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SUPERVALU Inc. (NYSE:SVU)

F3Q 2014 Results Earnings Call

January 9, 2014 8:00 AM ET

Executives

Steve Bloomquist - Director, Investor Relations

Sam Duncan - President and CEO

Bruce Besanko - Executive Vice President and CFO

Analysts

John Heinbockel - Guggenheim Securities

Ajay Jain - Cantor Fitzgerald

Scott Mushkin - Wolfe Research

Chuck Cerankosky - Northcoast Research

Karen Short - Deutsche Bank

Edward Kelly - Credit Suisse

Stephen Grambling - Goldman Sachs

Bryan Hunt - Wells Fargo Securities

Operator

Good morning. My name is [Tallinn], and I will be your conference operator today. At this time, I would like to welcome everyone to the SUPERVALU Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the conference over to Mr. Bloomquist. Sir, you may begin.

Steve Bloomquist

Thank you, and good morning, everyone. I want to welcome everybody to SUPERVALU’s third quarter fiscal 2014 earnings conference call. Joining me today are Sam Duncan, Chief Executive Officer and President; and Bruce Besanko, Executive Vice President and Chief Financial Officer.

Following prepared remarks, we will open up the call for your question. So that we can accommodate as many people as possible, I would ask you limit yourself to one question with one follow-up.

The information presented and discussed today includes forward-looking statements, which are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our most recent 10-K filing. A replay of today’s call will be available on our corporate website at www.supervalu.com.

With that, let me now turn the call over to Sam.

Sam Duncan

Thanks, Steve. And let me welcome everyone to SUPERVALU’s third quarter conference call. This morning we reported third quarter adjusted earnings per share from continuing operations of $0.13. Adjusted EBITDA was $175 million for the quarter bringing year-to-date adjusted EBITDA to $596 million.

During the quarter we made progress on a number of important initiatives in all three business segments and I again, want to thank all of our employees for their efforts and commitment this past quarter, especially during the busy holiday selling period.

One of the real highlights for this quarter was the sales momentum we continue to see at Save-A-Lot, where both corporate store and network ID sales were positive and again showed sequential improvement.

Network ID sales were positive 1.7%, a first positive quarter since Q4 of fiscal 2012, while corporate store identical sales were positive 5.4%., in our Retail Food segment identical store sales were negative 1.9%. Finally, Independent Business sales were down 3.7% compared to last year.

Moving to our segment results let me start with Independent Business where our year-over-year sales were down $74 million or 3.7%, a large part of the sales decline was attributable to the loss of larger accounts earlier in the year where independent retailers chose to go in a different strategic direction.

In addition, we continue to experience softness in our military business, which was impacted by the temporary closure of commissaries during the government shutdown. Now that we are past our year-end holidays we are working to turn the discussions we have had and the relationships we have built into new customers what we call affiliations.

Operating income was up from last year as a result of improved gross margins, which included higher year-over-year income from professional services and good cost control. Our logistics team has a done a great job managing expenses, one of the company’s real strength especially in light of sales challenges we have faced.

Our operating results continue to reflect the benefits of rightsizing our distribution center network where appropriate and the basis point mentality that has been a trademark of the supply chain organization. Over the past two years we have consolidated the volume from warehouses in Ohio and Wisconsin into other facilities to lower our overall operating cost.

Another cost saving initiative we announced this past quarter was investment in 35 semitrailer trucks powered by compressed natural gas, compared to traditional trucks the CNG fleet is expected to lower our overall annual operating expenses, while reducing oil consumption by 1 million gallons and lowering greenhouse emissions by 1,300 tons per year. We will closely monitor the economics of this pilot program and may look to roll it out to additional DCs in the future.

Last quarter, I introduced our single source initiative with the retailers to concentrate their produce purchases with us. Their purchase concentration provides us with efficiencies and ordering and operations which allows our customers to improve their cost of goods and lower their strength.

We are now up to approximately 75 customers on the program and look to build upon the results it has generated. Single source supply and CNG fueled trucks are examples of how we are working on driving topline sales, while diligently managing our cost structure.

To repeat what I had said last quarter, the clear number one priority for our Independent Business segment remains topline sales and we continue to push hard to improve these sales while continuing to deliver the high service levels that our customers expect.

Let me move on to Save-A-Lot, where corporate IDs improved sequentially for the fifth straight quarter coming in at positive 5.4%. Network IDs were positive 1.7% reflecting a sequential improvement of 210 basis points compared to Q2.

Save-A-Lot results this quarter continued to reflect the benefits from the fresh cut meat program that we are rolling out to our corporate stores. Our renewed focus on produce across the entire store network, a reduction in insight margin made during the first two quarters of the year and perhaps more importantly, the greater level of confidence that our licenses have in Save-A-Lot and the Save-A-Lot team.

For the quarter, corporate store customer counts and average ticket were both up compared to a year ago. Operating income at Save-A-Lot increased largely as a result of cost reductions made earlier in the year.

