales for your customers or attrition and just help us walk us through what the plan is on the top line there?

[Dave Staples:]

Sure. Well, Kelly, I think as we look at our customer base in this environment, we talk a little bit about that annual attrition. There’s probably, in normal years, a 1% to 3% attrition. Some of that is flat to slightly down comp sales in some of our customers. Other customers are going to experience sales growth. I mean, we have a really wide variety of customers and a real wide variety of performance levels. So I think the health of our customer base is good, and so I think overall that will be a pretty consistent component of our sales. We expect to be able to attract new customers, and so we’ve been good at that. I think we offer a differentiated alternative. I think we work hard to help them see ways to be more competitive in this environment through the programs we present to them and through the partnering we try to provide in bringing some of our retail knowledge to bear to help them with issues they may be facing as well. And I think we continue to expect growth as we work to think through how we can use our network to solve more and more issues of existing customers as well as provide new customers unique ways of getting their product to market. So I think it’s really a variety of different segments or different efforts that will provide that growth we are looking at.

[Kelly Bania:]

And I think Mark you mentioned about 70 basis points of inflation and I think that was at distribution, can you help us understand what you are planning for the year in your outlook in terms of inflation and what’s happening at retail inflation as well?

[Mark Shamber:]

Yes. So I mean, I would say on the distribution side, I think that we are probably looking at anywhere from 50 to 100 basis points. I mean I know that there have been differing reports that have come out that have ranged higher than that, but I think we have seen that for the past couple of years and it hasn’t necessarily materialized. So I think that in the range of what we experienced in the fourth quarter, we probably have something along those lines blended in for the full year, but as you look at the retail side of things, as we have talked about, although we are able to pass it along on the distribution side, it doesn’t necessarily always translate into the same at retail. And so I think on the retail side, we are probably matching a little bit lower than what we are seeing in the distribution from an inflationary standpoint. Retail, for the fourth quarter, was probably 52 basis points, about 20 basis points lower than what we saw on the food distribution side, but the categories, I would say the categories vary a bit more widely at retail than they do on the food distribution end.

[Kelly Bania:]

Okay, that’s helpful. And maybe just an update on just how turnover is trending generally, it sounds like the operational issue at one of the facilities was maybe exacerbated by some turnover issue. So maybe just help us understand how that is across the organization and how you are planning on managing that through the year?

[Dave Staples:]

Yes. I would say actually we have put a lot of work into turnover. As you get into tight labor markets as our industry has experienced, you want to be the employer of choice. And so we have taken numerous actions over the course of last year and we continued to – and we expect to continue to take the right kind of actions, not all of which are monetary, right. There is a lot of issues in just how you work with your associates. In our retail operations, dress codes, value lunches, ability to work the kind of schedules that fit their lifestyles. The same types of things in the distribution center, the right kind of shifts, I think, all go a long way in improving our results and we have actually seen our turnover decline in retail. We have seen our turnover decline in our manufacturing operations pretty consistently and distribution I think it’s been relatively stable. It’s maybe up a little bit, but nothing overly concerning, but it’s clearly a focus for us as the year goes on.

[Kelly Bania:]

Okay. Last one for me and then I will hand it off, but it sounds like the guidance – you explained the pressures in Q1, but it sounds like a lot of these pressures either cycle or are expected to improve post-Q1. So I was just curious how you feel about – is that conservative enough and how much cushion is built in there for just kind of unexpected issues as we move through the year?

