Spartan Stores, Inc. Q3 2010 Earnings Call Transcript

| About: SpartanNash Company (SPTN)

Spartan Stores, Inc. (NASDAQ:SPTN)

F3Q10 Earnings Call

February 4, 2010 9:00 AM

Executives

Dennis Eidson – President and CEO

Dave Staples – EVP and CFO

Alan Hartline – EVP, Merchandising and Marketing

Analysts

Karen Short – BMO Capital Markets

Bakley Smith – Jefferies & Co.

Ajay Jain – Hapoalim Securities

Chuck Cerankosky – Northcoast Research

Operator

Greetings, and welcome to the Spartan Stores Incorporated Fiscal 2010 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

Ladies and gentlemen, I must remind you that comments made by management during today’s call will contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates and projections that involve significant risks and uncertainties.

Actual results may differ materially from the results discussed in these forward-looking statements. Internal and external factors that might cause such a difference include among others, competitive pressures among food, retail, and distribution companies, the uncertainties inherent in implementing strategic plans and general economic and market conditions.

Additional information about risk factors and the uncertainties associated with our forward-looking statements can be found in the company’s earning announcement, annual report on Form 10-K, and the company’s other filings with the SEC. Because of these risks and uncertainties, investors should not place undue reliance on forward-looking statements. Spartan Stores disclaims any intention or obligation to update or revise any forward-looking statements.

It is now my pleasure to introduce your host, Mr. Dennis Eidson, President and CEO for Spartan Stores Incorporated. Thank you.

Mr. Eidson, you may begin.

Dennis Eidson

Thanks Rob. Good morning, everyone, and thank you for joining our fiscal 2010 third quarter earnings conference call.

With me this morning are members of our team including Executive Vice President and CFO, Dave Staples; Executive Vice President of Merchandising and Marketing, Alan Hartline; Executive Vice President of Retail Operations, Ted Adornato; Executive Vice President Wholesales Operations, Derek Jones; and Executive Vice President and General Counsel, Alex DeYonker.

This morning I will provide you with a brief overview of our business progress and third quarter financial results. And Dave will then provide you with a more detailed look at the financial results and our outlook for the fourth quarter, as well as provide some guidance for fiscal 2011. I will then rejoin the call and give my concluding remarks.

I will begin by saying that we are pleased to continue reporting relatively strong operating profits and EBITDA by historical standards. These financial measures remain amongst the highest levels that we have achieved in recent memory. I believe it’s important to place this performance in the proper context.

Despite the significant economic, market, and competitive challenges, on a year-to-date basis, we generated cash from operations of $54 million and EBITDA of more than $80 million. We are also well on our way toward achieving annual EBITDA of a $100 million or more. This would be our second consecutive year of generating a $100 million in EBITDA, and only the second time since we have become a public company nine years ago.

Now putting our numbers aside for the moment, I would like to provide a little bit more color on the current operating environment. As you know, Michigan’s economy is suffering, we mentioned in our press announcement that the official unemployment rate during the quarter was approximately 15%, and our state has had the highest rate of unemployment in the nation for a staggering 45 consecutive months.

When considering the underemployed and those who have started seeking employment, Michigan’s unemployment increased to a rate that exceeded 21% during the third quarter. As a result, the economic and market conditions that we have been working through weakened further during the third quarter, and consequently consumer spending continues to be restrained.

Consumers appear to be buying only for their immediate needs and are very focused on value. While price is clearly an important component of value, we all understand that value is certainly more than just price. Customers also place a lot of importance on convenience, service, variety and freshness. And as a company we have been focusing on addressing all of the drivers.

In our retail segment, I am happy to say that we are making good progress on our value scores based on our internal consumer surveys, perceptions about both price and value have been improving. While we are pleased with the direction of these scores, we are working to get even better and believe there is ample room to improve.

In our distribution segment, now more than ever, we have remained focused on providing a value-added experience for our independent customers. We have expanded private label offerings and the sharing of their merchandising and promotional strategies, we continue to work with our customer base to satisfy their consumers’ desire for value.

During the quarter, we also continued to experience product price deflation that we believe impacted sales in both of our segments by approximately 2%. Both our distribution customers and our corporately-owned stores also continued to experience an increasingly intense competitive environment as the existing competitors fought for share and new supercenters and value formats opened in the trade area. In addition, our retail fuel margin is at a very difficult comparison to unusually high levels in the year-ago quarter.

Despite these business conditions, we continued making significant progress with our business plan. During the quarter, we completed a major remodel project and closed the nearby store. We opened three more fuel centers bringing our total to 24, closed one underperforming store, and we sold a store to one of our distribution customers.

We also continued to make progress on our Glen's customer loyalty program. Though this program is only six months old, we are beginning to gain more insight about customer shopping preferences, which enables us to better understand the effectiveness of our marketing programs and to make appropriate adjustments that will deliver even more value to our customers.

