Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

The Fresh Market (NASDAQ:TFM)

Q3 2013 Earnings Call

November 21, 2013 5:00 pm ET

Executives

Kenneth Levy

Craig Carlock - Chief Executive Officer, President and Director

Jeffrey C. Ackerman - Chief Financial Officer and Executive Vice President

Analysts

Karen F. Short - Deutsche Bank AG, Research Division

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Charles Edward Cerankosky - Northcoast Research

Mark Wiltamuth - Jefferies LLC, Research Division

Kelly A. Bania - BMO Capital Markets U.S.

Brian Cullinane - Wolfe Research, LLC

Jason DeRise - UBS Investment Bank, Research Division

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

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

Benjamin Brownlow - Raymond James & Associates, Inc., Research Division

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Mark R. Miller - William Blair & Company L.L.C., Research Division

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

Operator

Greetings, and welcome to the The Fresh Market Third Quarter 2013 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ken Levy. Please go ahead, sir.

Kenneth Levy

Thank you, operator. I'd like to welcome everyone to The Fresh Market's Third Quarter 2013 Earnings Call. Joining me on today's call are The Fresh Market's President and Chief Executive Officer, Craig Carlock; and Executive Vice President and Chief Financial Officer, Jeff Ackerman.

Before we begin, I want to remind you that any forward-looking statements we may make today are subject to the Safe Harbor statements found in our press release and SEC filings. Our third quarter earnings release and related financial information, including any non-GAAP or adjusted financial reconciliation tables, are available on our corporate website, under the Investor Relations section. After our prepared remarks, we will have time to answer your questions.

Please note that a replay of this call will be available for 30 days on our website at www.thefreshmarket.com.

With that, let me turn the call over to Craig.

Craig Carlock

Good afternoon, and thank you for joining us today. As you read in our earnings release this afternoon, The Fresh Market reported consolidated sales growth of 13.4% and earnings per share of $0.23 in the third quarter. Our base business continues to perform well and we made strong progress on our expansion plans by opening a record 10 new stores in the quarter. With solid gains in comparable store sales and improving margins, our core business is growing profitably, which is a testament to the strength of our team and the execution of our merchandising and operational plans.

I would like to remark on comparable store sales and gross margin expansion. As we previewed last quarter, we maintained our promotional cadence into Q3 and we successfully drove traffic into our stores. Comparable store sales rose 3.1% this quarter and customer traffic rose 2.8%, making this the third consecutive quarter of rising customer traffic growth. We realized this improvement even with increasingly challenging economic conditions as the quarter progressed.

By strategically designing our promotions, not only did we drive increases in traffic in the most recent quarter, but we also expanded gross margin by 40 basis points. Strong execution on sales events and since we have deployed promotions, resonated with customers and allowed us to increase customer transactions. Our investments in business intelligence systems and our continued refinement of proprietary tools also enabled store associates and merchants to improve forecasting and ordering, resulting in a meaningful reduction in perishable shrink.

We also made great progress on new store openings this quarter. We opened 10 stores, which is a record for us. These stores opened on-time and on-budget and, in some cases, ahead of schedule and under budget. Of the 10 stores we opened in the quarter, 6 were in markets where we have greater brand awareness. This group of 6 stores, on average, is exceeding our internal targets for sales. Our brand continues to resonate with consumers in these markets and their response to our fresh food offering and engaging customer service has been strong.

In markets where we have less brand awareness, we are seeing mixed results. I would like to discuss Sacramento and Houston, specifically, as these stores are weighing on our profit growth. I recently visited our stores in the Palo Alto and Sacramento markets. I was very pleased with our execution in these 2 markets. Our food was fresh, appealing and well-presented. Our employees, some of whom were recently promoted from within, were excited and motivated, leading to excellent customer service and, as a result, customer feedback has been positive at these locations. Sales in our Palo Alto store are well within the range of our new store opening levels. And in fact, sales are ramping better than expected.

In the Sacramento area, it is taking longer for us to build traffic. We have made some adjustments to our marketing plans in these stores, and we are monitoring their performance closely. We continue to maintain our positive long-term view of this market's potential.

In Houston, we entered the market with a 4-store lease transaction. This was a large strategic investment in 4 former grocery sites, which paved the way for more rapid expansion in Houston and other communities in the state, than would have otherwise been possible. This investment also allowed us to develop our brand more quickly with customers and gain greater leverage in the real estate community.

Sales in our 4 Houston stores, as a group, are solid, as customers are enjoying the shopping experience we offer. Sales relative to our investment in 2 stores are not yet where we'd like. This performance may reflect the fact that the 4 stores are in close proximity to each other.

To better understand market dynamics, we engaged a third-party firm to assist us in conducting market research in Houston. We are pleased that this research shows that we have a strong conversion rate when customers are exposed to our products, store environment and customer service. Therefore, we have instituted plans in the market, designed to drive brand awareness and customer trial by leveraging targeted promotions, enhancing community outreach and augmenting advertising. While it is too early to draw conclusions, we anticipate that these actions will accelerate the learning curve and adoption rate by customers in this market.