We have also been assessing the long-term impact of the SNAP, our Food stamp program changes that began in November, which has prove challenging given the overlap with the two key holiday selling periods.

Our initial thinking is that Save-A-Lot is seeing a net adverse sales impact of slightly less than 1% and that customers are largely offsetting lower EBT benefit levels with cash purchases. We will continue to monitor the impact of this change on our business as we do other economic factors.

As I mentioned last quarter, we continue to see momentum around our produce program following our nationwide produce seminars, the implementation of more rigorous standards for screening produce coming into our DCs, added quality assurance staff and more tailored regional assortments all of which has helped drive produce IDs that are approximately 800 basis points above the rest of the store.

It is also worth noting that our meat program is strengthening, in part due to the rollout of meat cutting and a portion of the corporate stores that we did not have it before, but also as a result of our focus across all of our fleet on executing with more variety, better pricing and improve messaging. As a result, meat department ID sales were approximately 1,000 basis points higher than the rest of the store.

Among the licensee stores, ID purchases improved this quarter, partly due to cycling the merchandising changes made in last year’s Q3 related to national brand special buys. In addition, the sequential improvement in licensee purchases reflects the higher confidence level that these retailers have in the Save-A-Lot brand, the team and the programs we are working to implement.

As we move through the balance of this year and into fiscal ‘15 growing Save-A-Lot store count both corporate and license in a more meaningful way will be a key part of our plans.

We have begun to hire additional real estate and development personnel, in addition to establishing the human resources infrastructure needed to support a faster growth rate. We are also in negotiations for a new dry warehouse facility that will allow us to more effectively serve a number of new markets and provide the foundation for future store openings.

Turning to Retail Food ID sales were negative 1.9% this past quarter. While gross margins were up approximately 100 basis points compared to Q2, with sequential improvement in both base margins reflecting lower levels of promotional spending and shrink as our retail banners continued to show improvement in balancing inventory levels and sales.

From a pricing and promotional perspective, we will continue to adjust and manage our investments spend on a quarter-to-quarter basis, as we balance sales and cash flow against our overall business objectives. Within the banners we accomplished a great deal in terms of improving our in-store conditions as we completed the initial phase of our model store project.

One of the areas we have been focusing on is improving our perishable departments, including meat and produce given their importance and how customers perceive the overall store.

As a result of changes we have made over the past several months, our sales mix in these two departments is now running up approximately 100 basis points compared to last year. This is largely the result of improved disciplines around receiving and handling product, as well as changing the mentality of our banners towards driving sales.

Beyond the perishable departments, we feel good about the overall look of our stores and the improvements we have made to the shopping experience, but we still have a number of initiatives we are working on to further increase our relevance to our customers.

For example, as our merchandising teams have reviewed our categories sets and space allocation, it became quite clear that we have a number of areas where we do not have enough linear feet devoted to the assortment, meaning key items are missing from our sales, two of the categories we are addressing now are pet and baby, later we will plan to introduce 25 to 50 new items in the coming months.

Items with the gross margins and demonstrated customer demand. It will take some time to review the planograms for nearly 200 stores and determine the most appropriate way to insert these items, but we are moving as quickly as we can to get this done.

Another area where our retail banners are making gains is in private brands, where we are running ahead of our internal sales penetration goals and where we have been able to generate significant savings from a cost of goods perspective.

Our private brand sales penetration has increased 75 basis points on a year-to-date basis compared to last year and we know we still have a significant opportunity in front of us.

From an operations perspective, our banners have done a nice job in sequentially lowering the level of shrink compared with Q2. As we introduced the decentralized operating structure and push the banners to drive for sale. I was not surprised to see a temporary increase in shrink.

In Q3 it became very apparent the banners were better able to manage the trade-off between sales and shrink, which gives us greater confidence as we set future sales and promotional plans.

Lastly, we have launched or we’ll launch shortly rebranding campaigns in all of our retail banners where our customer messaging has been disjointed and often times confusing, when complete these banners will have a much more clearly defined identity, which we will be communicating across all platforms, including in-store signage, weekly ads, customer emails, mobile devices and banner web pages.

These campaigns create a much cleaner look to how each banner presents itself to its customers, which is a dramatic departure from our prior look. I would point you to our SHOP ‘N SAVE website, if you want to see an example of one of these rebranding efforts.

I’m pleased that the progress we have made and believe our banners are better positioned to be successful. We will continue to focus on providing clean and vibrant stores delivering strong product offerings and running each of our locations with one primary goal in mind our customers.

With that, let me turn the call over Bruce for his comments on the quarter and our financial condition. Bruce?

Bruce Besanko

Thank you, Sam, and god morning, everyone. As outlined in this morning's press release, for the third quarter of fiscal ’14, we reported net income from continuing operations of $32 million or $0.12 per diluted share.

This figure includes $3 million in net after-tax charges comprised of a multi-employer pension plan withdrawal charge, asset impairment, contract breakage and other costs, partially offset by a gain from the sale of a property, excluding these items net income from continuing operations was $35 million or $0.13 per diluted share. Pro forma adjusted EBITDA as outlined in Table 5 of our release, totaled $175 million for the quarter and $596 million year-to-date.