We continue to be very pleased with the performance of our private label program as its sales penetration continued improving in the quarter. Based on items scanned on a comp store basis, our private label sales penetration reached 27.2% during the third quarter compared to 26.4% in the same period of fiscal 2009. Additionally, we launched nearly 250 new items during this year and firmly believe that our private label program has more room to grow.

In the distribution segment, we are pleased that on a year-to-date basis, we have achieved a net gain in distribution customers and we continue to enjoy one of the lowest attrition rates in the industry. We believe there is solid opportunity to expand sales with existing customers and to attract new customers continue to exist.

With that overview, I will turn the call over to Dave. Dave?

Dave Staples

Thank you, Dennis, and good morning, everyone. I will now provide some additional details about our third quarter financial results, review our outlook for the last quarter of fiscal 2010, and provide some general guidance for fiscal 2011.

Consolidated net sales for the 16-week third quarter were $786.9 million compared with $781.9 million in the year-ago quarter. The increase was related to the incremental sales from our acquired stores and the opening of three additional fuel centers. Our sales trends were adversely affected by the weak economy, significant product price deflation, market competition, and consumers’ continued shift to private label products.

The consolidated gross margin rate for the third quarter increased 90 basis points to 21% from 20.1% in the last year’s quarter. The improvement was due mainly to the higher mix of retail sales, which represented approximately 56% of consolidated sales compared with 49% in the last year’s third quarter.

Operating expenses were 19.3% of net sales compared with 17.8% of sales in the same period last year. The rate increase was due primarily to incremental cost and sales related to the acquired retail stores, a $715,000 store closing charge, and lower sales volumes, partially offset by lower incentive compensation expense, and other expense reduction initiatives.

I want to point out that we accrued significantly lower levels of incentive compensation cost in the third quarter relative to last year. This year’s incentive compensation was approximately $2.1 million lower than last year’s third quarter. And on a year-to-date basis, we are running $3.5 million lower than the year-ago period.

Third quarter operating earnings were $13.7 million in this year’s third quarter compared with $17.9 million last year, which was a third quarter record due in part to the inflationary environment that existed at that time. EBITDA for the quarter was 3.3% of net sales compared with 3.8% in the same period last year.

Earnings from continuing operations which included higher interest expense related to the additional borrowings for the VG’s acquisition were $5.3 million or $0.23 per diluted share compared with $8.1 million or $0.36 per diluted share last year.

Net earnings for the third quarter were $5 million or $0.22 per diluted share compared with $8.3 million or $0.37 per diluted share in last year’s quarter. The net earnings included a loss from discontinued operations of $200,000 or $0.01 per diluted share compared to earnings from discontinued operations of $200,000 or $0.01 per diluted share last year. The earnings from discontinued operations in the prior year relate to the divestiture of our farm retail operations.

Turning to our business segments, third quarter distribution sales were $343.6 million compared with $397.9 million in the same period last year. The sales decline was due primarily to the reclassification of $44.2 million in sales to the acquired VG’s stores to our retail segment, product price deflation and the weak economic environment. Again this quarter, we estimate that approximately 2% of the distribution sales decline is related to product price deflation.

Distribution operating earnings however, improved for the 17th consecutive quarter to $11.7 million from $11.1 million in the same period last year. The improvement was due primarily to an improved sales mix of higher margin products, lower employee incentive compensation and benefit costs and lower operating expenses.

Lower inflation related procurement gains however, were mostly offset by the benefit of a $200,000 LIFO inventory evaluation credit this year compared to an expense of $900,000 last year.

Third quarter retail sales increased 15.5% to $443.4 million from $384 million in the same period last year. The sales increase was due to the incremental sales contribution from our acquired stores, the operation of three more fuel centers, and higher average retail prices at our fuel centers. This increase was partially offset by 6% lower comparable stores sale and the loss of $6.4 million in sales related to three stores that have been closed and one that was sold since last year’s third quarter.

We estimate the price deflation impacted comparable store sales by approximately 200 basis points. In addition, we believe that competitive store openings contributed approximately 200 basis points of the decline, and the increase in private label sales contributed approximately 30 basis points to the trend.

Third quarter operating earnings were $1.9 million compared with $6.8 million in the same period last year. The operating earnings decline was due to lower sales volumes, lower gross margin rate, and a non-cash charge of $715,000 related to a store closure.

Product price deflation, heightened market competition, and the weak economic climate contributed to the lower profit margins, as well as much lower fuel margins compared with the third quarter last year. We estimate that the lower fuel margins this year cut our third quarter operating earnings by approximately $1.8 million or $0.05 per share. These impacts were partially offset by a lower LIFO inventory charge of $100,000 in this year’s third quarter compared with a $500,000 charge in the same period last year.

Our balance sheet, capital position, and cash flow generation remains strong. Year-to-date net cash generated from operating activities increased by 16% to $54.3 million due to improved inventory leverage and working capital management, as well as the timing of certain payment.

