Fairway Group Holdings' (FWM) CEO William Sanford on Q1 2015 Results - Earnings Call Transcript

Aug. 7.14 | About: Fairway Group (FWM)

Fairway Group Holdings (NASDAQ:FWM)

Q1 2015 Earnings Call

August 07, 2014 4:30 pm ET

Executives

Nicholas Gutierrez -

William E. Sanford - Interim Chief Executive Officer

Kevin McDonnell - Co-President and Chief Operating Officer

Edward C. Arditte - Co-President and Chief Financial Officer

Analysts

Steven Forbes - Guggenheim Securities, LLC, Research Division

Mark Wiltamuth - Jefferies LLC, Research Division

Judah Frommer

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Fairway Group Holdings Corp. First Quarter 2015 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host of today's conference, Mr. Nico Gutierrez, Manager of Finance and Investor Relations. Sir, you may begin.

Nicholas Gutierrez

Thank you. Good afternoon, ladies and gentlemen, and welcome to Fairway's earnings call for the first quarter of fiscal year 2015. With me today are Bill Sanford, our Interim Chief Executive Officer; Kevin McDonnell, Co-President and Chief Operating Officer; and Ed Arditte, Co-President and Chief Financial Officer.

By now, everyone should have had access to the first quarter earnings release, which went out this afternoon. The release and accompanying slides are available on the Investor Relations section of Fairway's website at fairwaymarket.com. This call is being webcast, 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 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 and other disclosures contained in Fairway's annual report on Form 10-K filed with the Securities and Exchange Commission on May 29, 2014, and the 10-Q filed this afternoon. Fairway assumes no obligation to revise any forward-looking statements that may be made in today's release or call.

In addition, we will present, in this call, certain non-GAAP financial measures that we believe are useful performance measures to facilitate a comparison of our operating performance on a consistent basis from period-to-period and provide for a more complete understanding of factors and trends affecting our business than GAAP measures can provide alone. Our press release and 10-Q present a reconciliation of these non-GAAP financial measures to the most comparable GAAP measure.

And with that, I would like to turn the call over to Bill Sanford.

William E. Sanford

Thank you, Nico. Good afternoon, everyone, and thank you all for joining us today. I'd like to start the call by providing a brief overview of our financial results. I will then update you on our recent Lake Grove opening and our work on enhancing customer communications. In addition, I would also like to update you on the lease we just signed for a new Fairway in Staten Island and the status of our CEO search. I'll then hand the call over to Kevin and Ed.

During the quarter, we reported net sales of $198.3 million, an increase of $11.5 million over last year's sales, driven entirely by sales contribution from our new stores in Nanuet and Chelsea. Our sales were modestly above our expectations. Same-store sales for the quarter were down 1.7%. The decline in same-store sales was mostly driven by 2 stores where our year-over-year sales decline was impacted by a competitive opening and a sales transfer to a new Fairway location. Excluding sales at these 2 stores, same-store sales declined approximately 70 basis points. Our adjusted EBITDA for the quarter was $11.1 million, again, modestly above our expectations.

Let me now turn to Lake Grove. We were pleased to see a good number of you at the grand opening, and I believe you saw Fairway's best new store, which contains design and merchandising initiatives we've been working on for some time. The store is just under 40,000 square feet of selling space, which is a bit smaller than most of our other suburban locations. Although with the improved layout, it doesn't feel smaller.

The store was designed with greater operational efficiency in mind, and we expect to run the store with significantly lower labor, relative to our other suburban stores. In addition, we've made meaningful progress on our in-store signage, and Lake Grove is the first location to roll this new, improved look. We think it captured the uniqueness that is Fairway, but it's also easier and simpler for our customers to read.