[Mark Shamber:]

Yes. I mean, Kelly, I think I will take the second part of the question. I mean, I always – first is that when you are giving a range, right, you’re always considering all the different factors that are in there and what could go right and what could go wrong and what areas that you can have direct influence over when you’re running a DC or when you’re doing things versus areas where you can’t control where – using the romaine recall, you’re taking consumer safety first and foremost. And in some instances or many instances when a recall is isolated and identified, you’re pulling the product based on that versus you’re pulling it without knowing where or what part of the country or if it’s even at all related to where you’re buying from. So I mean, the high and the low ends of the guidance sort of reflect that. I think that, as we talked in the last call, we’ve been looking for – in fiscal ‘18, we were looking for some improvements within the Caito business that we didn’t necessarily see materialize, and I think we – for this year, we’ve guided a little bit differently on the Caito side of things. It doesn’t mean that internally we’re not looking for those levels of improvement, but we may have, from an external standpoint, baked that in a little bit differently on a year-over-year standpoint. So I mean, I think, in setting the guidance, it’s a range that we feel that we can achieve. And there are some things that will go in our favor, and there are some things that will go against us, and that’s why we give the range. But I think we’re comfortable overall with where we’re coming out with and what we are seeing trend-wise, but we did need to highlight some of the items that are in the first quarter that are very specific that, once we get through those, will either be in the run-rate or will be back to normalized levels.

[Kelly Bania:]

Okay, thank you.

[Mark Shamber:]

You are welcome.

[Operator:]

Thank you. And we have another attempt from Christopher Mandeville with Jefferies. Please go ahead, Mr. Mandeville. Your line is live. Okay. He actually has disconnected. And the next attempt comes from Renato Basanta from Barclays.

[Renato Basanta:]

Hey, good morning guys. Thanks for taking my questions. Just to follow-up on inflation, you are clearly seeing a bit of an acceleration there, one of your competitors commented on the potential for forward buying being a positive factor. I am just wondering, is that something you are seeing and given what you know now is that something that could potentially be a positive into Q1?

[Dave Staples:]

Well, I mean, in anytime in our business when there is inflation as a distributor, it’s always an opportunity to forward buy. So, that’s a core component of how distribution works. We will take advantage of those opportunities if they come. As Mark alluded to, we are probably expecting inflation next year somewhere in that 1%, 1.5%, that isn’t what we would call rapid inflation or rampant inflation. And so we think there will be opportunities, certainly more than there have been in the past and we reflect on those types of events when we come up with where we think we are going to end for the year.

[Renato Basanta:]

Okay, that’s helpful. And then just from a pass-through perspective, you mentioned some of the inflation issues in produce, but just broadly, given the price increases being pushed through by some of the CPG companies, I think it would be a little a bit helpful if you could give us some more color on your ability to pass-through inflation, both on the retail side and the distribution side?

[Dave Staples:]

Yes. So on the distribution side of the business, we work in a cost-plus model and so we pass inflation through. If you get into the commodities, sometimes that’s a little choppier, and it may take a little longer if there’s a rapid spike in some meat or produce category to pass-through. But over time, that type of inflationary, upward or downward to be honest with you, at distribution passes through. Retail, it can be a little choppier, and what you usually find is, on the inflationary side, as prices move up, the market responds, but probably lags a little bit of the increase at distribution. And vice versa, as those prices adjust and come back, we typically, on the retail side, lag the reduction a little bit. And over the long term, inflation is beneficial, and so I believe the market, as always, will pass it through, sometimes at a differing pace, but eventually, it’s going to pass-through.

[Renato Basanta:]

Okay. And then just on your supply chain, you have referenced the reach and capability and just overall efficiency enhancements. So I am just wondering if you could provide more details on what you are doing there and just the timing of when you expect to see some of those benefits hit the P&L?

[Dave Staples:]

Sure. We are doing a lot of things in the distribution segment as evidenced by the growth we have experienced. We are partnering with people on the West Coast and using our partnerships from other segments of our business to facilitate expansion of our food distribution business on to the West Coast where we are able to buy into their facility and use their fleet already intact to distribute at a much more fair price for our customers. We are using hub and spoke models in our distribution network to enable us to reach parts of the country where we may not have physical assets. So we are really leveraging the utilization of our assets as well as partners that we have formed over time’s assets to expand our capacity as we find opportunistic acquisitions or as we find other ways to continue to build this network out. And I think we’ll continue to evolve and grow into that kind of a plan over the next few years. Every year, we seem to find another opportunity that enables us to solve a problem for a customer we have or a new customer, and we’re able to evolve our network to meet that. And we’re also experimenting with different-sized trucks. Because of some of the business we have been able to take on – it’s a different load parameter than our traditional business, we are able to move down to a smaller truck and enabled to actually move into a differing category of driver, which a smaller truck is more efficient for the type of delivery, has higher fuel mileage per gallon as well as being able to go to a different category of driver, we can save on driver costs. So it’s all those kinds of things that we have put together to drive our efficiency that we believe will continue to improve our results as we move through this year.