Total long-term debt including current maturities and capital lease obligations was $203.8 million, which was a modest increase from the balance at the end of the second quarter. The increase was attributable to certain real estate financing activities and the timing of inventory purchases following the holiday selling season.

Our long-term debt-to-capital ratio of approximately 0.43-to-1 and a debt-to-EBITDA ratio based on trailing four quarters EBITDA of 1.9-to-1 remained healthy. We also have approximately $120 million of availability under our existing credit facility. We expect our debt and inventory levels to return to more normalized levels in the fourth quarter.

We continued to make progress with our capital investment program during the third quarter. In addition to finishing a major remodel project, we also began construction of a new D&W Fresh Market and a new Family Fare store, which will be a relocation of an existing Felpausch facility. The D&W Fresh Market will open during the first quarter of fiscal 2011 and the Family Fare relocation will take place late in the second quarter. Additionally, we completed a real estate transaction that will allow us to undertake another relocation project in the future.

I will now cover our near-term outlook and provide some guidance for fiscal 2011. We expect the retail comparable store sales trend excluding fuel to decline by approximately 2% more to 8% in the fourth quarter due to the inclusion of the acquired stores, the cycling of our highly successful eight-week grand opening of a relocated store and the continued difficult retail climate. We do however expect an improvement from that level beginning in the first quarter of fiscal 2011 as we cycle through competitive openings and no longer are comparing results against grand opening activity.

In the distribution segment, we expect sales to decrease by a rate that is slightly higher than the decline reported in the third quarter excluding the impact of the acquired stores. These factors will continue to compress year-over-year earnings in the fourth quarter.

Looking out to fiscal 2011, we now expect annual earnings for the year to be slightly higher than the level we will achieve in fiscal 2010. As stated in our press announcement, by the end of fiscal 2010, we will have made significant progress on our retail, distribution, and information systems capital investment program. In fact during the past three years, we have invested more than a $140 million in our operations. As such, we intend to reduce the level of our capital investment in fiscal 2011 to approximately $30 million to $35 million.

Our total capital expenditures for fiscal 2010 are expected to range from $48 million to $52 million with depreciation and amortization expense ranging from $34 million to $35 million and total interest expense including the implicit non-cash interest cost related to our convertible notes of approximately $16 million to $16.5 million. During the fourth quarter, we expect to reduce our distribution inventory and overall debt levels. We expect our long-term debt to decrease by approximately $10 million.

I will now turn the call back to Dennis for his closing remarks. Dennis?

Dennis Eidson

Thanks, Dave. I want to start my concluding remarks by mentioning that our management team and all the associates here are doing a terrific job considering the current economic and market challenges. And although the economic and competitive climate will remain challenging and likely get modestly worse before improving, we expect to sustain our solid financial and operating performance as we navigate through this difficult period.

Our near-term outlook is cautious. Over the long-term, I believe there are good reasons to be optimistic as more favorable business trends begin to develop late in fiscal 2011. For example the rate of product price deflation should begin to temper in the coming year, at the same time we start to cycle the competitive store openings.

Additionally, we also believe that Michigan’s unemployment rates will begin to stabilize. The warehouse consolidation and cost restructure initiatives that we began in the fourth quarter will provide benefits in fiscal 2011.

As you may have read in recent press announcements, we have reached an agreement with the collective bargaining unit employees at our Plymouth, Michigan dry grocery warehouse that paves the way for the transition of these operations to our Grand Rapids distribution center.

The re-racking project at our Grand Rapids facility has significantly improved our space utilization and leaves us with capacity to serve both existing and new customers. In addition to the operational efficiency improvements, we expect to gain from this decision, our distribution customers will benefit from an improved quality of service through the consolidated facility. We expect to complete this service transition by the end of the fourth quarter.

In conjunction with this initiative, we also reduced certain administrative support positions to better align our cost structure with the current level of business activity. We believe that these initiatives will help ensure that we remain a low-cost and an efficient grocery distributor for many years to come and we will strengthen our leadership position in Michigan, while improving the opportunities to expand services into adjacent markets. We expect to realize additional inventory and working capital improvements once the warehouse consolidation project is complete.

On the retail side, we are also having opportunities to increase the penetration of our private label sales, especially in the fresh food categories. In fact, we intend to introduce more than 100 fresh private label products during fiscal 2011. We are also very pleased by the fact that nearly 90% of our sales at our Glen’s stores are being made by customers who are enrolled in our loyalty program. While we have yet to extract the full benefit of the program, we are encouraged with the early results with the knowledge and insight that we are beginning to obtain in the process.

We expect to leverage this knowledge to expand the program and make it even more effective by bringing customers better value and rewarding their shoppers – our shoppers’ loyalty. As you would expect, we will continue to look for ways to satisfy an increasingly value oriented consumer given our view of the environment in Michigan.

