Roundy's Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: Roundy's Supermarkets, (RNDY)

Roundy's (NYSE:RNDY)

Q1 2013 Earnings Call

May 09, 2013 4:30 pm ET

Executives

James Hyland

Robert A. Mariano - Chairman, Chief Executive Officer and President

Darren W. Karst - Chief Financial Officer, Executive Vice President and Assistant Secretary, Chief Financial Officer of Rac-Holding and Executive Vice President of Rac-Holding

Analysts

Edward J. Kelly - Crédit Suisse AG, Research Division

Matthew J. Larson - Robert W. Baird & Co. Incorporated, Research Division

Andrew P. Wolf - BB&T Capital Markets, Research Division

Operator

Good afternoon, and welcome to Roundy's First Quarter 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded at the request of Roundy's. If anyone has any objections, you may disconnect at this time.

I would like to turn the call over to Mr. James Hyland, Vice President, Investor Relations and Corporate Communications. Thank you. You may begin.

James Hyland

Thank you, Sharon. Good afternoon, ladies and gentlemen, and welcome to Roundy's First Quarter 2013 Earnings Conference Call. With me today are Bob Mariano, Chairman and Chief Executive Officer; and Darren Karst, Executive Vice President and Chief Financial Officer.

Our first quarter 2013 earnings release crossed the wire approximately 4:00 p.m. Eastern time today. If you have not received the release, it is available on the Investor Relations section of Roundy's website at www.roundys.com. This call is being webcast, and the replay will be available on the company's website as well.

Before we begin, we would like to remind everyone that the prepared remarks contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance and, therefore, undue reliance should not be placed upon them.

We refer all of you to the risk factors contained in Roundy's press release issued today and the company's annual report on Form 10-Q and other filings with the Securities and Exchange Commission for more detailed discussions of the factors that could cause actual results to differ materially from those projected in any forward-looking statements. Roundy's assumes no obligation to revise any forward-looking projections that may be made in today's release or call.

Also in the company's earnings release and in today's prepared remarks, we include adjusted net income, adjusted EPS and adjusted EBITDA, which are non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of adjusted net income, adjusted EPS and adjusted EBITDA to the most directly comparable GAAP financial measures and the other information required by Regulation G are included in the company's press release issued earlier today.

I will now turn the call over to Bob Mariano. Bob?

Robert A. Mariano

Thanks, Jim. Good afternoon, everyone, and thank you for joining us today as we discuss the results for the first quarter of 2013. I will briefly these results, discuss key metrics for the quarter and spend some time updating you on our market initiatives for our Milwaukee stores. Darren will then review the financial results for the quarter. At the end of our remarks, we'll open up the call for questions.

When we spoke to you last quarter, we envisioned the marketplace for 2013 to be similar to what we saw in 2012. And so far, that has proven that be the case. We have the cautious customer, continued competitive unit growth and increased pricing and promotional activity, all taking place in a low to moderate inflationary environment.

While we continue to face these hurdles, particularly in our core markets, we made progress on a number of our customer-centric business strategies in the first quarter. Key metrics where we experienced further sequential improvement during the first quarter included: first, same-store sales as adjusted for holiday shifts have improved sequentially over the last 2 quarters; our average transaction size increased versus the fourth quarter; unit volume trends continue to improve; and finally, the sales of our Chicago stores continue to be robust and grow at double-digit rates. Profitability continues to increase in Chicago as we fine-tune the operating levers we previously discussed.

For the first quarter, sales increased 4.8% to $983.5 million. The increase was primarily the result of a combination of new Chicago area stores and a 1.3% increase in same-store sales. When adjusted for holiday calendar shifts, that Darren will review in more detail, same-store sales declined by 0.8% in the first quarter.

For the quarter, we experienced a 5.2% increase in average transaction size, while our customer count decreased by 3.7%. The majority of the increase in transaction size were driven by our merchandising and marketing initiatives that are focused on driving a bigger customer basket, as well as the effect of a larger portion of sales coming from Mariano's, which does have a higher transaction size in our core markets.