Next, we're pleased to announce the new lease for a Fairway location in Staten Island. We've been working on this project for more than 1 year. The store will be a part of a new development, which is an expansion and renovation of the Staten Island Mall, a location which has an estimated 12 million-plus customer visits each year. We're excited about the sales potential of this new market, an area and demographic mix that we believe is well suited for Fairway. We expect this new store to open in late fiscal 2017.

Finally, and before I turn the call over to Kevin, I wanted to update you on our CEO search. As you may remember from our last conference call, Fairway has retained the leading executive search firm. We have reviewed many potential candidates, and we've had face-to-face meetings with a number of them. I want to stress that these processes are very difficult to predict with regards to when they will be concluded, but we are excited about the quality of the candidates we have seen.

Now let me turn the call over to Kevin.

Kevin McDonnell

Thanks, Bill. I'd like to start off by providing a few updates about some of the sales and merchandising initiatives we've been working on, and provide you with a bit more detail on our customer communication efforts. I also want to update you on the new production center and actions we have taken to improve Fairway's operational business processes.

As previously communicated, we remain focused on increasing our prepared foods and [indiscernible] offering. We've applied many of our learnings in the prepared food category to the new store in Lake Grove. For those of you that have visited our new store, you will notice that we have co-located our fresh food departments. This change not only enhances our ability to leverage our labor, but also provides for a much stronger merchandising statement. We have integrated into the hot and cold bar many of the fast-moving deli products, which were historically behind the deli counter. The addition of more self-serve items allows us to reduce customer waiting time and improve staffing levels.

Our emphasis on the ready-to-eat is particularly important in Manhattan, as we look to capitalize on the heavy daytime traffic and convenience-focused customers surrounding many of our stores. As we look forward to the opening of our TriBeCa location, we believe there is unique opportunity to provide an expanded offering of prepared food to cater to the daytime population, which is some 250,000 people, in addition to the densely populated residential neighborhoods of TriBeCa and Battery Park City.

On the marketing front, we recently introduced a new 12-page monthly food magazine, which better enables us to communicate Fairway's differentiated product offering. This is particularly important in areas further from Manhattan where our unique format is not as well known. This is a shift from the old approach of distributing weekly flyers with a price-only message and now brings to focus the core competencies of Fairway Market. The July version highlighted "love local", and with each subsequent month, spotlighting a new theme, such as natural & organics, Fairway private label and international products, among others. The magazine, which is distributed to over 900,000 households, in addition to being handed out in the store, touches upon the depth of Fairway's selection, product origin, description, price and even has some recipes and unique facts.

As a complement to the magazine, we have spent a lot of time redesigning the look and feel of our in-store signage. The updated signs parallel the magazine's design to provide a seamless visual transition between the monthly flyer and in-store communication. As an example, our "love local" initiative introduces the customer to a purple compass icon in the monthly magazine. Once in store, the customer can find the same color and symbol across our signage and shelf pegs placed throughout the store, identifying certain products with those attributes. While Lake Grove is the first store designed with the new signage system, we will integrate this new program into all of our stores throughout the remainder of the year, with some of these changes already in place.

On the last quarterly call, we discussed our recent relationship with Google Express to provide same-day delivery in Manhattan, with recent plans to expand to other boroughs. As a complement to the Google Express platform, we have started our -- using Instacart for an added layer of convenience and broader delivery scope. These services provide an additional level of convenience for our current customers and expand Fairway's virtual footprint to a broader customer audience throughout New York City with minimal investment on our end.

Shifting to the centralized production center, we are in the final approval phase of the project and expect to be operationally with over produce activities later this quarter. We will quickly follow with our kitchen and bakery operations. As you will recall, this facility has the capacity to help us service approximately 30 stores in the greater New York metropolitan area. From an operational perspective, this facility will give us the opportunity to reengineer our basic production processes and enhance our ability to achieve economies of scale.

In addition, we have appointed one of our more experienced executives to the new role of Vice President of Business Process. In this new role, Mike Conese will be a leading -- will be leading the effort to improve and enhance our processes to eliminate redundancy and waste throughout our operations. Mike is well suited for this role, and we think that this move further complements the efficiencies we will get from the production center. This appointment is part of our plan to enhance our operational productivity. More to come on this topic in the upcoming quarters.

Before I turn the call over to Ed, I would like to go into a little bit more detail on our gross margins. Most of the year-over-year decline in gross margin is the result of lower merchandise margins, primarily due to the margin squeeze from cost inflation and targeted price reductions across our store base. It is no secret that prices have been rising in a number of perishable departments, such as meat, seafood and dairy. However, despite these rising costs and an evolving competitive landscape, we remain focused on making sure that our commitment to valuable holds true, which at times means absorbing cost increases.

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

Edward C. Arditte

Thank you, Kevin, and good afternoon, everybody. Thanks for joining us. Let's start at the top of the P&L. During the first quarter, sales increased approximately 6%, to $198 million, compared to $187 million in the prior year. Our comparable store customer count was down 3%, but the average basket was up 2.4%, which led to an overall decrease in same-store sales of 1.7%. The benefit of the Easter/Passover holidays, which shifted to the June quarter this year, was largely offset by a 100 basis point impact due to sales transfer between existing and new Fairway locations, as well as the impact from a recent competitive opening. Our gross margin for the quarter declined 190 basis points year-over-year. There were 3 main components that impacted our year-over-year results, including occupancy expense, targeted price reductions and inflationary pressures.

Our occupancy expense increased 50 basis points, as a percentage of sales, due to increased rent at existing stores and higher rent, as a percentage of sales at our newer stores, as they ramp up to expected sales volumes. We made certain targeted price reductions to reinforce our value proposition in the market. And as Kevin mentioned, we also experienced cost inflation in certain perishable departments, including meat, seafood and dairy. We chose to pass along only a portion of these price increases to keep our prices competitive in the marketplace. For example, our meat department margin declined approximately 400 basis points, as we maintained our competitive positioning and did not fully pass on the cost increases to our customers. Despite the higher cost in a number of categories, Fairway remains committed to offering a compelling customer value proposition.

On the expense side, on a year-over-year basis, store expenses, excluding depreciation and amortization, were down 20 basis points. The decrease in store expenses was primarily driven by increased in-store labor efficiencies, enhanced cost disciplines and the maturation of some of our newer locations. Now this is an area where we made good progress, but there's still an opportunity to do better, and our team is focused on continuing to improve our store productivity.

Next, our Central Service expense declined $0.5 million, to $9.3 million, in the first quarter of fiscal 2015, from $9.9 million in the same period of the prior year. Central Services, as a percentage of sales, declined 60 basis points year-over-year, primarily due to lower labor costs in connection with our organizational realignment program. This expense category can fluctuate quarter-to-quarter, but we continue to believe that we can manage Central Services to be a lower percentage of our sales over time.

Next, our adjusted EBITDA for the quarter declined $1.6 million, to $11.1 million in the quarter, compared to $12.7 million in the prior year. The decrease in adjusted EBITDA was primarily attributable to the reduction in our gross margin rate. Store opening costs for the first quarter were $1.7 million, compared to $3 million in the first quarter of fiscal '14, and the production center start-up costs were $1.4 million, compared to $0.5 million in the prior year. Approximately $700,000 and $800,000 of store opening and production center startup costs in fiscal '15 and fiscal '14, respectively, were noncash due to deferred rent. Interest expense for the quarter was $4.8 million, a decrease of $600,000 over the prior year, and that resulted from a lower borrowing rate on our senior credit facility. Approximately $1.3 million of our interest expense was noncash.

Now let's turn to the balance sheet. We ended the quarter with approximately $65 million of liquidity, comprised of approximately $49 million of cash and $16 million of revolver availability. During the quarter, we generated approximately $5.5 million of cash from operations. Our total CapEx spend for the quarter was $14.3 million, including $5.8 million for the new production facility and $6.9 million for the Lake Grove location with the balance for equipment upgrades and enhancements at existing stores. On a project-to-date basis, we spent approximately $13.5 million for the new production facility with approximately $7 million of projected spend remaining over the balance of the fiscal year.

Now let me spend a minute on our real estate pipeline and update you on our current thinking with respect to new store openings over the near term. With Lady Grove now opened, our next store will be TriBeCa, which we are now targeting for an opening towards the end of the current fiscal year, which ends on March 29 of 2015.

Based on our current real estate pipeline, we are now estimating 1 to 2 new stores for the next few years. We have the Hudson Yards project, which we currently plan to open in the latter part of fiscal '16. But at this point, we don't have a second location for our next fiscal year. Our strong preference is to make sure that we open locations with solid revenue potential and we will only open a second store in fiscal '16 if an attractive opportunity becomes available to open within that time frame.

The Staten Island lease that we announced today is expected to be 1 of 2 locations for fiscal '17, opening late in that fiscal year. Again, this is a build-from-scratch project, so timing is always difficult to predict this early in the process. We are also engaged in a number of other pipeline discussions that would potentially fill in a second store for fiscal '17 or begin to fill in our store opening calendar for fiscal '18. Again, our focus is to ensure, to the greatest extent possible, that each and every location we open is a high-quality Fairway store, with very strong volume and contribution potential.

Now before we open the call for Q&A, let me also comment on our guidance for the second quarter and for the full year. First, for the second quarter, we see revenue very similar to the first quarter, and we're guiding to revenue of approximately $197 million. It's important to note that we typically see our quarter sequential revenue decline approximately 5% in the summer months in comparison to the June quarter, due to summer vacations and New York City residents who leave the city for summer weekends. As a result, while our revenue for the quarter is expected to be very similar to the actual revenue we generated in the June quarter, it will be sequentially lower at our existing stores, particularly those in Manhattan. And this revenue will be made up by sales from our new store in Lake Grove.

With respect to EBITDA for the second quarter, the revenue dynamic I just mentioned will impact EBITDA as higher margin revenue within -- in the existing stores, particularly those stores in Manhattan, is replaced by the lower EBITDA from a new store that is in the early stages of the ramping process. This, combined with the ongoing cost inflation dynamic in our perishable product areas, is expected to adversely impact our gross margin. As a result, we're guiding to second quarter EBITDA of approximately $8 million to $8.5 million.

For the full fiscal year, we now expect sales to be in the range of $805 million to $815 million, and adjusted EBITDA to be in the $45 million range. Given the timing of the TriBeCa opening, we will likely incur all of the capital and preopen spend during the third and fourth quarters of this fiscal year with no sales or EBITDA contribution from the TriBeCa location. That said, we expect TriBeCa to be a solid contributor, as we move into our next fiscal year.

Thanks for joining us on today's call. Operator, we're now ready to open up the line for questions.

Question-and-Answer Session

Operator

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

Steven Forbes - Guggenheim Securities, LLC, Research Division

It's actually Steve on for John today. So even though we're only 2 weeks in, given the lower operating costs model at Lake Grove, what has been your experience so far with day-to-day operations and overall customer service? And with that, have you been surprised by anything, whether good or bad?

Kevin McDonnell

Steve, it's Kevin McDonnell. Obviously, we're only 2 weeks into the opening of Lake Grove, so it's very early. But I would say that we are feeling pretty good about the customer engagement in the store. We've had a lot of customers go through the store in the first couple of weeks. Our service level to the customers have been excellent. I believe the service that we're providing is really top-notch, so I think the efficiencies that we're working into the system are working well. So we're pleased. But again, we're 2 weeks into a new store.

