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Fairway Group Holdings (NASDAQ:FWM)

Q3 2014 Earnings Call

February 06, 2014 4:30 pm ET

Executives

Nicholas Gutierrez

Charles W. Santoro - Executive Chairman

William E. Sanford - President

Edward C. Arditte - Chief Financial Officer and Executive Vice President

Analysts

John Heinbockel - Guggenheim Securities, LLC, Research Division

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

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

Mark Wiltamuth - Jefferies LLC, Research Division

Judah Frommer

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

Operator

Good day, ladies and gentlemen, and welcome to the Fairway Group Holdings Third Quarter Fiscal 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I'd now like to turn the call over to your host for today, Mr. Nico Gutierrez, Manager of Finance and Investor Relations. Sir, you may begin.

Nicholas Gutierrez

Thank you. Good morning, ladies and gentlemen, and welcome to Fairway's third fiscal quarter earnings conference call. With me today are Charles Santoro, Fairway's Executive Chairman; Ed Arditte, Co-President and Chief Financial Officer; and Bill Sanford, Interim Chief Executive Officer.

By now, everyone should have had access to the third quarter earnings release, which went out this afternoon, as well as the second press release announcement, search and organizational changes. Both of these releases are available on the Investor Relations portion of Fairway's website at www.fairwaymarket.com. This call is being webcasted, and the replay will be available on the company's website as well.

Before we begin, we would like to remind everyone that the prepared remarks contain forward-looking statements and the management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them. We refer all of you to the risk factors contained in Fairway's annual report on Form 10-K filed with the Securities and Exchange Commission on June 6, 2013. Fairway assumes no obligation to revise any forward-looking statements that may be made in today's release or call.

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

Charles W. Santoro

Thank you, Nico, and thank you, all, for joining us today. We have a full agenda, so let's get started by addressing management changes and the initiatives that were in our press release issued earlier today.

I am very pleased to announce that Bill Sanford, Fairway's President since April 2012, is assuming the role of Fairway's Interim Chief Executive Officer, replacing Herb Ruetsch, who for personal and family reasons, is retiring after 15 years at Fairway, and the last 2 years as our CEO.

All of us at Fairway would like to take a moment to thank Herb for his years of dedication, loyalty and countless weekends, holidays and late nights of hard work and commitment. I know that Herb's family will enjoy having him back and Herb's legacy, in our mind, will always be his invaluable role in helping transform Fairway from a small family business into an iconic, growing specialty food retail powerhouse, serving some 20 million customer visits annually in the tri-state area. Herb will remain an important part of Fairway going forward as a special advisor to the company, continuing to provide insight into what Herb loves the most, merchandising and our customer experience.

Bill Sanford, our Interim CEO, brings continuity, strong leadership and organization skills, and has also played a very important role in Fairway's wealth[ph] , development and success over the last 5 years of his involvement at Fairway, including in his previous roles as Chief Financial Officer and most recently, as President. Bill brings his wealth of former senior-level public company experience and deep knowledge of logistics, distribution and consumer analytics.

I'm also very pleased to announce that Kevin McDonnell, our Chief Operating Officer; and Ed Arditte, our Chief Financial Officer; will each assume the position of Co-Presidents, while retaining their current Chief Operating Officer and Chief Financial Officer roles. Kevin and Ed work very closely together and these promotions are designed to bolster and enhance operations and productivity initiatives as Fairway moves to its next level of growth and scale. This is also timely as fairway prepares to roll out its production center and important new store openings later this calendar year.

We will continue a CEO -- we will commence a CEO search shortly and will consider qualified individuals, both within and outside of Fairway, who we believe possess leadership, merchandising and organizational skills to meet our long-term goals and opportunities.

Our senior leadership team is extremely strong and is supported by a very deep group of operators and merchants, and we believe that these changes support our organizational growth and enhance our ability to execute some very demanding goals. And Bill and Ed will later touch on some important operations and organization initiatives currently underway.

Turning to our business and financial update. Fairway continued to make progress during this past quarter on a number of key areas of our business, including the development of our real estate pipeline, continued growth of our private label category, margin expansion initiatives and continued focus on enhancing business processes.

We also continued to expand our market share with the opening of our 14th store located in Nanuet, New York, and have grown our customer account by approximately 27% over the prior year's third quarter. So we are very excited about our long-term prospects and opportunities.

During the third quarter, Fairway achieved record revenues, $206 million, a 23% increase over last year's reported sales, increased our merchandising margins by approximately 50 basis points and increased our gross margins 10 basis points to 31.9%.

EBITDA growth, however, was disappointing. Our adjusted EBITDA grew from $12.4 million to $12.8 million and came in below our expectations, in part, as a result of higher store and operating-related expenses as a percentage of sales, including discretionary investment into long-term initiatives, such as social media, e-commerce and website design. Our operating performance was also negatively impacted by lower-than-planned holiday sales in the second half of the quarter.

As a number of retailers have found, the third quarter was a difficult operating environment, particularly the latter half, with generally weaker consumer sentiment, a soft overall retail backdrop and a shortened calendar between Thanksgiving and Christmas.

In addition, those of us in the New York area faced a tougher comparison against the third quarter of last year due to Hurricane Sandy. Our sales in the third quarter of last year were positively impacted by the combination of pre- and post-storm stock-up and the absorbed market share from competitors that were not fully operational for some period of time subsequent to the storm.