[Renato Basanta:]

Okay, that’s helpful. And then just if I can sneak one last one in, it’s been about 1.5 months since you closed Martin’s. Any color or update on the synergies there, maybe anything to quantify? And then just any details on where those synergies would be coming from? That would be helpful. Thanks.

[Mark Shamber:]

Yes. I mean, I would say that it’s still too early on that front. I mean, we have had the first of what we would say are three reviews internally and the next one is not due for another week, 1.5 weeks and if we had felt that we were in a better position to provide some updates or share some details, we likely would have done it for this call. But as much as we see a lot of positives coming out of the process, it’s still a bit early to try to be communicating something as to timing and the level of how things are going to play out.

[Dave Staples:]

I guess, let me just chime in a little as well. I mean, I think we are very happy with the Martin’s operations for this 7-week period. It’s moving just as we expected. It’s a great team. They have a great handle on their markets, and their sales trends have stayed right in line with our expectations, maybe even a little better as we’ve moved through these 6 weeks. As far as the synergies are concerned, we are going to move at a deliberate pace here because we are so happy with this team and these operations. And we’re gleaning the obvious ones right out of the gate as we adjust some of the team that we don’t feel is as critical to the future success of the operation. And other things that impact the ongoing operations, we’re going to be a little bit more deliberate about because the last thing we want to do is disrupt this operation, which is we believe a very high-quality operation. So Mark will, as he said, will have more details as we go forward, but we’re going to be very prudent and move at the pace we believe keeps these strong operations where they belong as opposed to just rushing to a synergy number.

[Renato Basanta:]

Alright, thanks. Best of luck.

[Dave Staples:]

Thanks.

[Operator:]

Thank you. And the next question comes from Scott Mushkin with Wolfe Research.

[Scott Mushkin:]

Hey, guys. Thanks for taking my questions. So I just wanted to talk a little bit about the competitive environment, I know you talked about 1% to 1.5% inflation, but clearly in a lot of these markets what Walmart does and I guess to a degree Aldi and Kroger do, will dictate the pricing environment? And I guess I was wondering if you guys are seeing anything different out of some of your competitors that make you feel that either your customers on the distribution side or your own retail will have a materially different operating environment as we go through the next year?

[Dave Staples:]

As always, Scott, the market has been price-orientated. I think we’ve been dealing with that with most of our markets for well over 1.5 years. If you’ll recall, our markets were ground zero for the Walmart pricing experiment and all these aggressive pricing when [indiscernible] entered the market, so if anything, I think we took the majority of that impact early on in this process. And we’ve probably seen some competitors move a little more in that direction and other competitors back off from maybe the real aggressive positions they took. All in, all out, in the majority of our markets, we’ve probably seen an easing of the extremely aggressive pricing stances that some people have taken. So, I don’t expect, I guess, anything irrational in our markets as we go forward. I think people will find ways to pass-through this inflation.

[Scott Mushkin:]

Okay. That’s terrific. And I actually have just two more here. So, the second question, it revolves around I think you said you expanded your or amended your credit to go out and do some M&A if possible. What I also I think, Mark, you mentioned you guys were right now at 3.2x. So, where’s your comfort level there? Are you comfortable taking that up? And when you think about acquisitions, and I’m making the assumption it’s on the distribution side, but I guess I’d want to make sure I’m right on that.

