Fairway's CEO Discusses F1Q 2014 Results - Earnings Call Transcript

| About: Fairway Group (FWM)

Fairway Group Holdings Corp. (NASDAQ:FWM)

F1Q 2014 Results Earnings Call

August 8, 2013 8:30 AM ET


Nicho Gutierrez - Manager, Finance & Investor Relations

Charles Santoro - Executive Chairman

Herb Ruetsch - Chief Executive Officer

Ed Arditte - Chief Financial Officer


John Heinbockel - Guggenheim

Edward Kelly - Credit Suisse

Erica Eiler - Oppenheimer

Mark Miller - William Blair

Robbie Ohmes - BAML

Scott Mushkin - Wolfe Research


Good day, ladies and gentlemen. And welcome to the Fairway Group Holdings First Quarter 2014 Earnings Conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions)

As a reminder, this call maybe recorded. I would now like to introduce your host for today’s conference, Nicho Gutierrez. You may begin.

Nicho Gutierrez

Thank you. Good morning, ladies and gentlemen, and welcome to Fairways first fiscal quarter earnings conference call. With me today are Charles Santoro, Fairways’ Executive Chairman; Herb Ruetsch, our Chief Executive Officer; and Ed Arditte, our Chief Financial Officer.

By now everyone should have access to the first quarter earnings release, which went out early this morning. If you have not received the release, it is available on the Investor Relations portion of Fairways website at fairwaymarket.com. This call is being webcasted and a replay will be available on the company’s website as well.

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

We refer all of you to the risk factors contained in Fairway’s annual report on Form 10-K filed with the Securities and Exchange Commission on June 6th. Fairway assumes no obligation to provide any forward-looking statements that maybe made in today’s release or call.

And with that, I would like to turn the call over to Charles Santoro, our executive Chairman.

Charles Santoro

Hello, everyone, and thank you, Nicho. Thanks for joining us today to update you on the company’s continued progress and financial results for our first fiscal quarter ended June 30, 2013, and our first quarter as a public company. Let me start by taking a few moments to update you on several positive developments at Fairway.

As most of you know on July 24th, we opened our Chelsea, Manhattan location, the 13th Fairway market and the fifth Fairway in Manhattan, and by the way the store opened in typical Fairway fashion with a host of shoppers lined up waiting for the store to commence business and a number of city and state dignitaries embracing Fairway’s addition to the neighborhood. It was a lot of fun for all of us and it was really good to see many of you on upon there.

Now, for those of you either live in the New York City area or have visited from time to time, you know that Chelsea is a young vibrant densely populated area and a very attractive location for Fairway.

But Chelsea location has approximately 70,000 square feet of retail space and it is therefore somewhat smaller than our other Manhattan stores. And while the smaller footprint of the Chelsea location will generate revenues in absolute dollar terms less than our other Manhattan locations.

We do expect that Chelsea’s productivity level will be very strong and on -- and fully on par with our other urban stores and well above our current company-wide sales average of approximately $1900 per square foot.

We also expect that gross margins will be very strong and in line with our other Manhattan locations as a result of high volumes per square foot, product mix and operating efficiencies. I should also note that the constructions build out cost at Chelsea came in at or below budget. We are very pleased about that.

Now, moving beyond Chelsea, we also remained intensely focused on our new store pipeline, including the full 2013 opening of our 14th Fairway location in Nanuet, New York, and we remained highly focused on the build out of our new production center in the (inaudible) Point area of [Nebrance] which we believe is on track to open later this year.

Importantly, on the real estate front we have a number of other exciting developments taking place in our pipeline of opportunities is expanding. And, I’m particularly pleased to announce that yesterday we signed a lease for a new Manhattan site located in the Hudson Yards neighborhood of Manhattan. So it is official. Fairway will be the anchor fruit tenant of this $12 billion Hudson Yards’ redevelopment project which will consists of approximately 6 million square feet of commercial space, more than 5,000 residential units, a luxury hotel, a direct connection to the Number 7 subway and 14 acres of new public space.

This development will undoubtedly also be a major New York destination which will serve as global headquarters to Coach and Time Warner among others and will drive in our view huge numbers of local residence, workers, visitors and tourist through this new development.

For those of you who have not yet read our press release regarding Hudson Yards, which went out earlier this morning, please let Nicho know, if you would like us to forward it directly to you.

But just a few more details in Hudson Yards, our Hudson Yards store, we expect will open mid-2015 calendar and will comprise approximately 45,000 square feet. It will be adjacent to New York City's famous High Line and occupy the base of the 52-storey South Tower which has nearly 2 million square feet of commercial space and this building will also be the new home to Coach, L'Oreal and SAP.

I should note that the development is one of the country’s largest privately funded real estate projects and it represents for Fairway an amazing endorsement of our food retailing model by the renowned and visionary developer, Steven Ross, related companies and their partners Oxford Properties Group. We appreciate the enormous amount of time they spent working with us to execute this lease and to design the space.

We are also finalizing lease negotiations for another Manhattan location slated for a late calendar 2014 opening or early calendar 2015 opening. We do expect to be in a position to follow up with more definite details about this site soon probably by the end of this quarter and as with Hudson Yards, this other Manhattan site will represent our full-size Manhattan layout and be located in fine demographics.

Finally with respect to real estate we are in advance lease negotiations for what we believe is a very strong suburban location. This particular location should have an early to mid-calendar 2014 opening and we do look forward to provide even more details in this location once we finalize the lease.

It goes without saying that we continue to focus on the development of our new store pipeline with a number of other attractive opportunities that are at various stages of negotiations and discussions.