I would like to conclude my comments with 2 more points. First, we remain committed to growing our brand nationally. We recognize that developing scale and building a brand requires investment. We believe that we are laying the foundation for future earnings growth and we remain confident that our fresh food offering, accompanied by great service and a warm and inviting environment is a concept that resonates broadly. Our lease pipeline remains robust. We have announced leases for 27 sites and many other potential sites are in various stages of negotiation, providing The Fresh Market with a clear runway for growth into fiscal 2015.

Second, I want to mention that in late September, Randy Young joined our team as Senior Vice President of Real Estate and Development. Randy brings tremendous experience to The Fresh Market, having worked in all stages of real estate development. His background with a number of national retailers and developers will help to inform our strategy and expansion plans. New site selection is a top priority for Randy and he has spent much of his initial time with the company meeting with landlords and visiting our markets.

Now, let me turn the call over to Jeff.

Jeffrey C. Ackerman

Thank you, Craig. We entered the quarter with the consumer acting a bit cautious, but customer activity slowed noticeably in the final month of the quarter, coincident with the October decline in consumer confidence. In this environment, The Fresh Market posted earnings of $0.23 per share on net sales growth of 13.4%.

Our 13.4% sales growth this quarter was driven by strong unit growth and increased traffic, responding favorably to our promotional activity. Promotional activity helped drive a 2.8% increase in traffic and a 30-basis-point increase in basket size. This increase in traffic was the largest increase for the company since Q3 of last year. This quarter, we were more promotional on proteins and seafood, and saw a produce inflation moderate from its heightened levels earlier this year.

Gross margin expanded 40 basis points to 33.5% this quarter. The primary driver of the gross margin increase was improvement in merchandising margin, spurred by improvements in shrink and other buying costs. This more than offset the expected rise in occupancy costs, which we discussed on our last call.

Selling, general and administrative expenses, as a percentage of sales, rose 60 basis points from last year to 24.4%. The increase was primarily attributable to new store openings and a rise in labor and benefits. Increases in depreciation and interest expense related to costs associated with our 4 capital leases in Houston.

This quarter, new store productivity was 83%. Return on invested capital, our primary metric for corporate performance, was 23.5%. This figure reflects a falling average store age, rapid unit growth and ongoing capital investments.

Moving to the balance sheet and cash flow statement this quarter, the company generated $36.2 million in cash flow from operations and invested $40.5 million in capital expenditures. Approximately 95% of these capital expenditures related to new stores.

The company's cash balance as of October 27, 2013, was approximately $14.6 million. The total outstanding balance on the company's revolving credit facility decreased 20% to $33.6 million.

As we look to the final quarter of the year, I want to highlight some items that will impact our performance. First, we will cycle on 2 discrete items in the fourth quarter. The first is a deduction that benefited our tax rate, resulting in a lower effective tax rate than the 37% rate we expect this year. The second item is a $900,000 insurance reimbursement for Hurricane Isaac and other storms. While the industry is facing some challenges with the consumer environment, we are confident in our plans to open 5 new locations and strengthen our base business in the fourth quarter. We also expect that occupancy costs will climb $3 million to $4 million from prior year levels, which reflects our larger store base and occupancy costs for stores opening in fiscal Q1 of 2014.

As we mentioned, late in the quarter, we saw a step down in consumer activity in October. We believe the current trends will continue through the fourth quarter and believe it is prudent to revise our financial outlook for the year. We now expect comparable store sales to finish the year up 3% to 3.5%; operating margins to be in line with the prior year; and full year earnings to be $1.42 to $1.47 per diluted share.

Looking beyond Q4, we are confident in our strategy for sales and earnings growth. Both Craig and I are excited about the groundwork we have laid to build a national franchise and extend our high-touch differentiated brand into new markets.

Operator, I would now like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Karen Short from Deutsche Bank.

Karen F. Short - Deutsche Bank AG, Research Division

Wondering if you could kind of rank, in terms of the negative impact on your comps, the deteriorating economic environment and, I guess, consumer confidence. And then, I guess, can you make some comments on where competition, increased competition, might rank or factor in?

Craig Carlock

Yes. We came into the quarter in the 3% range. And actually, our sales accelerated the first couple of months of the quarter, north of where we've been for the year. And then they decelerated about 200 basis points in the final month of the quarter. So that was a significant impact felt across the chain. And I would rank that first as far as sales impacts. Competitive activity is something that we've been experiencing. It's -- but I would not say that, that's what drove the comp down.

Karen F. Short - Deutsche Bank AG, Research Division

Okay. And then just following up. Jeff, I guess, when I look at the guidance here, you adjusted EPS guidance a bit in the second quarter, based on preopening expenses and higher SG&A. I guess, I'm still struggling a bit to understand what caught you guys by surprise as it related to your revised guidance in this quarter. Because your comps, if you ended up at the 3.5% for the year, that's 4.4% in the fourth quarter. I mean, that's not really that far off your historical range. And your new units are kind of in line with what you had expected. So any more color there?

Jeffrey C. Ackerman

And so the primary driver for the adjustment in guidance is really the top line. As we looked at margins and expenses, there were some puts and takes but, all in, it really was the top line and so we're just expecting that -- a lower comp sales rate for the balance of the year. And as we open stores in this environment, it becomes increasingly challenging, so we're asked -- we're looking at making adjustments to that as well.