[Dave Staples:]

Yes. So, I guess, Scott, as we amended our facility because a we were in the process of, you know, closing the Martin’s acquisition, and when you use up some level of capacity to do that, it just seemed like the appropriate thing to do. Because as we look out over the next couple years, we believe opportunities are going to present themselves. In our experience, whenever our industry has gone through these, type of times, where cost pressures may be a little higher, the competitive environment is sharp, we seem to find opportunities present themselves at reasonable multiples. So, we basically want to be prepared for that and felt that this was the right time to do that. And so, I think really that’s the basis for what we did. As far as leverage, I think you know us pretty well. We don’t look to take this company to an unsustainable level of debt. And so, we will work to bring our current levels down, but also be prepared for those opportunities. And should an opportunity arise that allows us to really execute our strategy, we’ll take advantage of it, and then we will certainly work to bring that leverage rate back down promptly. So, our vision has always been, over the long-term, we like to be in that 2x to 3x at the high. But we’ll, for the right opportunity, move above that, but then we’ll bring it back down.

[Scott Mushkin:]

Alright perfect. And then my final question is regarding omni-channel. And really this goes to, I guess, more to your distribution customers and if they’re having a hard time dealing with omni-channel. We hear that from people, that obviously Instacart is helpful, but the Click and Collect business is somewhat difficult, we’re hearing, for some of the small- and medium-sized operators to bring in. I was just wondering what your thought process is there and what you’re?

[Dave Staples:]

Yes. We’ve actually put a lot of effort in finding solutions for our customers. And as we’ve looked out and as we assess the landscape, we’ve really seen Click and Collect as a great opportunity for our customer base as well as our corporate stores. And as you know, in our corporate stores, we’ve invested in that, and it’s really been a great product for us. So, what we’ve done in our distribution customer base is we’ve gone out and we’ve vetted who we think are outstanding purveyors of services such as Click and Collect, services such as loyalty cards, umbrella services where our customers can actually provide personalization, to some degree, using different types of technology. And so, we’ve really taken to our customer base a suite of service providers that we think are top-notch and allow one-store operators to 40, 50-store operators to have a very economical and practical way of offering these types of services to their customers. So, we feel good about the progress we’ve made in that area as well as we feel pretty good about what we’ve done in our operations. And with the addition of Arif, we really feel good about how we’re going to take this kind of thought to the next level, both for us and for our customers.

[Scott Mushkin:]

Perfect guys. Thanks for taking my questions.

[Operator:]

Thank you. And the next question comes from Chuck Cerankosky with Northcoast Research.

[Chuck Cerankosky:]

Good morning everyone. Dave and Mark, when you’re looking at growing the company, we’ve seen retail take a bigger portion of, say, acquisition opportunities recently with Martin’s and presumably with the resolution of Gordy’s. You end up with some more stores. Is retail getting more of a focus or is that more opportunistic? And do you want to maintain a particular balance between retail sales and the two distribution segments you have?

[Dave Staples:]

Yes. Chuck, that’s a good question. If you look over the last two acquisitions, they have actually been somewhat equal in volume. The Caito acquisition was roughly $450 million, and the Martin’s acquisition was roughly $475 million to $500 million, as Mark alluded to. So, I don’t know if it’s been tilted. Our last acquisition certainly was retail. Our strategy is really to build out this national network that serves these three planks, food distribution, military distribution and retail. And so, the main focus of our strategy would be in sort of that distribution or tangential type operations that we believe diversify the company as well as continue to build out this network. But as far as our other segments are concerned, we will be opportunistic. And in retail, to the extent there’s a very strong operation that’s tangential to the current markets or within the current markets we serve, we will make the acquisition there. But I think, over the long-term, we will be canted more towards building out this network and diversifying our operations into higher-growth areas.

[Chuck Cerankosky:]

Thank you.

[Operator:]

Thank you. And the next question comes from Paul Trussell with Deutsche Bank.

[Damon Polistina:]

Good morning. This is Damon Polistina on for Paul. Can we talk about retail a little bit? You said there was a holiday shift and weather impact comp. Can you quantify that in the fourth quarter?

[Dave Staples:]

It’s difficult to quantify the impact of the weather. I mean, we can certainly see it on the we obviously track it in the different markets as to where we see weather impacts on a year-over-year basis, where you’ve gotten snow or bad weather in one year versus not. And you can certainly see the impact in the comps. But that happens year-to-year, quarter-to-quarter, so I don’t think that we felt it was big enough to try to call out and try to specifically identify because you get into sort of estimates on estimates. But we did certainly feel that it impacted because we had a fair amount of snow here in the Michigan markets this year or last year in December, and we had almost nothing in 2018. And with the holiday shift, just we experienced a little bit of last year where New Year’s Eve moved into one fiscal year versus out. And then you’ve got that weekend sort of shift where you seen, New Year’s move into the beginning of the week, and it certainly delayed folks doing some of their purchasing into what would now be the first quarter of ‘19. So not something we were going to try to call it out and quantify as to what the impact was on the results. But it certainly was an impact on some of the comps for the fourth quarter.

[Damon Polistina:]

Okay. Thanks. And then looking to 2019, what’s your kind of expected cadence for comps throughout the year? Do you expect improvement as we go through? And then also, what are you seeing from an uptick with your new brand positioning in the stores that have that?

[Dave Staples:]

Yes. I mean, I would say certainly we expect an uptick as we go throughout the year. I mean, we’ve gotten some brand positioning in some additional stores that will happen later in fiscal ‘19. We’ve been a little bit vague intentionally for competitive reasons on that as to not identify the markets or the exact timing until that launch. But I mean, I would certainly expect the comps to improve. And then the second part of the question again was.

[Damon Polistina:]

Oh, it was just on in the stores that have utilized the new brand positioning, how have those performed compared to the stores who haven’t?

[Mark Shamber:]

I would say that we’ve been quite pleased with their performance. I mean, there’s always opportunities to tweak and make it better. And as we do the first ones and we move on to the next ones, we make minor adjustments to get further improvements on the returns. But I don’t know, given that it’s a limited number of stores, that we ever call out specific stores individually. So, I wouldn’t attempt to share that information. But I would say that we’ve been pleased in the ones that we’ve launched to date.

[Dave Staples:]

Yes. And let me just, I guess, expand maybe a little bit on retail. We’ve made a number of changes to our team over the course of the year. Tom Swanson stepped up to the role of our general manager in the late fall, and we added directors to the key departments in our retail operation. With that change and then as well with the bringing on of Lori as of Monday so she’s now an experienced veteran here at the company we have made, I think, significant strides in the team leading our retail operations. And actions like that are the kind of things that made us feel even more comfortable with an acquisition like Martin’s. So, I believe the strength of this team we’ve put in place is going to help us really continue to make our retail operations what they need to be to win in this environment. So, we feel really, really good about the team we’re putting together here, and we look forward to see how we do in this repositioning because we’re pretty excited with what we’re putting forth.

[Damon Polistina:]

Thank you. That’s helpful. And the last one from me, I know on the private brand with the military, just your expectation you’ve been behind your expectations a little bit in the last couple quarters. Can you kind of describe the progress you’ve seen there?

[Dave Staples:]

Well, I mean, we’re behind our original expectations. I don’t know we continue to be behind our expectations. I think we’ve adjusted our expectations in there, and it’s moved along. I think there is a tremendous opportunity in the military. When you look at an organization doing the volume they do, and if you assume you would be at an industry average, say, 25-ish percent of private brand penetration, I mean, it’s a billion-dollar sales opportunity. And so clearly, back at the inception, we had high hopes of a fairly rapid launch and seeing those, kind of sales transform in a relatively short period of time. But DECA has to operate how DECA feels is appropriate, and there’s a lot of different influences on the DECA team that they have to consider when they make these choices. And so, they determined the appropriate pace is different than they originally thought it would be and different than we understood them to expect it to be, and we respect that. They need to go at the pace they feel is right for their business, and we’re happy to move at whichever pace they prefer. We expect to continue to see growth. We expect to see nice growth next year in the private brand program, and we expect that program to really help DECA accomplish its objectives of, over time, increasing the foot traffic into their operations and providing this benefit for our military heroes, which as you all know, is a real key part of our culture and belief system, and we’re proud to be a part of that.