Edward C. Arditte

We're also -- let me just add, this is Ed Arditte. We're also seeing good feedback on social media. We're getting good feedback from our customers. I think for those that have the opportunity to be with us on that opening day, have had the opportunity to interact with our customers that were there. They were really excited about Fairway opening in that area. So to Kevin's point, it's -- we're really very early in the process, but we're feeling good about what we're seeing.

Steven Forbes - Guggenheim Securities, LLC, Research Division

And then just with the overall competitive environment, so you obviously mentioned the impact that you're seeing. But is there much difference between your urban locations and the suburban locations? Anything to just -- to call out?

Kevin McDonnell

Yes, Steve, it's Kevin again. The difference between urban and the suburban, typically in the suburban, we have much stronger price competitors. And those strong price competitors are the ones who are primarily not passing along all the cost increases in the form of retail advances to the customer. So we're primarily seeing a lot of that margin pressure in the suburban areas.

Operator

And our next question comes from the line of Mark Wiltamuth of Jefferies.

Mark Wiltamuth - Jefferies LLC, Research Division

Any second store for fiscal '16? Or just waiting to see if you get a good opportunity for that second store in '16?

Edward C. Arditte

Mark, we missed you -- we missed the first part of your question. Can you just repeat it, please?

Mark Wiltamuth - Jefferies LLC, Research Division

Yes. So on the fiscal '16 stores, you were expecting 2, and you said you had not found the second one yet. Are you ruling out that one or you're saying you're just waiting to see if you could find a good location for the second one?

Edward C. Arditte

I think it's the latter. We're not ruling it out. There are some possibilities. But at this stage, we want to let you know that, as we sit here today, the only signed lease that we have for '16 is the Hudson Yards project. We will act for something that meets our standards, meets our requirements for '16 if it presents itself. But at this stage, it's still unknown.

Mark Wiltamuth - Jefferies LLC, Research Division

And how much lead time would you need to sign a lease and actually execute on that fourth quarter opening? Like, when would you have to announce something to get that executed?

Edward C. Arditte

It really depends. If it's an existing location, that we can move into pretty quickly, we can probably turn it into a Fairway in 4 months or so, okay? That key is, is it that type of relocation ready to go or is it something that needs more substantive work and construction? To the extent it needs more substantive work and construction, that's obviously going to delay the process. So we have time. We're focused on it, but we wanted you to understand that, at this point, we have just the one signed lease.

Mark Wiltamuth - Jefferies LLC, Research Division

Okay. And for fiscal '17, were you saying up to 3 before and now it's definitely 2, or were you more fuzzy on that previously?

Edward C. Arditte

No, I'd say, we certainly -- we think we have the ability to do up to 3 in '17. But what we're telling you now based on our pipeline, what we're seeing, and obviously Staten Island is the first step to fill in '17, based on that, we thought it prudent to guide to the 1 to 2. Clearly, if we had an outstanding opportunity, we would take that very, very seriously and want to open a third in '17. But again, I'd prefer to put that in the category of opportunistic, rather than base plan.

Operator

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

Judah Frommer

It's actually Judah on for Ed. First, I just wanted to touch on the change in real estate pipeline over the last few quarters. Do you think it's more you guys not wanting to do certain locations that you maybe have looked at in the past? Is it something on the developer side, the economy in the cities you're looking at? What do you think is going on there?

Edward C. Arditte

I think we are very, very focused on making sure that the right -- that the locations that we sign leases for are very, very strong locations for Fairway. I think the announcement today for Staten Island, for those of you who know the area and know that's -- the Staten Island Mall, know the demographics around that, 12 million-plus customer visits a year is a very, very big number. And so that's the type of thing that we want to be able to do. I would tell you that just about everything in our pipeline is of that type of characteristic. And those are the things that we are focused on. I think based on the way we see the pipeline today, we thought it best to talk about 1 to 2 stores a year, let you know specifically what we have. And then to the extent that there may be opportunities beyond that, it isn't the base plan, it's additive to the base plan as such point in time as we have that type of a development.