We have plans to further enhance the value of our product offerings and services allowing us to bring our customers a comprehensive set of offerings that will continue to include fuel promotions, discount pharmacy programs, private label products, and special price promotions. And to that end, we intend to enhance the communication of those offerings and are currently in the process of developing an even more effective promotional campaign. This program will feature in-store as well as add circular enhancements.

I want to conclude my remarks today by personally thanking all of our hardworking managers and associates for their efforts during these challenging times. We will now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question is from the line of Karen Short with BMO Capital Markets. Please go ahead with your question.

Karen Short – BMO Capital Markets

Hi, everyone.

Dennis Eidson

Good morning.

Dave Staples

Hi, Karen.

Karen Short – BMO Capital Markets

Hi, so a couple of questions. Maybe talking about the comps, the deceleration that will happen from the third quarter into the fourth quarter based on VG’s partially, can you maybe just separate the two like how much is VG’s and how much is this grand re-opening?

Dennis Eidson

Karen, I think although we would like to provide even more color for you, because I have such a tight geographic marketplace, I think we prefer to stay away from that specific of data. But you are reading it correctly, as we pointed out, that’s a little bit tougher environment on the east side of the state.

Karen Short – BMO Capital Markets

Okay. Yes, I guess by my math the VG comp is really not good. I mean to – if you assume your store base – your existing store base is kind of doing a minus five or six comp. The difference on VG’s is fairly dramatic. But can you comment on that at all or –

Dennis Eidson

Well I think the VG’s, the impact at VG’s is causing the overall comp number to decline, and trust me, I mean it's hard to even write negative 8 on a piece of paper and talk about that being the comp, but that is what we view the marketplace is going to bring to us in Q4. But I think more importantly than that, more – doing pretty good about cycling out of those comps early in fiscal ’11 as we talked about and the rate continuing to improve from there.

So I think we have relatively significant bump in the road, but not one that we can’t overcome. And we are feeling confident that the strategies we have in place are going to continue to deliver solid performance on the bottom line.

Karen Short – BMO Capital Markets

And maybe can you give a little color on the traffic versus ticket, I guess, tonnage kind of in the third quarter and then what the change would be in the fourth quarter, is it mostly traffic, is it tickets?

Dennis Eidson

It is both, Karen. It is – I will say that the impact of traffic is being felt more in Northern Michigan than it is in the balance of our portfolio. The Glen’s market is extremely challenged with unemployment. Some of those Northern Michigan communities are really struggling. In the Northeast part of the state, November to December, the unemployment went up from 16.7% to 18.7% as an example of what we are experiencing up at Glen’s. So that is kind of impacting the traffic a little bit more significantly, but we are feeling it on both sides.

Karen Short – BMO Capital Markets

Okay. And then just to – just -- if I can just I guess paraphrase the third quarter, you also – so you have the $0.05 gas margin head, obviously the environment is tough. But you also had $0.03 sort of the higher integration expenses, right, that was a like a million dollar shift in the third quarter, that was in the fourth quarter last year, is that right?

Dave Staples

You are talking about the $750,000 for the retail store closing?

Karen Short – BMO Capital Markets

No, I was just talking about the overall integration expense. I thought that in the second quarter you had pointed out that this year-over-year, this third quarter will have a shift in the million.

Dave Staples

Right, I think it’s mostly the integration related. I think what we were referring to is the $750,000 for the store charge. We highlighted that – I mean $715,000.

Karen Short – BMO Capital Markets

Okay. And then in your CapEx, can you maybe highlight or kind of give us some details on what you are cutting out, your reduction in ‘11?

Dennis Eidson

We have – we have got two new stores that we are building, one here in Grand Rapids that’s a fill-in and we have a new store in Battle Creek that’s under construction. But the biggest delta of what’s coming out is less remodeling activity than we had in fiscal ’10.

As we’ve pointed out, we have spent quite a bit of capital primarily in retail store remodels over the past several years and we are getting to a place where we are pretty comfortable with the base. So the remodel schedule will be significantly less than it was a year ago.

Karen Short – BMO Capital Markets

And then when I think about the benefit of the DC consolidation throughout the fiscal year, is that pretty evenly spread or is that more backend loaded or how?

Dave Staples

Yes, I think that will – it will roll I think relatively evenly. I mean – because the real heavy lifting happens this quarter. We really do the transitioning. Now clearly in the first quarter you know you still have clean up, but we’ve disclosed that one time net number of $200,000 to $600,000 that we thought might wrap up a lot of those inefficiency charges in the first quarter. But yes, the benefits from the consolidation from an operational perspective should begin pretty much on track in the first quarter.

Karen Short – BMO Capital Markets

Okay. And then I guess last question or two maybe, if you could talk a little bit about the competitive environment like where – what kind of operator you are seeing mostly from or is that broad based? And then what’s your – in terms of the number of competitive openings in 2011, number of supercenter, number of new Meijers, number of smaller format Meijers, can we get some color on that?