Karen F. Short - Deutsche Bank AG, Research Division

What do you mean by that, in terms of making adjustments to the opening? [indiscernible] promotional [indiscernible]?

Jeffrey C. Ackerman

Now, I want to make sure it's clear there. What we're talking about is our new store openings. As we look at the performance of them in this environment, as we open them and look at what the impact may be with a softer consumer environment, whether people are willing to try something new, we're just taking a more cautious tone on our expectations for those.

Operator

Our next question comes from Charles Grom from Sterne Agee.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Just a follow-up on Karen's question. Just wondering, when you look at the slowdown here in October and it sounds like into November, are there any similarities to the slowdown that you guys experienced in the third to fourth quarter of 2012 or even back to 2008 and 2009 period? Anything like, what transaction size or customer behavior during the week or anything that you can share with us?

Craig Carlock

Chuck, this is Craig. This does feel similar in that the effects were felt across the network of stores, tied very closely to the political and economic climate in the country. There wasn't a particular pattern that emerged that made us think this was an operational event because we saw consistency. So in that sense, it feels very similar. But there wasn't anything particularly different about certain days of the week or certain stores that we can call out.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Okay. And this -- my follow-up question is when you look at the success of some of the recent promotional events that you guys have been doing, the Tuesday Specials, the BOGO Tuesdays, the weekend deals, I'm wondering how you're evaluating their success and ensuring that you're not going to go too far, given the slippery slope that sometimes promotion -- an increase in promotional cadence can lead to?

Craig Carlock

I think that we want to make sure that these events do a number of things: one is that they bring in traffic; two, that when we look at the sales and the margin implications that we're satisfied with the results; and three, that we fully understand the cannibalization. So we want to make sure that a Tuesday event isn't siphoning business from Mondays or Wednesdays or weekends. And so we look very carefully at all of those things and then we make our judgments. We are -- have a great deal of sensitivity to the very question you raised. And we've put a lot of analytical horsepower, frankly, against understanding these promotions. And that's part of it. The second thing I would say is we remain focused on doing all of the other things that we should be doing to draw-in customers. And that is running good stores that are clean, fresh, well-staffed, friendly folks who are motivated and positive. And so we focus as much or more time on all of those things as we do on the promotions.

Jeffrey C. Ackerman

Chuck, this is Jeff. Just quickly building on that. Again, if you look at the quarter, we saw our margins expand and our traffic accelerating. So we felt like the promotions were very well executed and balanced.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Okay, great. And then, I guess, my last question would be just with regards to when you go into new markets, going forward, how are the 4-walled margins going to compare to, say, when you were going into new markets 4 to 5 years ago? It appears that there's going to be a little bit of change in promotional intensity, maybe a little bit more advertising. Just wondering if you guys have started to model that out with some of the new markets that you're signing up leases for?

Craig Carlock

It feels premature for us to say that we have changed our pro forma economics for new stores. I think what we're saying is, we've gone into some markets, we want to create brand awareness, we are undertaking a number of steps in Sacramento and Houston to create that brand awareness, we're going to learn a bunch of things from what we tried right now. But at this point, we're not anticipating a major change to our new store economic model. I think, when it happens, we'll be mindful, we'll have it right in front of us, we're very returns-oriented, we'll certainly want to capture all those costs. But at this point, what we're saying is, in a handful of stores we want to try some new things, we'll learn from that and then we'll go from there.

Operator

Our next question comes from Chuck Cerankosky from Northcoast Research.

Charles Edward Cerankosky - Northcoast Research

Could you, just to start off, Jeff, reiterate what you said about the occupancy costs going up? I didn't quite catch all of that.

Jeffrey C. Ackerman

Yes. So we expect the occupancy cost to be about $3 million to $4 million higher than the prior year and that relates to our increased store base.

Charles Edward Cerankosky - Northcoast Research

And that's for this year?

Jeffrey C. Ackerman

That's correct, for the fourth quarter.

Charles Edward Cerankosky - Northcoast Research

All right. Okay. That's basically what I missed here. All right. As you went into Houston, with 4 stores all at once, I would imagine that was more noticeable to the competition, as well as the consumers. What kind of competitive reaction did you see?

Craig Carlock

Well, we perceived Houston to be a competitive environment and I think folks are very sharp on price in that market. It's tough for us to ascertain whether they're sharp on that, because we're there or that's just how they operate. I feel like our problem in Houston, the things we're working on, are related to getting more folks into the store brand awareness than what our competitors are doing.

Charles Edward Cerankosky - Northcoast Research

Okay. How would you describe the shift in product mix in the third quarter towards the end versus the beginning as a result of some of these economic headwinds you faced?

Craig Carlock

I don't think we saw a discernible trend. I mean, our basket sizes were fairly consistent with prior quarters. We just had fewer people coming into the stores in October than we did in August and September.

Operator

Our next question comes from Mark Wiltamuth from Jefferies.

Mark Wiltamuth - Jefferies LLC, Research Division

Just wanted to dig in a little bit on new store productivity. You came in at 83% here this quarter. I know you said you had started in August at 85%. Maybe give us a little more color on across that new store group. What was the new store productivity number in the new markets versus the markets where your brand identity is a little more known?