Judah Frommer

Okay. And just us your thinking kind of internally in your internal planning, would you say your kind of internal estimates for store productivity and profitability have changed at all for new stores over the last year or so? You're not comping your new stores to an Upper East Side or a Harlem anymore, you're comping them to the new stores that you are building. So has productivity expectations come down at all for new stores that you're building?

Kevin McDonnell

Overall, I guess it's how you're defining productivity. In Lake Grove, our modeling for productivity out of that store will be higher than it would have been for pre-existing, suburban locations, based upon the changes that we've made to the stores.

Judah Frommer

Okay. And in the city stores, Chelsea's very different from an Upper East Side, has the model kind of changed there at all?

Kevin McDonnell

Well, we had to change the model there. As we've opened up that store, based upon the demographic, the low basket size and the extremely high customer count. So we've had to make adjustments in that store that really are, I would say, very unique to that store. And that store Chelsea really does not model after an Upper East Side or a 74th Street location.

Judah Frommer

And is it fair to say that TriBeCa will be closer to Chelsea on the spectrum than one of your uptown stores?

Kevin McDonnell

We think that TriBeCa, we will have a large daytime population that we need to service with a very robust prepared foods offering. But we also do believe, based upon the demographics of the area, that we will have significant nighttime population that we'd model more after the Kips Bay store. So we think it's going to be a mixture.

Edward C. Arditte

Judah, I just wanted to add one thing to build on what Kevin said, and I'm completely in agreement with what he said. But what I want to add is that Kevin and the operations team, and particularly in Lake Grove, made very good strides in -- on the cost side of operating the store. And you heard us talk about how we believe we can really operate a store in a more efficient labor formula. I think the steps that we're taking with respect to our focus on business process, that Kevin and his team are focused on, along with the production center coming online, we have a lot of things that are working that we think over time are really going to help us on the business process side and give us some flexibility. So I wanted to add that in as well.

Operator

And our next question comes from that line of Rupesh Parikh of Oppenheimer.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

This is Rupesh Parikh. I just want to delve a little more into the price investments that you made during the quarter. I know it may be still early, but are there any reads on what you're seeing so far from some of the price reductions?

Kevin McDonnell

Yes. Again, it's Kevin. We have rolled out a, I would say, a modified kind of EDLP type program in 3 of our locations, 2 of the existing and in Lake Grove. We've measured that over the past 6 or 8 weeks or so, during the life cycle of the program, and really are starting to see some very encouraging results. We're seeing up to a 30% increase in the overall volume in units. And enough really to overcome, from a gross profit dollar perspective, the investment down in the retail. So mostly winners in that -- now we have some we have to work on, but very good indications, again, out of that program, and our intention is to continue to roll that out to the other stores.

Rupesh Parikh - Oppenheimer & Co. Inc., Research Division

Okay, great. And then just moving on to the full year sales guidance. Is that guidance reduction strictly related to TriBeCa or is there some other factors that are being involved in that forecast?

Edward C. Arditte

No, TriBeCa's really the biggest factor. And our thinking now, based on the project, some of the things that Kevin and Bill talked about in this call and previous calls, relative to the way we want to design and build TriBeCa. And our guidance is based on TriBeCa not making any sales contribution this year.

Operator

Thank you. And I'm showing no further questions in the queue. I'd like to turn the call over to Ed Arditte, Co-President and CFO for closing remarks.

Edward C. Arditte

Ladies and gentlemen, thanks for joining us. Certainly if you have any follow-up questions, please feel free to reach out to me or to Nico. We look forward to speaking with you on our next quarterly call when we report on our second quarter results. Thanks very much for joining us today.

Operator

Ladies and gentlemen, thank you for your participation on today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.

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Fairway Group (NASDAQ:FWM): FQ1 EPS of -$0.22 misses by $0.11. Revenue of $198.3M (+6.2% Y/Y) beats by $1.39M.