Dennis Eidson

Yes, I think we can. The competitive environment I think probably like it is everywhere in the country is probably ratcheted up a bit. Everybody here is fighting for share. I don’t know what anybody’s numbers are, we know what ours are. But I would be surprised if we are – if our competitive set is running positive comps in our marketplace. We continue to see pressure on every day pricing as well as promotion. We did make some investments in pricing in the quarter, particularly center store based commodity items are under significant amount of pressure and we – that’s where we have made the majority of our investment.

We are also feeling – the limited assortment guy, Save-A-Lot, and all the – there is a little bit more presence. And we now have Save-A-Lot regularly running an ad which is a little bit outside of what was their historical go-to-market strategy, and they almost feel very high-low in some weeks as we look at that.

Particularly at the beginning of the month, Karen, where this whole government assistance money hitting the street and driving sales was something we didn’t feel as acutely as we do today, but we are doing well at the beginning of the month, and now we are feeling that softness at the end of the month. So all that’s playing into it, but I couldn’t say it’s critical or overly irrational. I think it’s extremely competitive.

In terms on the competitive – of the competitive openings coming into next year, we have a Meijer opening in Northern Michigan in a core retail market for us which is going to occur in our first quarter.

Karen Short – BMO Capital Markets

And that’s a supercenter or a smaller format?

Dennis Eidson

It’s supercenter. To my knowledge on the Meijer smaller footprint 100,000 square foot store, they have opened one store, and they have announced a second one, both in Illinois, so we don’t know of any announcement of any smaller footprint stores here in the State of Michigan at the moment, don’t know anymore than those two.

Karen Short – BMO Capital Markets

All right, okay.

Dennis Eidson

So that would be one Meijer up there in Northern Michigan. We have got a Super Wal-Mart coming in the third quarter in our core retail market in Metro Detroit for us. And then there are some multiple other – couple other Meijers and then other Super Wal-Mart that would be more an ancillary markets to our core retail. So clearly a diminished impact of supercenter activity vis-à-vis what we experienced this year.

Karen Short – BMO Capital Markets

Okay, great. Thank you.

Dennis Eidson

You’re welcome.

Operator

Thank you. Our next question is from the line of Bakley Smith with Jefferies & Co. Please go ahead with your question.

Bakley Smith – Jefferies & Co.

Hi, guys? Good morning. Most of my – actually most of my stuff was related to – I was going to ask about the competitive activity. I guess my question would be, as you look at your customers and sort of strategize the answer to the alternate formats, I mean do you feel like when – I guess my question is, are you losing people to those formats, someone irrelevant to what you are doing? Do you think people are just going to Wal-Mart, Meijer, et cetera, or you mentioned – you said a lot – you mentioned I believe all the – I guess my question is, if you price to get them back and do they come or do you feel like, since you are fighting a fight where people’s mindset is taking them to larger format or alternate format? I mean I guess with the idea that do you therefore need to be or is it useful – is it a useful investment to price to keep up with those guys or are you generating what you want to generate when you price to compete with the bigger formats?

Dennis Eidson

The answer to, are we relevant, we clearly believe we are relevant. We believe the offer resonates. But I think if you were to conclude at what point we are not relevant I think you would be saying I think the conventional supermarket sector isn’t relevant, I don’t think anybody believes that. I think what we are experiencing here is ground zero for this economic recession is really – there is a lot of noise in the marketplace.

When you look at U6 unemployment number, the underemployed, it’s really it’s like 21.5%, that’s nearly one in four folks want a full-time job and don’t have one. So it’s making the numbers here very difficult. Again as I said earlier, I don’t know anybody else’s numbers, but I would be surprised if anybody is running positive based on what we are seeing and our own observations what we see promotionally.

So when we price, where we price, let me just remind you how we price is, because our primary competitor here is supercenters and limited assortment stores, we are very focused on their pricing metrics. So we are a pretty tight delta to Meijer. Where there is a Save-A-Lot in the marketplace, we are synced right up, not only on the key items, but we also go the extra step of merchandising those key items and mask quantities at the same or better retails of the limited assortment guy in order to drive that value perception to the consumer.

And then what we also try to do is be that easier shop, so when you add in things like pharmacy where we have robustly grown and our script count continues to be positive even throughout this environment and fuel along with the promotional program that we think is extremely relevant and competitive everyday price we are relevant. I just think we need to get through what has now become the worst economic environment we have had in Michigan and anybody here’s lifetime that we can remember.

But I toast [ph] that by saying I said earlier in the call the fact that we have gotten through this tough quarter, we have two consecutive years of $100 million of EBITDA, and remember we are cycling what is basically a record year last year that we are doing these comparatives against. So I think we are in the right place, we are going to do more to drive that value equation. I spoke a little bit about that. There will be a campaign launch early next year to help us with that image, but I think we are going in the right direction.

Bakley Smith – Jefferies & Co.

