SpartanNash Company
Q1 2009 Earnings Call Transcript

Published: 31 Jul 2008

[Operator:]

Good morning, and welcome to the Spartan Stores, Inc. fiscal 2009 first quarter earnings conference call. (Operator Instructions) I must remind you that comments made by management during today’s call will contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates, and projections that involve significant risks and uncertainties. Actual results may differ materially from results discussed in these forward-looking statements. Internal and external factors that might cause such a difference include, among others, competitive pressures among food retail and distribution companies, the uncertainties inherent in implementing strategic plans in general economic and market conditions. Additional information about risk factors and the uncertainties associated with our forward-looking statements can be found in the companies earnings announcements, annual report on Form 10-K and the companies other filings with the SEC. Because of these risks and uncertainties investors should not place undue reliance on forward-looking statements. Spartan Stores disclaims any intention or obligation to update or revise any forward-looking statements. At this time I would like to turn the call over to your moderator, Craig Sturken.

[Craig Sturken:]

With me this morning are members of our team, including President and Chief Operating Officer Dennis Eidson; Executive VP and CFO Dave Staples; Executive VP of retail operations Ted Adornato; and executive VP and General Counsel Alex DeYonker. I will provide you with a brief overview of our first quarter progress and then Dave Staples will give you more details on our first quarter financial results and outlook. I will then rejoin the call to provide you an overview of our plans for the remainder of fiscal 2009. As our financial results show, fiscal 2009 is off to a good start. Our operating and net earnings had solid increases this quarter and we reported our ninth consecutive quarter of sales growth and net sales. In addition, first quarter net sales on both a consolidated basis and in our retail segment reached six-year highs. During the quarter we continued investing in our retail store base through our capital improvement program. By the end of the first quarter three major remodels were completed at acquired Felpausch stores and reopened under the Family Fare banner. Two additional remodels were substantially complete, including one Felpausch store and one Glen’s Market store. Early in our second quarter the Felpausch store was rebranded under the D&W Fresh Markets banner and the Glen’s store was rebranded as a Glen’s Fresh Marketplace store. Both stores have exceeded our sales expectations through the first four weeks since their grand reopenings. We will discuss more details about these projects later in the call. It’s important to understand that the majority of the remodel activity during the past three quarters has been in our Felpausch stores which will not be included in our comparable store sales numbers until the fourth week of the second quarter. We expect our capital improvement activity to positively affect our comparable store sales trends as we move through the remainder of the fiscal year. Our distribution business performed very well as we continued to benefit from volume growth due to higher sales to new and existing customers. First quarter consolidated net sales improved nearly 13% while operating earnings increased more than 26% despite the additional Easter holiday sales included in last years first quarter. We are pleased to achieve these growth levels despite the current economic factors affecting the consumer. I believe it’s important to consider that economic cycles are not moot to the company’s operating in Michigan. We have been operating for some time and have produced solid results despite the challenging environment and we believe our management team has the experience to successfully adapt our business strategies to the economic conditions that prevail. During the quarter we exited 13 of our 14 Pharm retail stores and sold the script files for all of these stores for a gain. Dave will cover more details about the transaction with you in a minute. We still have one Pharm store closure pending and expect to complete the sale of that stores script file during the second quarter. From a distribution perspective we experienced volume growth from the new business added last year and are making measurable progress with efficiency improvement programs. With that overview I will turn the call over to Dave for a detailed review of our first quarter financial results.

[Dave Staples:]