Now let me turn our -- let me turn the conversation over to our net scheduled store opening in Nanuet, New York. This location is scheduled to open in the fall of calendar 2013, that this fall and we expect to complete the build out at or below our original construction budget and we believe we have the potential to open the store in advance of our initial target date of November 1, 2013, perhaps by a few weeks. Nanuet represents our 14th store and with Hudson Yards, and our two nearly completed leases, our backlog stands at an incremental three stores for a total of 17 stores.

As previously mentioned, we are also on track to commence operations at our new production center later this year. We believe that this facility will have the capacity to support approximately 30 stores in the Greater New York Metropolitan area and it is important for a variety of reasons, including potential labor optimization and fringe benefits which will help drive gross margins in the future. Let me importantly discuss now our financial highlights for the quarter, before I turn the call over to Herb and Ed.

Our operating results for the quarter ended June 30 were strong and provided a very positive start to our fiscal year. Net sales for the quarter were a $187 million, a 21% increase over the first quarter of the prior year, our sales growth was driven by new store openings and excludes the contribution from our Chelsea location which as we mentioned earlier opened during the first month of the second quarter and a few weeks later then we had initially targeted.

I’m also pleased to announce that our same-store sales continued to remain positive with first quarter. Same-stores sales up 1.4% despite absorbing an estimated 90-basis point impact from the shift in the timing of the Easter pass way holiday this calendar year versus last calendar year. And we do expect at this point to continue positive same-store sales in the second quarter despite reopening of our Chelsea location during the first month of this quarter.

I’m also pleased to announce that our gross profits for the quarter increased 21% to $61.4 million and as a percentage of sales increased 10 basis points over the prior year, despite the change in our urban-suburban store mix.

We expect to continue to drive gross margin expansion over the next few years with vendor leverage serving as an important driver in the current fiscal year and our production center and private labor initiatives serving as important drivers in fiscal ’15, ’16 and beyond.

We are also pleased to announce that our adjusted EBITDA for the quarter was $12.7 million and ahead of our expectations. This performance was driven by strong EBITDA contribution from new stores, gross margin improvement and the continued leveraging of our central services. And let me note that this is after absorbing added public company costs and higher insurance premiums resulting from Hurricane Sandy which Ed will discuss shortly.

So, overall, we feel very good about our first quarter and our outlook for the full fiscal year. And we do believe that Fairway is very much on track with regards to our business performance, our margin enhancement initiatives and our real estate development and strategy.

With that, let me turn the call over to Herb and Ed who will provide more details on both operations and our financial results.

Herb Ruetsch

Thanks, Charles. Let me emphasize that that’s the best Q1 in company history. You will likely hear me say that into perpetuity as we start each quarter’s discussion. Same-store sales were very gratified then we have a continuing expansion in same-store sales.

Basically would have to flip the numbers to understand the trend in same-store sales from Q4 to Q1. Take the 90 points, take a lot of Q4 and add into Q1 and you really have an expansion of about 80 points is our best estimate in same-store sales during that period. Now there is an ebb and flow to that and is affected by the honeymoon period of one year open stores, it’s affected by sales transfer periodically and a number of factors, although we see a continuing trend of positive same-store sales and growth demand number.

What this translates up, let me just say, the same store sales, we look at some of the data below it. It’s really a combination of customer transaction growth, wholesale basket size and that’s important to note that there really is a continuing benefits of price optimization, our increased penetration in private label which we will talk about in a little bit and the various merchandize and customer service efforts that we make every day in the store.

This all translates to a run rate of about 20 million customer business per year that’s very, very significant and that will grow at a rate of 20% plus into perpetuity, as I mentioned before about our Qs. We see this as a continuing growth and I think that’s what everybody heard us say on the road and we all understand that that’s where we’re going.

We’re really about extending the store base. We work hard on same-store sales, but the story here really is 1910 story, you will hear that from Ed, the growth and the real estate development is really the significant part of our story.

On margin enhancement, Charles did mention that we continue to experience leverage with our vendors as we grow and we’re very pleased to announce we’ve extended our agreement with United Natural Foods. This provides significant cost and operational benefits for the company and we’re very proud to move forward in partnership with them they are great supplier for us and we’re happy to have made that deal.

Additionally, the instruction on our new production facility has begun and we will expect to be into our Phase I in about six months, could be seven but we think right in that range is where we’ll begin to move our produce for stock operation, which as you know, we mentioned this in our last call. It’s already functioning in adjacent building. We’re getting some benefit on the strength side by going into that facility temperature control.

So we’re kind of ahead of ourselves a little bit there but it just make sense to do that as we transition the new facility and we make that transition to the new facility that much smoother.

So the Phase I which we’ve talked about earlier is really produce for stocking, is core bakery operation that would include bagels, baguettes, bread, things like that and four compulsory operations which are basically the food that you see, spread through our daily showcases at our prepared food and hot bar mixes.

That’s Phase I and that’s really our first focus that will be completed I would say in the eight to nine months area we’ll have all those areas under our belt and in the facility and running. And that’s when we’ll start to see the margin benefit which will result from labor savings in store operations and also from control, inventory control, production control thereby yielding shrink benefits.

Phase II is really things like quality production, cheese packaging, dry fruit nut packaging. Those types of items are very, very strong paybacks, as we’ve wanted this as a company. We’re going to accelerate that as quickly as possible at Phase II and there’re some Phase III operations and we’re going to move as quickly as possible.

That may affect our pre-opening expense on these items in the current year but we think it’s the right thing do, these are very, very strong payback operations and we’re going to move forward very aggressively on them

Let me talk a little bit about our private label that’s our -- really our third major push on margin. As I mentioned in our last call, we’ll be introducing 100 plus new conventional items later in the fall that should yield in the neighborhood of $5 million of sales. We believe at least 50% of that will be incremental sales benefit and really increase our penetration in this area.