Well, I mean – obviously you would tend to agree that the relevance of the conventional format is obviously still in place and all that. I guess my question is more – is it the best use of your spending to kind of go after people that maybe are going to end up going across the street anyway and perhaps if you could protect margins a little bit by just saying, hey, these guys are going to shop us no matter what. I guess is it a fight worth fighting to try to get in there with – and I am not saying on – obviously there’s items you have to be competitive, but I am saying for certain – for a seasonal type items or whatever is it – is it worth going after the customer that right now is picking some of these formats is just where he or she wants to go.

Dennis Eidson

It is a balancing act, Bakley. I mean there is – some art to go with the science. And we are certainly – we are cognizant of the fact that we need to deliver bottom line. We think we are staying true to the strategy we have in place. We think it is generating results that will be – we would all like to do better, we think are fairly reasonable return in this environment. We kind of look at those almost one-off.

As an example, we decided to play in the third quarter in the turkey game. Wal-Mart came out and they were $0.40 a pound on turkeys across the country and we beat that price in our strategy around promoting for the holidays. We think that was the right thing to do. Our core consumer deserved to have a price equal to or better than – in this case better than Wal-Mart. And we have a belief that if you win that early holiday of Thanksgiving, you get some benefit going forward. We’ve got a lot of positive comments from consumers about how they appreciated the local grocer stepping up and providing extreme value. And in some markets we were actually $0.29 in turkeys. So I don’t think there is just a bright line that you say you are not going to crossover here or there.

Bakley Smith – Jefferies & Co.

Okay. Thanks very much.

Dennis Eidson

Thank you.

Operator

Thank you. (Operator Instructions). Our next question is from the line of Ajay Jain with Hapoalim Securities. Please go ahead with your question.

Ajay Jain – Hapoalim Securities

Hi, good morning, and thanks for taking my question. First on deflation, is it possible to just quantify the level of deflation in Q3 based on your cost of goods? And I also wanted to just revisit the question on average ticket and customer count in the latest quarter, if you have any feedback or if you can just quantify that a little bit further, I would appreciate that? Thanks.

Dave Staples

Ajay, when you look at deflations, we mentioned in the script, we are around the 2% mark, we think. I think as you looked at deflation, it was interesting as it went over the quarter, some categories deflated had been running say at an inflationary rate and moved much closer to flat and maybe even a tad deflationary by the end while other categories that have been higher deflation moderated over the quarter. So – but in the end when you mix all that together, just I guess to try to let everybody understand this isn’t some simple everything moves in the same direction analysis, about 2%.

Ajay Jain – Hapoalim Securities

Okay, and as it relates to, just trying to quantify the average ticket and customer count. I know that Dennis mentioned that they were both down and both had some relative impact, but is there any frame or reference you can give?

Dave Staples

I mean we don’t disclose the specifics, but I mean the trend slightly worsened for us in the quarter, so I mean there was a slightly higher trend. I mean it is basket and it is transaction, and may be slightly higher weighted to the transaction as a result of that activity up at Glen.

Ajay Jain – Hapoalim Securities

Okay, great. Thanks for that. And just in terms of the comp guidance for Q4, you have already talked about this, but can you give any additional color on the operating environment and what’s really behind the incremental sales weakness, because I am under the impression that the official unemployment Michigan is basically stabilized at around 15% over the last few months. And Dave, I think in your prepared comments, you talked about the impact of private label and competitive store openings on comps. But assuming the job situation has gone dramatically worse within your markets, I am just wondering if you have any further comment on what’s behind the current rate of sales decline and where were you seeing the biggest impact right now from a top line perspective?

Dave Staples

Well, Ajay, I guess first off I want to just expand a little upon your unemployment comment, because I don’t think we agree with that. I think what – when you look at the overall unemployment rate in Michigan, it looks as though it’s stabilized and it looks as though it maybe it even declined slightly. But when you look deeper into it, you’ll find that mostly I think because people dropped out of the market, out of the employment labor force, in other words.

I think if you look at that U6 number, which the U6 number is really unemployment factor that’s published that includes underemployed and what you would call people sort of dropped out of the market, that actually is a four quarter rolling average that increased from about 20.9% to 21.5% over the third quarter. And then when you look at markets outside of Southeast Michigan where you had people drop out of the labor force, you will have anywhere from a 0.5% to almost 2% increase in the unemployment rate in November and December. So it’s a little bit more mix when you look at the high level.

So our belief actually is over the course of the third quarter, the unemployment situation in Michigan worsened some. And our belief is it may worsen some a little bit even into this fourth quarter. But then we do believe it will stabilize and over the next fiscal year and then we will see some modest pop back like everyone else is talking about. But we will lag behind. So I guess that’s first how I would characterize that.

And then I would say, the majority of that incremental run rate is really the VG’s inclusion and this cycling of the re-grand opening. And I wouldn’t under – I don’t want to underemphasize the cycling of the re-grand opening, this was a phenomenally successful program for us. In the first weekend of the re-grand opening, that store did almost $900,000 in a week. And so this benefit of that is somewhere between $1.2 million and $1.5 million in just a quarter for just that recycling. So that’s a part of the trend increase.