Consolidated net sales in the third quarter were $4.0 billion, a decrease of 1.0% compared to last year. As a reminder from last quarter, net sales for all periods now include fees earned on the transition services agreement, what I’ll refer to as TSA for short. Independent Business sales were $1.91 billion, a 3.7% decline from last year's $1.99 billion although profitability in the segment was up year-over-year, which I'll go into in a minute.

ID sales were down compared to last year due to several factors. First, sales were impacted by lost accounts, including two large customers who chose to leave SUPERVALU. This volume loss will be a headwind for the next three quarters.

Second, we continue to see pressure on our military business attributable to the loss of sales from previously closed commissaries and due to the government shutdown where we lost approximately one week’s worth of sales. Finally, we have earned in only a nominal amount of new business this quarter partly due to the difficulty in persuading potential customers to switch wholesalers during the holiday months.

Remember to that this decline in sales include the slower pace of new business from prior quarters that would've contributed to Q3. As Sam stated now that we’re into the new calendar year, we’re more optimistic that we can add new customers to our ID business.

Network sales of Save-a-Lot were positive 1.7%, a sequential improvement of 200 basis points from the second quarter. ID sales from corporate stores within the Save-a-Lot network were positive 5.4%, which represented the fifth consecutive quarter of sequential improvement in sales for the stores we operate and the second consecutive quarter of positive IDs for these stores. Both sales figures include the impact of 100 basis point reduction in inside margin we made earlier in the year, 50 basis points in Q1 and 50 basis points in Q2.

Within our Retail Food segment, ID sales in the quarter were negative 1.9%, a sequential decline from last quarter's negative 0.9%. Customer counts were down 2.5% while basket size increased by 0.6%. Our overall estimate for cost inflation was approximately 0.75% for the quarter. Consolidated gross margin adjusted for our $3 million multi-employer pension withdrawal charge was 14.3%, up 120 basis points compared to last year.

Both this year and last year now include the TSA fees which increased $38 million year-over-year and was the primary driver of the overall change in gross margin. Approximately 30 basis points to the gross margin change was driven by lower infrastructure costs, primarily related to merchandising and marketing functions resulting from cost cutting initiatives, as well as better supply chain costs, partially offset by price investments of Save-a-Lot and within Retail Food.

Consolidated SG&A expense was 11.6% of sales compared to 12.3% last year, adjusted for one-time items, including store closure charges and a gain related to a credit card settlement. The 70-basis point decline was a result of our year-over-year cost savings initiatives and lower depreciation expense.

As I called out last quarter, remember that our SG&A expense for all periods no longer includes reduction attributable to TSA fees as we move those fees into revenue. Net interest expense for the quarter was $52 million, compared to $63 million in fiscal ‘13. The change was driven by lower average rates and outstanding balances in our senior notes, mainly those that mature in May 2016 and June 2021.

Moving from our consolidated P&L to the segment results, Independent Business operating earnings excluding the net charges primarily related to the multi-employer pension withdrawal and asset impairment, partially offset by a gain from the sale of property was up $5 million this quarter versus last year.

As a percent of sales, it’s equated to a 30-basis point improvement, which was driven by stronger gross margins and included the benefit of strong expense management and higher levels of professional services. At Save-a-Lot, operating earnings was $40 million for the quarter compared to an adjusted $37 million last year, which excludes asset impairment charges of 4.1% of sales compared to 3.8% last year. Operating earnings improved as a result of strong cost controls particularly around corporate overhead and benefits.

For Retail Food, operating earnings for the quarter, excluding a $1 million favorable severance charge reversal from earlier this year was $23 million, or 2.2% of sales compared to $8 million last year or 0.7% of sales after adjusting for the gain on a credit card settlement that was partially offset by an asset impairment charge. This 160 basis point improvement in operating margin reflects 120 basis points in lower depreciation expense with the balance coming from the administrative cost reductions, which were partially offset by investments and price.

Finally, our corporate segment showed an operating loss of $12 million compared to $65 million last year. Similar to the second quarter, the change from last year was primarily driven by the $38 million in incremental fees under the TSA as well as lower employee related expense due to cost reduction initiatives. Also as a reminder, remember the last year's expense included administrative cost related to the sold retail banners that weren’t covered by the prior TSA.

I know from a number of discussions I've had with investors that there's still some confusion around the TSAs. So let me see if I can add some clarity. The TSA fee is $200 million annually offset by certain services assumed by Albertson’s LLC and NAI shortly following more stringent action.

These offsets are neutral to SUPERVALU because the loss TSA revenue represents costs that were not incurring to provide the transferred services. In addition, we’ll receive $60 million in fiscal ‘14 as the year one transition payment which helps us to absorb the higher administrative cost that exists as we right size our cost structure.

We recognize approximately $36 million of the transition payment in the first quarter, $18 million in the second quarter and $4 million in the third quarter, the remainder will be recognized in Q4. This recognition pattern was based on our estimates of the timing of the cost would come out of the company and was intended to be an offset to temporarily stranded costs in our P&L.