In addition, the increased transaction size was due in part to minor inflation as our average retail price was up about 1% year-over-year, as well as a slight benefit from the holiday shift of New Year's and Easter. The decrease in customer count was relatively consistent with the past couple of quarters and was primarily the result of continued effect of competitive store openings.

As I just mentioned, we continue to be focused on merchandising and marketing initiatives to drive transaction size, as well as grow unit volume. Unit volume trends improved in quarter one, and we generated our third sequential quarter of improvement.

In the first quarter, we continued to execute on 2 of our customer-centric initiatives, including driving higher sales of perishables and Own Brand products. Our perishable business now accounts for 34.6% of total sales, approximately 160 basis points higher than 1 year ago, the highest ever for first quarter. Our Own Brand products ended the first quarter at 22.5%, our highest rate ever and a 260-basis-point improvement over last year's first quarter. At the end of quarter one, our Own Brand portfolio consistent of over 6,100 products.

Regarding competitive activity in the first quarter, the landscape was relatively unchanged from prior quarters. We anticipate 21 competitive store openings in our markets for 2013, 6 will be supercenters and 15 will be conventionals, down from 24 competitive openings in 2012. The majority of these openings will take place during the second half of 2013.

We estimate that the dollar impact to our same-store sales in the quarter from new competitive square footage added over the last 12 months was approximately 230 basis points, which is down 40 basis points from the first quarter of 2012.

Now let me spend a few minutes discussing our core markets and, more specifically, the Milwaukee market. During the third quarter of 2012, we began a market renewal project in a test group of 14 Milwaukee area stores. Our objective is to position our Pick 'n Save stores as the best conventional grocery operator in our market. How do we do that? The answer is we seek to provide a superior shopping experience for our customer built around a service-oriented culture.

Our goal is to set ourselves apart from other competitors in the market, and we accomplished this in part through strategies, such our investment in our fresh departments, developing unique approaches to pricing and merchandising and investing in customer service.

As we mentioned last quarter, in our 14 test stores, we are making changes in product and merchandising that are similar to some of our strategies at Mariano's in Chicago. We have invested in service in order to improve the in-store expense by focusing on the front-end checkout experience, in-stock position, variety and freshness in the perishable departments and increased attention to service during the highest traffic times of the day. We are also testing some different pricing and merchandising approaches that demonstrate better value to our customers.

We continue to receive very positive feedback from our customers. But as we also said in last quarter, we are measuring the financial results of this initiative. During the first quarter, we continue to closely monitor a number of key metrics at our 14 test stores versus a controlled group of stores. We continue to see both improved operational and financial results as the outcome of the strategies -- as a result of the outcome of the strategies we implemented. Therefore, we have made the decision of roll out our market renewal strategies to the remainder of the Milwaukee area stores. However, we want to be judicious and measured in our rollout, so we intend to stage the rollout over the remainder of this year.

Our success criteria involve a number of key components, but overall, we expect to see improvements in same-store sales, as well as store-level EBITDA. Based on our rollout plan, we anticipate these improvements to be more meaningful to our operations in 2014.

One of the most important definitions of success will be measured increase in customer satisfaction. Based on our feedbacks so far, we are encouraged. Also, I want to reiterate that our renewal strategies are an ongoing multiyear process as great service and fair pricing is perpetual, not finite.

Now I will focus on additional areas we are working on to drive greater operating efficiencies. Previously, we discussed our expense reduction efforts relating to outsourcing our inbound transportation. Our original intent was to have it completed by midyear 2013. We started the transition in January this year but so far, the outsourced program provided by our transportation partner has not met our expectations, both from an operational and financial perspective. Therefore, we are currently reviewing other alternatives to help achieve the expense reduction outcome we plan to achieve. We have remained committed to reducing our distribution cost in this area. However, expect it to be more relevant in 2014.

In the Chicago market, we opened our ninth Mariano's store in Frankfort, Illinois during the first quarter, and we opened our 10th store in Harwood Heights, Illinois during the second quarter. We have 3 more openings scheduled for this year, which will bring us to a total of 13 stores by end of the year. The Mariano's banner continues to exceed our expectations, with low double-digit same-store sales. In addition, we are pleased with our ever-increasing talent bench, which is critical as we open more stores.