Craig Carlock

I don't think we break it out that way, Mark. I think we're 80% to 90%. It's been where we thought it would be. We came in at 83% and we expect to finish the year 80% to 90%. But we are, I think, being upfront. So we've got a couple of stores in Houston that are lower than we thought -- want them in sales relative to the investment we made, and the sales in Sacramento were soft. So...

Jeffrey C. Ackerman

I'll just add that in Houston, we had -- 2 of the stores were either at or above the kind of 80% to 90% range, and 2 of them were below. So as we said, as Craig had said before, it's a bit mixed.

Mark Wiltamuth - Jefferies LLC, Research Division

Okay. And on the SG&A, up 60 basis points, so that was certainly much more than most expected. Is there some new store spending going into that to build brand? Or was it all just timing of the preopening expenses?

Jeffrey C. Ackerman

Well, a part of it was we were geared up for a greater volume. And so we saw some deleverage on expenses. And the other parts really were a rise in benefit cost and then the preopening expenses. And those 2, alone, probably accounted for about a 40-basis-point increase.

Mark Wiltamuth - Jefferies LLC, Research Division

And then I would imagine the preopening part of it was expected, that was probably not a surprise. So there was a surprise more in the deleveraging, just from the weaker sales, is that where the surprise came?

Jeffrey C. Ackerman

That's right.

Operator

Our next question comes from Kelly Bania from BMO Capital Markets.

Kelly A. Bania - BMO Capital Markets U.S.

I was wondering if you could talk a little bit more specifically about the Sacramento stores, because I believe they opened up in late September, during the quarter. And I think you'd mentioned you'd already hired a consultant to evaluate those and are implementing some changes to community outreach and advertising. So just curious, how quickly were those changes made, post the opening? And what do you think, based on the feedback that you've got and the changes that you have made, is a reasonable time frame to expect some improvement in those stores?

Craig Carlock

Yes. So the -- we opened in Roseville in October of 2012, and then we opened 2 more in late September, as you mentioned. Well, we've hired a field-based marketing manager to drive traffic into the stores by reaching out to civic organizations and other parts of the community. So I don't know that I'd say it's a consultant, as much as it's an employee who has experience in this area and will help us partner with civic groups and others to get folks into the community. We will measure this carefully. This is not something we've done in the past. We're excited to explore this. We've also done the same thing in Houston. We've hired someone who's done this for one of our competitors in Houston. So we'll learn, we're hoping to see benefits next year. We're very focused on driving sales and improving profitability right from the get go.

Kelly A. Bania - BMO Capital Markets U.S.

And just a follow-up. So would all 3 of those Sacramento stores be performing about the same? And is there any difference in your site selection process or new store opening process or customers that you think you initially drew in that may be different than the past?

Craig Carlock

Could you repeat the question?

Kelly A. Bania - BMO Capital Markets U.S.

Sorry. Just was curious, if all 3 of those stores would be performing on a similar basis, because one was about a year ago and 2 are more -- a lot more recent. And just curious if there's any differences for those 3 Sacramento stores that are -- you had a different site selection process or a new store opening process or do you think you drew any different customers in than you normally draw? Or any other conclusions that you can help us understand what's going on in those stores.

Craig Carlock

I think the conclusions are, honestly, straightforward. It's taking us longer to build our brand in the Sacramento market than we had anticipated. We feel like we're executing very well. We feel like the folks who come into the store have a good experience. We get very positive feedback from customers. We feel really satisfied and happy with our operational conditions. But we're just not attracting as many people as we would like, and we're going to put a lot of effort in attracting more people. But I can't say that 1 or 2 stores is behaving differently than, say, the third one. They're all -- it's fairly similar.

Operator

Our next question comes from Scott Mushkin from Wolfe Research.

Brian Cullinane - Wolfe Research, LLC

This is actually Brian Cullinane on for Scott. Just wanted to touch maybe a little bit on the Affordable Care Act and what you guys were expect -- have you -- or what are you thinking about in terms of expenses and what you're forecasting, kind of, for the next few quarters? What that impact might be from the Affordable Care Act?

Craig Carlock

I think we're experiencing higher health care costs this year, but we would assign those higher health care costs this year to just health care inflation, in general, and a high level of claims. And I think, for next year, we're expecting the inflation, but we're not assigning a lot of change in our expense pattern to the Affordable Care Act.

Brian Cullinane - Wolfe Research, LLC

Okay, that's great. And then maybe any impact -- potential implications, for your core customers that they may be facing higher premiums. Have you guys -- is that -- do you feel like that's any part of the slowdown? Or are you forecasting any -- have you heard back from customers that this might be an issue for them, going forward, and are they worried about that?

Craig Carlock

We haven't heard that question. I don't know that we've asked a lot of customers about how they're impacted. I really feel like the slowdown was related to the activities of October and the political climate and the government shutdown and those kinds of things, more than an actual change to the program.

Operator

Our next question comes from Jason DeRise from UBS.

