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spk10: Good morning and welcome to the Spartan Nash Company third quarter 2020 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Chris Mandeville, Managing Director of Investor Relations at ICR. Please go ahead.
spk05: Good morning and welcome to the Spartan Nash Company third quarter fiscal year 2020 earnings conference call. On the call today from the company are Tony Sarsom, President and Chief Executive Officer, and Mark Schamber, Executive Vice President and Chief Financial Officer. By now, everyone should have access to the earnings release, which was issued yesterday at approximately 4.30 p.m. Eastern time. For a copy of the earnings release, please visit Spartan Nash's website at www.spartannash.com forward slash investors. This call is being recorded, and a replay will be available on the company's website for approximately 10 days. Before we begin, we would like to remind everyone that comments made by management during today's call will contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates, and projections that may involve significant risks and uncertainties. Actual results may differ materially from the results discussed in these forward-looking statements. Internal and external factors that may cause such differences include, amongst others, disruption associated with COVID-19 pandemic, competitive pressures among food, retail, and distribution companies, the uncertainties inherent in implementing strategic plans and integration operations, and general economic and market conditions. Additional information about the risk factors and uncertainties associated with Spartan Nash's forward-looking statements can be found in the company's earnings release, most recent annual report on Form 10-K, and in the company's other filings with the SEC. Because of these risks and uncertainties, investors should not place undue reliance on any forward-looking statements. Barton Nash disclaims any intention or obligation to update or revise any forward-looking statements. This presentation includes certain non-GAAP measures and comparable period measures to provide investors with useful information about the company's financial performance. a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measure and other information as required by Regulation G is included in the company's earnings release, which was issued yesterday. And it is now my pleasure to turn the call over to Tony.
spk07: Well, thank you, Chris, and good morning. It is a pleasure to be speaking with many of you for the first time as President and CEO of Spartan Nash. I am proud to be part of this organization, and I'm energized to address the opportunities we have ahead of us. Let me begin by thanking my predecessor, Dennis Edson, for what he and his team have done over the past year since he stepped back into the CEO role on an interim basis. His leadership, through an extraordinary time in our country and our world, is a legacy I plan to build on. I look forward to working with him and the other members of the board of directors as he resumes his role as chairman. As I reflect on my journey ahead, I realize what a privilege it is to lead a Fortune 500 company a top grocery distributor, and a company that takes great pride as a leading supplier to our brave men and women in the military. Throughout my career, I've maintained a focus on building people-first organizations and have maintained a strong commitment to transparent communications. I believe that this combination builds trust with our associates, customers, and suppliers and is imperative to our collective success. During my first nine weeks on the job, I've had the pleasure of meeting hundreds of associates at our stores and distribution centers. In those visits, my first objective was to listen and understand what drives their success and challenges on a daily basis. I'm inspired by the level of passion we have within this organization and our unrelenting commitment to serve our customers. I plan to share more specific objectives for the organization over the coming months. However, my immediate goal is to ensure that we are leveraging our existing competencies to yield improvements in our operating performance. Our financial results have underwhelmed in recent years, and I am confident that together we can achieve more. I will work to pair the insights I have gained with the operational strategies to unlock the true potential of our organization. Among other areas of focus, I believe that we need to act with a certain level of urgency to make meaningful improvements in our supply chain. We will make investments in human capital, in our facilities, and other resources to ensure our supply chain has the support it needs to operate with efficiency and a high level of execution. I've had the opportunity to lead many fine organizations in similar industries and will draw upon that experience as we work to make the most of the opportunities in front of us. In my three decades of leadership in the food industry, I've developed a deep understanding of every facet of the consumer packaged goods and food distribution businesses. Over 35 years, my experiences have ranged from packaging machine operators to plant manager and a great many GM and functional leadership roles. My most recent role as CEO of both Borden Dairy and Ready Pack Foods, I succeeded in developing people-first cultures and supporting our teams to renew our commitments to innovation and customer service. In both roles, I was able to lead our teams to be best-in-class operators in the industry. In short, I'm no stranger to challenges, and as CEO here at Spartan Nash, I certainly intend to apply my supply chain and organizational development expertise to transform our company into a world-class operator and one that can deliver on sustainable growth over the long term. Let me end by thanking you for your well wishes and support. I'm thrilled to be here and very excited about the journey ahead. With that, I will now turn the call over to Mark to review our third quarter performance and provide an updated guidance for the remainder of the year.