We recently launched Fairway’s first foray into a package chicken. It’s a antibiotic-fray, born natural chicken and we’re running above $80,000 a week on just that item right now. It’s been very, very well received. It increases our penetration into the private label. It’s a very strong margin item for us and the category itself, most importantly, the category itself has elevated and that’s where you want to see when introduced private label items that your category is not just cannibalized it’s actually moved up and elevated. We’re very pleased with the launch of that item.

As you know our goal is to move from 7% to 14% overtime and that should be three years to four years and we feel very good about these young starts we have this year. And we estimate on average somewhere between 10% and 15% depending on the category of item of gross profit margin improvement, each time we introduce our private label item.

So if I get 50% sales increment and I get a margin improvement of let say 12.5% on average, I feel pretty good about the strength of this program the power it’ll have inside our business at the revenue and at the gross margin lines.

Finally, we’re looking very hard at our nutritional and health and beauty aids and vitamins and supplements areas. We think there is some opportunity for expansion here and we are working closely with our merchants. So not lonely reset the items where within some of our stores or suburban stores we’ve gotten kind of a very high profile.

We’ve really come to realize and we find that reducing that profile from where you’ve got a really good customer service to help a customer get a vitamin that’s 12-feet in the air down to reachable level is yielding very significant benefit for the company and we also believe that the selection and the profile of the area can be deepened and broadened as well and that will also be a focus of private label, as well as our organics of our specialty areas.

So, and finally, I’d just like to say it is great to see a lot of you at our Chelsea opening. We opened that store with a customer account that is third place in the company. We’re very, very excited about this.

We opened it in end of summer, it’s the quiet time of year but with a customer account ranking number three in our profile we’re very, very excited about the prospects of Chelsea and it was great to see you guys there the next day I think I arrived with 12 seconds left before I have to speak at the opening very exciting day.

Anyway, I’d like to turn the call now over to Ed Arditte our CFO and thanks guys for listening into.

Ed Arditte

Thanks Herb. Let’s start with the topline. We had another strong quarter with net sales of $187 million which was a 21% increase over the prior year. The increase in net sales was driven largely by the sales contribution from three new stores specially Woodland Park, Raspberry, Kips Bay, which accounted for over 93% of our sales growth on a year-over-year basis.

Same-store sales contributed the balance of the sales growth. Now this pattern of 90% plus of our sales growth coming from new stores should continue well into the future given the structure of our business model.

As Charles mentioned, gross margins were 32.9% for the quarter, a 10-basis point increase over the prior year primarily due to an increase in our merchandize margin as a result of improved inventory management and our continued work with our vendor base.

We are on track with our margin enhancement initiatives and we think there’re significant upside potential from our new central production center in the [Hud Point] section of Nebraska. We expect to see these benefits in the next fiscal year and certainly beyond.

Now, next, Central Services, which we define as our general and administrative expenses adjusted for certain non-recurring expenses, continue to leverage in the first quarter despite having the burden of additional public company cost.

As a percentage of sales, Central Services declined 10 basis points to 5.3% of sales from 5.4% in the prior year. As we’ve discussed with you, the leverage of our Central Services expense will be one of the primary drivers of our adjusted EBITDA margin expansion over the next few years along with our gross margin expansion initiatives that both Charles and Herb discussed.

In our current fiscal year, you should see most of this leverage occur in the back half of the year when we get truly the most significant revenue contribution from the opening of Chelsea and also the opening of Nanuet.

Next, we grew our adjusted EBITDA to $12.7 million in the quarter. Let me point out that this strong growth was tempered in the first quarter of the current fiscal year due to the suburban mix of our new store openings and approximately $450,000 of public company and incremental insurance cost. As Charles mentioned the after effect, if you will, of the impact of Sandy on the insurance markets.

Fairway has a strong operating leverage outlook as we discussed with you. And our overall expectation of adjusted EBITDA growth in excess of our sales growth remains on track for the full fiscal year.

Now, obviously the IPO transaction running through the quarter made the numbers a little bit of challenge to sort out. So in connection with that, we did incur approximately $18.1 million in fees and expenses that were charged to the P&L and included in our general administrative expenses.

We tried to help you as best we can with our presentation and throughout the press release what we tried to do is isolate those items in order to help you compare our operating performance on a consistent basis from one period to the next.

Moving on, store-opening cost for the quarter were $3 million, down from $5.8 million in the prior year despite the several week delay in the opening of Chelsea. We estimate that we incurred approximately $1.5 million of additional store opening expenses as the result of the Chelsea delay and that’s relative to our original plan. Although these incremental expenses will be -- won’t really be reflected until we get to our second quarter.

We remain focused on controlling these store opening expenses and expect to continue to drive this number down on a per store basis over the next few years. Labor clearly is our most significant opportunity this year and I think we made progress actually at Chelsea ex the delay. So to simplify your analysis of pre-opening, we have isolated the production centre start up costs from our store opening costs on the face of our P&L, given the very different nature of these items.

Internally, as you now we treat store pre-opening and production center start-up costs as a component, a truly meaningful component of our project total investment. And our return on capital analysis always takes these costs into consideration when measuring against our target hurdle rates.

Now, shifting to the tax line, we recorded a non-cash income tax provision of $2.4 million. We expect our tax provision for the year to be approximately $3.5 million with majority obviously this provision to the full year allocated to the first quarter. It’s important to note that this is a non-cash charge and that Fairway will be shielded from cash taxes for some time well into the future, due to tax net operating losses well in excess of $100 million.

Now, let’s turn to the balance sheet, we currently have approximately $91 million of liquidity that includes $70 million of cash and basically $21 million of capacity under our credit facilities. We feel real good about our cash generation over the balance of the year. And we will be closely monitoring potential opportunities to reduce our interest expense as we’ve done multiple times over the last 18 months.