Jason DeRise - UBS Investment Bank, Research Division

So I wanted to ask about anything that may be different about the pipeline of new stores over the next year, let's say, versus what you opened in the last year. And, I guess, what I would ask in particular, is there any kind of skew between urban, suburban, rural? And are you adjusting the work that you're doing today, I guess, to build the pipeline for a year beyond that, based on what's been happening over the last 12 months?

Craig Carlock

Yes, appreciate that question. Next year's pipeline is fairly established, so I appreciate the notion of adjusting. But at this point, we have plans for next year and we're executing against those plans. We've made commitments, we've signed leases, we have stores under construction. So to the extent we would make any adjustments, they really will be felt in 2015 or later. But I would say we're very excited about our pipeline, and we've got 6 stores that are, you can see in our website, that are in Houston and Dallas and parts of California, so I think that's what you're getting at. And that's going to be about the same, or maybe a little less than this year. We -- we're excited about those stores. I think the bigger adjustment, frankly, will be we will really want to be mindful, and we've been mindful in the past, but making sure the investment level is appropriate for the sales levels that we're experiencing. Does that makes sense?

Jason DeRise - UBS Investment Bank, Research Division

Yes. Yes. And then, I guess, in terms of some of the stores that you've opened up over the past year that we don't end up talking about too much, because you're focused on Houston and California. But maybe, can you talk about some of the other new markets that you've entered where things have gone better? And if there's any pattern to the type of demographic of those areas compared to a Houston or a California entry?

Craig Carlock

We -- I appreciate that we've had many, many, many successful openings and I would not want what we're experiencing in a handful of stores, to taint our real estate process because we've got some great sites that we've opened that are very profitable and very popular with customers. Now, I think that we've seen that we can be successful up and down the East Coast. We've got great stores that we've opened this year, from Pennsylvania to parts of New York to Florida. And so we're very excited about that -- those stores and those locations. Our view has been that we have benefit from brand equity in some parts of the country, in the Southeast, in particular, but then we're able to build our brand in other parts of the country. And we've seen ourselves do that over and over again.

Jason DeRise - UBS Investment Bank, Research Division

And can I ask, on the competitive environment, I mean, if you're doing the assortment right, it's generally newer items or different items than everybody else, but has that SKU overlap changed, perhaps, over the last year or so? Are you finding that your competitors, whether they're conventional or differentiated, that they're stocking more of the same items?

Craig Carlock

Well, to the extent that we feel competition, I would suggest it's more from store openings than from them changing how they compete. Does that makes sense? In other words, when our competitors open stores, that's more impactful than when our competitors add some items or take some items out or changed prices.

Jason DeRise - UBS Investment Bank, Research Division

Okay. And then the last thing that I wanted to ask about, in terms of the basket size being up, was that item up as well, and then maybe not so much on the inflation side? Or was that mostly driven by inflation?

Craig Carlock

So the basket size was not up a whole lot and we saw that, really, the -- there's more inflation.

Jason DeRise - UBS Investment Bank, Research Division

Okay. I guess that was different than what happened, I guess, in November and December last year, where it seemed like it was more trip base that was cut. So is there anything that, I guess learning from that, helped keep people coming to the store even if they were buying less? Or is it not comparable that way?

Craig Carlock

Could you say that again?

Jason DeRise - UBS Investment Bank, Research Division

I guess, just drawing a parallel to November and December last year, when consumer confidence was weak because of the political situation, and comparing that to October. I think last year, if I understood correctly, traffic was down was the main issue, it wasn't really items or anything particular about that. This time, it seems like traffic was still pretty good but then the items in the basket were down. Or was traffic really great leading into it and then traffic fell off a cliff in October.

Craig Carlock

It's more like the latter. It was -- our sales accelerated in August and September and dropped in October and that was driven by traffic in all 3 months.

Jason DeRise - UBS Investment Bank, Research Division

And then, I guess, last, just following up one more time on that. In January of this year, as we got past that political environment, the traffic recovered. Are you seeing that currently or is there some lingering concern by consumers because of still a somewhat unresolved political environment?

Craig Carlock

I think our view is we want to take a pretty cautious tone going through the holidays and we also are mindful that debates could heat back up in January.

Operator

Our next question comes from Stephen Grambling from Goldman Sachs.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Turning to expenses, so with the, essentially, the incremental rent that you're getting in the back half of this year, I think in the past, it sounded like you thought you'd cycle over that into next year, potentially. Is that still the case or as you continue to open up stores, is it really just an ongoing expense?

Jeffrey C. Ackerman

Are you referring just to the higher rent costs -- just -- that we have associated with having a bigger store base? I'm not sure I understood where -- your question on that.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

So it seemed like you were front-loading -- well, this shouldn't be front-loading, but you're bringing forward some stores that drove down your expectation for expenses or up the expectation for expenses in the back half. And so as we move into next year, is that something that you should be cycling that would be lower? Or as you just continue to open up stores, will it be pretty consistent?