We have generated 5 consecutive quarters of solid EBITDA performance out of our mature Mariano's stores and are increasingly encouraged by how our more established stores, as well as our new stores, are maturing. We attribute that to: one, the growing acceptance of these stores by our customers; and secondly, to our operating teams ability to manage our costs and expenses to drive increased store margins.

The success of our Mariano's stores is becoming fairly well-known even in markets we don't serve, and this is mostly due to word-of-mouth customer communication versus any real advertising effort on our part. I would tell you the most frequent question we are asked by our prospective customers is, "When are you building a Mariano's in my neighborhood?" We remain confident about our expansion and opportunities and now believe the Chicago market can support more than 30 stores.

Let me now turn the call over to Darren to provide some additional financial details on the quarter. Darren?

Darren W. Karst

Thanks, Bob, and good afternoon, everyone. As Bob noted, net sales for the first quarter of 2013 were $984 million, an increase of $45.3 million or 4.8%, from $938 million in the first quarter of 2012. The increase primarily reflects the benefit of new stores and a 1.3% increase in same-store sales.

Same-store sales comparisons were positively impacted by approximately 210 basis points as a result of the 2013 Easter and 2013 New Year's holiday shifts, while these gains were partially offset by the increased effect of competitive store openings, the continuation of a challenging economic environment and the shift during the past year to more generic pharmacy sales. Adjusted for the effect of the calendar shifts only, same-store sales declined 0.8%.

Gross profit dollars for the first quarter of 2013 increased 2.2% to $262.5 million from $256.8 million in the same period last year. Gross profit as a percentage of net sales was 26.7% for the first quarter of 2013 compared to 27.4% in the same period last year. The decrease in gross profit as a percentage of net sales primarily reflects greater price and promotional investments in certain markets and increased strength, partially offset by an increased perishable sales mix.

Our operating and administrative expenses for the first quarter 2013 increased to $235.8 million from $226.1 million in the same period last year. The increase in operating and administrative expense dollars was primarily due to increased operating costs related to new and replacement stores.

Operating and administrative expenses as a percentage of net sales decreased to 24.0% in the first quarter of 2013 from 24.1% in the same period last year, due mostly to increased fixed cost leverage resulting from higher sales.

Interest expense for the first quarter was $12.2 million, a decrease of over $2.6 million or 18% from the prior year, primarily due to the favorable impact of our debt refinancing in February 2012, which lowered our debt levels and reduced interest rates.

For the first quarter of 2013, net income was $8.6 million or $0.19 per share compared to reported net income of $2.3 million or $0.06 per share and adjusted net income of $10.6 million or $0.28 per share for the first quarter of 2012. Adjusted net income for the first quarter of 2012 excludes an $8.4 million after-tax charge or $0.22 per share for the early extinguishment of debt and onetime IPO expenses.

Additionally, it's important to note that the prior year earnings per share is not comparable to 2013 because the share count from the first quarter of last year is not fully reflective of all the additional shares that were issued in connection with the IPO.

Adjusted EBITDA for the first quarter of 2013 was $44 million compared to $48.7 million in the first quarter of 2012. The decrease was primarily due to the effect of the continued challenging economic and competitive environment on our sales and gross margin.

Our effective tax rate for the first quarter of 2013 was 40.5% compared to 12.4% for the first quarter of 2012. The low effective rate in the first quarter of 2012 was primarily due to the favorable settlement of last year -- or favorable settlement last year of certain open tax issues, which, while not significant in dollar terms, had an unusually large positive impact on our first quarter 2012 tax rate, due to our reduced pretax income in the first quarter 2012. Our tax rate guidance for 2013 now reflects a range of 40% to 41% versus a static number, which we think better reflects our expectation that our full year tax rate could be slightly higher than 40%.

Capital expenditures for the first quarter of 2013 were $11.5 million compared to $6.9 million in the first quarter of 2012. The increase from the prior year was primarily related to timing of expenditures mostly associated with new store opening.