If you really pay attention to our interest expense over this period, you’ll see we’ve taken a number of good reductions in interest expense as we again taken advantage opportunistically of opportunities to do so.

Now, before we open the line to your questions and before we get to Charles’ closing remarks, let me provide a bit of color on our outlook for the second quarter and the balance of the fiscal year. Our current estimates target second quarter sales growth of approximately 15% allowing for the slightly delayed opening at Chelsea.

As you know, the summer months are typically lower volume months for food retailers in our region, especially, in urban locations where we find the customer based tends to leave the city during the weekend or also for summer vacations.

Turing to adjusted EBITDA, in the second quarter, we expect to continue to improve our margin on a year-over-year basis, despite absorbing approximately $900,000 of public company and higher insurance costs in the second quarter again, higher public company and higher insurance, the insurance due to the insurance markets in a post Sandy environment.

Now, let me turn to the full year. We continue to see positive sales momentum and see annual sales growth tracking at approximately 20%. Very consistent with what we have previously disclosed to you. All of our current information in case that we have the potential to accelerate the opening of Nanuet, and this location, we think at this point will open in the mid October timeframe several weeks ahead of what we originally had planned.

In addition, we expect to open Nanuet at or below our budgeted net investment cost. Lastly, we expect same store sales remain positive throughout the reminder of the year. You add that all up, therefore, what you get for the full-year, the combination of our top line growth combined with a gross margin initiatives we talked to you about, and which we’re performing against and the leveraging of our Central Services is expected to drive adjusted EBITDA at a faster rate than our sales growth resulting in year-over-year margin expansion.

Now, with that, let me hand it over to Charles for some closing comments. And then we’ll go to your Q&A.

Charles Santoro

So we’ll go to Q&A in a moment. I just would conclude by saying we really feel good about where we are right now. We’re obviously ecstatic about the announcement with respect to Hudson Yards. It is for anyone on the New York area that is a huge event and a major validation of everything we look to become by people who are leaders in our real estate community.

We feel really good about what we are going in the context of this year. We feel very good about our pipeline. We are very, very grateful, to our investors for providing us with the capital that we now have with the purpose of pursing these growth strategies. I will also just note that we would like to offer invitation to anyone on the phone, who would like to come and join us for Nanuet opening at all likelihood mid-October. We’ll give you detail as time goes on. If you would like to come and join us, please, let Nico know, and will arrange if he would want. We’ll arrange a VIP pre-opening tour. It is kind of fastening to see the backside of the store but you never will see as customer but it is quite an amazing thing to see as well.

So with all that said, let me now open the call to Q&A.

Question and Answer Session


(Operator Instructions) our first question is from John Heinbockel of Guggenheim. Your line is open.

John Heinbockel - Guggenheim

Charles, let me ask you about the pipeline. So, three openings for next year, I think we have a sense of two of them. The third one, is that still likely to be an urban store? I think that was the idea.

Charles Santoro

John, I think that’s probably good about but we have to hedge it because we have multiple conversations underway that may give us a variety of option so. I think that for the purpose of this conversation, that’s probably the right perspective to take. But I do want to point out that we do have a variety of options that we’re considering.

John Heinbockel - Guggenheim

And then when you think about the pipeline and the opportunities you are getting, do you -- I know four was the target for the following year. Do you still think that's right particularly with Hudson Yards being one of those, or do think there's an opportunity and a capacity to do one more than that?

Herb Ruetsch

John, we’ve always indicated we feel confident about our ability to open four stores that year and very much to the point we are highly motivated to look for a powerful fifth location. So, we remain very much focused on that objective obviously. We’ll be able to talk about it, when we’ve done it.

But we have a great real estate pipeline, I think the development, the development Hudson Yards and their selection of us as their food retail anchor helps you all appreciate how powerful a partner Fairway is to any landlord with any real estate in the kinds of demographics we’re looking for. And announcements like this and are going public and the capital we have, only accelerates our range of options and our deal flow.

John Heinbockel - Guggenheim

And then just finally on the topic of real estate, what are you guys seeing, and what do you think will happen with real estate costs? I don't know if you’re seeing more competition for sites, but certainly the attractiveness of urban locations is becoming better known. Do you think real estate costs go up from here because of the competition, or -- because you are a particularly attractive anchor that’s not really going to happen to you?

Charles Santoro

Let me start by saying as you know all of our real estate, in Manhattan and elsewhere is full fair market value. So we’re already observing the full wait, of New York City real estate. And so to answer your question, the primary driver of our employees is based on those locations that we think best serve our strategic needs.

When we reach out into those locations, we are always embraced by the landlords, because, as we mentioned on many occasions we believe and many landlords believe we are excellent partners and make their real estate more valuable than other options they have. We have not seen -- to your point, we have not seen any market change in real estate rates in New York City. They remain outrageously high.

And we continue to absorb that. Obviously there will be what they will be our model with our margins particularly in the city given our product mix, continue to provide us, over flexibility we need to observe those costs comfortably as you well now.

John Heinbockel - Guggenheim

And then just lastly at, not that it is critically important, but the sales guidance you talked about suggests an ongoing positive comp at least by my math. Is that fair?

Charles Santoro

I think that’s fair John. Again we feel good, as we said about our same-store sales outlook for the full year. As we talk to you about -- we talk about modestly positive. We’ve done well the last several quarter as Herb mentioned. And I think -- I think our trend continues and we feel good about that.

I came back at the point that I made on the call as you very well know, that for certainly the foreseeable future, when I say the foreseeable future I’m talking about certainly the next several years. 90% part of sales growth is going to come from new stores and that’s why the pipeline that we were working on is so important to us but same store sales matters too. And we’re doing everything we can to drive it along the lines that we’ve talked about.