We've also announced that Fairway's undertaken an organization realignment that is commencing this quarter and will likely continue over the next several quarters. Our organization has developed and grown substantially over the past several years, and this realignment will allow us to remove redundant costs and streamline parts of our business model to enhance overall productivity.

When fully implemented later this calendar year, we believe that we have the opportunity to remove significant expenses from operations, perhaps in the range of a net $3 million to $4 million annually. The onetime cost of this program will likely be approximately $7 million and will be substantially severance-related.

On the real estate front, our next 2 openings, our Lake Grove, Long Island, likely opening at the end of our first fiscal quarter; and a new store in the lower Manhattan neighborhood of TriBeCa, which is currently scheduled to open in the late fall.

For the 2016 fiscal year, we have already announced one signed lease for a store in the Hudson Yards development in Manhattan, which the developer expects should open in the middle of calendar 2015; and one signed Letter of Intent for a New York City location, which will likely open in late calendar 2015 or early calendar 2016. I'm also pleased to announce that we have 2 additional Letters of Intent for suburban locations under advanced negotiations, with both locations potentially available in calendar 2016.

The fourth quarter of our fiscal year is off to a solid start, with some tangible signs that our process improvement initiatives are beginning to take hold. Nonetheless, we do plan to continue to make incremental long-term growth and strategic investments throughout the quarter, including investments into marketing and promotional initiatives designed to reinforce our strong customer value proposition and enhance our overall customer experience.

These initiatives should take several quarters to provide measurable financial return, but we believe they will ultimately strengthen our brand and reinforce our customer's perceptions of value in important ways, particularly as we open new locations and expand our customer base into new neighborhoods and regions.

With that, I would like to introduce Bill Sanford, our Interim Chief Executive Officer.

William E. Sanford

Thanks, Charles. I'd like to start by also thanking Herb for his contributions and leadership over his many years of service at Fairway, and we all look forward to working with him as a special advisor to the company.

As Charles mentioned, we are intensely focused on taking our organization to the next level by scaling our operations to support our growth. As part of this initiative, Kevin McDonnell will oversee store operations and merchandise. We've also recently formed 2 parallel teams to manage store operations; one for urban stores and one for suburban stores. We believe this structure allows us to use scale and leverage to more efficiently manage our business.

In addition to the district operations managers, all Fairway veterans, who oversee our urban and suburban operations teams, we have appointed district merchandising managers and a team of product category specialists to enhance and support merchandising efforts.

I'd also like to highlight some positive initiatives underway at Lake Grove, our first store in Suffolk County, which we believe will further enhance the productivity of our suburban model going forward.

Our store design and merchandising teams, led by Kevin McDonnell, have continued to leverage the learning curve of higher openings and engineer improved process efficiencies, which we believe will reduce suburban store operating expenses by at least $1 million annually, while also providing new merchandising concepts that we believe will resonate with our customers. We also expect that these initiatives should reduce new suburban store construction costs.

As noted earlier, Lake Grove is expected to open late in our first fiscal quarter, slightly delayed from our original April target, as our ability to obtain possession of the store has been delayed.

I'm also very pleased to announce that we have amended the lease for our 74th and Broadway location, and extended the provision, which would have given the landlord the option to terminate the lease on or after June 2017.

The amended lease extends this optional lease termination trigger date through February 2029. Fairway will still retain the rights to enter into a new lease upon completion of construction of a new building with at least equal square footage to the current lease. So we're very pleased with this outcome.

During the quarter, we introduced approximately 50 SKUs to our growing selection of high-quality Fairway-branded offerings. A few of the new private-label products, which you will now find in our stores, include Greek yogurt, organic and antibiotic-free turkeys, and 12 kitchen essential cooking sauces, among others.

For the quarter, Fairway-branded products grew, as a percentage of sales, nearly 100 basis points on a year-over-year basis. As mentioned before, we continue to view our private-label category as an important margin and revenue driver, and will be rolling out approximately 170 additional Fairway-branded products over the next 2 quarters.

Separately, our new centralized production facility continues to progress and remains on budget. We expect to begin shifting certain operations into this facility in the late spring. As we have noted in the past, we believe this new facility can ultimately support approximately 30 stores in and around the tri-state area, and when fully operational, should further simplify and streamline our production operations and provide labor efficiency and shrink benefits in the medium- to long-term, as our store count grows.

Thanks, everyone. I'd now like to turn the call over to Ed.

Edward C. Arditte

Thanks, Bill, and good afternoon to everybody. Thanks for joining us for today's call.

Let's start at the top of the P&L, where net sales for the third quarter grew 23% to $206 million, largely driven by the contribution from our new stores, as well as the net sales from our Red Hook, Brooklyn location, which as you recall, was closed for the last 9 weeks of the third quarter in the prior year. Excluding Red Hook from both periods, net sales for the quarter grew 17%. More importantly, on a year-over-year basis, our customer transaction count is up 27%, and excluding Red Hook, it was up 24%, demonstrating our ability to capture market share through store growth.