VG’s coming in and it certainly a part of it, and then the decline in unemployment a little bit tougher economic environment. But the VG’s and the cycling of the grand opening is a significant component of that trend change.

Ajay Jain – Hapoalim Securities

Okay, thank you, Dave. And I also had a question in relation to vendor support, are you starting to see any incremental relief for manufacturers in terms of industry pricing? And as a hypothetical to the extent that you do get some additional vendor support going forward, would you be inclined to reinvest those benefits in the form of lower prices or not necessarily?

Dennis Eidson

First question, we have not seen an appreciable difference in the amount of vendor support as we look at that metric. And secondly, I think it would depend on how it comes, Ajay. If the support is simply the fact that they are reducing everyday price cost of goods, on the wholesale segment, clearly we just reduce it immediately and we pass that on to all the stores that buy out of the house and then we would appropriately act at retail mindful of the competitive set.

If it were in additional promotional spending and it is likely in this environment that we are in today that we would probably aggressively spend that to attract more customer traffic and top line sales. There has been more activity with the supplier community on coupons. Coupons are up significantly in terms of the numbers that are being dropped. I think the national number is like an 8% improvement. Our coupon redemption is significantly up.

I think our quarter number says we are up like 32% on coupon redemption in the quarter, again that customer is driving toward value. And we have actually kind of invested with coupons. In some markets, we doubled coupons everyday up to a $1. Other markets we’ve run promotional – week-long promotional campaigns where we double up to some multiple. And it does seem to pulse and has a role as part of the promotional portfolio.

Ajay Jain – Hapoalim Securities

Okay, great, thank you. And just lastly, Dave, I think on last quarter’s call, you gave some confirmation that the VG’s integration would be slightly diluted for this year. Can you just give an update on that process and if possible just clarify the earnings impact for this year and if you expect any residual impact on earnings heading into fiscal ’11?

Dave Staples

I think we would just – we would stay with that. I mean we do believe that, all in, the VG’s operation will still be slightly dilutive. It’s obviously a difficult environment on that side of the state. I don’t think we see any changes to that.

Ajay Jain – Hapoalim Securities

Okay, thank you.

Operator

Thank you. Our next question is from the line of Chunk Cerankosky with Northcoast Research. Please proceed with your question, sir.

Chuck Cerankosky – Northcoast Research

Good morning, everyone.

Dennis Eidson

Good morning, Chuck.

Chuck Cerankosky – Northcoast Research

Dennis, can you talk about how prepared foods did during the quarter and how the quality mix or product mix changed versus a year ago?

Dennis Eidson

I have – I am going to let Alan respond to that.

Alan Hartline

Yes. Chuck, from a center store standpoint, we continue to see a number of categories that resonate like frozen foods and the dinner segment continue to go up, particularly it’s some of the lower segments within there. From a fresh standpoint, rotisserie chicken is still very relevant, our fried chicken program still resonates. And then from our central kitchen where we are vertically integrated here, we have produced a number of easier to prepare meals. And although we have got a little base, we are seeing three-fold multiples within that segment. And we started it in D&W and we continue to offer that up in other banners as well. So that’s a focus for us that’s clearly resonating with the customer.

Chuck Cerankosky – Northcoast Research

And these would meals either prepared in the store at or at central area?

Alan Hartline

Yes. It’s in our central kitchen.

Chuck Cerankosky – Northcoast Research

Okay. Dennis, when you are looking at your value proposition here which is price, quality, convenience, and just couple of other things you mentioned, can you talk about where price ranks right now versus a couple of years ago?

Dennis Eidson

Chuck, we are just over a year in our using the customer sat vehicle that I was quoting from, so I do have year-over-year numbers. Price is the metric on that survey that improved the most year-over-year. So – and as you know it’s the an important driver of value. And we are really proud of that, because we – when we started on this value initiative a little over a year ago, we had an objective to move that number and we have done it.

It still remains a number that’s relatively low on the score, but when you think about the positioning of a conventional supermarket against competitive set of limited assortment stores like dollar stores and supercenters, we don’t have that bulk price position, but we are delighted with the improvement in the price proposition.

Chuck Cerankosky – Northcoast Research

You are talking where you were and now where you are perceived to be?

Dennis Eidson

Correct.

Chuck Cerankosky – Northcoast Research

Okay. Do customers care about quality right now? Well, I am sure they do. But can you sort of quantify that where that matters and things like store convenience, store locations?

Dennis Eidson

Yes, we track those on the survey and frankly, interestingly, every one of our – virtually every metric has improved and improved from a statistically significant -- in a statistically significant way. So they are all moving in the right direction, which again gives us a lot of confidence that the plan we have in place is resonating.