Herb Ruetsch

Hey, John if you think about it John, we feel really good about the same store sales comps that we have been showing on in the context of the quarter that we’re talking about and the current trends we see, particularly in the context of our incredibility rapid geographic expansion. In another words, the number of new locations we have.

I think about what we work a year ago, and the number of store accounts we had one year ago. We hadn’t opened Kips Bay. We hadn’t opened Chelsea. We weren’t about to open Nanuet, and in addition to that we have this three incredible real estates opportunities in our pipeline.

So, we are really pleased about what we’ve done, we’ve accomplish to goals we have set out to accomplish. And yeah, we do expect to be able to drive over the course of the year, continued same store sales comps and yes, it is not the measure driver of our increase profit but obviously it helps.

Charles Santoro

And John just one -- One last comment, these positive same-store sales comp are being drive by additional traffic and increase market basket all at about a 3% profit differential from where we were before we started our price optimization effort so, very, very significant that the profit dollars being driven by this increase our actually out sizing the revenue growth it’s self.

Herb Ruetsch

Just to point out again for most of you know that’s but, that’s not because we increased prices by 300 basis points. We have optimized prices. In areas where we were too low, we have raised prices, in areas where we felt we need to be more competitive we have reduced prices. The net effect of all that’s probably about half of the 300 basis points, the rest is the shrink tax that has been reduced as resulted better, better volume in multiple categories.

Charles Santoro

All right, Operator. Can we move on the next question, pleased?


Thank you. Our next question is from Edward Kelly of Credit Suisse. Your line is open.

Edward Kelly - Credit Suisse

Hi. Good morning guys, and congratulations on the Hudson Yards announcement.

Herb Ruetsch

Thank you.

Edward Arditte

Thank you.

Edward Kelly - Credit Suisse

Charles, and Herb, I am curious about Hudson Yards. Was there -- to the extent you can share color on this but was there competition for that site? How intense was it? And why do you think you end up winning the location?

Charles Santoro

Let me say, what I think is appropriate to say and I am not going to be in any way indirect. For those who live in and around New York City, I think they understand that Steve Ross in related to our phenomenal and probably the leading real estate development group. They are incredibly focused on details.

This project -- and again Steve Ross, for those who don’t know this, was the developer of Time Warner Complex. And for those who know the Time Warner Complex. There is a food retailer at the Time Warner Complex as well.

They were very deliberate in everything. They are doing at Hudson Yards, very deliberate about every detail. It is going to be a truly amazing place. The anchor food retailing complex will set the tone that it affects everyone who goes there. From a tourist to an office worker to purchase vending many thousands of dollars per square foot to buy beautiful residential real estate or to rent it.

So, I hope that answers your question, I don’t think we need to say any more. Steve Ross is very focused on details. He is focused on credit and experience over there unlike any other experience. He wanted the best of everything.

Edward Kelly - Credit Suisse

And you know question on the Chelsea, I was wondering if there is -- I know it’s early but if you could drive any sort of color so far on what you are seeing performance, customer reaction, early things it may be a learning and what are you seeing anything fro competition?

Herb Ruetsch

The competition in the city is -- there is never the same type of response as we see in the suburbs. Suburbs focuses drop prices that’s typically the competitive drought. So people do what they do and they were barred to get customers on their doors we do. But we are very pleased about it, to put traffic in the store.

We are at number three in that store. That’s a 17,000 square foot store. It does encompass the entire Fairway experience. I am sure you have been thrilled by now. But this is 17,000 square feet and we have more foot traffic in that store than most of the other stores in our chain.

We are very, very pleased with that. Some of the traffic is lighter traffic, then sandwich traffic around mid day, that’s very very down there. And we are starting to see as people start to come back from vacations and weekends and things like. We are seeing those bigger baskets really fill in. But we are super happy about the traffic, I mean, that is really is how you get the store building.

Lot of people in the store is how you go. We’ve made some improvements in the store, coming right at the gate, we actually added an extra aisle of organic product coming out of the gate. We always do things like that. We respond to what we hear, what we see in the market right out of the gate. So we are very pleased with the foot traffic side of the business and the revenue level considering it is summer time. We are very pleased with the outlook on the store.

Charles Santoro

Let me also add that we have a really good product mix there. We have a very high margin product mix and with the heavy foot traffic what we are noticing is growing basket sizes as customers come in and learn more about the store. It is interesting to note that along with the upper East side and certain other locations in New York, there can be -- it’s really significant shifts between summer volumes and fall volumes.

And for example, at our E side location last year we saw about 27% to 28% shift in volumes -- increase in volumes from summer period to the fall. Chelsea, if anything is that and more. So we actually are -- we feel we’re in a very good position with a lot of foot traffic, a lot of enthusiasm, right feedback, growing basket sizes, customer learning the store and obviously position to benefit from the shift in basket size patterns and foot traffic patterns when people come back from vacations. We feel really good about it. It is a remarkable location. It is a beautiful store and we are thrilled to have it.

Edward Kelly - Credit Suisse

Last question for you shifting gears and to suburban locations, given that we have Nanuet coming up. Could you give us a little bit of color on how some of the more recent suburban openings have been progressing and just what you're seeing on that side particularly maybe like the Woodland Park store?

Edward Arditte

Yeah. All suburban stores continue to progress. Right now we are -- Woodland Park stores particular is going against the honeymoon period of last year. So, our revenue comparisons are negative during the honeymoon period. We expect that to turn during August as we get into September and be a very significant contributor to same-store sales and the profitability of the store is now in the black.