Our same-store sales decreased 1.7% during the quarter, driven by essentially equal declines in the customer count and average basket size. The decrease in same-store basket size and customer transactions is largely due to the effects of Hurricane Sandy, which, as Charles mentioned earlier, resulted in pre- and post-storm pantry stocking, as well as absorbed market share from competitors that were closed for some period of time following the storm. Some of our stores also picked up sales from Red Hook customers who shopped at other Fairway locations, such as Harlem and Douglaston, while Red Hook was being rebuilt.

Now as many of you know, with the exception of our Red Hook location, our stores were all open the day following Hurricane Sandy. In addition, due to the timing of New Year's, we estimate that approximately 30 basis points of sales were shifted out of the last week of this most recent third quarter and into the first week of our fiscal fourth quarter.

As Charles mentioned, for the third consecutive quarter, we improved our gross margin. The 10-basis-point increase was largely driven by an improvement in our merchandise margin of approximately 50 basis points, partially offset by higher occupancy costs as a percentage of sales. Importantly, during the quarter, we continued to work with our vendor partners on improved pricing, as we leverage the benefit of our growing size and scale.

As we've stated, we remain very focused on the primary drivers of gross margin expansion, which include the combination of vendor leverage, private-label growth and our new centralized production facility.

On the expense side, as previously communicated, we were able to achieve significant incremental leverage on the Central Service expense, the component of general and administrative expenses that directly relates to the operations of our business, even after absorbing approximately $300,000 in incremental public company costs over the prior year.

On a pro forma basis, to include approximately $12.7 million in lost sales at our Red Hook location during the third quarter of last year, our Central Services expenses declined 70 basis points as a percentage of sales. Again, largely due to enhanced cost discipline.

Our adjusted EBITDA in the quarter grew from $12.4 million to $12.8 million, and was adversely affected by higher operating expenses at our new locations, which is typical during the first phase of operations, as new stores begin to ramp to maturity generally within 1 to 2 years. In addition, softer holiday sales in the second half of the quarter and the effect of Hurricane Sandy led to reduced fixed cost leverage over the prior year.

Now as you do your comparison, it's important to note that last year's results, really prior to the IPO, do not include approximately $500,000 of expenses each quarter from public company and increased insurance cost, due in part to our new stores and in part to rate increases resulting from Hurricane Sandy, which have affected many businesses in the New York metropolitan area.

Turning next to interest expense. For the quarter, we had approximately $5 million of interest expense, a decrease of about $2 million over the prior year, primarily due to a lower borrowing rate on our senior credit facilities and the subordinated note that we repaid in March of 2013. Approximately $1.3 million of our $5 million of interest expense was noncash in the quarter.

Also, during the quarter, we settled the remaining portion of the insurance claims related to Hurricane Sandy and received a final payment of $4.4 million. The settlement resulted in a $3.1 million gain in the quarter, which is excluded from our EBITDA calculation.

In total, we received approximately $19 million for both business interruption at Red Hook and property damage, and I'd like to complement the work of our team and our partners at AIG in getting this resolved quickly. Incidentally, we're also taking steps at Red Hook to help mitigate the impact to our store from severe weather-related events in the future.

Moving now to the tax line. We reported an income tax provision of approximately $26 million to reflect a full valuation allowance against our deferred tax assets. The allowance reflects the fact that the company's projected taxable income over the next 5 years will not be sufficient to utilize the net operating losses that were reported as deferred tax assets.

Now, it's very important to note that the deferred tax valuation allowance is noncash and has no impact, no impact, on the company's ability to utilize approximately $120 million of net operating losses against future taxable income, and we can use those through approximately the year 2033.

Turning now to the balance sheet. At quarter end, we have approximately $73 million of liquidity, comprised of $54 million in cash and about $18 million of bank revolver availability.

Excluding IPO and transaction-related expenses in both periods, we generated approximately $7 million of cash from operations during the first 39 weeks of fiscal '14, an improvement of nearly $10 million over the prior year.

Next, during the quarter, we spent about $10 million on capital expenditures, inclusive of $4.9 million for the completion of Nanuet, $2.2 million in connection with the continued work on the production center and $1 million for early work on the Lake Grove location. The remainder of the CapEx spend was for equipment upgrades and enhancements at existing stores.

Now, before I turn the call back to Charles, I'd like to discuss our thoughts on the fourth quarter and provide you with our preliminary thoughts beyond that timeframe.

Our fourth quarter is off to a good start through January, despite the extreme cold weather and snow that the tri-state area experienced since the start of the new year. We will, however, have a calendar shift of the Easter and Passover holidays out of the fourth quarter, our current quarter, and into the first quarter of our next fiscal year, which we estimate contributed approximately 90 basis points of same-store sales in the fourth quarter last year. The fourth quarter, typically, has somewhat lower sales than the third quarter, due to the Thanksgiving and Christmas season in our third quarter.

We are also investing in targeted promotional initiatives beginning this quarter and do believe they will provide support to same-store sales, but not likely until later quarters in this calendar year. And as such, we expect our sales to grow roughly 10% over last year's reported fourth quarter numbers.

While some of our productivity initiatives will begin to contribute to EBITDA this quarter, the combination of lower sequential sales, higher occupancy at our Broadway store and incremental investment into promotional initiatives, is expected to result in adjusted EBITDA margins equal to or slightly higher than our third quarter, based on our current assessment of the quarter.

Now as we've discussed earlier on this call, our plan calls for us to open Lake Grove in the late spring and TriBeCa in the late fall. Consequently, our guidance for fiscal 2015 at this time is only in regards to those 2 sites.