What I might anecdotally say to around quality is if you look at the brand portfolio, the fresh market brand on a relative basis is outperforming the balance of our brands. And as you know, we go to market there with a more upscale positioning with an emphasis on variety and quality so you'll find larger sizes of fruit, for example, in the produce department, et cetera. So it is interesting in this environment and admittedly those stores are placed in a demographic geography that would support that, but that they seemed to be more resilient than the balance of the portfolio.

Chuck Cerankosky – Northcoast Research

All right. When you look at the easing of deflation, which might mean a bit of the inflation, how concerned are you about having a negative impact on volumes?

Dennis Eidson

No, I think modestly concerned. I don’t think we are going to see ramp in inflation. If you look at these deflation numbers, Dave was talking about negative 2% that we just experienced in this quarter and you kind of compare that to a year ago, at least on the wholesale side, we were seeing the inflation of like 8% -- 7%, 8% a year ago right, so our delta is big.

I think if you had 7%, 8%, 9%, you would see that reduction in units, and we actually saw that a year ago. But I don’t think anybody is anticipating the inflationary return will be anything like that. I think we are seeing maybe modest inflation. I think the experts are predicting somewhere in the middle of the calendar year, we may see this begin to turn, and what, 2% or 3% is kind of the numbers that are being kicked around. I just don’t think it will be overly significant, Chuck.

Chuck Cerankosky – Northcoast Research

All right, then it’s all about taking the royalty card to other banners. Any thoughts on that at this point?

Dennis Eidson

Lots of thoughts on that. I would say to you that maybe a bit unlucky relative to the timing of our launching this, because there is just so much noise in the marketplace. And we launched it in Glen’s in the Northern Michigan, unemployment as I pointed out, and in Northeast it’s almost 19%, it is not too dissimilar on the other side. It’s probably been more difficult for us to understand what the impact of the curve has been compared to our expectation.

So we are a believer, we like the data we are getting, we have tactically applied some of the learnings in some instances with very significant responses. So I have no reason to believe that we won’t ultimately roll that out, but I couldn’t give you a timeline just yet.

Chuck Cerankosky – Northcoast Research

So you want some a more normalized environment I guess before you would roll it out?

Dennis Eidson

Yes, these are more normalized environments. When we get to the middle of this year, we will have year-over-year comparatives, we will be able to better track customers’ behavior. And – but I think the card is, having the data is important; however, you get it, we happen to have chosen a card. Having the data to be able to make more informed decisions about the consumers’ habits I think is critical for any food retailer going forward. You have to have a vehicle that collects the data.

Chuck Cerankosky – Northcoast Research

All right. And then finally are you seeing any of your independent retailer customers stores available for sale back to you, I am thinking of onesies and twosies here, any of that’s going on in the market that could be an opportunity?

Dennis Eidson

There is nothing that is imminent. That is really a process that goes on over the course of a relationship with independent retailer, but I wouldn’t be surprised if some of that doesn’t develop as we get into 2011.

Chuck Cerankosky – Northcoast Research

Okay. Thank you very much.

Operator

Thank you. (Operator Instructions). Our next question is a follow-up from the line of Karen Short with BMO Capital Markets. Please go ahead with your question, ma’am.

Karen Short – BMO Capital Markets

Hi, thanks. I just had two housekeeping and then a broader follow-up. Dave, what tax rate should we think about for 2011? And then also you said you had two new stores in 2011, can you give us the timing on those?

Dave Staples

Yes, so the tax, I have used about 39.9. I think that’s a fair rate, all in. The stores, there’s two new stores, but one is a relocation of an existing store. So in our Grand Rapids market, we have that D&W Fresh Store, that will open up early in the first quarter, and then I would say middle of the first quarter. And then the second store which is the relocation of a Family Fare store, actually a Felpausch store, that will become branded as a Family Fare, that happens middle of the second quarter.

Karen Short – BMO Capital Markets

Okay. And then if I were to just think about VG’s, I am curious, when you took the team over, what do you think the price gap was with say a Kroger and also Wal-Mart and what do you think it is now, where is it now?

Dave Staples

Well, I mean think based on our studies in the acquisitions, we are always very tight to Kroger, and I think we still are very tight to Kroger. I think to Meijer the supercenter there, I actually I think they were fairly in line with our corporate strategy, and I think we continue to keep them in line with our corporate strategy.

Karen Short – BMO Capital Markets

Okay. So right now what we are seeing in terms of the operating margin is just broad based, it’s not necessary we VG’s needing to be repositioned?

Dave Staples

Correct.

Karen Short – BMO Capital Markets

Okay. Thanks.

Operator

Thank you. There are no further questions within the queue at this time. I would like to turn the floor back over to Mr. Eidson for closing comments.

Dennis Eidson

Okay. Thanks. Rob. Well, if there are no more questions, we will conclude the call. And on behalf of Dave and everyone here on the Spartan team, I thank you for joining our call today and we will look forward to discussing our fourth quarter and year-end results with you during the next call. Thank you.

Operator

This concludes today’s teleconference. You may disconnect your line at this time and thank you for your participation.

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