So, it -- we see that following a very similar trail to a lot of our suburban locations. Stanford is a great example. Stanford is contributing about $3.5 million of EBITDA a year right now and that came from potentially a loss position in the first year of operations and it opened in ‘10.

So we say Woodland Park following the same pattern. It’s a little bit different there and now we got into a price war as we discussed in earlier calls. And we also discussed that on the road. That is behind us. We are not just building business working with the communities and building our sales volume in that store. So our outlook is very, very strong on that and all other suburban stores in that population.

Herb Ruetsch

Let me just say the following, just to be clear. Woodland Park, we have seen a steady increase in volumes -- adjusted in Woodland Park over the course of calendar 2014. So that’s obviously very, very positive for us. With respect to Stanford, the $3.5 million is on an annualized. And on an annualized basis, Stanford would be even higher than that we feel very good about Stanford.

Westbury is rapidly approaching the volume levels and on any given week, it can equal the volume levels of Plainview which is amazing given how strong Plainview is and how many years it has been established in that local market. And we are finding the average basket size at Kips Bay continues to grow and again that store has been extremely well received and again that store has a very attractive product mix which is driving strong full load EBITDA margins. We feel very good.

Edward Kelly - Credit Suisse

Thank you.

Herb Ruetsch

Operator, next question please?


Thank you, our next question is from Brian Nagel of Oppenheimer. Your line is open.

Erica Eiler - Oppenheimer

Hi. This is Erica Eiler filling in from Brian.

Herb Ruetsch

Hi Erica.

Erica Eiler - Oppenheimer

How are you?

Herb Ruetsch


Erica Eiler - Oppenheimer

So a lot of my questions have already been answered but I guess I just wanted to dig in a little deeper to into gross margins, definitely a little better than what we are looking for this quarter. You guys have been great about telegraphing the drivers of gross margin going forward. Maybe you could just provide a little more color on, how we should think about margins going forward, maybe the progression of margin improvement over the coming quarters and dive a little bit deeper into that for us. Thanks.

Herb Ruetsch

Erica, I offer a couple of that perspective one is obviously the longer term perspective that we talk about which is that we have three very specific initiatives, vendor leverage, Fairway branded products and obviously the production center all of which are drivers of gross margin as we go forward here.

Charles spoke in his comments about vendor leverage obviously has greater potential to contribute this year’s gross margin. But as we move into the next couple of years and beyond the other two programs will ramp up in terms of their contribution to our improved gross margins.

So, the longer term perspective is really driven by those three initiatives. As we think about the quarter that we just had, with improved gross margin our merchandize margin was up nicely and overcame the slightly higher occupancy costs. Charles did talk about the fact that we reset a number of leases. We are now really full year market rate, if you will and therefore as we move forward we grow the business, we should leverage off of those occupancy costs going forward.

But in the quarter, our merchandize margins more than offset the increase in our occupancy costs. As we think about the next few quarters, we feel good about our gross margins obviously it is very, very difficult for us to project 20 basis points here and 30 basis points there. When we are talking about an overall gross margin that is in the -- in the 30% plus range that we are in today.

So we can’t really be that specific other than to say there is a good sense of confidence among the team here, about the things that we’re doing both in the short term and in the longer term to enhance our gross margins.

Charles Santoro

And let me add the following. We had enormous opportunity on an annual basis to continue to leverage Central Services. Even as we do grow those Central Services costs and we grow them always in anticipation front loading if you will, the expenses involved in safely growing our business.

And so we also focused very heavily on our adjusted EBITDA margins as a percent of sales. And on an annual basis, we have given guidance before that we do expect that there is very significant, very meaningful upside for us over the coming two to three years driven as Ed said by the production center, driven by vendor initiatives, driven by private label and driven by leveraging central services.

Erica Eiler - Oppenheimer

Okay. Great. That’s helpful. Best of luck in the coming quarters.

Charles Santoro

Thank you very much.

Herb Ruetsch

Thank you.


Thank you. Our next question is from Mark Miller of William Blair. Your line is open.

Herb Ruetsch

Good morning, Mark.

Mark Miller - William Blair

Good morning and congratulations as well on the Hudson Yards site. It looks fantastic. To be clear then, is there -- that site is going to be opening. It looks like maybe in fiscal '16, is there another site that you expect to open in fiscal '15 to be at ‘17 or is that just going to be determined as we get into…

Herb Ruetsch

The number 17 was obviously just taking that site plus the junior leases and I gave indications of dates on those and our current account at ‘14 including Nanuet. As you know, we are very much involved in driving other announcements in other locations and we will try and give you a advance warning as we get closer to sign leases.

We have the two leases that are nearly completed. And as I indicated by the end of the quarter, we would hope to be in a position to announce both of those and will continue to be driving that pipeline very, very aggressively. So yeah, we do believe we are going to be on track in the context of our guidance for new store counts.

Mark Miller - William Blair

Terrific. And then can you give us some context around the quarterly progression in sales growth. I want to make sure I understand, I think you said 15% sales growth in the September quarter and you listed 21%. So you have got there more stores both last quarter and this year, sorry -- this quarter year-on-year.

Is the forward sales growth a function of Chelsea opening up a little bit later than planned and the honeymoon period that you are lapping in Woodland Park and then Chelsea basket size. It sounds like it might be a little later you initially planned. Are those the three reasons for the deceleration?

Herb Ruetsch

Well I think Mark and I would answer this way, obviously we opened up Chelsea in the summer months. We are pleased with the way it’s developing. I think the quarterly progression through the year, we feel real good about 20% for the full year sales growth. We just did at 21 because of the later Chelsea opening guided you to a 15% for Q2.

The combination of Chelsea kicking in, in the fall period which is as you know can be very, very significant change and any web opening as we talked about potentially in that mid October timeframe that starts to really drive along with the holiday season a very big third quarter and fourth quarter for us.

So we see the full year in that range. Q2 obviously has this bit of a down, Chelsea being the primary driver. And then we move into the fall where we really accelerate with the two new stores and finish the year strong in Q3 and Q4.

Charles Santoro

But I would say specifically, last year second quarter effectively had the honeymoon benefit. That would be the month or so when you open a new store in the sales do always exceed the trend line at Westbury and at Woodland Park. We have one store now which is a city store that we always knew would open in the summer but in the city, the summer effect of a honeymoon period is deferred until people come back from vacation.

It creates a strange calculus but leads us in our view very much to entrap for accomplishing the sorts of number that Ed described in the context of the full year. And as you know we -- we are trying to guide towards the full year. We give you the best info we can on a quarterly basis, but we will reiterate we feel very good about where we are in the context of the full year, the quarter that just ended and the quarter that we are in, in the context of this conversation. I hope that answers your question. We can always -- we can always pick the conversation up.

Mark Miller - William Blair

Yeah. That's fine. It's just a bit of anomaly this quarter and then stepping up. And then just one quick one if I may, the $1.5 million pre-opening on Chelsea, kind of surprising. It is that high with a couple week delay, but that doesn't signal anything higher for pre-opening going forward?

Herb Ruetsch

Let me specific here. So let’s -- just break this apart because we do want everyone on this call to know we remain focused on pre-opening for all the right reasons. We don’t want to spend the money. We want to bring that expense down. We gave guidance that we would focus first and foremost this year on managing labor, and if you back out the delay in Chelsea, our labor cost were down. We did manage labor successfully and we think you’ll see an even more dramatic result in the context of the Nanuet labor number.

So with respect to Chelsea and with respect to Nanuet, we’re driving down the pre-opening component of labor. With respect to both of those locations, the possession date component that has been principally non-cash but GAAP-related expense of real estate from the time we take possession start building out. It does represent significant components they’re function of the way to lease the structure when it was negotiated. Those we were very clear that with respect to both of these locations we were not going to be in a position this year to change leases that were negotiated some time ago.

However, beginning in future rollouts you’ll see improvement by us in those areas and we know that to be the case to the degree that someone can know something in advance and we’re driving and structuring deals to bring back component down.

And then finally as you know it is the simply mathematical leveraging of all of our fixed real estate related expenses. This year over -- in the context of new store openings over two stores, now we do have the production center as well which will get some allocations because obviously our production team is focused on talking about that as well. And so obviously mathematically that number becomes smaller and smaller as the number of store openings grow. We’ve just confirmed the store -- we’ve just confirmed to the best of our ability the store growth that we expect in the future.

Importantly, we brought down the cost of construction. The absolute dollar cost of construction has come down in the context of building at our stores. Nanuet net of TIs will probably come in the range of $30 million perhaps below, that’s substantially lower than our build out cost were several years ago which would have been several million dollars higher.

And at this point we believe that our actual construction cost net of TI per Nanuet will be below our construction budget. And in Chelsea we believe that we’re at or below and I’m hedging a bit because all the numbers aren’t in. But, we’re inclined to believe it actually came in below budget, very positive developments for us.

Mark Miller - William Blair

Okay. Thanks for that color.

Charles Santoro

Okay. Mark thanks. Operator, next question?


Thank you. Our next question is from Robbie Ohmes of BAML. Your line is open.

Robbie Ohmes - BAML

Good morning, guys. And my congrats as well on that Hudson Yards announcement, that's amazing. Actually just two follow-up questions. One is, I think you guys in the past have tracked self-cannibalization and I was curious, if you could give us sort of an update on the self-cannibalization headwind, to the maybe the copy just reported and how we should or should not think about that playing out over the next several quarters?

And then the other question is, Ed, you called out a few categories in your comments. Is there any other detail you can give us in terms of what may be surprising you in category trends or what you see driving same-store sales and margins and if there's differences between what is going on in the suburb versus urban locations in terms of category trends? Thanks.

Charles Santoro

So, good questions, with respect to the self-cannibalization whatever the right nomenclature is. We just find and give you the data points we can. We’re finding that at our plenty of store the negative comp that was generated as a result of the Westbury opening has substantially closed. We indicated last time it was running less than half of what it was the time the store opened.

So good news there whatever sales transfer there was seems to showing and that was predictive, it’s a sign of brining new people into the store and the people who’re in the store are spending more money. That’s a real data point.

With respect to Chelsea which is just opened, it’s very difficult for us to know whether that’s impact in any other location. I can tell you, that Kips Bay continues to grow seasonally adjusted. So if it is impacting Kips Bay it’s not something that we can easily measure. Although, there is no question remind that there has to be some people going into Chelsea that have shopped elsewhere in our system.

We don’t see that 74/3 that’s still counting positively, amazingly with the volumes that store has but still counting positively and we don’t see it in our other locations, so that’s something that we had kind of predicted would happen.

I have no doubt that in the context of the first quarter there will have to be some impact in the context of Chelsea, particularly when we get into September but it’s not measurable and it’s likely to be something that would burnout very, very quickly right now however we can’t point to anything. What was the other part of your question?

Robbie Ohmes - BAML

Just if, Ed, can maybe give us a little more detail on what really we stood out in categories and if there were any differences in category momentum in the urban stores versus the suburban stores and maybe just calling out what’s really driving the, if there’re any standard categories really driving the comps across the business?

Ed Arditte

Robbie specifically to the gross margin performance and where I think we made very good progress in the quarter, particularly as I said on the merchandise margin. I think we’ve got a very disciplined process here for managing categories and managing margins and Kevin McDonnell deserves a lot of credit for the leadership he shows on that front.