Consolidated net sales for the 12-week first quarter reached a six-year high, increasing 12.8% to $586.7 million or from $520.2 million in the same period last year, which included approximately $6 million in sales related to the Easter holiday. The increase was due primarily to the acquired retail stores, higher distribution sales to new and existing customers and incremental fuel sales. Gross margin for the first quarter increased 60 basis points to 19.7% from 19.1% in the first quarter last year. The improvement was due mainly to the shift in sales mix between distribution and retail and an increase in distribution gross profits due to the elimination of sales related to the Felpausch acquisition, partially offset by growth in the lower margin fuel sales and the Felpausch retail stores. As a percentage of sales first quarter operating expenses increased to 17.1% from 16.8% in the same period last year, reflecting a change in mix of our sales and additional costs related to five major remodels at our retail stores of which three held grand reopenings during the first quarter. This years first quarter includes $800,000 in remodel related costs compared with $500,000 of start-up costs related to the Felpausch acquisition in the same period last year. Last year also included $500,000 of Michigan single business tax which has been replaced by an income tax that is included in our taxes on income this year. First quarter operating earnings increased 26.4% to $15 million from $11.9 million in the same period last year. The improvement was primarily the result of the acquired Felpausch stores and new distribution business partially offset by the absence of Easter holiday sales this year and high remodeling related costs. First quarter earnings from continuing operations increased 22.4% for $7.6 million or $0.35 per diluted share from $6.2 million or $0.29 per diluted share in the same period last year. Net earnings for the first quarter reached $9.9 million or $0.46 per diluted share, compared with $6.5 million or $0.30 per diluted share in the year ago period. Net earnings included $2.3 million or $0.11 per diluted share in earnings from discontinued operations. Earnings from discontinued operations related primarily to an after tax gain related to the sale of Scriptless at 13 out of the 14 Pharm stores. As Craig mentioned the Scriptless sale for the remaining Pharm sales expected to be completed during the second quarter. We expect to incur an after tax loss in the second quarter of between $300,000 and $700,000 related to the closure of rhis remaining store due to lease and other exit costs. Turning to our business segments, first quarter distribution sales increased 5.6% or /$298.1 million from $282.4 million in the same period last year. The sales improvement was due primarily to increased sales to new and existing customers. The sales increase was partially offset by the reclassification of $20.6 million in sales to our now owned Felpausch retail stores and the assets of approximately $3 million in Easter holiday sales in last years first quarter. Distribution operating earnings improved 43.7% to $7.5 million from $5.2 million in the same period last year, which is a first quarter record. The improvement was due to higher sales volumes, improved sales mix and increased cost leverage partly offset by higher LIFO inventory charges. First quarter retail sales in creased 21.4% to $288.6 million from $237.8 million in the same period last year. The sales improvement was due to the contribution from acquired stores, higher fuel sales, and sales gains from stores remodel last year. Comparable store sales increased 1.6% excluding both fuel sales and the Easter holiday sales from last year. Our comparable store sales increase was somewhat below our recent run rate average due to unseasonably cool and wet weather in our Northern Michigan market during the late spring and early summer and the consumers’ response to economic conditions. We expect our comparable store sales number to improve about the first quarter rate during the upcoming quarter. The rate improvement will be due to our capital investment program, the Felpausch stores being included in our comparable store sales numbers during the fourth week of the second quarter as well as a return to more seasonal weather in Northern Michigan. Additionally we expect the comparable store sales trends to improve as our marketing and merchandising programs effectively address the existing consumer purchase trend. Through the early part of the second quarter we’ve experienced a noticeable increase in our comparable store sales. First quarter retail operating earnings increased 12.8% to $7.5 million from $6.7 million in the same period last year. The improvement was primarily the result of the acquired Felpausch stores reduced shrink rates partially offset by the start-up costs associated with the remodel activity during the first quarter and the absence of the Easter holiday sales this year. Total long-term debt including current maturities declined $3.9 million to $150.6 million as of June 21, 2008, from $154.4 million at March 29, 2008. The debt reduction was due to improved profitability and the near doubling of year-to-date net cash generated from our operations to $13.7 million from $7.4 million in the same period last year. In addition our cash position increased $10.7 million primarily as a result of the sale of the Pharm stores, Scriptless and inventory liquidations, as well as the continued improvement in our operations. I will now cover our outlook for fiscal 2009. We expect comparable retail store sales to increase in the low to mid-single digits during fiscal 2009 excluding the fact of fuel and the Easter holiday sales, which was included in both the first and fourth quarters of fiscal 2008 but will not occur in either quarter during fiscal 2009. We completed major remodels on two additional stores in the second quarter and expect to complete remodels on two or three more stores during the third and fourth quarter. In addition, we expect to complete a major relocation project for on store, substantially complete construction of a new D&W store during the fourth quarter and open up the four additional fuel centers during fiscal 2009. We expect to incur additional start up costs from employee training, marketing, promotion, and store repositioning of between $2 and $2.5 million during the remainder of fiscal 2009. On the distribution side we expect to generate additional revenue in sales volumes from our new business during the remainder of fiscal 2009 but not at the same rate as in fiscal 2008 because we will cycle the Martins business early in the second quarter and the sales gains from customer purchases of Farmer Jacks stores during the second and third quarter. We anticipate capital expenditures for fiscal 2009 to range between $55 and $60 million. These expenditures will allow us to continue our successful capital investment program, including rolling out our Family Fare and D&W offerings at certain posh locations and further optimizing the performance of our entire retail store network. Depreciation and amortization expense should range from $26 to $29 million and interest expense should be approximately $11 million.

[Craig Sturken:]

I want to reiterate that fiscal 2009 is off to a good start. We are very pleased with our capital investment program as it is producing the sales gains we projected and is allowing us to solidify our retail market share. However, we still see many opportunities that will improve the profitability of our operations. During the remainder of the year, we will continue integrating the Felpausch acquisition; continue with our capital investment program targeting stores and markets with the best growth potential; and refine our marketing, merchandising and promotional activities in order to capture and more fully realize the profit improvement potential of select retail stores. We believe that significant opportunities exist to enhance our consumer offer at market served by stores being remodeled and those scheduled to be remodeled. We are just beginning to benefit from the performance potential of our Felpausch acquisition and expect to continue making progress improvement in their sales and profit performance during fiscal 2009. As mentioned earlier, we finished major remodel work at three Felpausch stores during the first quarter. In addition, we finished remodeling one more Felpausch store and one Glen’s store during the first week of the second quarter. The three first quarter remodels include improved product assortment, new marketing and merchandising programs, and store lay out and equipment improvements. These stores have been rebranded as Family Fare stores and customer responses as well as preliminary sales trends are better than we originally expected. The Felpausch store remodeled in the second quarter was rebranded and turned into a D&W. The fresh parameter of merchandising and lay out at this store was dramatically improved and we added a Starbucks café and significantly expanded the stores product assortment. The Glen store remodel is our first Glen’s Fresh Marketplace format, It includes many of the upscale attributes of our D&W fresh market stores such as Starbucks café and significantly expanded and improved perishables and wine offerings; however, it still retains the local market center store product offerings of a traditional Glen’s market. This store now represents a truly special shopping experience and product offering in the Northern Michigan market. Customer response to both of these stores has been exceptional during the first few weeks since their grand reopenings. In our distribution division we expect the benefits of new business added during the past year to temper as we fully cycle this business beginning early in the second quarter; however we are continually seeking expansion opportunities in contiguous states and with new customers. In addition, we still have productivity enhancement opportunities in this segment related to warehouse input and inventory management. We are currently engineering our dry grocery operations and expect this initiative to produce efficiency improvement benefits through out the second half of the fiscal year.

[Operator:]

(Operator Instructions) Your first question comes from Blakely [ph] Smith of Jefferies & Co.

[Blakely [ph] Smith of Jefferies & Co:]

I was interested in what you said about the [inaudible] why do you think the contracts [oh] had improved in the second quarter. I mean is it merchandising, is it simply inflation, what are you saying? Your tone sounded pretty positive about 2Q.

[Craig Sturken:]

There are really two elements. First of all in the spring we had poor weather up north and the Glen’s Markets banner really was affected by sort of a lack of traffic in the Lakes regions. So that really affected us primarily in the month of June. Also, the Felpausch stores could not be included as part of our comp sales because they had not completed the first annualization. Remember while we put capital money into the Felpausch stores so we are enjoying the great comps in those stores in which we’ve made the investment, but we have not been able to include them as part of our comps analysis.

[Blakely [ph] Smith of Jefferies & Co:]

It sounds like you guys continue to do positive on fuel, what we’ve noticed is it’s been a driver for the industry, yet at the same time we’re seeing independent fuel operators under a lot of stress with higher prices and credit cards going higher. How are you making fuel work for you and do you remain committed to it as you go through your capital plan?

[Craig Sturken:]

First of all, yes we are committed to it and the magic of fuel for our partner stores really is the relationship of our fuel centers with our supermarkets. As a matter of fact, over 30% of the fuel transaction includes some kind of discount that is generated through a purchase in our supermarket. So, we have a very synergistic relationship that means more to us than, say, a convenience store.

[Blakely [ph] Smith of Jefferies & Co:]

Then you said, as you look out at your remodels that you still plan to expand the number of fuel centers, just generally speaking.

[Craig Sturken:]

Absolutely.

[Blakely [ph] Smith of Jefferies & Co:]

One last question on the M&A front just from a distribution or a retail side. Clearly markets are in turmoil to a certain degree, but do you see any opportunities over the next 12 months?

[Craig Sturken:]

If I did, I couldn’t really tell you that. As stated in my script, we will continue to pursue acquisition opportunities or new business opportunities in a contiguous trade area.

[Operator:]

Your next question comes from Charles Cerankosky with FTN Midwest.

[Charles Cerankosky:]

If we’re looking at the quarter a year ago, as well as the fourth quarter of the fiscal ’08 year, Craig could you talk about what you’re seeing changed in consumer sentiments, spending, behavior, that sort of thing?

[Craig Sturken:]

Well you know we are experiencing the same things that everybody else in our industry is experiencing. We’re of course able to deal with some of this stuff primarily because we have the experience. I mean Michigan’s been a tough market for the past several years, so I think our organization is prepared to deal with some of theses things and they’re not new to us. I think private label might be one of the things that are really working well for us. We invested in a private label program for the last five years. The organization has been developing what I consider to be one of the best private label programs in the food retail and it’s paying off for us. I mean this is the time when a good, solid, robust, private label program will work. I think if you were to say anything that would be sort of the star of our operation. The other thing is we have a pretty good capital plan. I mean we’ve been able to acquire businesses and invest in these businesses and make them far more productive then they were before we acquired them. If you look at D&W and Felpausch they are working nicely for us. We’ve also been able to pick off a, a one and two stores, which we really don’t talk about very much because it’s small, but you know the onesies and twosies have really helped us also. So, we’re pretty happy with what’s going on.

[Charles Cerankosky:]

So you’re saying a somewhat more challenging consumer environment. How is the consumer behaving around your fresh categories, not only in the D&W stores, but I’m looking for a comment regarding the entire chain and that would include everything from the better custom meat to well-prepared foods and produce and organics where you offer it?

[Dennis Eidson:]

I think it is very difficult to really get a great read on that whole trade down environment. I will tell you in Petoskey we did this remodel and we really up-scaled the store and put natural organics and fresh offering in the store just took off like a rocket ship. So there is an example where regardless of the economy, that demographic profile is really resonating, our offer is resonating with them significantly. We continue to see natural organics do very well. I would say too that we have focused ourselves from a commercial perspective, from some of the middle and down markets, with a more aggressive promotional strategy on center of the plate protein. We are driving some of the mix change trying to give our offer more relevance. The meals made easy promotion that we’re running, I think, has gotten a little bit of traction so again we’re trying to add value to that consumers shopping experience while putting some fresh foods in with some core staples in order to make that shopping experience easier and add more value. Lots of moving parts and we have such a diversity in demographic that I’m not sure I have a good one size fits all answer for you.

[Charles Cerankosky:]

I guess it’s a good thing, you don’t have a one size fits all. Is it getting more difficult to maintain the differentiation against your super center competition?

[Dennis Eidson Craig Sturken:]

Well I don’t think so. I think in some respects it’s a little bit easier and because of our size I think we find ourselves being a little more nimble than our competitors. When your footprint is pretty tight, we live here, we know the marketplace. Craig talked about the private label emphasis, our numbers are terrific, and we’re pleased with that. Blakely asked about the fuel and we’ve been experimenting with some different type of fuel promotions and unequivocally the stores that have fuel on pad are clearly performing better than those without fuel. We’ve done things with items to drive volume in the supermarkets, we’ve aggregated some volume incentives to get a gas discount, and as you know we’re consumers at the pump with that fuel discount. Why do you think that, when you trek out you go to the pump, you see the retail fuel drop $0.20 a gallon, it’s pretty powerful for the consumer to see that and again we think it adds to the whole value proposition.

[Operator:]

Your next question comes from Karen Short from Friedman Billings Ramsey.

[Karen Short:]

Dave, what was the LIFO charged in last year’s quarter?

[Dave Staples:]

The LIFO charge, if you noticed also in the press release we put that back in the chart. We built that out.

[Karen Short:]

Oh yes, yes, yes, I’ve got it. Then I don’t know if this is something you have the ability to provide now, obviously we have refereed [ph] the numbers for the first quarter now, taking the prime our of those segments. Do you happen to have the EBITDA and for distribution of EBITDA and then for retail the revenues and EBITDA in a restated basis for the next three quarters?

[Dave Staples:]

That’s sitting right with me, but that’s something we could talk about. You can kind of get, I think, a feel for that run rate because if you look at our chew last year we ended up restating the year in the quarters when we put it in discontinued ops; so you have the run rate from last year and then you have this quarter, because when you put it in disco ops it comes out of all those numbers.

[Karen Short:]

Then just looking at your distribution margins sequentially, obviously normally the second quarter and the fourth quarter have the highest margins and first and third are lower, but I was just noticing that last year your distribution margins in the third quarter were flat sequentially from the second. I was wondering if there was a reason for that. I’m looking to model this year, obviously forgetting the noise with the firm. I’m wondering if I should have seen that we still had 3Qlower than 2Q, as in was last year an anomaly versus the trends?

[Dave Staples:]

Yes I think with everything going on you’re more just throw up a run rates are always the way to look at it and any one quarter at any one time you can get a blip here or there.

[Karen Short:]

Okay then on your tax rate, it was a little higher than I would have expected so can you just explain that, I know it was formulated?

[Dave Staples:]

Yes what happens is, is Michigan has changed their rates and so there is sort of two events, the first event is that obviously the Michigan’s business tax now is an income tax, so that changes the historical run rate, which you already anticipated. Then what happened in the Pharm transaction well the Michigan income tax is theoretically an income tax they also include a gross receipt tax and so when we sold the Scriptless out of the Pharm stores that’s treated as a gross receipt and so Michigan gets a cut of that, even though the locations are predominantly in Ohio. It just gets into a formulaic type of deal. The reality is, because of the gross receipts from the Pharm we had to pay more Michigan income tax. That is an event that is for this quarter only, whereas when we move forward then the rate will go back down more to that 39.1% that we say is more normalized. That will have a little impact, I guess, in the second quarter because we’re at that final transaction, but that’s just one, nowhere near the same magnitude, it would be, I think, fairly insignificant.

[Karen Short:]

On your $2.5 million of remaining start-up for the year, how will that be split through out the quarter?

[Dave Staples:]

Well if you divide the stores into a, the key will be the two to three in the third and the major relocation in the fourth, they will be the predominant drivers of that. The new store that is substantially complete with new accounting rules will contribute as well in the fourth quarter. Actually maybe late in the third as well, because once we sign the lease we have to start amortizing the ground rent and then there will be certain costs as you’re getting ready to open, depending on when we actually finish it going into next year. I would say maybe the heaviest component of that would be I the third quarter, but you’re going to still see sort of a pro rata share of that into the fourth. It’s driven by those events that we talked about.

[Karen Short:]

Obviously your margins came down in retail. Did you comment on how much promotional or grand re-openings might have had an impact on your margins at retail?

[Dave Staples:]

Yes if you look at what we put out it was $800,000, but then for disclosure purposes we had about $500,000 of start-up last year and for the Felpausch; so if you’re trying to net unusual items there is like a $300, 00.00 impact.

[Karen Short:]

But you’re lumping promotional spending right?

[Dave Staples:]

[Inaudible]

[Operator:]

Your next question comes from Sarah Lester with Sidoti and Co.

[Sarah Lester:]

I have a question just about inflation, if you’ve seen competing rate sellers, especially the super centers passing on inflation to customers and also talk about how successful you’ve been at passing inflation to customers?

[Craig Sturken:]

You know the inflationary run rate in Q1 is not a lot different than what we saw in Q3 and Q4 and I would say the competitive climate is about the same. Item by item there are some categories where they are a little tougher to move. The market is moving slower. Others they move immediately, but on balance I think it’s about average. I don’t think we’re feeling inhibited by the ability to pass on inflation generally speaking.

[Sarah Lester:]

During the past quarter have you felt like it’s a little bit tougher or was Q1 comparable to Q3 for last year?

[Craig Sturken:]

I think it’s comparable.

[Operator:]

Your next question comes from Edward Como [ph] of Four Rivers Capital.

[Edward Como [ph]:]

I was wondering, Craig, if you could talk a little bit about the distribution business. I have a little trouble backing out all the moving parts on distribution in terms of just looking at the ongoing profitability of let’s say, your business with existing customers. Is the margin continuing to go up because of the efficiencies you’re putting in place plus passing along some inflation, things like that, or is that relatively stagnant and the improvement in profitability is from the new customers?

[Craig Sturken:]

Lot’s of things are helping us on a distribution side. Naturally the new business, the higher volume we put through the distribution center. It helps us with a fixed cost rate etc… We are a dynamic company in that we operate two businesses with both a retailer and a wholesaler. We are not like a softer sibling chain whereas let’s say market gains or forward buy with the price increases would go for the retail side of the business. You know you think Kroger’s okay, it all shows up in a retail, on some big bucket, where with us all of that stays on the distribution side. So what you’re seeing is a benefit to our distribution on all of the procurement that does not get passed on to the retailer. Because we are a wholesaler we treat our retail stores exactly like we treat any other retail store that we supply and that really is helping us on this issue.

[Dave Staples:]

The other point that’s maybe worth making, it’s not in the script, but when we eliminate Felpausch like that profitability, we eliminated Felpausch from the distribution business over a year ago, but the profitability stays in the distribution P&L and has the effect of increasing profitability rate of distribution.

[Edward Como [ph]:]

One of the other things I was getting at was that during times of inflation, historically, sometimes the wholesalers can make a little bit more in extended profit either on forward dye or a whole host of other tools you have available to your retail customers. I was wondering whether or not you were continuing to see that. I was trying to get down to what your ongoing distribution profit growth is, whether it’s accelerating or flat or whatever.

[Craig Sturken:]

I think, yes it is. It’s in our profit growth, but I don’t see any real changes in the short-term from what we’ve experience per se Q3 and 4 and our first quarter.

[Operator:]

Your last question comes from Charles Cerankosky from FTN Midwest.

[Charles Cerankosky:]

Craig or Dennis could you talk a little bit about the outlook for adding new distribution customers this year and were there any in the quarter? Also, how much of the distribution segment sales increase reflected inflation in the quarter?

[Craig Sturken:]

On the new customer front, you know us Chuck; we are always working on that. We feel that there are opportunities for us. We think there are a lot of good opportunities for us. We look at the entire arena, we know who our competition is, we have a relationship with retailers and it’s something that we work hard at. But, if we had something cooking I couldn’t tell you that. It’s just not anything that we could disclose. We don’t see the future any different than the past when it comes to being able to add new distribution of business. On the inflation front, there is inflation. We are not seeing any different kind of inflation rate than anybody else in the industry is. It’s in the low single-digits and it’s reality, it will probably stay with us for awhile. On a macro front, the gasoline thing, which is in our total numbers, which we don’t report at as comp, but the gasoline, $4.00 a gallon gas is in a tax.

[Charles Cerankosky:]

So if we took say 3 to 4 percentage points out of the sales growth in the distribution revenue in the quarter that would be accurate and reasonable?

[Craig Sturken:]

That’s probably a reasonable guess, yes. If there are no more questions we’ll conclude the call. On behalf of Dave and Dennis and everyone at Spartan I thank you for joining us and look forward to our next conference call. Thank you.