[Damon Polistina:]

Thank you.

[Operator:]

Thank you. And the next question comes from Ajay Jain with Pivotal Research Group.

[Ajay Jain:]

Yes, hi good morning. I think a few months ago, Dave, you guys expressed some optimism that Fresh Kitchen was heading towards better-than-breakeven performance as you begin to cycle some of the startup costs. And obviously, there was no way to anticipate the recent lettuce recall. But can you confirm the profitability for Fresh Kitchen in Q4? Like, how far below breakeven was it in Q4? And then what’s the current run rate, if you can comment?

[Mark Shamber:]

Yes, Ajay. I mean, the kitchen is a sub-segment of Caito, which is a sub-segment of Food Distribution, so that’s not a level of profitability or loss that we would ever sort of share. I mean, obviously, because once you start putting that out, it sets the expectation going forward. I mean, I would say that, look, it was losing money, and while we’ve seen progress on a year-over-year basis, it hasn’t been at the rate that we would like or expect.

[Ajay Jain:]

Okay. But incrementally, can you confirm if things took a step back in terms of profitability from Q3 to Q4?

[Mark Shamber:]

Honestly, I didn’t think of it from that perspective because of some of the seasonal sides of things. I mean, the fourth quarter is a softer quarter just in general within that whole space. Ajay, I know we’ve got a follow-up call. I can get back to you off-line on that to answer the question. I don’t know it directionally right off the top.

[Dave Staples:]

I mean, Ajay, to follow-up a little bit, the fourth quarter was relatively consistent with the prior year fourth quarter, which was not our expectation. We did expect it to improve.

[Mark Shamber:]

Right.

[Dave Staples:]

And it didn’t. And so, there’s a number of issues. When you get into some of the commodity volatility we’ve had, when we get into but you know what? All that aside, we took on a lot of new business in the quarter. I mean, I think the sales in the kitchen were up over 30% for the quarter, and as we’re trying to get a team in place there, a workforce and a consistent management team, I think we’ve finally brought forth a consistent management team, and we’re working hard on that consistent operation team. When you increase the volume like that, regrettably in this phase, we found it to cause a lot of inefficiency. We’re very focused on the kitchen and fresh-cut, so as we turn the corner into this year on fresh-cut, the team has done, I think, a great job in keeping a real strong and developed management team. And it’s done a great job in stabilizing and reducing the turnover in its manufacturing force. And as we’ve adjusted some pricing to take care of the cost increase, we’ve seen, the last 2 weeks of fresh-cut are really feeling pretty good for us. Now 2 weeks does not make a trend, but it certainly begins one, and so I think the management team in our fresh-cut operations is feeling pretty good about what they’ve done. And assuming the stability in the commodities holds for us, I think we’ve seen a nice move in the kitchen or in the fresh-cut. In the kitchen side, I think as we learn we learn every quarter, I think, in the kitchen because, as you know, this is a startup for us. This is something we’ve not run before. Obviously, the management team we’ve brought in has run kitchens, but they’re learning as we bring new business in, new accounts in, what kind of products are profitable, which aren’t as profitable. And as we assess the kitchen operations, we believe we have some SKU rationalization to do, and we certainly have some productivity enhancements to make. We will keep a really strong view on how the kitchen progresses. There is, some very interesting opportunities out there. There’s still probably about a half a year to a year off as far as being really transformational on the type of business we’re doing. But we will see improvement in these Caito operations over the course of this year. We will find one way or another that that will happen. And so, our expectations are, as we go along the year, the operations are going to improve or we will look at other actions to make that trend better.

[Ajay Jain:]

Thank you. That was very helpful. If I might ask a follow-up question on guidance, when you laid out the five factors that are impacting the first quarter guidance, it seemed like a lot of those headwinds are company specific. So, Dave, in response to the earlier question on the pricing environment, it sounded like you’re not necessarily seeing a change there and you’re not seeing irrationality in the market. But I just wanted to confirm how much of the competitive backdrop how much that might be factoring in in terms of the cautious outlook for Q1.

[Dave Staples:]

I think, Ajay really, I think we try to confine the topics there for Q1. We really had the four main issues being the rebate change, which is a, it’s a timing issue that we have to work through; Caito, as we just talked about; Columbus, which we’ve talked about; and the interest rate impact. The retail environment’s competitive. I mean, there’s no question. Like I said earlier, I think we took the main competitive pricing charges and impacts 1.5 years ago, but that while they’ve lessened, they’re still, I would say, some aggressive pricing in our markets. We’ve been working through that. That continues to be a challenge for our retail environment. Our positioning takes into account some of the levels of this pricing, and we’re really hard in our retail side of the business to rethink our stores. And that’s what this positioning is about. How do we work through the fresh side of the store? How do we mix that center store differently? How do we improve the quality of the experience for the consumer? How do we demonstrate to the consumer our social consciousness and that we are the kind of social partner they want to be with? How do we continue to do that better than the other guy and allow us, on an overall basis, to be that store they want to shop and address these issues of total value as opposed to just price? So, I think our environment will continue to be challenging, as I’ve said, and so I think I guess I don’t see I guess my point to you is, I don’t see any dramatic changes in it other than it remains challenging.

[Ajay Jain:]

Great. Thank you very much.

[Operator:]

Thank you. And the next question is a follow-up from Kelly Bania with BMO Capital.

[Kelly Bania:]

Hi thanks. Just a couple of quick housekeeping questions. Just what are you expecting in your outlook for ‘19 on LIFO, stock-based compensation? And as you think about Project One and the savings you called out there, how much of that are you expecting to land in 2019?

[Dave Staples:]

Okay. So, there’s a few questions there. I mean, I would say, Kelly, that if the current inflation trends hold, we would expect to see an increase in LIFO on a year-over-year basis because last year, we bounced around a little bit. But it’s so hard to predict as to how many SKUs and how broad-based it is from that perspective. But I mean, I would say that there’s probably flat to a little bit up from that standpoint, but not a significant change if again, if the current trends hold. If we start to see more inflation, that’s where it would flow through accordingly. On the stock-based comp, I do have that. I’m not sure if I’ve been sharing this. I’m not sure if I brought that page in. But I think that it’s probably up maybe, like, 4% or 5%. I don’t think it’s a huge number. In my recollection, I want to say it’s always in the range of $0.5 million, give or take a couple hundred thousand dollars, so maybe up a half million-ish. The third one what was the third part again? I’m sorry.

[Kelly Bania:]

Just on Project One savings. I think you called out 24 months’ timeline there, so I was just curious how you expect that to play out in this year.

[Dave Staples:]

Yes. I mean, I think from our standpoint, I mean, we’re still going through and identifying the areas in which we’ve got initiatives. I think that we’ll start to get some of those savings in the back half of the year, and how quickly they’re able to be implemented and what I think we’ll be at a run rate for maybe it’s a quarter of the items, maybe it’s a little bit more, a little bit less, by the end of the year. How that translates into dollars and what that does into 2019 is still a little bit premature, and that’s really where we deferred it until talking a little more clarity on the first quarter call because, at that point, we’ll have a much more defined list as well as knowing what the costs are for some of that. And so, I can share numbers here, but I’d be just taking a guess, and I’d be probably revising them substantially in the first quarter. So, we deferred on that because we’re just not far enough along to be able to give good guidance there, and I’d rather not put out something that I’m going to change significantly 3 months from now.

[Kelly Bania:]

Got it. Thank you.

[Operator:]

Thank you. And as there are no more questions, I would like to return the call to management for any closing comments.

[Dave Staples:]

Thank you everybody for participating on the call today, and we look forward to speaking with you again next quarter.

[Operator:]

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