I think our teams do a very, very good job and I think we’ve had almost across the Board progress on strength, not to say that there isn’t more opportunity there we think the production center will help us there when it’s fully open running.

We’ve seen good progress, and I’m going to turn it over to Herb her in a second. We’ve seen good progress on our major categories, our major selling categories. As you know produce, organics, meat, seafood, all of these are big categories for us and I think all are doing well. Herb?

Herb Ruetsch

So we’re still seeing Robby the basic trends in the industry where our folks are moving from conventional items into organics, into specialty, into the better foods in life which is really our strategy to take people from the everyday food choice and improve their food consumption.

So you still see those trends moving through the business then point into our meat department we’ve had some fairly significant progress there. We’ve introduced the private label all natural antibiotic chicken recently, which has given us and made pop in that category and we do see a broad fresh food power in the movement of our sales. So it’s really it’s more of a story of the broader trends in the market and we’re experiencing them here with some sweets we’re making some very specific moves.

Charles Santoro

Okay. Operator, we have time for one more quick question.


All right. Our next question will be from Scott Mushkin of Wolfe Research. Your line is open.

Charles Santoro

Hi Scott.

Scott Mushkin - Wolfe Research

Hey, guys. How are you doing? Thanks. Thanks for taking me at the end and it’s nice to be joining you guys on the call so it’s going to be quick a lot of questions been asked in great detail so I appreciate it. Just want to get a little bit and I know you talked about this before but the cadence of the gross margin improvement expected specifically from the central facility as we get that open and running is there a chance that it could as we open it up it could pull back margins a little bit and then we just bring forward, I just want to get thoughts there?

And then the second question I know we talked about comp a lot, I just want to get a feel or even a little bit better than the adjusted quarter or they about the same I don’t know if you have any comments on that?

Charles Santoro

Let me start with…

Scott Mushkin - Wolfe Research

Thank you.

Charles Santoro

Hi. It’s Charles. Let me just start with the last question first and go into the production center. So with respect to if I heard the question right you’re asking how is -- effectively how is July looking at question.

Scott Mushkin - Wolfe Research

Yeah. I guess that’s effectively the question Charles?

Charles Santoro

July is positive -- July our same store sales comps are positive and that is after giving effect that’s even battling on the opening of Chelsea and again, we’re really not in a position to calibrate what effect it had on other stores other than to say intuitively we think at least initially some people from other locations did come into explore the store.

So we feel with one town and again it’s a quiet summer month. We feel we can sit here and say that we do believe we want to drive positive comps, September is always an important and good month for us and we think we’re well-positioned Summer end so little bit earlier this year so we think of a New York Metro area it’s kind of accelerating vacation schedules, and August that’s probably Nanuet going to be a good thing for us. But I hope that gives you some perspective that’s what we have to share with you at this point.

Ed Arditte

Let me turn to the production center and give you a couple of thoughts. And first at this stage, I think at a higher level, Scott, we have talked about the production center over a period of time being capable of driving up to a 100 basis points of margin expansion at the gross margin line.

We continue to believe that today, in fact, I think we feel even stronger about it today as our planning has progressed and we’ve gotten more specifically into some of the things that Herb talk about moving some of our Phase II activities into Phase I.

Now, I don’t that -- but you should not expect that that will play out in fall in 2015 or ’16. I believe that in ’15 we’ll be in a transition year obviously how it plays out through each of the quarter so ’15 we’ll be in better position to announce probably two to three quarters from now as that rollout plan is really nail down.

But, certainly, as we move beyond ’15 into ’16 and ’17, we see very, very meaningful gross margin opportunity in there and again, we could see 100 basis points we obviously know and you’ve heard this from us before. We know that not everything always goes exactly the way you plan, so just as we have very significant plans for our vendor initiatives and for our private label, collectively we’re working probably 250 to 300 basis points of opportunity. What we’ve talked about collectively is 100 basis points of margin expansion from those three activities.

Herb Ruetsch

Let me just say the following, we’ve been very good and made great progress in reverse engineering that facility in enormous detail around what we need to want as we grow and our primary focus will always be in doing it right. I think that a year from now you’ll begin to see the benefits in our bottom line in some form or fashion, we’ll roll it out carefully as you would want us too over the course of the balance then of calendar 2014 and therefore, in calendar 2015 we would expect to start to see meaningful benefits coming out on an annualized basis.

In the meantime, if anything as we’ve gotten more into it, we have found that the two itself represents an even more powerful component of our business than we would have indicated three months or four months ago.

We’ve made a number of key hires these are world-class individuals with world-class backgrounds, partners our merchants and this, I think it’s safe to say that we believe this facility will be unlike any other. We are not tying to over engineer. We’re trying to make it fail proof and work for our system specifically.

So we do believe it’s going to be a really important driver for us and we’ve also said just on the issue of margin now jumping to adjusted EBITDA margins, that we do believe over the next three years on a run rate basis we will drive 200 basis points to our EBITDA margins as a percentage of sale.

That’s on adjusted basis within the next three years. We continue to believe that it’s very, very doable. We see a variety of ways to get there, the menu of opportunities for us will put us substantially higher than that, but as Ed mentioned we’d like to allow Murphy’s Law it’s always there and so we’re giving you kind of a hedged and realistic perspective and what it is we’re trying to do.

Herb Ruetsch

Okay. Ladies and gentlemen, thanks for joining us for today’s conference call. Nicho and I’ll be available for follow-up questions over the course of the day and obviously, over the next several days. We look forward to seeing you either on our travels or certainly as Charles mentioned at the grand opening of Nanuet, and certainly we look forward to our next earnings conference call which will be in the early November timeframe. Thanks for joining us today.

Charles Santoro

Thank you everyone.


Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!