spk03: Thanks, Tony, and welcome to everyone joining us today on the call. Net sales for the third quarter of fiscal 2020 increased by 3.1%, or $61 million, to $2.06 billion versus 2019 third quarter sales of $2 billion. Our adjusted EPS for the third quarter came in at $0.70 per diluted share compared to adjusted EPS of $0.30 per diluted share in the prior year's third quarter, an increase of 133%. GAAP EPS came in at $0.56 per diluted share in the quarter compared to a loss of $0.01 per share in the third quarter of fiscal 2019. The increase in profitability from the prior year quarter was driven by higher sales volume, improved gross margin rates, and increased leverage of our operating expenses particularly in retail store labor and certain of our fixed costs. Increases in incentive compensation and a higher rate of supply chain expenses serve to partially offset our increased profitability. Shifting to our business segments, net sales and food distribution increased by $73 million of 7.8% to $1.01 billion in the third quarter, driven by the combination of continued sales growth with existing customers and incremental volume associated with the impact of COVID-19. Inflation moderated to 1.12% food distribution in Q3, a significant pullback from both the second quarter rate of 4.43% and the third quarter of fiscal 2019's inflation rate of 1.68%, as meat prices were nearly flat in the third quarter following the significant second quarter increases, while produce inflation levels nearly doubled sequentially. Reported operating earnings for food distribution in the third quarter totaled $9.2 million compared to $11.7 million for the prior year quarter. During the quarter, we made the decision to abandon a trade name to better align our transportation operations and provide a more integrated solution to our customers, resulting in a $7 million impairment of the trade name. The decrease in reported operating earnings for food distribution was largely due to this asset impairment charge, as well as higher supply chain expenses from both the dollar and rate perspective, and a higher allocation of corporate administrative expenses. These increases were partially offset by the incremental profitability from higher sales volume in the quarter. Adjusted operating income totaled $15.7 million in the quarter versus the prior year's third quarter adjusted operating income of $15.5 million. Adjusted operating earnings exclude the asset impairment charges and other items detailed in Table 3 under the food distribution segment in yesterday's press release. Retail net sales came in at $597 million for the quarter, compared to $562 million in the third quarter of fiscal 2019, an increase of 6.2% or $35 million. Our comparable store sales were 10.6% for the third quarter of fiscal 2020. Comparable store sales benefited from the shift toward food at home and also reflect our strong customer penetration. These results also reflect increases of over 175% in our e-commerce sales for the quarter, and continued favorability in our private label sales, particularly compared to competitors. We also continue to benefit from higher EBT sales, although not at the same levels as earlier in the year. Early in the fourth quarter, we held a grand opening for our new Martin store in Elkhart, Indiana, replacing a previously closed store as part of the redevelopment of the city's River District, increasing our current store count to 156 stores. Third quarter adjusted operating earnings in the retail segment came in at $22.6 million compared to $7.3 million in 2019's third quarter. Retail reported gap operating income of $22.3 million for the quarter compared to $6.7 million in the prior year's third quarter. Our profitability improvement was driven primarily by the sales increase during the quarter, while we also benefited from improvements in our margin rates, which include lower inventory shrink, as well as favorable variances in labor rate. partially offsetting these items with higher incentive compensation due to the improved segment performance. Military net sales of $452 million in the third quarter decreased by $47 million, or 9.5%, compared to prior year quarterly revenues of $499 million. Sales continued to be negatively impacted by commissary restrictions and base closures during the quarter, as many bases maintained a higher alert level that either limited or did not allow visitors thereby reducing the number of shoppers who could access the commissaries. Military generated an operating loss of $2.5 million on both a reported and adjusted basis in the third quarter, compared to a reported loss of $2.6 million in the third quarter of fiscal 19, and an adjusted operating loss of $2.5 million for that quarter. Improved margin rates were effectively offset by a combination of the lower sales volumes, an increase in allocated corporate overhead expenses, and expenses related to Hurricane Sally. Interest expense decreased $3.9 million in the third quarter of fiscal 2020 to $3.5 million due to the combination of lower interest rates and lower average debt levels resulting from our increased profitability and improvements in working capital compared to the third quarter of fiscal 2019. In the first three quarters of 2020, we generated consolidated operating cash flows of $224 million compared to an increase of $84 million over the same period in fiscal 2019. This increase was largely due to our higher profitability and the improvements in working capital that I mentioned a moment ago. These improvements resulted in free cash flow generation of $178 million in the year-to-date period compared to $93 million in the same period over the prior year. During the third quarter, we declared $6.9 million in the form of cash dividends, and Spartan Ash didn't repurchase any shares in the third quarter. Our total net long-term debt decreased by $145 million during the first 40 weeks of 2020, ending the third quarter at $519 million compared to $664 million at the end of fiscal year 2019. Our net long-term debt to adjusted EBITDA leverage ratio fell to 2.3 times as of the end of the third quarter, from 3.7 times as of fiscal 2019's year end, driven by the combination of our