That said, our preliminary thinking with these 2 sites opening in the targeted timeframe is for revenue to grow in the high-single digits over our full year fiscal 2014 revenue. A third site, if it was to materialize in the year, will provide additional upside to our revenue and EBITDA growth.

Now, based on this level of revenue growth and taking into account a number of cost factors, including the increased rent at the Broadway store in connection with the amended lease, and healthcare reform-related expense, which we currently expect to impact us beginning in our fourth fiscal quarter of fiscal '15, we currently estimate EBITDA to grow at a slightly higher rate than our revenue growth.

Now I should note that we are not expecting to see any material benefit from the production center throughout this current or this next fiscal year. The management team's major focus for fiscal '15 will be to bring the production center online and to focus on operations to enhance our productivity. These efforts should position us very well as we open new stores in fiscal '16 and beyond.

Longer term, we believe our store growth potential and margin initiatives represent meaningful upside to our current margins. Naturally, this upside is subject to a number of factors, including uncertainty surrounding the timing and type of new store openings and the effect of health care reform, as well as the general economic environment and overall competition, among others.

We remain disciplined and focused on doubling our store count and driving towards 30 stores or more over the next 5 years. And we currently believe the combination of this growing store base and our margin enhancement initiatives should drive 200 basis points of incremental adjusted EBITDA margins over current levels within this timeframe.

With that, I'd like to turn the call back over to Charles for some closing remarks.

Charles W. Santoro

Thanks, Ed and Bill. And as you've all heard, this is an extremely busy and exciting time for Fairway, as we position our company for continued strong growth and make investments to support our powerful long-term growth opportunities.

As always, we are intensely focused on building our operations by enhancing our processes and productivity, while also growing our market share and brand. And we believe, our unique merchandising mix, competitive pricing and in-store customer experience, has positioned Fairway to grow its market share and store count here in the tri-state area, and over time, beyond. Longer term, as Ed noted, we continue to believe that Fairway has the opportunity to grow the store count to approximately 30 stores in the tri-state area over the next 5 years or so.

Beyond that, we continue to believe that the broader tri-state area and that the northeast corner of the U.S. can accommodate very significant additional growth opportunities for Fairway.

And as we have grown, we have always been [indiscernible] with our customers, both old and new, enthusiastically and passionately embrace our unique retailing format and in-store experience. We remain highly energized by the long-term growth opportunities in front of us and look forward to continuing to build our great Fairway brand.

Now, before I turn the call over to the operator to take Q&A, let me just say, for those of you who don't know, let me just say how pleased we are to have General Robert Magnus join our Board of Directors.

General Magnus retired in 2008 from the United States Marine Corps after a 39-year career. His position prior to retirement was the 30th Assistant Commandant of the Marine Corps, where he was the second-highest ranking senior officer in the Marine Corps and responsible for some 230,000 marines and some 20,000 civilian employees.

Magnus has also held many important and diverse management roles within the Marine Corps in areas such as strategy and operations, and he has an extensive experience in logistics and planning, areas where his input, we believe, will be very valuable to Fairway. So again, we welcome General Robert Magnus to our Board.

Let me now turn over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of John Heinbockel of Guggenheim Securities.

John Heinbockel - Guggenheim Securities, LLC, Research Division

So if any one of you guys -- there seems to be a little bit -- and I think we can understand a little bit why, there seems to be a disconnect between -- top line looks okay. These new stores, stores in general, are performing well. Yet, that volume is not translating to the bottom line. So maybe if you -- and I know some of it may be how you've built the business up in anticipation of 25 to 30 stores. But Charles or Bill, maybe you can walk through what do you think are the 2 or 3 things that you need to do most to get profitability kind of where productivity is? And then, secondly, do you have a general thought, long-term, if you think about adjusted EBITDA margin with this base of stores, looking out a couple of years, what do you think a fair run rate is for this current group?

Edward C. Arditte

John, this is Ed. Let me respond to the first part of your question. If I don't get to the second, please remind me. I think, as you look back on the last 3 quarters and the progress that we've made in a number of different areas with regards to certain areas of our margin focus and our productivity, we've made good progress on private label. We've made good progress on vendor leverage. We -- particularly this quarter, showed good leverage on our Central Services expenses. So, a number of those areas are working well in the current environment. Our production center, as you know from our conversations, is really designed to help us really in '16. It comes online in '15 and really starts to contribute in the latter part of the year and into fiscal 2016. So our focus operationally is very, very much on the important key drivers of margins as we move forward here. Accordingly, as we indicated this quarter, our merchandise margins were ahead nicely. And I think that's a good testimony to the fact that these areas that we have been working did in fact play well. We're also, as you know and as we highlighted in our comments, making certain strategic investments in a number of different areas that we believe position us for long-term growth, and importantly, long-term scalability, which will help the EBITDA line. We have more work to do on direct store expenses. We told you that, that was something that was an issue this past quarter. That's an area that there is a very, very strong focus on the part of the management team, and that's an area where we expect to make good progress. We are initiating and have begun to initiate the organizational realignment, which will take some costs out of the business. And we think now is the right time for us to be doing that. So, we think that the things that we're doing operationally are designed to build and enhance long-term scalability. We feel good about our ability over the next few years to enhance our margins from the areas that we're focusing on. But at this point, I don't think I'm comfortable or ready to say a particular number out there 2 or 3 years from now. We're going to focus on these things. We're going to tell you each and every quarter how we're doing on these things, and then we'll go from there.