Jeffrey C. Ackerman

As we look at the timing -- so you're talking about, really, for the fourth quarter, that's correct, we did say that we've been able to accelerate some of the store openings in the first quarter of fiscal 2014, and that's driving some costs in this quarter. So that, really, whether or not we cycle that, we'll again look at just the number of stores that we open in the first quarter of 2015. And as Craig mentioned, our objective is to really smooth out the number of stores that are opening each quarter, so I would expect us to be at a similar level.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

And then a follow-up on the Affordable Care Act. I mean just -- I guess, why aren't you embedding any kind of incremental costs from that into the next couple of years? So is there something with your current health care plan or...?

Jeffrey C. Ackerman

Yes, sure. So just let me make it clear. We have already implemented everything that's required under the Affordable Care Act. And so we really already have that in our expense base, you would have seen that in the third quarter. So if you were looking for a big movement, you've already seen it.

Operator

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

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

Wanted to ask you if you could help me clarify, I think, Jeff, you mentioned there were 40 basis points of expense. Was that sort of above budget or just above the year ago? And was that -- were those both in -- I think you mentioned in new stores and in health care. But you also mentioned deleveraging, the last month not being so good in sales. But you said it was the last -- I just want to make sure I understand which 2 buckets it was, was it new stores and the health care costs that caused the 40 bps?

Jeffrey C. Ackerman

Sure, Andrew. So the question was, and I think someone had asked, what was causing the year-on-year deleveraging? And so they asked about the 50 basis points that we saw in the quarter. And my response to that was that preopening expenses and health care costs, health care claims costs, were a little over 40 basis points, 40 to 50 basis points. And the claims costs are more individual-event driven, they're not related to, say, the Affordable Care Act or something like that.

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

Okay. So that's what I was getting at. So at least by my calculation, sort of, the deleveraging by the last month being slower than you expected and the labor load not being balanced to that, was less -- was 20 basis points, about $0.01, in that neighborhood. Is that how do you think about it?

Jeffrey C. Ackerman

It was a little more than that but it was partially offset by some favorability that we had and leverage that we had on corporate G&A.

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

Okay. And the other thing I wanted to follow up is just on California and Texas. Roughly, it sounds, the way you're portraying it, is that about half the stores are close to plan and about half are below plan. I just want to make sure that is the correct characterization. And I also want to just ask you plainly, do you think any of that, on the stores that are running below plan, that, that would be more related to site selection than to brand awareness?

Craig Carlock

We follow the same process for selecting these sites. We look at the same information. We have the same people involved, as all of the stores that are very, very, very successful. So we're open-minded that we -- gosh, we ask ourselves that question. But at this point, based on some market research in Houston and based on things we hear in the community in Sacramento, we think people are just less familiar with us. I would also point out that, in Houston, the stores are in pretty close proximity to one another and so we felt like that the population density would enable us to still achieve the sales levels we desired because they're in such great areas with large numbers of people. But that hasn't proven to be the case so far.

Operator

Our next question comes from Ben Brownlow from Raymond James.

Benjamin Brownlow - Raymond James & Associates, Inc., Research Division

You touched on the pricing landscape a little bit. At this point, do you feel that it's a rational pricing environment heading into the holidays?

Craig Carlock

Yes. We've monitored our competitors' prices for Thanksgiving meals, for turkeys. We're comfortable with our pricing. We're comfortable with their pricing. For a couple of our specialty competitors, they're at the same price they were last year and so are we. So from what we've seen, I would consider it rational.

Benjamin Brownlow - Raymond James & Associates, Inc., Research Division

Okay. And when you think about the product categories heading into the holiday, are there categories that you feel like you're better positioned, either from a cost standpoint or offering, that you can help drive traffic year-over-year? And, I guess, along those same lines, from the expense side, do you feel like you're better positioned to manage store level expenses at existing sites if you see the softness continue?

Craig Carlock

Yes. So on category readiness, we strive to be ready in every category, but I will tell you, at the holidays, people really appreciate the quality of our proteins and our entrées and then the items that they will have for entertaining. And so we feel like we do a tremendous job at the holidays and that our seasonality really speaks to that because we get tremendous bumps around the holidays. And then what was the -- I'm sorry what was the second question there, Ben?

Benjamin Brownlow - Raymond James & Associates, Inc., Research Division

Do you feel like you're better positioned to manage store-level expenses?

Craig Carlock

Yes. I think we are, for a couple of reasons. That -- while the decline in October was disappointing, it wasn't as abrupt as last year, in November. And so we were able to glide our expenses or glide our labor modeling down. So we have that flexibility. We are carefully watching this and we feel better positioned. But anytime sales decline for any retailer, it is difficult to keep the same ratios and margins rolling. And so we've -- are focused on doing the very best we can.

Operator

Our next question comes from Kate Wendt from Wells Fargo Securities.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

So I just want to follow-up, it's not skewed [indiscernible] from the new stores, but actually asked in a different way. I think that I read an article about your Lynchburg, Virginia opening, that there were several hundred people waiting in line to get into the store. And I'm wondering, as you compare those type of experiences versus in other markets, do you think it's a function of just greater brand awareness in the entire state or differences in marketing, if you're in another store or just the fact that maybe it's a less competitive market where The Fresh Market stands out more versus competition?