From a cash flow perspective, net cash flows provided by operating activities for the first quarter 2013 was $13.9 million compared to cash used by operating activities of $6.9 million during the first quarter 2012. The increase in cash provided by operating activities was due primarily to higher net income, as well as decreased inventory levels, partially offset by the timing of payments for inventory, both of which are related to the earlier timing of the Easter holiday as compared to 2012.

In the first quarter, we also used cash to pay a quarterly dividend of $0.12 per share, as well as pay down debt. Our total long-term debt at the end of the first quarter of 2013 was $692 million, down from $697 million at the end of fiscal 2012. We had no borrowings outstanding under our revolving credit facility, and we were in compliance with all covenants under our credit agreement.

At quarter end, our total debt-to-EBITDA ratio under our credit agreement was 3.4x, while our interest coverage ratio is 4.3x. As of March 30, 2013, we had $65 million in cash and cash equivalents and $97 million of availability under our revolving credit facility, which provides us with significant liquidity.

Today, we announced that our Board of Directors approved a quarterly cash dividend of $0.12 per share. Our dividend policy remains unchanged. Future declarations are subject to board approval and may be adjusted as business needs or market conditions change. As to guidance, with the exception of applying a range of 40% to 41% to our tax rate guidance, as I previously mentioned, the remainder of our 2013 guidance remains unchanged.

That concludes my financial comments. And at this time, I'll turn the call back to Bob. Bob?

Robert A. Mariano

Thanks, Darren. I'd like to conclude by saying that we have an enthusiastic team of employees who are leading the charge at our Milwaukee -- on our Milwaukee renewal efforts. They continue to make a difference in providing a superior shopping experience for our customers. Our growth banner, Mariano's, continues to generate excitement with each customer in Chicago area. Our current strategy continues to build around 5 store per year. And as I mentioned earlier, we are increasingly confident that the Chicago market can support more than 30 Mariano's stores. Our current capital plan is structured to meet that goal, as well as to continue to pay down debt and reward our shareholders with a dividend.

With that, we'd like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Edward Kelly of Credit Suisse.

Edward J. Kelly - Crédit Suisse AG, Research Division

Could we maybe start with the Milwaukee market and the test stores, Bob? And maybe could you just provide a bit more color on exactly what you're doing within the stores, the type of lift you've seen from a sales perspective, what the cost is, by the way, from either in -- both in expense base, as well as capital?

Robert A. Mariano

Okay. From a capital perspective, these are, frankly, modest capital expenditures, which fit well within our current plan. So there's no significant capital change required. In terms of the things we're doing, I think I said it pretty clear. The service and the experience, also the top focus of store teams, as well as the types of merchandising and promotional activities, we're trying in these 14 -- have tried in these 14 stores. I really honestly don't wan to characterize the sales lift that we've been enjoying in those stores. As we said, we'll continue to monitor the information and watch the metrics. And that the 14 led us to a position of wanting to move into other stores. More work to do, and we'll continue to evolve the things that we'll do in the stores that will impact our customers. And let me also say this, we have not fully executed in the 14 with all the things we want to do. We have to be measured in our change management with our stores. So there is more to follow, and we'll continue to work very diligently. And as we said, this is going to take us a multiyear effort, and we believe we're headed on the right track with the stores.

Edward J. Kelly - Crédit Suisse AG, Research Division

How much of the effort is around the perishable side, given that you're comparing it to Mariano's'? And then, what have you seen, if anything, from a competitor response yet?

Robert A. Mariano

We are extensive -- we are extremely focused on the fresh side of the store in terms of the presentation. As you could appreciate, the products, the fresh fruits and vegetables that we sell in the Pick 'n Save is exactly the same fruits and vegetables we sell at Mariano's. So it has to do with freshness. It has to do with the assortment available to the consumer, and the presentation that they see when they walk in the door. In the 14 stores now, we're getting comments from the customers such as, "Gee, I'm not quite sure what you did here but whatever you did, just don't stop doing it, " Customers that have been with us for 10 and 15 years. I've been here for 15 years and this is the best the store has looked, and I'll be shopping here consistently over the next several years. So we're getting very nice comments from our customers. And that's really where the battle will be won, is with the customers one at a time. So in terms of a competitive impact, I -- because we haven't called out the 14, which stores they are, it's pretty tough for anyone to kind of discern that we've got an effort going forward because it's not obvious if you just walk in the store -- if you're a customer, you kind of get it. But if you just walk into the store, you're not going to be aware of what we're doing. So it's designed to impact our shoppers, not necessarily be obvious to the competitors.