strong debt pay down as well as our 35% increase in year-to-date adjusted EBITDA to $190 million. We expect to make further progress on our leverage ratio in the fourth quarter. As covered in yesterday afternoon's press release, we are updating and narrowing our fiscal 2020 earnings guidance. For fiscal year 2020, we now anticipate adjusted earnings per share from continuing operations of approximately $2.42 to $2.50 per diluted share, compared to our prior projections of $2.40 to $2.60. Our updated guidance reflects the continued benefits of sales trends associated with COVID-19 and the related increases in consumer demand that we are experiencing, offset by estimated non-cash stock warrant expense of $6 million to $7 million, or $0.13 to $0.15 per diluted share in the fourth quarter associated with the issuance of warrants to Amazon, as disclosed in our Form 8K filing in October. For accounting purposes, this warrant expense will be reported as a reduction in sales and will negatively impact our gross margin rate in the fourth quarter of fiscal 2020. Reported earnings per share from continuing operations are expected to range from $2.09 to $2.17 per diluted share, compared to our prior projections of $2.13 to $2.41. We now expect fiscal 2020 adjusted EBITDA to range from $237 million to $242 million compared to our prior guidance of $232 to $242 million, consistent with our projected increases in operating earnings. Our guidance reflects capital and IT capital expenditures in the range of $80 to $85 million for the fiscal year. Depreciation and amortization are expected to be $88 to $90 million. Interest expense is now expected to range from $18 to $18.5 million. Also, our guidance reflects an adjusted effective tax rate of 23.5% to 24%, while our reported effective tax rate is now expected to be 13% to 13.5%. Before we open up the call for Q&A, I'd like to take a moment to thank Dennis Edson for his leadership of the company after jumping back into the CEO seat for the last year plus. and also to wish him a happy retirement as he continues as chairman of the board. And finally, I'd like to publicly welcome Tony to Spartan Ash, and the executive team and I look forward to working with him as he leads us into our next phase of growth. With that, I'd like to turn the call back over to the operator and open it up for questions.
spk10: Thank you. We'll now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. This time, we'll pause momentarily to assemble our roster. Okay, our first question comes from Chuck Sarenkoski from North Coast Research. Please go ahead.
spk06: Good morning, everyone. Good morning, Chuck. Tony, you mentioned a sense of urgency around improving the productivity Spartan supply chain. Do you see any low hanging fruit there? Or can you talk about some projects you want to get to quickly to improve the operating margin within food distribution?
spk07: Well, a great question, and I'll caveat this one and many others today with the notion that I've been here six and a half weeks. I don't have absolutely everything figured out yet, but as I look at our DCs and our performance overall, it's clear that we have opportunities at a high level. We have process opportunities the way we run our DCs. We have some infrastructure opportunities. We have aging IT systems, for example, so I think there's a number of productivity areas we can go hunt. I don't think there's any one panacea, but there's certainly a number of areas we can go make improvements and get a turnaround there. So I'm in the need to do that exercise right now, figure out which ones to take on first and how we go about them.
spk10: The next question comes from Karen Short from Barclays. Please go ahead.
spk00: Hi, good morning. This is Kate Howard on for Karen. First, congratulations, Tony. We look forward to working with you. I guess my first question is, can you talk about how much of an impact lapping the exit of fresh production had on the food distribution segment from a year-over-year standpoint?
spk03: Yeah, so it's a helpful question, Kate, and it's a little misleading in the way we report the segments as to what that did to food distribution. So from an external standpoint, as we've had in the press release, the food distribution segment was up about 7.8% for the quarter. But if you were to adjust out for the fresh production and some of the business either from the kitchen that went away last year that we're lapping and you know, as we talked about at the end of the first quarter, we're exiting the fresh cut business. You know, I would say that the food distribution, like the core food distribution without the KITO impact on it was probably 500 basis points higher, so it was probably closer to a 12.7, 12.8 for the quarter. And, you know, when we talked last quarter about the about 15.5, you know, we probably weren't clear enough is that that was the food distribution portion and it was not netted with KITO in the way we would externally report it. So, you know, I would say that we did see some moderation during the course of the quarter in order to end up at that 12.8 in food distribution. But, you know, we definitely were X the KITO production business about 500 basis points higher.
spk00: Okay, that's really helpful. And I guess kind of along those lines, can you share what current trends to date are in both food distribution and at retail?
spk03: Yeah, I mean, I think that we would see – well, we would say that we've seen a little bit of moderation further, but it's been choppy. And so, you know, it's difficult to understand if just the way – you know, some of the different states reopening or impacting that or, you know, if there are other factors that are at play. But, you know, I would say that from the numbers that we averaged for the third quarter, you know, we're probably, you know, as we sit here today, maybe 100 to 150 basis points off that. Certain parts of retail, certain, you know, certain geographies that are maybe more open than others might be off to a greater extent, but we're probably, you know, 100, 150 basis points down.
spk00: That's great. Thank you.
spk10: The next question comes from Scott Mushkin from R5 Capital. Please go ahead.
spk09: Hey, guys. Thanks for taking my questions. Tony, welcome. I'm excited to work with you guys and work with you. I'm glad Dennis found a great successor. Anyway, I just wanted to clarify what you just said, Mark, actually. So you said the sales are down about 100 and 150 from where they were running?
spk03: Well, from the average of the quarter. I mean, it's a little tricky just, you know, from where they were running per se, but, you know, from the average of the quarter, we're down a little bit.
spk09: Okay. So then, and maybe, Tony, you don't have an answer to this yet, but, I mean, obviously this military business has been – you know, a drag on the company for a really long time. Have you put any thoughts into, you know, what to do with it? Is there anything to do with it? Is it something that, you know, we need to stick with? Or how should we think about that?
spk07: Yeah, it's a great question. So, and it's, you know, obviously, as you know, it's a long legacy business and a lot of history and pride in serving the military. But the military results are not acceptable. And so that business will change. It has to change. And we're going to look to harkening back to my previous question, how much of that is in operating efficiency? I don't think we'll find all of it there, but that's an appropriate place to start. And we'll find other ways to improve it. But, you know, my broad commitment here is to grow Spartan Nash top line and bottom line, and military has to play, and it hasn't. So there will be changes there for certain.
spk09: So then this is, again, more of a strategic question. Maybe it's not fair because you have six and a half weeks under your belt, but Spartan's always been acquisitive. I think you obviously signed an incredible contract with Amazon. How are you initially thinking about the growth trajectory of the company? Obviously, there's work to be done on the operational side, which I think you framed, but looking out a couple of years, how do you think this business grows, both maybe organically and then also through M&A?
spk07: Well, I think it will grow in both those ways. And I think we will be, you know, as we said in our previous calls, I believe we'll be, you know, opportunistic if we have an opportunity to grow in retail. But the big thrust of our growth will be in distribution, and we'll look for ways to expand that. And expand it with new customers or growing some old ones, and then look to set up new beachheads for growth. And we have, of course, great opportunities geographically to do that. So I think we'll be probably more aggressive in looking at acquisitions in the distribution space, if that makes sense, and probably more opportunistic in the retail space.
spk09: That's terrific. Do I have time for one more, or should I just get back in the queue?
spk03: I think we're okay at the moment. We're doing well on time.
spk09: Okay. So then this is more of a shorter-term question. I mean, obviously COVID is escalating across the country. And so it's kind of a little two-part question. Number one, are you seeing in places where it's, you know, really starting to surge and it's starting to close down, are you seeing improvements in the sales trajectory? That's number one. And number two is I wonder if you could give us a little look into the independent grocer growth. You know, obviously when COVID, you know, started up, they were big winners in comparative, like maybe a Walmart or something like that as people flocked there. So it's kind of a two-part question that I'll yield. Thanks.
spk03: Yeah, so I mean, I think on the on the overall trends, and as you've highlighted with some of the COVID cases rising back up, I don't know that we've seen anything really measurable that we could call out through the last few weeks. You know, the trends that we have in certain geographies have been relatively consistent. There's been maybe a week or two where they were a little outside of the norms or outside the trends from that standpoint. But I don't know, like, let's say if we said Michigan as an example, I don't know that as Michigan suddenly has had an uptick in cases that we've seen anything significantly change. But, you know, that may be part of the governor hasn't, you know, moved our protocols further. And so that could be driving it or You know, there's aspects where the kids are still in school in many respects. And so, you know, as more and more schools shut down and go to a hybrid model working remote, we may see greater impact there. But it hasn't been sustained and or clear enough to point to anything specific in that regard, Scott. And then as it relates to the second question, look, I mean, I think the independents, they continue to benefit in this environment. You know, we look at We look at their numbers and, you know, even in a normal year, right, there are some independents that are doing great and there are some independents that are middling. I would say that with the tailwind that's come to food at home and benefiting the independents, you know, they're all benefiting, but they're not all benefiting to the same degree. And so just like we have in a normal year where we could point to some folks being up and some folks being down, we've got folks being up, but up to different degrees. I think the one thing that really hasn't been much in play until maybe the last month or so, maybe even the last two months, is that there was certainly a pause on competitive openings during the peak of COVID. Folks weren't doing construction. Folks weren't going out and setting new stores, opening new stores. People were focusing on running what they had. And now that, you know, now that the country's reopened to varying degrees, you are seeing that some of the competitive openings against independents in different geographies are now occurring. They might be months later than they were originally planned. So I think that maybe the only recent change in dynamic is that, you know, competitive openings that have been paused for a significant period of time are, you know, either back on the calendar and or occurring. You know, the independence of all benefit is just varying degrees based on their competition as well as their individual execution.
spk09: Terrific. Thanks for the answers. Appreciate it.
spk10: You're welcome. Next question comes from Greg Badish-Canyon from Wolf Research. Please go ahead.
spk04: Good morning. This is Spencer Hannison for Greg. Congratulations, Tony, on the new role.
spk05: Thank you.
spk04: So if we look at 2021, how well positioned do you think you are to just keep the sales and EBITDA gains from 2020? And then when consumers start to split their baskets again, what do you see as some of the biggest factors driving where they choose to shop?
spk03: Well, I mean, it's a little early to be predicting 2021 simply because we're not sure what the sales trends will be coming out of the holidays and going into next year. But You know, I mean, I think that, you know, to the extent that there's a, you know, a longer-term shift of food at home from food away from home and, you know, look, we all take the news of a possible vaccine as a positive, but you also get sort of a refresher that it's going to be six to nine months before that's widely available. And so, I mean, we've talked before that in the northern geographies where we primarily operate, you know, it's quite likely that, you know, folks are not going to be going out to dinner as much as they were before because they'll need to be indoors. And frankly, if the number of COVID cases continues to spike, you know, occupancy levels that have been returned to 100 or maybe 50% capacity may be cut back further. And so that should help our numbers going into 2021. I'd like to think that we retain a good portion of the EBITDA and the sales that we've generated. But, you know, honestly, not willing to kind of put anything down as to a range until we get through the year end and see what the trends are as we start off for the new year. So, you know, I think you can understand that. I mean, we've tried as far as to set some guidance and, you know, based on what we've seen for the expectations and, you know, we've managed to sort of stay in the range and occasionally, you know, it's been a little lighter than what we projected. But, you know, we're all trying to predict the future in something we've never seen before. And then, I'm sorry, Spencer, the second question was, the second half of the question was about retaining the business. Yeah.
spk04: How do you expect consumers to quit their business again?
spk03: Yeah, I mean, I think that from our consumer perspective, you know, we brought folks into the store that, you know, may have previously shopped with us that have been, you know, you know, refreshed and getting to see, you know, how we've changed over the years and we're working very hard to make sure that those customers retain, we retain those customers. I would tell you that, you know, what we've seen on the private label and owned brand side, where, you know, we've made some market share gains and we've been able to keep those. I mean, our owned brand's growth in the third quarter was pretty much consistent with our comp, whereas we saw for a lot of our, you know, a lot of our competitors, you know, that they were maybe 200 to 300 basis points lower as national brands returned to the store. And so I think we're doing a good job with that, with the quality of the products that we're offering and the price points. You know, and I think that consumers are looking at what, you know, what their bottom line, you know, purchase is going out the door compared to maybe when they were shopping at a competitor and saying that we're, you know, we're on par or a reasonable difference. And so we're able to retain those customers. And we'll have to keep working at it. But I think we've been pretty successful to date.
spk04: That's a great color. And then on your distribution centers, can you talk about how much incremental volume you could put through your existing facilities before you'd need to add capacity just as you start to add new customers?
spk03: Yeah, I mean, that's really a function of the type of volume and where it comes, right? I mean, there's some distribution centers that could easily handle – you know, a half-billion of incremental volume based on their size and current capacity and what we've done in the past. There are other distribution centers where, you know, an incremental $50 million might lead us to go off-site either because of the size of the distribution center or the types of orders that we receive there. So it's not a one-answer-fits-all kind of response, but I would say that You know, we've built out our infrastructure and we're looking at growing towards the future in a scenario that as we add additional capacity, that it relieves capacity off of other distribution centers. And so we, you know, we benefit maybe in two or three locations as we need to add space. And so I think it will be incremental builds that would not be that significant of an increase on our capital expenditures. And, you know, hopefully in many instances we'd just be able to fit it in with a normal year-to-year CapEx. But certainly if we had a big spike in one year, you know, it's not unreasonable to think that capital allocation could go from the roughly 1% we generally have done to maybe one and a quarter, 1.3. But I think that that's more of a one-year scenario versus a need to get into a cycle like that going forward. I think that we can manage our growth within the capital plans that we have right now.
spk04: Great. Thank you.
spk03: You're welcome.
spk10: The next question comes from Kelly Banya from BMO Capital Markets. Please go ahead.
spk01: Hi. Good morning. Thanks for taking our questions. I also just want to express congratulations and welcome to you as well, Tony, from all of us here. Thank you. I wanted to just kind of go back to that comment, I think, Mark, that you made about the 500 basis impact from Kaido. And can you just walk us through how that same dynamic may have impacted the past couple of quarters in the food distribution segment?
spk03: Yeah, yeah. I mean, I can, Kelly. I mean, it may take me a second just to be able to best answer for the first quarter. You know, here's, you know, so just maybe as a refresher, it was at this time a year ago that we announced, well, yeah, I mean, no, it was the second quarter last year, so I apologize. But in the second quarter of last year, we announced that we were going to exit the fresh kitchen business and that we were considering disposition of fresh kitchen and fresh cut. And at that point in time, we talked about the fresh kitchen business being maybe a you know, $50 million or so on a run rate. And we wound that down during the course of the third quarter. It may have been a little bit into the fourth quarter. And so, you know, that took away a portion of the business. But then as we mentioned on the first quarter earnings call, you know, we were in the process of growing the fresh cut and shifting some volumes around when we lost a significant customer. And based on that customer's volume, within the fresh cut business, we just couldn't make the fresh cut business profitable quickly enough to sustain that customer's loss and try to rebuild. And so we made the difficult decision to exit fresh cut. And so as we look at where we are right now, you know, the numbers earlier in the year are probably that we're down, you know, we're down probably 35 to 40 million on a year over year basis. in both the second quarter and third quarter in sales from those portions of Kaido. There's probably a little bit that's in there on the distribution side because they do some food service business and the food service business has been softer. In the first quarter, that number is maybe down 30 to 35 million because we did operate the fresh cut business for the bulk of the first quarter. We wound it down starting in like the March timeframe. So almost around the timeframe that COVID started giving a significant sales lift, you know, we started to see that go down. So, you know, when you look at it in the numbers that we were putting up in food distribution in the first quarter, second quarter, really didn't, really didn't, you know, kind of factor into the call out. And, you know, we just kind of reported the combined numbers. But, you know, as we've talked about, there were some questions after we did the earnings release last night. you know, not missing it in the third quarter makes it seem as if our ongoing food distribution business had greater weakness than maybe others in the space are reporting. And so thought, you know, it would be helpful to clarify that, particularly when we got the question this morning.
spk01: Okay. That's helpful. And I guess, Tony, you had mentioned just investments and capital. I think you called out some IT that is a little dated. I guess, should we think about maybe Spartans shifting a little bit more into an investment phase here? Because it feels like there's been some focus on just cost-cutting over the last couple of years. And I'm just curious how you think about that dynamic, if you can elaborate on that at all.
spk07: Sure. Well, without having to comment on the past investments, looking forward, you know, just pure cost-cutting I don't think is an appropriate way to think about how we're going to make our investments. We will certainly make investments that make us more productive because that productivity gives us the license to go grow our business. And I think of these things as a virtuous circle, if you will. And so I think we will look to balance those investments, balance them between things that make us more productive and things that make us more capable of serving our customers and things that give us greater capacity, as Mark mentioned a moment ago. So I think those things will all work in balance, and that's the way I think about our investments going forward.
spk01: Okay. And I guess, you know, with the Amazon announcement last month, lots of questions there. I don't know how much you can say, if at all, but How should we think about modeling that in over the next couple years? And really, what's the driver behind that? I mean, what's happening for Amazon that we should think about drives the growth there for you?
spk03: Well, I think that last question is probably a better question for Amazon than for us. I'm not sure that for any customer that we should sort of be discussing what's driving their growth. But Look, I think, you know, we would be shocked if we didn't get a question about Amazon on this call, right? And so, given the announcement last month. You know, I would say, look, we've been doing business with Amazon since back in 2016 when Dennis was in the CEO seat and Dave was in the COO seat. And we talked then about how we were doing, you know, grocery with them, some shell and some frozen. and, you know, that we are working with them within the Amazon Fresh and Prime Now parts of the business. And that relationship has continued over the last four and a half, almost now five years. And, you know, I think that the announcement, you know, certainly indicates that we're going to continue to work with them. And, you know, there's an opportunity for Amazon, which we hope they fully take advantage of, you know, to purchase, you know, up to $8 billion over the course of seven years or less in order to, you know, get the warrants to be able to exercise in our stock. And, you know, the cadence of that we wouldn't necessarily discuss. We wouldn't share. You know, if Amazon ever becomes significant enough of a customer where they'd be north of 10% of sales, we'd obviously disclose that. We haven't disclosed that previously. But, you know, if you do the math, if there's $8 billion in purchases over seven years to fully vest the exercisability of all the warrants, that would average out to, you know, north of $1 billion in sales over that seven-year period. So we hope they do that, you know, over that time frame. And if they'd like to get that done even sooner, that would be a welcome benefit on our end. So, you know, we've worked with them for a number of years, continue to work with them. They've been a great customer and We look forward to continuing the partnership.
spk01: Thank you.
spk10: You're welcome. The next question comes from Damon Polistina from Deutsche Bank.
spk08: Please go ahead. Good morning. Congratulations, Tony. Yeah, so can you just speak to kind of the promotional environment you're seeing in retail, how it's changed over the last couple of months compared to kind of the high epidemic? Have you seen competitors become more promotional?
spk03: You know, I don't know that we've seen – I think a couple of things there, Damon. I would say that over the last few months we've seen, you know, there was a period of time where some competitors stopped running print ads and only went digital. I would say that, you know, looking at the space, promotions are down overall. I don't know that competitors have gotten, say, more promotional than maybe where they were pre-COVID, but I think that the promotion levels are, you know, slowly inching their way back to, you know, normal levels, and at what point and what date we get there remains to be seen. You know, there are some challenges, which is why, you know, you just won't be back to normal levels because there's some products that you can't even secure still. And if you were to secure it and put it on promotion, you know, it would be gone in a flash. And, you know, in that regard, you know, folks need to make sure they have an ample supply if they're going to try and put it on promotion. And if you can sell it all at full cost, you're, you know, some of the things like the cleaning supplies and disinfectants, you know, those don't need to be promotional for an environment. So I don't know that there's been any significant change there, but I would say that the levels have risen from where they were during the spring, but they're still below where they were, you know, in the beginning of the first quarter of 2020.
spk08: And then one more for me, just on e-commerce, it was up 175% this quarter. Can you just speak to kind of the consumer's response to your offerings and then kind of where you see that business coming out to as far as percentage of the mix and then kind of the profitability levels of that business?
spk03: Yeah, so I mean, I'll answer the last question first. I mean, we've spoken that our e-commerce business is profitable, but it's not as profitable as a consumer going into the store and shopping on their own. So, I mean, we've made great inroads over the last couple of years to increase the profitability of that business, but, you know, a customer going into the store and shopping versus us having a personal shopper, you know, the savings you get from not having the cashier does not equate to the time it takes the personal shopper, so that's for sure. you know, as a percentage of our business, you know, I would say that in the case of the stores that have e-commerce, you know, it's running a little bit north of 4% of sales in the third quarter. And so, you know, pre-COVID, you know, that was closer to like two, two and a quarter. So that, you know, that does kind of match up with the north of 175% that, you know, we referenced. And, you know, we would say that You know, those consumers, you know, we certainly are down from the peaks where people weren't willing to go into the stores. But, you know, we've certainly seen that a great deal of the incremental volume that we've picked up has been pretty sticky, and that new customers that we got during that time frame continue to utilize the Fast Lane offerings that we have and the other e-commerce offerings. And then, you know, as we've always seen with some of the Fast Lane business, that they – that they basically fill in during the week or they go into the stores for certain offerings in addition to what they're buying for e-commerce. And so we're getting an overall greater percentage of that consumer's basket by virtue of the e-commerce offering that we have.
spk08: Thank you.
spk10: The next question comes from Peter Sala from BTIG. Please go ahead.
spk02: Great. Thanks, and congrats, Tony, on the position, on the role. I just wanted to come back to the conversation around capital investment. Tony, when you think about next year, do you think you'll be making more changes in terms that will need more capital investment or more operational investments next year as you maybe plan for increased volume from some new customers?
spk07: I'm going to clarify your question. So you're saying will the investments as we prepare for bringing on new customers be more capital or process oriented? Is that the essence of it?
spk02: I'm trying to understand if you'll be making a little bit more capital investments next year versus prior couple of years?
spk03: I mean, I don't think that it would be measurable. I mean, again, I mean, any given year, we can be as little as 90 basis points of sale and maybe as high as 1.1%. So, you know, I think we'll probably be in that range. I don't know that it's a big shift. And honestly, this year, more than any other year, with all the delays associated with COVID, it's quite possible that some of the capital doesn't get spent Just because of the way the timing plays out and I'll give a very perfect example is that we're looking to do some work in a distribution center right now and we're having trouble getting permitting and the permit's been in for a number of weeks but we haven't gotten it approved because there's only a handful of people that handle that in the office. and it needs to go through two or three levels and more. And in that particular municipal office, three of the folks that would be associated with getting us approval are currently all with COVID. And so that's a scenario where we're going to be delayed spending the capital simply because, you know, of world events, not that we would otherwise not spend the money. So, you know, I mean, I can say next year being a little bit higher, but it's more likely going to be because of things like that than, you know, if I were to have customer growth that we suddenly need to spend an extra $30 million.
spk02: All right. Thank you very much.
spk10: The next question is a follow-up from Chuck Sarenkoski from North Coast Research. Please go ahead.
spk06: Thanks for the follow-up. In looking at the Amazon relationship, I'm sort of focusing here on the share count going forward. It's up to them when they hit certain spending thresholds with you, which in turn allows them to exercise the warrant. Is that tied to any particular part of the year? Is there any predictability in that process so that we can have a better idea on where the share count is going to be? And I understand you're going to be using the Treasury method, so if you could comment on that a little bit, Mark, it would be helpful.
spk03: Yeah, so that's a very complicated question. Let me try to explain it as simply as I can. You know, so the agreement allows for Amazon to have the ability to purchase up to 5.4 million shares subject to certain vesting conditions. Approximately 20% or about 1.08 million of those warrants vested upon execution of the agreement. Those warrants could be exercised today or any day from now to the remaining six plus years on the agreement. Additional vestings occur with some requirements which are not public and won't be public, but will certainly reflect warrants expense over time as as the conditions of those vestings are met, and that'll be in our numbers and be in our guidance. As it relates specifically, Chuck, then to your question about the shares, yes, I mean, without going into all the accounting, it'll be the Treasury stock method, which basically takes, says that for the proceeds you would get from the exercise of the warrants, you would take that cash and apply that against buying back the stock on the open market. In a very simple example, if the stock doubled, you would only get dilution of 1.25% versus 2.5% simply because you could buy back half the shares on the open market because they would be at double the price. All the folks with your models, the information is out there publicly. Do the math and see what the dilution would be. You know, the dilution varies based on where the stock's trading at that point, but it would be a fraction of what's currently exercisable simply based on where the stock is currently trading. And if there's further questions, I can walk someone through it offline, but that's probably the most accounting talk anybody wants on an earnings column.
spk06: And then the timing of additional vesting is not tied to anything, but how much Amazon purchases going forward after the initial?
spk03: Yeah, I'm not going to comment on what the vesting criteria are, but there are different vesting criteria as to how they achieve that. That was redacted from the document, so we're going to keep that appropriately confidential.
spk06: All right, thank you.
spk10: The next question is a follow-up from Scott Mushkin from R5 Capital. Please go ahead.
spk09: Hey, guys. Thanks for taking my follow-up question. So I just want to get some clarification on a couple things. If you guys are fully engaged with a retailer, both dry and fresh, how much of the store do you think you control or distribute to? Control is the wrong word. Is it 60%, 70%? Is it 80%? What would you put that number at? Yeah, I mean, I...
spk03: I guess I would say it's a function of, you know, what they're doing DSD. But, I mean, I would say like a good penetration for us. Some retailers north of 50% would be a strong penetration, but probably a max penetration would be closer to 70%, maybe 65%. I mean, again, it's all mixed driven by how much shelf space, how much center store, you know, how they've got that broken out. But, you know, north of 70% would be unusual. 60 to 65 might be a normal max, and there are some retailers, depending upon what they're carrying and where they're devoting their space, it could be lower.
spk09: And your expectation with Amazon is that they're going to be a full partner, utilizing everything you guys do?
spk03: I wouldn't want to comment on that because I don't know that I know enough about their relationships that I should comment as to whether or not that would be our penetration with them. whether in any of the different areas that we serve them.
spk09: But, Mark, I think you probably answered, are you going to service them with fresh and dry grocery or just dry?
spk03: No, we continue to do fresh and dry, yeah. I mean, we've done, you know, that would be some of the perishable product that we reference in the case of chill.
spk09: Okay. So, you know, kind of taking a step back and looking at the relationship and Amazon's plans, I'm struggling to understand why it's not in their interest to go way beyond if they're growing their store base and their other capabilities in consumables, why they wouldn't want to blow through these targets. I mean, it's, you know, clearly would help your equity a ton. And so if they're growing this business, I'm just trying to understand why it wouldn't be in their, you know, vested interest to exceed these targets.
spk03: Well, again, you know, that's probably a better question for them. I would say that we would welcome that as long as it's not some crazy level of growth that would be difficult for us to support. But, you know, I mean, that's a question for them. I mean, we're certainly here and ready to support them as a customer and all of our customers, you know, in any of their efforts to grow their business and, you know, that's We help our customers succeed with growth, and we all succeed, and so that's a win-win on the front, and that's no different from the single-store independent to our largest customers. I would not disagree, but the individual customers have their different reasons for making their decisions, and we're there to support them as much as they want to work with us, and we always would like it to be more.
spk09: And you can support them nationally?
spk03: I think, yeah, I think we feel comfortable. I mean, we're supporting some other customers on a national basis. And, you know, as we continue to grow, you know, depending on where our growth comes, you know, our footprint may expand. And, you know, I think we can still fit it within, you know, our capital expenditures that we've been asked about a couple of times. But, yeah, I mean, we're able to support folks nationally now. We do that. And we've been doing that for a number of years for a handful of customers.
spk09: Great. Thank you for letting me follow up.
spk10: Sure. Again, if you have a question, please press star, then 1. There are no more questions in the queue. This concludes our question and answer session. I'd like to turn the conference back over to Tony Felsom for any closing remarks.
spk07: Great. Well, thank you so much. And I just want to thank all of you for participating in today's call. It was great to get a chance to meet you in this fashion and looking forward to working with you in the future. Certainly appreciate the opportunity to share a little bit of my personal background as well as give you this update on the third quarter performance. And, again, looking forward to the next time we get a chance to speak. So with that, I wish you all a great day.
spk10: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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