Craig Carlock

I think that it's all 3 of those. I do think we benefit from the brand equity in the Southeast, in a town like Lynchburg. I do think there's less competition in that particular town than there are in a lot of other places where we operate. And that particular store opened on 9/11, and we did some special marketing events in the community to recognize first responders. And so we did a number of things that all came together to make that a tremendous opening.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Great. And maybe for Jeff, how should we think about insurance with some of the stores in Houston and California, the additional SG&A taxes impacted in the advertising that you're going to be wrapping around those stores, that are not going be material to the overall reported number?

Jeffrey C. Ackerman

Yes, Kate, so we've factored that into the guidance. And so, as Craig mentioned, we have several programs that we're implementing in Houston. And as we understand better the traction that we get with those, then that will inform our decisions about what to do going forward, and we'll be able to give you an update on that on our next call.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Okay, great. And then just a final one. With gross margins still trending higher, do you ever think about, particularly in maybe a weaker consumer environment that may last for who knows how long, investing more in your everyday prices, in addition to promotion, to kind of promote repeat visits, it seems like you actually have some nice opportunities on the margin side to be able to offset it if you chose to do that.

Craig Carlock

We're considering that, particularly, in newer markets where we're trying to build brand awareness. And one of the vehicles that a retailer can use to build the brand awareness is price. And so while we don't want to, at all, change our go-to-market strategy or confuse our customers or any of our employees about what we stand for, there is an opportunity, I think, on certain perishable items to run some events using price as a lever to get people into the store. And you're right that the margins we're gaining by growing our scale can be used in some of those newer markets. That's something that is top of mind for us and we're excited about that. So in particular, we have some Thanksgiving specials in some of our newer markets that are priced better than they will be in some of our legacy markets.

Operator

Our next question comes from Mark Miller from William Blair.

Mark R. Miller - William Blair & Company L.L.C., Research Division

The number of leases signed for future locations, second quarter, was 30 to 27 here. I'm wondering, is the plan to slow things down a bit and just understand better how you can affect change in some of these new markets. And so, I guess, you said '14 is pretty much done, but for '15, does it make sense for the organization to just really concentrate on where you've been successful, give it some time in these new markets, just to see if you can get the comp gain in the out years?

Craig Carlock

So there's 2 questions there. One of the reasons that number, statistic -- that reports dropped from 30 to 27 is we just opened 10 stores in the quarter. So that's part of the dynamics at work. I would not say that we are slowing down. So, Mark, it really just reflects how many we've just completed opening. The second point, as far as, gosh, does it make sense to slow down and take stock of things, again I would -- I'd go more toward let's take stock of the investments required in our certain markets to make sure the investments are consistent with the sales levels we're generating. So to me, it's not a faster or slower. It's more of an expense and investment set of decisions. But I don't want folks to miss the point here, our base business is doing very, very well. We're comping 3.1%, it would have been a lot better than that, had we not had the events of October. Our margins are growing. Our stores are opening on time, they're opening under budget. We're very excited to grow our company. And so we just want to -- the adjustments we make, I think, will be more around expense and capital, than around what markets we pick.

Mark R. Miller - William Blair & Company L.L.C., Research Division

Yes. I mean, I guess, the thing that's kind of frustrating here is the comps are okay, I mean, they're slower than the last month. Gross margins are up. I mean, usually you're most of the way home from that. So it just seems like this element of new stores is what's creating disruption for the company and for investors. And so I'm just trying to think, is it essential for The Fresh Market to make a continued push in these new markets at the same pace? Or would it be perhaps more prudent to just let's focus more energy in the existing markets. It seems like there's still a lot of room to grow Southeast, Northeast, Midwest and do more there.

Craig Carlock

I think the question of balance is very, very good. And I would say that we had frankly entered the year, and our last year, planning on the California openings. And then we had a wonderful opportunity to take advantage of this Houston deal. And so those happen to fall this year at the same time. And you're right that having both of those investments in the 2 most populous states of the nation, far from Greensboro, has weighed on our profit growth this year, there's no question about it. So if we could balance with more, let's call it, footprint stores and less frontier stores, we would welcome that. But I would also say, as we think about that balance, I think about balance and capital requirements just as much as geographic requirements. Does that makes sense?

Mark R. Miller - William Blair & Company L.L.C., Research Division

It does. I guess, we'll just stay tuned to see what '15 looks like, but I appreciate it.

Operator

Our next question comes from Ken Goldman from JPMorgan.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

One thing I don't understand yet about Houston, if the issues are store proximity and brand awareness, why wouldn't these factors affect all 4 stores relatively equally? Wouldn't Store A and Store B, for example, if they're near each other, siphon customers from each other, rather than only A taking from B. And, I guess, similarly, wouldn't a lack of brand awareness affect all stores equally, too? I guess...

