SpartanNash Company

Q2 2021 Earnings Conference Call

8/19/2021

spk09: Good day and welcome to the Spartan Ash Company second quarter 2021 earnings call. All participants will be in a listen only mode. Should you need assistance, please signal conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Chris Mandeville with ICR. Please go ahead, sir.
spk04: Good morning, and welcome to the Spartan Nash Company second quarter 2021 earnings conference call. On the call today from the company are President and Chief Executive Officer Tony Tharsen and Executive Vice President and Chief Financial Officer Jason Monaco. 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 in a replay. It will be made available on the company's website for approximately 10 days. Before we begin, the company would like to remind you that today's discussion will include a number of forward-looking statements. If you will refer to Spartan Nash's earnings release from yesterday, as well as the company's most recent SEC filings, you will see a discussion of factors that could cause the company's actual results to differ materially from these forward-looking statements. Please remember, Spartan Nash undertakes no obligation to update or revise these forward-looking statements. The company will also make a number of references to non-GAAP financial measures. The company believes these measures provide investors with useful perspective on the underlying growth trends of the business, and it is included in yesterday's earnings release, a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. And it is now my pleasure to turn the call over to Tony. Tony?
spk05: Thank you, Chris, and good morning, everyone. Overall, Q2 is a strong showing for Spartan Ash, with both our top and bottom lines exceeding expectations. Like the rest of the industry, we have been challenged by historic labor shortages, strains on global supply chain, and rising prices. However, I could not be more proud of how the team overcame these obstacles in our second quarter. I am encouraged by our momentum heading into the second half of the year, which is reflected in our decision to improve our full-year guidance. Jason will provide details on our updated outlook, but first I wanted to cover a few highlights from the quarter. I'll begin with food distribution. Our warehouse labor and transportation costs remain unfavorable and worsened in recent months. Nonetheless, our supply chain team proved resourceful and agile, taking swift actions to manage inventory and profitability. The team strategically reduced inventory by over $60 million during the quarter. This inventory reduction allows the distribution centers to operate more efficiently and provides a solid foundation for the supply chain transformation initiative to begin. I'll share more on this initiative shortly. In the retail segment, our top-line trends are proving quite resilient as we cycle last year's COVID lift. Sales remain higher relative to 2019 levels. On a two-year basis, our comps have improved from 9.3% to 12.1%. The demand for food at home has persisted, and our stores benefited from an overall increase in traffic compared to the prior quarter. Regarding digital sales, we've seen over 100% growth since 2019, and to continue the expansion of our digital channel, we recently opened our first micro-fulfillment center. Lastly, in our military segment, we continue to realize top-line headwinds. Domestic traffic across the DECA channel is down as shoppers have not yet fully returned to bases after leaving to shop elsewhere during the pandemic. While these trends have caused the segment to trail expectations, our team has been working proactively to leverage positive trends within exports. The team is also executing gross margin initiatives, which have already produced favorable results. With regard to our 2021 key performance indicators, we are making progress on many fronts. Our private label efforts are ahead of our expectations year-to-date, and we continue to build momentum through the year. Notably, we continue to make improvements within our assortment, pricing, and marketing. Specifically, we've taken steps to redesign our labels and launch new items in the fresh category. We are also getting our private label products in more homes through the expansion of our locations that offer fast lane and ready-to-eat home delivery. We continue to see favorability within our gross margin profile, and we're focused on our broader gross margin efforts across the company. We're seeing exceptional cost increases, some of which must be passed on to consumers. Meanwhile, our procurement team is actively negotiating the best possible terms with our suppliers. Overall, we are satisfied with the results, even as we navigate uncertainties related to inflation and cycling pandemic trends. Regarding our human capital indicators, we saw continued strong performance in safety, resulting in reduced incident rates due to our intense focus on safety awareness. Our newly energized safety team is implementing a myriad of process improvements to strengthen our performance. Everything from the introduction of universal stretching routines to prevent injury and promote wellness, to incorporating new safety discussions before all meetings. These small acts of safety help to support our people-first strategy. The safety team is also playing a critical role to implementing appropriate mitigating measures in response to our recent COVID surge. We are still quite challenged with the associate hiring and retention due to this highly competitive labor market. To put the challenge of this unique labor market into perspective, company-wide we currently have over 4,000 open positions. As you might imagine, we have taken a number of proactive measures to help us maintain a pipeline of top talent. To accelerate hiring, we recently raised the starting wage for numerous positions, which has helped attract more candidates. We've also shortened the length of time required in positions for associates to become eligible for benefits. On the retention side, we are heavily focused on associate recognition, and we're excited to launch a number of new associate recognition programs for the front line and for our leaders. We are also investing in more diversity, equity, and inclusion programming, as well as training and development for associates. We are expanding our total rewards with additional discount days in our retail stores, tuition reimbursement, wellness benefits, and more. As I said in our Q1 earnings call, we are facing a war for talent, and we are taking significant steps to win this war through our people-first culture. On to our final KPI, improving distribution service levels. This ties directly to our supply chain transformation initiative that we announced last quarter. Today, we want to provide more details on this initiative, which will address the short-term challenges in the supply chain. It will also allow us to capitalize on the growth of our network in the long term. Based on the blueprinting phase we recently completed, we have organized this initiative into the following work streams. Warehouse operations, sales and operations planning, inventory optimization, network strategy, and procurement. Starting with warehouse operations, we are incorporating best practices across the network through process standardization and guidance