Charles W. Santoro

And let me just add to that, again, to pick up some of the points. But we are, above all, a growth business. And we are always trying to balance between investment into the future of -- with short-term profitability standards and profitably goals and objectives. But we do believe that the investments we're making right now into the marketing, into promotions, into human capital, into the production center, are essential and important to us, to capitalize on the very large long-term growth opportunity that we have in front of us.

And that's why we're making those decisions.

John Heinbockel - Guggenheim Securities, LLC, Research Division

I wanted just as a follow-up to that. Do you think as you address direct store expenses and other issues, can you -- what's your confidence level that you can do that without adversely impacting comps or how stores open up?

Edward C. Arditte

I think we feel quite good about it. We've actually made some progress in this past quarter, and while it didn't show in the numbers, I think as we move forward, we have much greater confidence in our ability to do that. This -- our focus on scalability, which will really play out over a handful of quarters, is something that we think is the right thing to do to position us for the long term. As organizations develop, they need to go through certain changes for the next phase of growth, and Charles referred to that in his comments. That's really where we find ourselves today. And so we -- the things that we're doing are designed to improve efficiency and scalability, and very little of any of it will come near the customer experience.

Charles W. Santoro

I would say that the streamlining and productivity that comes from the process that we're undertaking right now will provide significant incremental resources for us to invest back into the business. And the investment back into the business is designed to enhance the overall customer experience in the levels we discussed earlier. And importantly, and Bill made this point, Lake Grove and other suburban stores that we opened will continue to follow the careful evolution of efficiency and productivity that we've come to harvest from our existing stores. That particular store, we believe, will produce between $1 million and $1.5 million annually of operational savings, while we hope and believe it will also probably increase the overall experience that our customers have when they go to the store. So we feel really good about what we're doing. And we think what we're doing is the right thing to do in the context of taking advantage of this long-term opportunity that we have. And you have seen us evolve over the years and you will continue to see us evolve and grow over the years in these ways.

Operator

Our next question comes from the line of Brian Nagel of Oppenheimer.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

A couple of questions. First off, and maybe a follow-up to the question, the prior question. But as you think about what you're undertaking at this point with the management transition, the investments and such, is there any discussion amongst your team to potentially step back a bit from some of the -- the rate of new store growth, and we recognize that a lot of this real estate is now locked in. But just think about maybe over the next 2 or 3 years, would it make sense to you to back off some of the growth? And I have a follow-up to that.

Edward C. Arditte

Let me -- Brian, let me answer it this way. We have 2 stores that we're focused on this year, Lake Grove and TriBeCa. We feel very good about both of them. We're also bringing a very important production center online, so that's a major focus of the management team in -- over the next 12 months or so. As we think about next year, 2015, which for us is mostly fiscal '16, we have 1 property, an exciting property that's under lease, that's Hudson Yards. We're very close on another New York City location that we hope to be able to announce to you relatively soon. And we have a number of others that we're in various stages of negotiation in. So we feel good about our ability to build those out. We're not over -- we're not building too fast, and our focus, we believe, on, importantly, productivity and scalability, we think is the absolute right focus for us, given where we are today. So I think the pace of building and new store openings is right, given what we're doing.

Charles W. Santoro

We have a very disciplined site selection process and set of criteria. The sites that we pursue are often what I would describe a signature sites. They involve very complex real estate negotiations and very complex development schemes. We are in a position to take advantage of the best of these as we see them. And that has always been our M.O. And so what you see is that philosophy manifesting itself in the context of the kinds of real estate sites that we're announcing, and we do believe we will be in a position to announce another lease for a very important New York City location shortly. This is the location that is currently in a Letter of Intent, and we are -- we believe we are nearly through lease negotiations. I say "believe" because we all on the phone know and understand that until a lease is signed, it isn't done.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Got it. And I said -- the follow-up question, just on competition. I've spent a lot -- my team and I have spent a lot of time at your Red Hook store lately, and there's been another major grocery that's opened not too far away. Any thoughts or any metrics you might give us on -- maybe any of the impact you've seen at Red Hook or elsewhere, with some of the competition coming to the New York market?

William E. Sanford

It's Bill Sanford. Obviously, Red Hook is one of our core stores. It's a very, very powerful location. It's a destination location, with 2 large parking lots. We get people from all over the area, including Manhattan, at that store. It's too early to tell how the Gowanus location of Whole Foods will impact. I can say that the impact so far has been moderate from our perspective. We have very loyal customers down there, and we're accustomed to competing against Whole Foods. They've opened up near our West Side locations, and in most of our suburban markets.

Charles W. Santoro

Let me just also say that, as Bill commented, the impact has been moderate and typical for the kinds of impacts we see initially when stores open around us. And that happens all the time. In any given location, there are always competitive events happening. We have been quite pleased with the results so far, and we would tell you that if you had been to the store this last weekend, you would have found traffic backed all the way up to the access street. Our parking lot was absolutely full. So a really important takeaway for us was just how sticky our customer relations are, even against the competition.

Brian W. Nagel - Oppenheimer & Co. Inc., Research Division

Not to be too nitpicky, but 2 sub questions under me. How would you define -- is there any numbers you can put around the term moderate? And then since that store opened, I think, it was mid-December, so now we're 1.5 months, a little bit more than 1.5 months. Has there been a change in the sort of cadence of that impact?

William E. Sanford

I would say that it's a difficult comparison. It was holiday season. It's during their grand opening. We had the noise from Red Hook last year. But 10% range, I would say.

Charles W. Santoro

And we -- I think the message we're trying to deliver is that it is a normal part of our business to have competitive events. We are used to it. We respond to it well. Our customers are very, very sticky. And what our focus is right now is to maximize our long-term goals to build our brand geographically in this area and beyond, and to continue to support and enhance our customer experiences and to continue to innovate.

Operator

Our next question comes from the line of Mark Miller of William Blair.

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

First, an observation and then a question. For a company with 14 stores, there's an amazingly a high level of complexity here. So my question then is going to be, can you just try to simplify for us what has changed in the fiscal '15 outlook? Because analyst estimates have about 30% adjusted EBITDA growth, and now we're looking for 10%. So I mean, there's a number of factors here, but if you could just distill it down for us in terms of what do you think are the biggest changes in the outlook.

Edward C. Arditte

Well, importantly, Mark, the first big thing is the fact that we're talking about 2 stores, and not 3 stores. And the store that's not in the mix is an urban store. Okay. So that would be factor #1. So mix and the timing and mix, and you heard us in our remarks make this comment, the timing and mix of store openings is obviously really important. Obviously, there are other things that we commented on as well during the call. We're planning in for our fiscal fourth quarter, which would be the first calendar quarter of '15, an impact from Obamacare or the health care program. Obviously, that -- we'll see how that continues to play out. We have higher rent at our Broadway location. But importantly, we also have the fact that a number of our new stores, including Chelsea, are ramping in a slower way than perhaps we would have thought a year ago. And so we feel good about the progress that we're making. We feel good about the way those -- the stores are being merchandised. We feel good about the improvement in our basket size and so on. So there are a variety of factors, but as we look at this stage, normally, we would think about giving you our guidance for next year in the fourth quarter. But at this stage, we thought it was important to give you our early thinking about '15, and a combination of all of these factors have had an impact and caused us to guide the way that we have.

Charles W. Santoro

I would also add that we are quite focused incrementally on making additional investment into the long-term growth prospects of the business. We mentioned merchandising and promotional activity that will accelerate. Again, we think that is the right thing to do, and we think it will pay -- believe it will pay dividends in later quarters.

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

And then to clarify on the expense savings, you see $3 million to $4 million annually. Is that expected to be in place through all of fiscal '15? And then we didn't, I guess, cover comp store sales. I mean, do you think -- in your expectations, do you expect to be comp-positive in fiscal '15?

Edward C. Arditte

Mark, let me take the first piece of that, which was the expense from the organizational realignment, the savings. We expect some of that to contribute in the current quarter, our fourth quarter of fiscal '14. And obviously, we would expect it to contribute on a full year basis throughout next year. On comp sales, at this point, it's too hard for me to give you a read on what that might be for next year. Our overall thinking is, and I think it's fair to say, your thinking could be that it wouldn't be terribly different than what we're doing this year. But at this stage, I want to use the term very, very preliminary with regards to that, and I reserve the right, obviously, when we get to our next quarterly call in May, when we're actually in the early part of fiscal '15, to give you a more definitive view on that.

Charles W. Santoro

But again, a part of our strategy in doing what we're doing and in our ability to take this organization to the next level of productivity is to proactively make sure that we are freeing up additional resources now available to invest back into the business. And so going back to the question of same-store sales comps, we will address that later on. But our objective in what we're doing is to enhance the current business, and we would expect over time that, that will translate into the store revenues.

Operator

Our next question comes from the line of Mark Wiltamuth of Jefferies.

Mark Wiltamuth - Jefferies LLC, Research Division

You had mentioned some of the stores were ramping slower than expected. Can you talk about which one other than Chelsea? And then give us a little Chelsea progress update on what you're doing there and what you still have left to go?

Edward C. Arditte

Yes, why don't we deal with Chelsea first and then we'll come back to the other part of your question.

William E. Sanford

Hey, it's Bill, again. Chelsea, as you know, is our smallest footprint store, especially in the city. We've learned a lot since we opened the store and we've been tweaking it all along. As Ed pointed out, our basket size has improved. We are rejiggering our merchandise a little bit to reflect what we're seeing in the market. It's profitable this quarter. It's going to be more profitable next quarter, we believe.

Charles W. Santoro

I think that really in the context of going back to the earlier question on the stores that were falling short, the area where we have fallen short from our initial views some year ago is with respect to the sales coming out of Chelsea. And with respect to Chelsea, we are operating at quite a high level in terms of revenues per square foot, but we are not yet at full potential. The store was profitable for the quarter. The store's profitability is expected to accelerate for this quarter. Nanuet was profitable as we calculate 4-wall EBITDA for the quarter just ended. And Nanuet is also expected to accelerate as the year goes on. So we have the classic situation of 2 new stores that are ramping up, and that is typical and traditional in our space. We would have expected Chelsea to ramp faster, more rapidly. It is nonetheless a good store and it's nonetheless a very important location for us. And as we've said to you before, we are focused on taking it to its full potential. We talked about in our last phone call, average basket size, which were in the teens. Today, we're in the low-20s. We're making good progress. Our primary focus on Chelsea is exactly what we told you we would do, focus on the core Fairway customer and focus on converting people who aren't familiar with Fairway into Fairway. And we're pleased with our progress to date, but that progress will continue throughout the course of the year. We'll be working that as we work all of our stores.

Mark Wiltamuth - Jefferies LLC, Research Division

And how is Nanuet doing versus expectations? I think, in the last call, you said it was running 20% better than planned.

Charles W. Santoro

Yes. Nanuet opened well in excess of our expectations. It has gone through the classic ramp-up and then ramp-down, followed by the slow ramp to maturity. So we would describe Nanuet just about where we would have expected it to be at this particular point in its evolution. Now I probably should point out for those who haven't been there, it is kind of a cornerstone of a brand-new outdoor mall. And that outdoor mall itself isn't complete, but when I say outdoor, for those who aren't in the New York area, it's been a pretty brutal winter. So we are very pleased with Nanuet, and we do expect Nanuet will go through a ramped-up phase, again, consistent with our other suburban stores as the year progresses. It is profitable. It's a gorgeous store. We've had terrific customer feedback.

Mark Wiltamuth - Jefferies LLC, Research Division

And on weather, in general here, in the quarter and into this current quarter, is it helping or hurting at this point?

Charles W. Santoro

It hurts us. The extreme weather hurts us because we're not large enough that we're, on the one hand, a destination and a convenience location in the New York area, and it's probably true throughout the country. When dramatic weather events happen unexpectedly, people tend to go to areas of convenience because the roads or the infrastructure may be compromised. So although there are scenarios where we could benefit from it, generally speaking, when a bad weather event happens, we lose net-net sales.

Mark Wiltamuth - Jefferies LLC, Research Division

Okay. And then on the holiday sales being weaker than expected, I know there was a negative Thanksgiving article. Did you find that there was impact on your Thanksgiving-related items?

Charles W. Santoro

The answer is that with the article, we don't think we have any -- we had absolutely no customer feedback whatsoever from the article, and we will certainly disagree with the conclusions of the article. We won't go into the reasons why over this phone call. We remain very competitively priced against our competition, such as Whole Foods. The season itself was affected by a number of events. One was, generally, we noticed within our customer base, weaker overall consumer sentiment. It was just in the market, we felt it. And we've now began to believe that many of our competitors felt it, perhaps not all, but the ones that we do talk to. Secondly, the fact that the period between Thanksgiving and Christmas was short and did affect and, typically, would affect us, and we had a fairly extreme transition. And I would point out that Hanukkah and Thanksgiving did occur on the same day. We do have a significant kosher element to our sales, and so it meant that for many of our customers, there was one less meal to buy. And then I think, just speaking only for ourselves, we noticed mathematically, that is we noticed simply in our numbers, that there did appear to be a shift in sales from the last week of this year, this quarter that just ended, that would be the last week of our quarter, which was December 29, into the first week of the new quarter. And it appears to us that whereas last year the numbers would suggest many of our customers ended the bulk of their holiday at the time of New Year, this year, it appears to us many people extended their holidays until the weekend following New Year's, perhaps because of the one-day shift. We saw it in the numbers nonetheless. So that was the reason why Ed made the comment that we think something like 30 basis points of our negative 1.7% may have pertained to the holiday shift.

Mark Wiltamuth - Jefferies LLC, Research Division

Okay. And the last question, the guidance for fiscal '15 is for the EBITDA growth to be slightly better than the top line. When do you think you'll kick into more margin expansion? Is it just a factor of the stores maturing?

Edward C. Arditte

I think it's a combination of a variety of things. I think that's quarterly one[ph] . I think as we head into '16 with the production center up and running, we would expect to see some benefits from that, along with the other specific areas of focus, again, private label continuing to grow and become bigger part of our effort, our vendor initiatives, and obviously, leveraging our Central Services. I think all of those together will continue to contribute to margin, but the production center coming online will be the next thing to help.

Charles W. Santoro

We have levered what we call Central Services, central corporate functions, and you see that near[ph] the numbers for this quarter and we expect that to continue generally. But importantly, we do continue to invest incrementally in the future of the business. There are positions, expensive positions that we recruit for all the time that go beyond our current needs. But they are very, very important to us as we grow. And that's something that we're going to continue to do. There will come a time, in the context of the timeframes we've talked about, we talked about, for example, a 5-year timeframe in 30 stores, where we get to the point where that scalability really, really sticks. But right now, we are very focused on continuing to invest proactively into our future.

Operator

Our next question comes from the line of Edward Kelly of Crédit Suisse.

Judah Frommer

It's actually Judah on for Ed. I just wanted to drill down a little further into these store openings. I think it's clear that we have 2 and -- as opposed to expected 3 in fiscal '15. For '16, it sounds like you have the West Side Railyards nailed down. You're expecting another one. Can you tell us if that's urban or suburban, and then kind of what else are you expecting in fiscal '16? We had 4 in our model and I want to see where that's going.

Edward C. Arditte

Yes. The other one we'll bring on, we would hope to be able to announce soon. We're -- as Charles said, we're in advanced negotiations. You never know, but we're in advanced negotiations. It would be an urban location. The other 2 that we're actively involved in, in conversations, not as the far along as the one that I just mentioned but actively involved, are both suburban locations, but very attractive suburban locations. And they involve what I would call major national real estate development companies, which is something that we think is a very, very important strategic part of our real estate strategy. Partnering with major real estate developers, as we did in Nanuet and as we are in Hudson Yards, is very, very much a part of our strategy. We've got good relationships, we have good dialogue, and we're increasingly seeing good opportunities as they look at new projects. Now those projects take time. They oftentimes involve building some things from dirt and need various approvals to move forward. But for us, we think they're very, very important and the right type of locations for Fairway to be located.

Charles W. Santoro

These are very unique locations, in many cases, not all, in many cases. And they're the kinds of locations that we very much want to be part of. And know, they're[ph] the kinds of locations, once they're built, that an organization like ours wouldn't be able to get into because the space would have already been leased to someone else. With respect to that other urban location, we do believe it's a powerful location, and we are looking forward -- we are very much hoping we'll have the opportunity to announce it formally in the relatively near future. Again, no guarantees.

Edward C. Arditte

So, Judah, just to come back. As you think about fiscal '15 and fiscal '16 relative to what you have in your model, we clearly have Lake Grove and we have TriBeCa for this year. As we indicated in our remarks, there is a possibility, but at this point, we're not ready to call it a probability, that there could be another store in '15. And then when we move to '16, we have -- really, it ends up being a timing issue. We have Hudson Yards, we have the other New York City location that we mentioned to you, and then we have 2 very, very interesting suburban locations that are in serious discussions. So how does the count actually turn out for '15 and '16? Time will tell. It will be a function of actually how these projects develop.

Judah Frommer

Okay. Okay. And can you expand a little bit on the merchandising and advertising initiative investments that you're making? Is that a kind of above and beyond what you initially anticipated, and other -- I think you mentioned social media, but kind of what else is being contemplated there?

William E. Sanford

Hey, this is Bill. It's a little too early to really expand on that right now. All I'll say is we are going to invest in generating foot traffic into our stores, and we'll get to you next quarter on specifics.

Charles W. Santoro

We -- we're not trying to be opaque here, but this is stuff that I think would not be to our advantage to talk about right now.

Judah Frommer

Okay. That's fair. And just an update on how preopening costs are going? I know you've been working on bringing them down. How's that looking with Lake Grove, and where do you expect it to go from there?

Edward C. Arditte

As you saw, preopening this past quarter was down year-over-year, but that's really tied to activity levels. We're working real hard to do that. Lake Grove, as we said, will open in the late spring. We'll have a better feel then. And when we get to May, our May conference call, we'll be reporting on our fourth quarter and we'll be able to give you a better feel. But it is an area, very much an area of focus for the management team.

Charles W. Santoro

I do think you can assume that the delay in the timeframe of the landlord passing possession to us will cost us in the context of that particular store. The flip side is that the organization structure or the management realignment that we have talked about today, as you come to know it in detail, provides by itself significant leverage for us in the context of controlling future preopening expenses. It's very much on our mind, and we can discuss that at our next phone call.

Nicholas Gutierrez

All right. Operator, we have time for one more question and then we'll bring it to an end.

Operator

Our next question comes from the line of Kelly Bania of BMO Capital.

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

I was wondering if we could just go back to a couple of the expense line items, particularly the direct store expenses. Because it sounds like they are coming in a little bit higher, but you also mentioned that you're seeing them ramp in a typical fashion. So I'm just wondering what is the surprise? Are there a couple of stores that are impacting it? Is it happening in most stores, and where in the store is that occurring?

Edward C. Arditte

Well, it -- direct store expense is, obviously, it speaks for itself, and it's an area of real focus for us. In the fourth quarter, the slower sales that we saw in the holiday season, relative to the expenses that we have in the store, cost us some basis points. As we move forward, this is a big area of focus for the management team. We think there are opportunities for us to get more efficient and streamline some things. The actions that we announced today with respect to organizational realignment are, again, designed to bring much more rigorous focus and process to the way we operate our stores, including the direct store expenses. So it's an area that we didn't do as well as we wanted to do in this most recent quarter. It's an area that we're very committed to doing better on in this quarter and future quarters, and it is the total expense that we have in our stores that we think we can be more efficient with.

Charles W. Santoro

But I think it's safe to say that the -- we're really at the scale and size now where we are in the position -- and this realignment really captures that. We are in a position to drive productivity and efficiencies throughout our stores that we really weren't in a position to take advantage of until we got to this level. It did involve some redundancies, it did involve over-engineering things. We're now in a position to begin to shed some of that excess and to use it for the purpose of not just creating additional profitability, but also for the purpose of making sure we manage and maintain store experiences and enhancement where we can. And again, going back to Lake Grove, you'll begin to see some of those initiatives. So this is a really important next step for us in our growth.

Nicholas Gutierrez

Okay. And ladies and gentlemen, thanks for joining us for today's call. We look forward to seeing you at various points, perhaps, over the quarter, and speaking to you again in May, when we will report on our fourth quarter and provide additional thoughts on fiscal 2015. Thanks for joining us for this evening's call.

Charles W. Santoro

Thank you, all.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Have a great rest of your day.

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