Craig Carlock

I think it's a couple of points. I think you're correct that if customers are -- the stores are borrowing different customers. But what we're saying is that result -- is that a couple are lower than we'd like and a couple are within the range of what's acceptable. Plus you've got one store that's kind of an outlier. So if you look at where they are, they're not equidistant from one another, and so there's a couple that are close together. The second point, on brand awareness, while we -- what we're saying is that in a state -- in a city, in a market with that many people, the best way for us to drive profitability is to get more people into the store, naturally, and the best way for us to do that is to drive brand awareness because a lot of people, even with 4 stores, who aren't familiar with us. But the folks who become familiar with us convert to us, according to our research, at a pretty nice rate, at the same rate they convert to our competitors. So that's very encouraging to us.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Right. And then one follow-up, if I can. I guess, I'm trying to get some concern -- or some comfort, rather, that the issues in Houston and Sacramento aren't symptomatic of a larger concern. Why should investors, looking at today's results, seeing Houston, seeing Sacramento, looking at these areas and thinking these aren't adjacent to your geographic comfort zone. Why should investors not look at your company and think maybe these guys can't extend their store base well beyond that comfort zone without some growing pains. Help me gain some understanding, if you can, about alleviating those concerns, because that is the main issue, I think, you'll face tomorrow.

Craig Carlock

Yes. I think that the -- and the concerns are different. In Sacramento, we've been slower to build sales and customer traffic than we'd like, and we're working to do that. And again, in Houston, the sales levels and customer acceptance have been solid. The results were mixed by store, but they're certainly solid. There's certainly people coming into our stores and enjoying shopping. The dynamic at Houston is profit growth being curtailed by a fairly significant investment associated with getting into those stores. And I would think that investment is going to enable us to get into other parts of Houston and other parts of Texas pretty readily and, in fact, it's proven to be the case. And then, I guess, the other thing I'd say is we expanded into Chicago and grew nicely from there. We expanded into the Northeast. We've got stores in Connecticut that are doing quite well, in New York State that are doing quite well. We've expanded into Philadelphia area, doing quite well. So there's just a long history of stores that have been -- and then the last point would be the Palo Alto store, which is in California, is going to earn us a nice rate of return, and it's doing just fine.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Great, can I sneak one more in?

Craig Carlock

Sure.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Does the shortfall in Houston versus expectation, and I know it's not drastic, but just a little bit, does it make you less likely to buy assets in bulk, as you sort of did there, rather than taking the slower, I guess, one-by-one real estate steps you've taken elsewhere?

Craig Carlock

I think that an honest examination of that transaction, as it gave us entrée into the market, which we're excited about, but we -- I think one thing we would consider is, gosh, we paid an inducement for the leases and it was a unique opportunity. We paid the inducement. But it was also as-is capital, so we had to put all of our own capital into it and market rents. And so there were a number of parts of that transaction that made that a significant strategic investment. I think what -- next time we'll look at assets in bulk, we'll just think -- be very mindful of the total cost of getting those assets.

Kenneth Levy

Operator, I believe we have time for one more question.

Operator

Our last question comes from Joe Feldman from Telsey Advisory Group.

Joseph I. Feldman - Telsey Advisory Group LLC

I want to go back to some of the -- one of the positives in the quarter, the shrink. And you'd mentioned some new systems and refinement of some proprietary tools helping with the forecasting. Can you give us, I guess, a little more color on that? And maybe what the opportunity is, going forward? I assume this was the first quarter where you had that benefit. Will we see something like that, going forward?

Craig Carlock

We've been working on reduced -- and all retailers do this, but we've been working on reducing our shrink for quite a while. We've made real progress, really, in the last 4 years, and our margin history would support that. We continue to think that we can buy better, negotiate better, transport and warehouse more efficiently and reduce shrink. And all of those things will provide reasons for our merchandise margin and then, therefore, our gross margin to expand steadily over time. So we're very bullish about our ability to build margins and that gives us the ability to take mind to the bottom line. Or, as Kate suggested earlier in the call, to reinvest in price or put some money into promotions in new markets or those kinds of things.

Joseph I. Feldman - Telsey Advisory Group LLC

Got it. And then a follow-up question. Just, do you guys -- I know you don't have a loyalty card program yet, and I say yet, maybe you'll develop one. I guess, the question I had was, does this kind of quarter make you rethink it? Would there be a more effective way of driving in the customers and repeat customers, measuring the frequency of the guys that are most loyal to you and hoping to have regional pricing and promotions to do that? Where are you thinking about that at this point?

Craig Carlock

I think we are not at the point where we 0 in and say, "We need a loyalty card." I think we are at the point, and where we would agree with you, is we want to understand more and more about our customers that we have. We want to understand more and more about the customers that our competitors have. We want to understand more and more about customers in different markets across the country. And so we are doing things to deepen our customer and consumer understanding, and we have a number of projects underway to do that, but we're not yet focused on cards.

Joseph I. Feldman - Telsey Advisory Group LLC

Got it. Okay. And then last question. Just -- can you give us an update on private label -- or private brand and kind of percentage of the store? And is there an opportunity there to -- with frequency and loyalty on maybe branded packaged goods?

Craig Carlock

Well, there is an opportunity. Our private brand continues to grow. We continue to add more products and more product categories. And our motivation has always been, we want to provide products that are fantastic and on a value that people cannot find in other places, so they make a special trip to The Fresh Market to buy them. So those products tend to have better margins, but that's not why we do it, we do it to get the customers into the store. Right now, we're around, I think, 14% of sales for private label products as a percentage of grocery, dairy or frozen.

I think we're-- yes. Okay. We want to thank everybody for calling in, and we look forward to talking with everyone again, in March.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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

Source: The Fresh Market Management Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts