SpartanNash Company
Q3 2015 Earnings Call Transcript

Published: 12 Nov 2015

[Operator:]

Good morning, and welcome to the SpartanNash Company's Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Katie Turner. Please go ahead. Katie Turner Thank you. Good morning, and welcome to the SpartanNash Company's third quarter 2015 earnings conference call. By now everyone should have access to the earnings release for the third quarter ended October 10, 2015. For a copy of the release, please visit SpartanNash's Web site at www.spartannash.com under For Investors. This call is being recorded, and a replay will be available on the company's Web site 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 among food retail and distribution companies, the uncertainties inherent in implementing strategic plans, 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 third quarter earnings release, fiscal 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 measures and the other information required by Regulation G is included in the company's earnings release, which was issued after market closed yesterday. And it's now my pleasure to introduce Mr. Dennis Eidson, President and CEO of SpartanNash Company, for opening remarks. Dennis Eidson Thanks, Katie. Good morning and thank you for joining our third quarter 2015 earnings conference call. With me this morning are Dave Staples, our Executive Vice President and Chief Operating Officer, as well as other members of our executive team. Today I'll begin by providing you with an overview of our business for the third quarter, and then Dave will share some additional details about the third quarter's financial results, as well as our outlook for the remainder of fiscal '15. Finally, I'll provide some closing remarks, and we'll open up the call to take some questions. We are again pleased with our ability to generate group third quarter adjusted earnings in a challenging sales environment. We believe that this is a result of our team's ongoing effort to strengthen our value proposition and the quality in the service that we offer our customers across our Retail, Food Distribution, and Military segments, combined with our ongoing commitment to drive efficiency. In our Food Distribution segment, we've continued to make significant progress on streamlining our network, which is one of our major supply chain initiatives. We have continued the integration of our Military and Food Distribution transportation fleets, and the initial results are promising. Although we're still in the early stages, we're encouraged by the potential economies of scale we can achieve as we reduce empty miles and improve efficiencies. At this time, all of our tractors and over a 100 of our trailers have been re-branded as SpartanNash, which facilitates them being utilized in the most efficient manner. On our warehouse front, we continue to explore our opportunities, including further consolidation that will benefit both our customers and the company. We are also implementing plans to significantly reduce costs related to trends, duplicative handling, and other warehousing functions, as we believe there continues to be meaningful benefits to be gained. We've also continued to rollout our merchandising and marketing strategies to all of our independent customers. We're pleased that certain elements by our virtual chain go-to-market strategy, including our value-added and expanded private brand programs are beginning to resonate with the existing distribution customers. Given the increasing importance of national and organic products to consumers, we've expanded and begun to rollout our private-labeled Full Circle brand to all of our independent customers. With Full Circle products, we're committed to delivering great tasting, 100% natural, organic, and environmentally-friendly products at affordable prices. Additionally, I'm pleased to report that the company and the union representing our Grand Rapids, Michigan warehouse, transportation, and maintenance associates ratified a new two-year labor agreement that was set to expire in October. This agreement will continue to provide our associates with a competitive wage and benefit package, while enabling the company to continue to increase operational efficiencies. While the independent food distributor market remained highly competitive, our well-positioned distribution network and highly relevant product offerings will allow us to grow our business organically, as well as enable us to take advantage of consolidation opportunities that may arise. Net sales in our Retail segment remain challenged as we continue to face a low inflationary environment, competitive openings, and cannibalization from new and remodeled store activity predominantly in our Western markets, as well as lower fuel prices. We estimate that competitive openings and cannibalization had a negative impact of approximately 220 points on comp store sales. The majority of this impact should recycle by the end of third quarter fiscal '16. Reduced oil prices also impacted the economy and employment rates, particularly in North Dakota, where some markets are heavily influenced by the regional oil industry. During the quarter, we continued to execute our strategy to invest in our Western store base by completing six remodels and re-banners of Family Fare in the Nebraska market. We've been pleased with the positive customer response, particularly on new in-store features, including expanded variety throughout the store with an emphasis on natural organic product, fresh store-made sushi, and Starbucks cafe's in three store locations. In the quarter, we expanded the rollout of our yes Reward loyalty program to our Fargo, Dickinson, and Family Fresh stores, as well as our recently-remodeled Nebraska stores. While the rollout of the loyalty program is a process and not an event, we're encouraged by the initial acceptance rates and the number of new households that continue to sign-up for the program. We continue to invest in the digital space as we upgraded our store better Web sites and mobile apps, and work to develop digital platforms that will allow our independent customers to offer similar programs. We anticipate launching our new digital distribution platforms in early 2016. As you know, pharmacy and fuel programs are a key part of our offer, and we continue rolling out our $4 and $10 generic pharmacy offering, as well as prenatal, antibiotic, and diabetic medications to the Western store base during the quarter. We anticipate fully implementing a program in these markets by the end of the year. In Michigan, our pharmacies posted a 1.1% increase in comp script count for the quarter, marking our 19th consecutive quarter of positive scrip comp growth. Our Michigan fuel centers posted a 1.2% increase in comp gallons sold for the quarter, and we continue offering fuel promotions in our Western markets by participating with third-party fuel centers. We continue to look for innovative offerings to provide additional savings and better engage our retail customers. On the product side, we continue to rollout expanded private brand programs for our retail and distribution customers, and the feedback has been very encouraging. In the quarter, we launched approximately 380 new private brand items, and our private brand unit penetration in our retail operations was 23.2%, which continues to place us above the national average. We ended the quarter with roughly 7,140 private brand offerings as we fine-tune our assortment, and for the remainder of the year we expect to introduce approximately 50 new items. The program remains a key element of our strategy to increase our value proposition and we continue to see upside in terms of unit penetration, particularly in our Western store base. Sales in our Military segment were down 3.4% for the quarter, due to a corresponding decrease of sales at the DeCA-operated commissaries. Although commissary sales remained soft, we are pleased to be presented with opportunities to bid on new lines of business, while breaking into new areas is no easy task, our reputation and superior positioning in this industry will hopefully allow us to capitalize on these opportunities. In an effort to continue to improve our efficiency, during the third quarter we closed our Junction City distribution center. This facility was underutilized and not strategically located, and all of the existing business was easily transferred to our Oklahoma City facility. As a result of this move, we anticipate better service and product quality for the military customers that were affected. Moving on to our capital plan during the third quarter, as I just mentioned, we completed the six remodels and re-banners to Family Fare, and other brands to market. So in fourth quarter we plan on completing some additional remodels mostly in our Michigan market, as well as close two stores in our Western markets, one of which is already closed. These were the results of the lease termination, and the expiration of a lease that we chose not to renew as part of our store rationalization plan. With that, I'll turn the call over to Dave for more details about our financials and for the outlook on the fourth quarter. Dave?

[Dave Staples:]

Thank you, Dennis, and good morning everyone. Consolidated net sales for the 12-week third quarter decreased 1.9%, to 1.78 billion, compared to 1.81 billion in the prior year quarter. The decrease was primarily due to lower sales in the Military and Retail segments. Consolidated gross profit margin for the third quarter was 14.6% compared to 14.4% in the prior year, and primarily reflects an increase in fuel margin rate, partially offset by the impact of lower inflation-related gains in the Military segment. Third quarter operating expenses would have been 224.3 million compared to 227.7 million or 12.6% of net sales in both period, if the merger integration, and acquisition expenses, asset impairment restructuring charges, and one-time costs related to cost reduction initiatives were excluded from both period. The adjusted third quarter result exclude 4.4 million in expenses related to merger integration, 800,000 in net asset impairment and restructuring, and 300,000 in one-time expenses related to cost reduction initiatives. One-time expenses were higher this year due to retail systems conversions, remodeled retail stores, and the loyalty program rollout in the Western division, as well as the repositioning of the distribution network. The prior year third quarter excludes 1.4 million in expenses related to integration, and 1.3 million in net restructuring gain. Adjusted EBITDA for the third quarter was 55.2 million, compared to 55.9 million last year, or 3.1% of net sales in both periods. Adjusted earnings from continuing operations for the third quarter increased to 18.6 million or $0.49 per diluted share, compared to 17.2 million or $0.46 per diluted share last year. These results exclude the impact of the previously mentioned charges of $0.09 per diluted share for this year's third quarter, and $0.01 per diluted share for the prior year third quarter. Turning to our operating segment, third quarter net sales for the Food Distribution segment were 762.3 million, compared to 764.3 million in the year ago quarter. Third quarter adjusted operating for the Food Distribution segment increased 12% to 17 million versus 15.2 million last year. The increase is primarily due to merger synergies and lower operating costs, including the impact of lower healthcare costs. In our Retail segment, third quarter net sales were 507.2 million, compared to 521.7 million last year. The reduction in sales was due to a 3% decrease in comparable store sales, excluding fuel, 13.2 million lower sales due to the closure of retail stores in fuel centers, and 11.4 million due to significantly lower retail fuel prices compared to the prior year, partially offset by sales of 22 million from the recently acquired stores. Comparable store sales reflect the low inflationary environment, and increased competition and cannibalization in the Western market. Retail segment adjusted operating earnings for the quarter increased to 13.2 million from 12.9 million last year. The increase is due primarily to the contribution from stores acquired in the second quarter, lower healthcare costs, and improved fuel margin, partially offset by the impact of negative comparable store sales, grand reopening costs, and higher shrink levels in our Western stores. In our Military segment, third quarter net sales were 506.0 million compared to 523.6 million in last year, due to lower sales at the DeCA-operated commissaries. Military adjusted operating earnings were 4.5 million compared to 5.7 million last year. The decrease is primarily due to the lower sales volume and lower inflation-related gains, partially offset by reduced healthcare costs. From a cash flow perspective, our current year-to-date operating cash flow was 129.9 million, compared to 117.4 million for the comparable period last year, primarily due to improvements in working capital. Total net long-term debt was 539.4 million this quarter versus 563.8 million at the end of last year. We remain committed to reducing our leverage worth the two times multiple EBITDA, and ended the quarter 2.3 times. In the fourth quarter, we will redeem for cash the entire outstanding $50 million aggregate principle amount of our 2016 senior notes using borrowings under our revolving credit facility. One-time charges of 1.1 million are expected to be incurred in the current year fourth quarter, and 15 of the redemption premium and the write-off of unamortized issuance bond. As a result of the redemption, we expect to reduce ongoing annual interest expense by approximately $2 million borrowing any future interest rate increase. I will now provide further detail on our outlook for the fourth quarter of fiscal 2015. Based on expectations of continued low inflation levels and challenging sales environment, we're slightly revising our fourth quarter guidance for adjusted net earnings from continuing operations to approximately $0.44 per diluted share excluding merger integration, and any other one-time expenses, which remains within the annual range previously provided. We now expect capital expenditures for fiscal 2015 to be in the range of 75 million to 80 million, with depreciation and amortization of approximately 83 million to 84 million, and total interest expense of approximately 21 million to 22 million, excluding one-time charges. This concludes our financial discussion, and I will now turn the call back to Dennis for his closing remarks. Dennis?

[Dennis Eidson:]

Thank you, Dave. In conclusion, we're encouraged by our programs on a number of fronts, as we continue to execute our strategy to improve on our operational efficiencies. We expect to end the year with momentum and build on this in '16 as we focus our efforts on the mission that will help drive sales and margins, in what we expect we will be in a challenging operating environment. We plan to make additional capital investments in our Western markets, and look forward to the continued rollout of our marketing and yes Rewards loyalty programs for all of our stores in the Western market. On the distribution side of the business, we plan to further optimize the supply chain, and our improved distribution in military channels, and we believe we're well-positioned to generate incremental business in both segments. We're committed to providing our Retail, Food Distribution, and Military customers with the convenience, quality in service that they've come to expect from SpartanNash. With that, we'll open up the call and take some questions.

[Operator:]

Thank you. [Operator Instructions] And our first question will come from Chuck Cerankosky of Northcoast Research.

[Chuck Cerankosky:]

Good morning everyone.

[Dennis Eidson:]

Good morning, Chuck

[Chuck Cerankosky:]

If you could, could you get into a little bit about the 3% decline in comps as to where it came from geographically? And then also, you talked about an opportunity to improve shrink. Could you discuss that in a little bit more detail, please?

[Dennis Eidson:]

Yes, I'll take the comp, and I'll let Dave respond on the shrink question, but on the comp, the 3.2 that we had in Q2 was about the run rate we ended up in Q3, right. And so, there wasn't material change, so the business kind of stayed on that same pace. So I'm a little bit hesitant to start doing a geographic breakout of the comps only because some of these geographies are pretty small, and competitive set isn't all that large. What I would say to you, and maybe this helps, hope it helps a little bit, that in the Michigan market we were just barely negative, and maybe that helps context the 3% comp. Dave, do you want to take the shrink question on that?

[Dave Staples:]

Sure. So, Chuck, as we look at the shrink, you have two issues, right. In a low inflationary environment, certainly that exasperates shrink in the retail world, as you're well aware, even to some extent in the rest of our businesses. And so I think if we look forward to it, and I think we think we have an opportunity, long-term, over the next year to 18 months to make an improvement in the shrink we're experiencing overall, but certainly in our Western division where our shrink rates have exceeded -- they are overall our expected shrink rate. Some of that is just to do with the type of work we're doing out there, with the remodeling and re-bannering, you end up with a lot more volatility in your inventory balances. So I think when you put all that together, that's where we get our opportunity from.

[Chuck Cerankosky:]

Are you seeing this in the West as you introduce more fresh to the stores and prepared items and getting used to what the selling rates are?

[Dave Staples:]

There's a little bit of that in some of the departments, and then it's just also the change-out in some of the product you're selling, remerchandising, and that all, I think falls into the mix.

[Chuck Cerankosky:]

All right, thank you.

[Operator:]

And the next question comes from Karen Short of Deutsche.

[Shane Higgins:]

Hi, good morning. It's Shane Higgins on for Karen. Dennis, you just mentioned that the comps during the quarter were relatively stable around minus 3%, slightly improved from minus 3.2% in the second quarter. Should we still expect that to continue into the fourth quarter? Any color you can give on recent trends would be great.

[Dennis Eidson:]

Yes, thanks. I think there's probably not any kind of an inflection point that would suggest we're going to all of a sudden go from negative three to positive one. So, generally speaking, I think we're probably in that neighborhood, and we haven't really given sales guidance, maybe I just did on the retail side, but, yes, I don't see the catalyst. Dave did mention in his remarks, and again about inflation and the lack of inflation, and that certainly is a challenge that we're feeling on both sides of the business at this position, as well as the retail side, and we're not unique to that, and I think that that's across the industry, and going from what we like to see in normal pace 2% to 3% inflation to in some parts of this business -- dry groceries is the biggest part of the business. And so, we're clearly at retail less than 1% inflation, and it also feels like the early read on Q4 is that likely inflation is going to soften even more than it was in Q3. So that's a little bit maybe more of a headwind.

[Shane Higgins:]

Is that -- are there particular categories that's causing that? I think you just alluded to the center store being slightly inflationary. Where is the deflation coming from?

[Dennis Eidson:]

Yes. We don't do this inflation metric by week, right. So we try to get prepared for these calls to be able to identify the trends. I do know that in the first four weeks of Q4 on the distribution side of the business, we went 1.3% more negative than where we ended Q3, and it was driven primarily by proteins. So in Q3, on the distribution side, the business actually was deflationary 30 points. The early fourth quarter, we're deflationary by another 100 points.

[Shane Higgins:]

Okay, thanks for the color. And just a last one here on the Retail operating margins for the quarter. They did improve slightly, despite the negative comp and the deflation that you just discussed. How much did the higher fuel margins help you guys? And what other factors contributed to the margin improvement in the retail side?

[Dave Staples:]

Yes, Shane, this is Dave. I think when you look at it overall I think you can contribute a large part of that certainly to the fuel center margins. So as you look at the dynamics in that business, it's a penny margin business. That's how it runs. And so when get substantial changes in the price of a gallon of fuel, it drives your rate very significantly in different directions. So all in all out, I would say that is the primary driver of the Retail improvement.

[Shane Higgins:]

And you guys also called out the lower healthcare costs. Was that meaningful? Any color there would be great?

[Dave Staples:]

Yes, I mean that's -- as we undertook the merger, that was an area we really saw opportunity in. And you have to give a lot of credit to our HR team and our operating groups, as they executed that plan, and have really looked at this item which, you know, is very sensitive, because it's very important to our associates. So we take it very seriously. Yet at the same time, as you're aware, it's incredibly expensive, and the rate of growth has been dramatic over the past five to 10 years. The team has done a great job, I think, of how they put the plan together in looking for ways to really manage that expense. And that it's been an area we've been able to really bring down dramatically with each company standalone perspective.

[Shane Higgins:]

Great. Thanks so much. I'll yield.

[Operator:]

And our next question will come from Scott Mushkin of Wolfe Research.

[Scott Mushkin:]

Hi, guys. Thanks for taking my question. So two things, obviously, the environment is tough, and we're hearing that from a lot of different people -- no inflation, not much demand. I guess, just taking a step back and going over all three of your segments, I'm trying to understand what changes the trajectory. In fact, it seems like this deflation issue is actually just flat out deflation now, so it is getting worse. Could it actually spill into package goods, where we just become completely deflationary in food? I'm just trying to understand what, in your mind, maybe changes the trajectory we're on, which seems like it's actually a slowly down slope, but then it's not just for you guys, but just generally in the industry?

[Dennis Eidson:]

Yes, oh, that's -- maybe that's $64,000 question. I mean I think, Scott, if you would have said to me that we were going to get this kind of dramatic reduction in gas prices, which we were all predicting, right, and that we wouldn't see more of that accrue to us in the food channel I would say, now, you're wrong. We're going to get -- fuel in Q3 was $0.87 a gallon, less than prior year. That's a lot of disposable income. It just didn't come back. I don't think the consumer feels back, with the participation rate in terms of employment is at the lowest level, since 1977. So even though [ph] the unemployment rates are improving, just less people are in the workforce, and then the median wages is down, not up pre the post-recession, and I just don't think the consumer has bounced back. It is a bit of an anomaly when you look at the whole space globally for food/groceries. Now there's very modest population growth, but you look across CPGs, and look at the kind of tonnage that's being reported in the most recent quarter, it daunting. Everybody is negative if you look at the last couple of years at General Mills, or Kraft, Heinz, or Bean Foods or Kellogg. So there's this slowing in demand. And that's with all channels being reported that we're feeling, so there's just less consumption for whatever reason. And this is exacerbated too, but in fact, remember, most of those items that we're selling today are smaller sizes than they were before. So, you don't get a half gallon ice-cream, you get a quart-and-a-half, and even then you get punished. I don't see an inflection point, Scott. I don't feel it. I think the negative downward pressure from energy is a headwind. And I think tonnage being soft, energy costs putting downward pressure. And I don't think CPGs have much of a desire to take the risk of raising prices now, and risk losing demand even further. So I think we're in for a bit of a challenging time. I think at the last quarter, I was asked a question what did I think was going to happen with inflation. As I thought the last half-a-year might look like zero. And maybe we'll get lucky if it's a zero. So we're going a little bit that way.