Edward J. Kelly - Crédit Suisse AG, Research Division

Okay. And Mariano's sounds like it continues to do well, I guess, well enough now that you finally said that there's going to be -- can be more than 30 stores. What ultimately lead you to that conclusion? How much of it was just sort of performance at the current stores versus reevaluating the marketplace itself? What do you think the ultimate goal maybe could be? And then how quickly can you ramp from here? Are we still talking about 5 stores a year or do we start talking about a bigger number than that?

Robert A. Mariano

I would tell you that -- with respect to pace, I would tell you the pace's about the same. In terms of our thinking to conclude that more than 30 would be appropriate, it's just both -- it would be both the maturation -- the success of our existing store base in the Chicago marketplace, as well as our assessment of the Chicagoland market.

Edward J. Kelly - Crédit Suisse AG, Research Division

Okay. And then last question for you is on the gross margin. The gross margin this quarter was weaker than what I thought it was going to be. Could you maybe just give us a little bit more color on the -- and the components of the decline? I guess, why was shrink higher as well for instance? And then how do we think about the gross margin for the rest of the year now?

Robert A. Mariano

I would tell you the -- probably the single largest contributor to the gross margin shortfall was the shift in shrink. The shrink came primarily in our perishable departments. We've already started to make an impact in core, too, on the shrink number. I think there will be continuing downward pressure on the shrink number. The other part that I would tell you in some of the markets, I think, not specifically in Milwaukee, but some of the outer markets may have promoted a little too heavy, given the size of the consumer market that was available. So there will be a slight over promoting in there as well. And in terms of looking for the rest of the year, I think we've said our comparisons are a little tougher in quarter 1 and quarter 2, and we feel pretty good about 3 and 4. So those comparisons are a little less aggressive. So I think we feel good about where we think gross margins will come in for the rest of the year.

Edward J. Kelly - Crédit Suisse AG, Research Division

Okay. So for the full year down but not nearly as much as the first quarter?

Robert A. Mariano

I would tell you that...

Darren W. Karst

Yes, that's right. It's mostly because of the year-over-year comparisons by quarter.

Operator

[Operator Instructions] Our next question comes from Peter Benedict of Robert W. Baird.

Matthew J. Larson - Robert W. Baird & Co. Incorporated, Research Division

It's Matthew Larson on for Peter. I just wanted to first kind of focus on the Minneapolis market. You recently closed a few stores there. Curious what the longer-term plan is for that Rainbow banner. How much additional opportunity there is to potentially rationalize underperforming stores? And then finally, is this a market that Mariano's could potentially be transferable to?

Robert A. Mariano

Well, I would tell you in terms of we did close a few stores. And as we have said on other -- on previous calls, as some of the underperforming stores at Rainbow, if their leases would come due, we would exit those stores. And that's exactly what we did. We had some stores that their leases came due and we exited those stores. So that was well-planned and thought out for what we did. With respect to the future, I really would rather not comment on what we see and where the opportunities are in Rainbow. I think we're in the process of thoroughly evaluating that and determining what we think is the most efficient financial, as well as market approach to the Minneapolis-St. Paul area.

Matthew J. Larson - Robert W. Baird & Co. Incorporated, Research Division

Okay, make sense. And then on the very healthy ticket gains in the first quarter. I think you said you received a slight benefit from some of the calendar events. Is there anything, I guess, aside from that to call out as far as what's driving that improvement sequentially?

Robert A. Mariano

I think we called out the about 1% is inflation, as we saw the average item go up in our area and...

Darren W. Karst

And the calendar effect was probably about 90 basis points, and then Illinois has a higher -- kind of a materially higher average transaction size. So that had about a 40-basis-point effect just because of the increasing sales from Illinois. But the remainder of it really was our focus on driving -- really driving volume, which has the effect of driving basket size.

Matthew J. Larson - Robert W. Baird & Co. Incorporated, Research Division

Would you describe the Mariano's ticket as quite a bit larger, obviously, on the store productivity basis you do quite a bit more sales per store? But average ticket, is that notably higher at Mariano's?

Darren W. Karst

It is.

Operator

Our next question comes from Andrew Wolf of BB&T Capital Markets.

Andrew P. Wolf - BB&T Capital Markets, Research Division

I think you described increased promotions and some. I just want to drill it down a bit. Is that increase from the prior run rate or is that just sort of maintained? I mean, are conventionals or anyone else, did the rate of promotionality actually increase this quarter?

Robert A. Mariano

No, no, it was about the same. So I would not characterize it as an increased level.

Andrew P. Wolf - BB&T Capital Markets, Research Division

Okay. And Bob, you said there were 15 new conventional stores you expect in your various markets. And I was just wondering -- is that kind of normal? I mean, you operate in some pretty big markets or is that still above normal? And what is sort of a normal fallout? What is that number net of closures and what do you hear out there from landlords or anything else in terms of what might be happening in that regard?

Darren W. Karst

Andy, this is Darren. I think at some point we do expect to see some closures. We're not seeing too many of those yet. Normally, you would see that, but they do tend to sometimes take longer than you'd expect. We include the Target PFresh conversions in that count. And I'd say in our markets, they're getting pretty close to having everything converted at least by the end of 2013. So putting that aside, I would say it's not a particularly abnormal number.

Robert A. Mariano

I think your question in terms of conventionals, there's more of them that look like Target, Walmart and alternate channels as opposed to stores that look like us.

Andrew P. Wolf - BB&T Capital Markets, Research Division

All right. Can you discuss or comment on the kind of the cadence -- a lot of retailers, restaurants, various folks had tough Januaries and Februaries, had a little more better sales in March and April. I know you're doing things specific to the company. But aside from that and aside, obviously, from the way calendar affected sales, do you see a similar cadence with any improvement later in the quarter and perhaps comment on any type of follow-through?

Robert A. Mariano

The quarter was pretty flat, I mean, in terms of -- there was no distinguishing cadence from period to period within a quarter, so we didn't see anything traumatic in that regard.

Andrew P. Wolf - BB&T Capital Markets, Research Division

Just wanted to follow on, on the -- your optimism that you can open more Mariano's. Is that due -- I mean, are you defining Chicagoland, the market a little more broadly in terms of the radius from Downtown or -- and into other cities? It looks like you're pretty close to like a Gary, Indiana, let's say. Or is it more you can get the stores closer to one another than you had envisioned? So that...

Robert A. Mariano

No, I think you got to remember, this is the third largest market in the U.S., and so a lot of folks here. So this is a good market, good expenditures available. So we haven't redefined what we call the Chicago market in our evaluation. So no, they won't be necessarily closer together, it's just there will be more communities.

Andrew P. Wolf - BB&T Capital Markets, Research Division

Because it's sort of almost a demographic reach type of thing where you're finding just a greater demographic draw?

Robert A. Mariano

Yes. And with the other part, too, that as we go into different areas and we see the ability of the store to perform in different demographic and economic areas, it suggest other areas after you learn how you're doing in those neighborhoods. So it's performing across a wide range of consumers.

Andrew P. Wolf - BB&T Capital Markets, Research Division

Okay. And just lastly, on Mariano's, I mean, are the new store economics -- the stores here you built more recently, are those still trending sort of sales and profit contribution-wise to your previous commentary and plans?

Robert A. Mariano

Oh, yes. Yes, they are, Andy. Yes.

Operator

And I am showing no further questions at this time. I'll turn the call back over to your host. Go ahead.

Robert A. Mariano

Thank you so much for your participation today. I just like to take a moment to thank all of our employees, our trading partners, our shareholders and, most importantly, our customers for all their support. We appreciate your interest in Roundy's and look forward to sharing our progress with you the next quarter. Thanks, everybody, and have a great day. Bye-bye.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

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