Because we've been able to remove costs somewhat quicker than anticipated, we've shown a nominal amount of net operating income from the transition payment largely in the second quarter. The TSA was put together to be largely breakeven for SUPERVALU in fiscal ‘14, going forward. Results will depend on the level of services being provided and the ability of SUPERVALU to manage the costs of providing those services. The complete TSA was filed with the Securities and Exchange Commission on March 26 of 2013 and will soon be posting a summary reference document to our website that covers some of its key points.

Now let's turn to the balance sheet. At the end of the quarter, our outstanding debt totaled $3.0 billion, an increase of approximately $30 million over last quarter. This increase at the end of our third quarter is very typical as we build inventories during the holiday selling season and reverses itself from the fourth quarter when inventories return to a more normalized level. Quarter end borrowings under our revolving credit facility totaled approximately $210 million.

Turning to our corporate pension plan, we've seen estimated funding levels improved substantially this fiscal year. At the end of fiscal ‘13, our plan was underfunded by approximately $860 million.

Based on current market conditions, including interest rates in the equity markets, we anticipate the underfunded level to drop roughly in half by fiscal year end. I say roughly in half because funding status can be very sensitive to market changes but we’re pleased with what’s happened to our pension this past year as I'm sure other large companies are with what's happened to their plans. Moving forward as the plans funding status improves, our asset allocation policy which more closely aligns fixed obligations with fixed income securities is expected to somewhat reduce the level of volatility.

Turning to cash flow. So far this year, we've used $172 million in cash within our operations compared to $22 million last year. The single biggest driver of this change similar to what we reported in Q2 is the fact we paid approximately $110 million more in cash taxes this year compared to F‘13.

In addition, we’re also carrying higher levels of working capital consistent with the investments we made in our retail stores. Capital expenditures for the year totaled $64 million, about $140 million less than last year as we focus primarily on maintenance items related to our retail stores and distribution centers. We’re now projecting full-year spending in the range of $120 million to $130 million below our original plan of $160 million.

For fiscal 2014, our view for full-year adjusted EBITDA has not changed since the last call. As we said last quarter, we’re not providing guidance for the year. However, again as we said last quarter, we expect adjusted EBITDA for the full fiscal year will be modestly lower than what we thought earlier.

And with that, let me turn the call back to Sam.

Sam Duncan

Thank you, Bruce. As I stated earlier, we have made good progress on our efforts to reposition this company for the future. We continue to look for ways to build on a historical strength to this organization and we remain focused on the two parties, I speak to each quarter, driving sales and cash.

I continue to challenge our leadership team to make sure we are working on to become more relevant to our customers, potential customers. We’re focusing on their needs and not our needs. We will remain focused on delivering the goods and services that customers want at a fair price and in a clean and inviting environment.

With that, Bruce and I will now take some of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Heinbockel with Guggenheim Securities.

John Heinbockel - Guggenheim Securities

Couple of things on Save-a-Lot. If we pull our meat and produce, would the network comps be positive or negative?

Sam Duncan

Bruce, you want to take that.

Bruce Besanko

Yeah. John, we're not going to go into that level of detail. What we can say though is as Sam indicated on his prepared remarks where -- the Save-a-Lot businesses is in the turn now. Their sales performance has been just wonderful. Those were up over 5% and the total network is up 1.7%. Part of that is the produce and the meat areas.

John Heinbockel - Guggenheim Securities

Because what strike me that there is -- whatever it is, it’s certainly not a big -- there is a more sustainable opportunity to drive grocery comps at Save-a-Lot. So how would you do that? Is that more marketing? Do you think you need to change the merchandising or pricing or what do you think are the keys to get that number up consistently?

Sam Duncan

Well, first of all, John, in Save-a-Lot, the key to our operation and our customers is produce and meat. And that’s where we lost the overall store business and our Save-a-Lot stores for quite a few years. In my mind, the center store is just an add-on our convenience to the customers.

Now, we are working on several things that Ritchie and his team are working on center store but our first priority was produce and meat. We are working on marketing programs, advertising programs, we are working on selection. We are working on improving our private-label quality. There's a lot of things that we are working on center store. But again, our first priority was and still is produce and meat.

John Heinbockel - Guggenheim Securities

And then lastly on Save-a-Lot, how quickly do you think you can get the unit growth up? What’s your thought process on -- is that going to be 50-50 corporate versus licensed?

Sam Duncan

It’s really hard to tell. It will be -- well, I will say it’s going to be more corporate than licensees just because it's so much easier to do, meaning it takes more time to find new licensees as you go into new market areas and even expand into existing areas, so it will definitely be more corporate stores.

John Heinbockel - Guggenheim Securities

Okay. Thanks.

Sam Duncan

Thank you.

Operator

Your next question comes from the line of Ajay Jain with Cantor Fitzgerald.

Ajay Jain - Cantor Fitzgerald

It looks like that based on the sequential weakness in retail food IDs, you still got some work to do on addressing price perception. So can you just talk about the progress you think you're making on price perception with a conventional retail format? Is this potentially like a multi-year process and also how do you think the customers are responding so far to the price investments that you're making, particularly at the center of the store?

Sam Duncan

Well, the customer response has been excellent because they've seen the dramatic reductions that we’ve made in price in a lot of very high sensitive areas like dairy, bread and many other ones. This is a long-term project that’s going to be in the retail banners because when I look back and reflect on this past year, it's an incredibly amazing on what we’ve got accomplished and I’m going to go in some other things beside retail. But when you look at this organization and the deal closed in the first quarter, this past year has been about reorganizing in new directions to our company and stabilizing the company and decentralizing and part of that is we did 1,100 personnel reps in this organization, that in my opinion it went almost flawlessly. And that’s due to the credit of our incredible human resources team, our legal team and others.

We had to establish also a new management team, not only in part of our retail banners but also our corporate and our head office. And we are all focused on driving sales and cash and we are going to continue to do that. And we are going to figure out ways to continue to work on fixed retail banners which is not going to be done overnight.

I'm incredibly proud of what our team has accomplished and it's amazing to me. And I don't think there have been very many people that would have guessed that we could have accomplished what we did and it’s due to the incredible people that we have in this organization, the new management team, et cetera.

But we still have work to do in the retail banners, so we’ve just recently got the [org] [ph] charts filled. And as you saw in Q2, our margin went down because we are doing some trial and error on pricing in our ads. And as you can see in Q3 that we’ve backed off of that, so we are going to continue to work on things and this will be a multi-year project.

Ajay Jain - Cantor Fitzgerald

Okay. And could you just talk about your philosophical approach on the price investments? I think sequentially your EBITDA run rate was stable, which is obviously positive but would you be willing to take a step back in profitability to fund those price investments if you felt that was appropriate or to what extent are you trying to manage that process by making sure that price investments are entirely pre-funded through cost-saving because I think that was the approach of your predecessor? Thanks.

Sam Duncan

Well, I am willing to give up EBITDA for growth because you will eventually get that EBITDA back over the long-term. Right now what we've done is just being try to stabilize the organization and retail is a big part of that. But what we can’t do is just say that we are going to give up EBITDA and not have incredible planning and things to do. That’s what we are working on right now is now that we’ve stabilized the retail in the rest of the company, we've got to go take a look at -- okay, what type of capital investment do we need to make to drive sales, how much is that, what do we need to do in certain areas of, Virginia could be different than Baltimore and Washington DC. But our focus is driving sales in these banners but not do it in a reckless way.

Ajay Jain - Cantor Fitzgerald

Great. Thank you.

Operator

Your next question comes from the line of Scott Mushkin with Wolfe Research.

Scott Mushkin - Wolfe Research

Hey, guys. Thanks for taking my questions. So, the first thing I want to talk about are sales. I mean, if I look, if I take a step back, Sam, Bruce, it looks like sequentially almost throughout the organization besides corporate Save-a-Lot, sales actually stepped back in the third quarter. So, I was just trying to get a feel for where you think things will be in the fourth quarter? I mean, we’ve heard from Family Dollar this morning, things are very tough out there. Are we in a situation where sales are just going to be harder to come by?

Sam Duncan

Well, a lot of that depends on the economic conditions. But again, I stated with the last question, when you look at the falloff in our gross margin in Q2, it was because we did some testing on some things in ad markdown and stuff, and we backed off of that in Q3 and that’s why you saw the sales. We were a negative 0.9 in Q2. In Q3, we were a negative 1.9. It’s going to continue to be -- again, we have just finished in totally organizing this department, the retail segment of our business the way we want it.

Again, this has been a -- this past calendar year was been a year of stabilizing. Now, we can move on to a new step in our improvement in this company. In the Wholesale side, what you have to look at is that we lost two customers. One had change of control that they elected to enact when the deal was done. When that happens, some people like it, some don’t. But also what is a big effect on that is the effect that the military business had at the closure of the government shutdown. But the most impactful thing that has hurt us on the Wholesale side is our pipeline of new customers or affiliations and what we call them. Because of these strategic alternatives announcement, whenever it was made, the minute that that was announced you are going to dry up in new affiliations.

So we have a -- had a 12 or 18 months timeframe where we did not have any new affiliations. We are working hard to fill that pipeline. So if you take the three things, the customers allowed us the two, the government shutdown and had we had just a normal run rate on new affiliations, we would have had positive sales in Q3 in Wholesale side. So you got to look at what’s happening in there.

Now, the military side is going to remain tough, no doubt about it. We are very fortunate that the Wholesale customers that we have, we have some just incredible customers and they are running nice comps and most of those because they just have a -- they are great retailers. But we are excited about all of our company again and we’ve just got a lot of things that we had to work on and we continued to work on.

Bruce Besanko

And I would just add two things to Sam’s comments, particularly around the Wholesale business. It is going to take time to bring that pipeline back up to speed. It's not something that’s going to change in the short run. It’s going to take -- it's going to take time and our run rate right now is about a third. Year-to-date run rate on new affiliations is about a third of what it's historically been over the last several years. So it's just going to take time on the Wholesale business and we are going to give it the time it needs.

Scott Mushkin - Wolfe Research

So as we look at sales outlook, it seems to me that this negative three to negative four for the distribution is kind of where things are going to be until you can turn around that pipeline, is that kind of how you would think about it?

Bruce Besanko

Yeah. I mean, I would say the business is working hard. Now that the holiday selling season is over, we are going to work even harder as we approach this new fiscal year and bringing in new affiliations. And we will wait and see as the year unfolds how that goes.

Scott Mushkin - Wolfe Research

And then the second thing is the retail business, which I know is the smallest part. Is negative sales kind of where given the environment is so tough, is that where we should have our heads negative?

Sam Duncan

It's going to be tough because we still have a lot to go in what we need to get done. But we are planning on making improvements as we go. We still have price investment where we need to take a look at. In some of our banners, we are short on space in produce and meat. Some of our banners in the store layouts are still built on the 80s and 90s where center store was more of a focus. It’s not going to take a tremendous amount of money to fix these, the layouts but it’s going to take some. But we've got enough projects that we needed to do in retail that’s going to keep us busy for quite a while. And we are going to focus on fixing the sales in that retail side of our company.

Scott Mushkin - Wolfe Research

And then licenses with the SNAP cuts, should we expect negative out of them as well and then I’m done? Thank you.

Sam Duncan

Well, the SNAP is going to have an effect on everyone, but we still have excellent opportunities on the licensees. As we've stated in our comments, they have gained more confidence in this new company. The management team, Ritchie and his team are doing a phenomenal job in working with those licensees. And what we are doing working with the licensees, they have not seen in many years and they tell us that in a very positive way. We still have a great opportunity in my mind to grow sales in the licensees. It’s just a time factor. They are going to react slower than what we can incorporate. It’s just the nature of the beast. And we still have the opportunities in the licensees and we are going to work on it.

Scott Mushkin - Wolfe Research

Thank you very much.

Sam Duncan

Thank you.

Operator

Your next question comes from the line of Chuck Cerankosky with Northcoast Research.

Chuck Cerankosky - Northcoast Research

Good morning, everyone. Sam, I was wondering if you could put the sales performance of the quarter in context of the cadence of holiday spending. You had I guess, Thanksgiving in your quarter, which ended November 30th. What can you tell us, how the Thanksgiving influenced thing, how you feel you participated in that with some of the price programs and could you give us a look at how December treated retail in Save-a-Lot?

Sam Duncan

Well, this was an interesting year for every retailer with the one last week in between Thanksgiving and Christmas. What we saw in Christmas, everything or most of the sales came late. It was really nerve-racking and from what I hear and talked to other people is the same way everywhere. But we are overall pleased with what we did in both, Thanksgiving and the Christmas selling season.

But also we had too, some effects with weather that also sometimes they help you. Of course, we’re still working through that today with this polar vortex that has hit the country. I know, in Minneapolis, even the polar bears have gone inside. But in our mind, we are very happy with what happened with Thanksgiving and Christmas. It was just very nerve-racking because it came so late on Christmas.

Chuck Cerankosky - Northcoast Research

Do you see anything in the sales mix that indicates the customers are feeling better about the economy, or is the SUPERVALU’s retail operations sort of independent from that because you said, you have so much other merchandising things to improve?

Sam Duncan

The customers are feeling better about SUPERVALU in general, because of what we have done in a very short time as far as improving the perishable operations of our company through better controls at store level. We are getting excellent comments from the customers about, they like what they're seeing, especially on the price side where pricing had gotten out of control.

But all in all, the customers liked the way that we're going the direction as do our franchisees in the Cub banner and also our licensees on the Save-a-Lot. I attend the meetings that we have with licensees and franchisees, we had that. And also our customers this past quarter and they all to a person said, they are very pleased with the direction that we are going and excited about the opportunities with SUPERVALU.

Chuck Cerankosky - Northcoast Research

When you look at sales trends and price investment trends, what are the customer’s sort of indicating or the categories where you need to do more work on price and promotion?

Sam Duncan

Well, first we have to get the -- what we look at is the top 250 items in a store and that covers a lot of department, in meat, ground beef produce as well as and in grocery or choicely your commodity items. They are noticing the changes that we have made. We are not where we want to be and we will make those changes overtime but again not in a reckless way. We have some opportunity gap yet on pricing that we’re working on.

Chuck Cerankosky - Northcoast Research

But it’s still largely within that, 250 SKUs that are highly visible to the customers.

Sam Duncan

Yes.

Chuck Cerankosky - Northcoast Research

Thanks a lot, Sam.

Sam Duncan

Thank you.

Operator

Your next question comes from the line of Karen Short with Deutsche Bank.

Karen Short - Deutsche Bank

Hi. Thanks for taking my question. Just to clarify on the retail comp, so is it fair to say that in the third quarter you were more rational on your promotions and I mean I think that your wording was more balanced promotion. And that is what caused the reversal on traffic trends because it would seem that in the second quarter you saw some improvement in traffic in that and you gave that back in this quarter. So I guess, the question is, is your customer really committed to your or are they just committed to the promotions? Maybe some color there.

Sam Duncan

Well, you got to look at our comps compared to what they were in the prior year which is an improvement. It’s just the change in Q2 and Q3. We made some pretty dramatic changes in the add pricing, in fact very dramatic and some of the add prices that it was probably you haven't seen in many, many years. As I said in the call on Q2, we wanted to see just what it would take ad wise, ad markdown to really drive a big improvement in comp sales, what that cost would be and we found out. And now that we have found that out, we did back off from what we were doing in Q2. But that was the right thing to do because we still have some lot of things that we need to work on our retail.

Our ads are still improved. They are just -- we were not as hard as we were in Q2. But again, you got to look at the comp improvement. Q2 was an anomaly because of the huge investment we made in markdown. You got to look at Q3, the improvement that we have made versus prior year.

Karen Short - Deutsche Bank

Yeah. Okay. That’s helpful. And then what percent of sales at both retail and Save-a-Lot are on EBT?

Sam Duncan

We don’t provide that level of detail. I would tell you though that the level of staff benefits in our Save-a-Lot business is significantly more than it is across the banners.

Karen Short - Deutsche Bank

Okay. And then just last question. In terms of product that you were supplying the licensees, anyway you could give some directional color on how that has increased in terms of penetration over the last year-over-year, anything would be helpful?

Sam Duncan

It has improved slightly but it's not where we want to be. And again that is because we still have to gain the total confidence of licensees, but we’re working on that. And Ritchie and his team are doing a great job on that and focusing on that. They're making -- continued to make visits to licensees to show them the results that we’re having on the corporate side.

So I feel good about what our future is with the purchase concentration rate with our licensees. We’ve just got to keep focusing on it and showing the great success that we’re having with the corporate stores.

Karen Short - Deutsche Bank

Okay. That’s helpful. Thank you.

Sam Duncan

Thank you.

Operator

Your next question comes from the line of Edward Kelly with Credit Suisse.

Edward Kelly - Credit Suisse

Yeah. Hi, guys. Good morning. Few questions, I think, they are all pretty quick. In Save-a-Lot with the new store growth, can you just, I don’t know what it remind us, I don’t know, if you have goodness in past, but what’s the investment per store for corporate owned store including inventory? And then, what do you think about as the payback period?

Sam Duncan

Well, you’re right, Edward, we haven’t given that information out. What I can tell you though is that the way that we’re going about new store growth is, I think, a little, maybe a little different. We’re going to be very judicious as we rollout these new stores to make sure that the economics work.

They do have, I think, from based on my experience and retail, they have a fairly consistent pattern of how they turn profitable over the course of the first few years. So, but we’re going to be judicious as we open these stores to be sure that when we open them and that when Ritchie opens them that they’re going to be good in profitable stores.

Bruce Besanko

(Inaudible) I’ll make some comments to the decision on corporate licenses is not based on how much we have to invest or not invest, it’s strictly a function of getting the right side and we can do things faster quicker on corporate stores because we make all the decisions.

So that's why we are going to open up more corporate stores and licensees, but we will definitely, we’re on the track of looking for new licensees in new marketing areas. But for us it's really of control versus no control and our focus is going to be on more corporate stores.

Edward Kelly - Credit Suisse

Okay. And then second question for you on the Wholesale business. You did talk about rolling that business. Can you just maybe provide a little bit more color on exactly how you win new business? How important is pricing going to be to that? Can you pick up new business and maintain current levels of margins, a little help there would be great? Thank you.

Sam Duncan

I have come to learn that new customers or affiliations what we call them is requires great patience. An example, Janel and I went out to visit a potential new customer. This about -- this time a year ago and we thought the decision was going to be very quick, but here things happened. It's a lot of work for a company to change suppliers. It is very hard.

But that one customer, we’re still waiting on a decision, we feel good about it, but it's just an incredible amount of patience that is required. But we are encouraged about the pipeline that we have where we are today, we've got a lot of exciting things that we are working on.

And again as we mentioned in the call that the holiday period is basically November 1 or even mid-October when company’s just shutdown as far as even thinking about changing any supplier and because it is a massive project, but we feel very good about where we are at and we are going to continue to work on it.

Edward Kelly - Credit Suisse

Okay. Great. Thank you.

Operator

Your next question comes from the line of Stephen Grambling with Goldman Sachs.

Stephen Grambling - Goldman Sachs

Good morning. Thanks for taking my question. Maybe a quick follow-up on, Ed’s question about the CapEx on Save-A-Lot, I know there are some details on the Cub franchises in terms of the payback period? Is there any kind of puts and takes you can compare with your corporate Save-A-Lot stores, what you expect there versus those stores and what’s outlined in some of the franchise docs?

Sam Duncan

Well, I probably refrain from commenting at this point, Stephen, on that, I would just tell you, we are going to be, as I said before, we’re going to be judicious as we open these new stores whether they are licenses or corporates and I will leave it there.

Stephen Grambling - Goldman Sachs

Okay. And then, thanks for the details on the TSA. As a follow-up to that, can you just help us understand maybe one of the -- some of the buckets of the cost that are within the TSA, is that primarily distribution, corporate, other costs?

Bruce Besanko

Yeah. So, couple of points on the TSA. So, first, we are going to be, as I said in the call, we are going to be putting out some frequently asked questions and answers that we hope will be helpful for our investors. And so that will probably be posted either Friday or early next week. So hopefully that some of the details of that we have in that document will be helpful.

In terms of the buckets of activities that are covered by the TSA. There are, I’d say probably the big three which surround information technology, the second would be financial and financial reporting activities, and then the third is around our human resource. So those that, that is -- that's what the large portion of what's covered in the TSA.

And I would just remind folks the TSAs goes back a while, although as a consequence of the transaction in March, it's changed. I made comment on the some of the dollars that are running through is one time for this year that is to say we had about $60 million of incremental TSAs, of which about $36 million was in Q1, $18 million in Q2 and then $4 million in Q3.

The remainder of that $60 million runs out in Q4. So we do have this disproportionate amount of grow over that we’re going to face next year as we turn the corner there. And then just one last comment and I know I said this in my prepared remarks but it's worthwhile because I think this is where some of the -- some of the confusion lies. We believe and we constructed the TSA so that it was largely breakeven to SUPERVALU.

And so going forward from our perspective is going to be important that -- that the level of services being provided to our TSA partner is we’re going to have to control the level of cost that -- that we incur as we collect those fees. And I will tell you that it is on the radar screens of Sam and I and the management team to be sure that that we align those costs with the fees that we collect.

Sam Duncan

Operator, we’ll take one more call please. One more question.

Operator

Your final question comes from the line of Bryan Hunt with Wells Fargo Securities.

Bryan Hunt - Wells Fargo Securities

Sam and Bruce, thank you. First of all I was wondering if you could maybe delve into the same-store sales at Food Retail with regards to competitive openings. We’ve heard a lot from your customers as well suppliers that all the growth in the industry is really coming from price impact, dollar, fresh formats and neighborhood markets. Is there anyway you can talk to us about competitive openings and overlap, which are roughly 190 Food Retail stores?

Bruce Besanko

I would just say that our competitive openings have been very normal or below normal compared to other years. So that is not a major factor in the negative comps that we have today or had a past few quarters. The negative comps are attributable to running poor operations and pricing out of line. When this -- when we got into this, when this deal closed, we had a mess in retail we had to clean up and we’re still working on that. But I got to tell you it was all self-inflicted.

Bryan Hunt - Wells Fargo Securities

Great. My next question is when you look at the 2016 notes, what's your view on having those turn current on the balance sheet and what’s your ability to partially fund the refinancing that with cash?

Bruce Besanko

Well. So we talk about our capital structure. Sam and I and the rest of the management team, we talk about our capital structure and in particular, the May 16 notes of those are the most -- the more recent of the bonds coming due. We talked about it and are in fact as part of the -- just the financial budgeting process that we’re going through now, we talked about the issues surrounding the bonds and what we may or may not want to do.

So I would just leave it to let you know where we’re engaged in looking at the bonds. We are not something that we don't think about and I think you should rest assured that I recognize the maturities coming due and I recognize the fact they will go current on the balance sheet by the end of our next fiscal year.

Sam Duncan

This is Sam. I will just say it's been a big focus of mine to is to not only to drive the sales in this company but to deleverage this company and that’s something that we focus on last year as you can see what we did in re-pricing our term loan and doing the Dutch tender on sum of the 16 notes. And we continually talk about ways to delever this company and I’m very proud of what we've accomplished and will continue to accomplish in the future.

Bryan Hunt - Wells Fargo Securities

And then my last question as when you look at working capital, the builds been I would say higher than historical type of growth throughout the year through the third quarter. Can you talk about what maybe your goal is in terms of bringing working capital down at the -- by the end of the year?

Bruce Besanko

I would -- I would tell you that there was -- there has been investment in the company particularly over on the retail side as we made investments in our retail banners and that has been, I think frankly what was needed in the company and I think it’s respective of the commitment of Sam and the management team has made to our customers on the retail stores. Our inventory build that you’ve seen in the most recent quarters is seasonal and that will be coming down. My view of the working capital is that we’ve managed it fairly well and I'm not saying anything that keeps me up at night.

Bryan Hunt - Wells Fargo Securities

Great. I really appreciate your time. Thank you.

Sam Duncan

Okay. Thanks everyone. Everyone has Steve Bloomquist’s number. So if you got any questions after the call please give him a buzz and I'm sure Bruce and I will be talking to some of you in the next few days or weeks. So thanks for attending the call.

Operator

Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.

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