[Scott Mushkin:]

That's good color. My follow-up question, because you started talking about the median income, the wages, there is definitely, and we've been tracking the data, a lot of -- it's one of those things you don't fully understand because, you pointed out, the participation rate is pretty low, but on the low end of the workforce, there's clearly a lot of pressure on wages going up. So as we look into next year, we've seen a number of the companies that we cover talk about this issue and concern. How would you frame it for your Company, and the thought of wages going up for the low-end workers, whether it's forced by minimum wage increases, or just that there seems to be a shortage of low-end workers. How do we think about it [indiscernible] part?

[Dennis Eidson:]

I'd say it's a real concern. We happen to have the majority of our workforce domiciled in the states of Michigan and Nebraska. And we have a fair amount in Minnesota. All three states, in the last year or so, passed legislation to ramp up the minimum wage rate. So we have that baked-in to our forecasted projections. And so we're seeing, experiencing, and budgeting for those increased wage rates in our business model.

[Scott Mushkin:]

Okay. So you feel like you've taken care of that issue just because of where you are. Are you having trouble finding people? We're hearing that, too, or is that not a problem for you guys?

[Dennis Eidson:]

I think it's more spotty in general about that. I mean, there are certain -- truck drivers, we all know, is a challenging vocation for us to be able to get drivers everywhere we would like them. So that one is clearly -- yes, we're having a challenge. The balance is -- it's a bit spotty I would say, Scott, and it varies by geography a bit.

[Scott Mushkin:]

Perfect. Thanks, guys.

[Operator:]

And next we have a question from Mark Wiltamuth of Jefferies.

[Mark Wiltamuth:]

Hi, good morning.

[Dennis Eidson:]

Good morning.

[Mark Wiltamuth:]

I wanted to ask a little bit about the Military segment. Obviously, you're struggling there with a structural issue, just that DeCA declines continue. Maybe could you give us an update on how steep the DeCA declines are currently? And then I am intrigued about the opportunity for expansion into new business lines, and I wondered if there were any notable RFPs for either troop feeding or post exchanges or anything like that, that's out there that we could monitor?

[Dennis Eidson:]

Yes, the color I would give you is just -- we've reported the negative 3.4 in the quarter. Despite being negative 3.4 we're, on a year-to-date basis, we're only slightly negative, it's negative 0.5, as we've done some good work, and building some of that base going into the year. DeCA in the quarter, they don't exactly match quarters like we do, right. So this is approximate [ph], but their negative store sales were greater than 6%, [technical difficulty] and that varies by geography as well, so it's not the same everywhere. So, that's kind of the structurally where that business is today. And the opportunity to do more with the military retail system, you will say that there are a couple of different opportunities there with troop feeding and maybe more with exchanges, and I would say there are even other -- we have this network that was going to many faces across the United States daily. And so, we think we're uniquely positioned from a logistic standpoint, plus I would just say to you that we believe we operated in this military retail space as maybe the most efficient player, and I think we've earned a lot of respect and the MDV team led by Ed Brunot really has done that, that's given us the opportunity to get engaged with some bidding on some other businesses, but I just don't think it would be appropriate for us to articulate, hey, we think it's here or there. When we're more successful, you guys will be the first to know.

[Mark Wiltamuth:]

Okay. But those are big government contracting processes, are there any sizeable ones that are out there that are up for bid right now?

[Dennis Eidson:]

The government is frequently bidding contracts. And so, I'd say that the perpetual thing that's always going on, so maybe the short answer is yes.

[Mark Wiltamuth:]

Okay. All right, we'll watch for news there. And thank you very much.

[Operator:]

And this will conclude our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

[Dennis Eidson:]

Thanks, Laura, and I just like to thank everybody for their participation today, and this concludes our third quarter, and I look forward to visiting with you at the end of Q4. Thank you.

[Operator:]

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