for issue resolution. The culmination of these warehouse initiatives will ultimately lead to greater operational efficiency and enhanced control of labor costs. As for sales and operations planning, we are implementing a more robust process that fully integrates all functions of the organization. This is the best way to ensure supply chain execution and excellence across the network. Improvements to sales and operations planning will help us capture changes to the business environment and bring those insights to our supply chain operators. This provides our teams with the lead time necessary to make adjustments to inventory, labor, and transportation capacity that match the current demand. This process will improve our ability to respond more quickly to broader business issues in real time and best serve our customers' needs. Regarding the inventory optimization workstream, we will focus on a couple of key areas. We will leverage data and analytics to better manage inventory across the entire network. This will improve efficiency in our distribution centers and reduce excess inventory. We'll also evaluate capacity by warehouse and temperature class to allow data-driven buying decisions. In short, these actions will help us ensure that we have the right products in the right location at the right time. To summarize where this project will take us from a financial perspective, the Supply Chain Transformation Initiative is expected to provide 15 to 30 basis points of supply chain benefits on a run rate basis. We are eager to continue to make progress on our supply chain transformation and we'll have more updates along the way. Lastly, I've been with Spartan Nash now for almost a year and plan to update the broader community on enhancements we've made to our strategy. Along with the leadership team, I am pleased to announce that we will be holding a investor day this December. Be on the lookout for more information in the coming months. I'm excited to share our refreshed strategy as well as comprehensive updates on the status of our supply chain transformation. I'll now turn the call over to Jason to walk through the financial performance in greater detail and provide you with an update on our full year outlook.
spk11: Jason? Thanks, Tony, and welcome to everyone joining us on today's call. Let's jump into the detailed results. Net sales for the second quarter decreased by 3.6%, or $77.5 million, to $2.11 billion, versus 2020's second quarter sales of $2.18 billion. We are especially pleased with how well our retail sales trended in the current year compared to the prior year sales, which included surges caused by COVID-19. Additionally, we've continued to see growth with certain existing food distribution customers, which partially offsets the decline from prior year. Our GAAP EPS came in at 47 cents per diluted share in the quarter, compared to 80 cents per share in the second quarter of 2020. On an adjusted basis, EPS for the quarter was $0.54 compared to EPS of $0.73 last year. The decrease in profitability from the prior year was driven by the lower sales volumes I mentioned earlier. These declines were partially offset by an improvement in the gross profit rate, where we saw an increase to 15.8% compared to 15.5% in the prior year quarter. Gross profit rate growth was driven by improvements within the food distribution and military segments. as well as a change in our overall mix to more margin-accretive retail and food distribution segment sales. Lastly, our rate of supply chain expenses increased in the current quarter compared to the prior year quarter due primarily to tight labor conditions and incremental costs associated with healthcare as associates returned to pre-COVID medical usage levels. Turning to our segments. Net sales in food distribution decreased by $33.3 million, or 3.1%, to $1.06 billion in the second quarter, driven by last year's pandemic surges. The decrease in sales was partially offset by continued growth with certain existing food distribution customers. Inflation was relatively steady, sequentially, but we did see significant movements between categories within the quarter. Further, we also saw an upward trend as the quarter progressed and early into the third quarter as some of the price increases from suppliers have taken effect. We still anticipate further increases for the balance of the year. However, as we previously noted, we anticipate that these increases will be passed through to our customers. Reported operating earnings for food distribution in the second quarter totaled $16.7 million compared to $14.4 million in the prior year quarter. The increase in reported operating earnings for the segment was due to favorable margin rates and lower asset impairment and restructuring charges. These increases were partially offset by a higher rate of supply chain expenses and the impact of lower sales volumes. Adjusted operating earnings totaled $17.4 million in the quarter versus the prior year's second quarter adjusted operating earnings of $17.9 million. Adjusted operating earnings excludes the asset impairment charges and other items detailed in Table 3 of yesterday's release. Retail net sales came in at $620 million for the quarter compared to $631.3 million in the second quarter of 2020, a decline of 1.8%. Our comparable store sales were down 2.7% for the second quarter due to the favorable effects of the pandemic in the prior year. However, Two-year comparable sales were up 12.1%, an increase of 280 basis points sequentially from the first quarter as the consumer shift towards food at home persists and our consistent focus on retail execution delivers. Second quarter reported operating earnings in the retail segment came in at $12.7 million compared to $24.5 million in 2020's second quarter. In addition to the sales volume impact I mentioned, This decrease was primarily driven by a reduction in fuel margin rates, higher asset impairment and restructuring charges, and higher healthcare expenses. Retail adjusted operating earnings were $15.4 million for the quarter, compared to $24.7 million in 2020's second quarter. Again, adjusted operating earnings exclude asset impairment and restructuring charges. Military net sales of $430 million in the second quarter decreased by about $33 million compared to prior year revenues of $463 million. This was primarily due to the continuation of lower volumes at domestic commissaries following base access restrictions implemented in the prior year. Reduced foot traffic continues to drive significant declines in domestic commissary sales. Overall, transaction count on a year-to-date basis is down over 12% from the prior year at domestic commissaries. Second quarter reported and adjusted operating losses in the military segment came in at $3.5 million in the second quarter compared to $4.9 million in 2020's second quarter, reflecting continued improvement in spite of the significant decline in volumes. In the first half of fiscal 2021, the company generated $73.6 million of cash from operating activities compared to $198.2 million over the same period in fiscal 2020. Looking at the second quarter alone, we generated over $105 million of cash from operations this year compared to $69 million last year. The increase in cash from operations during the quarter relates primarily to substantial reductions in inventory that have been strategically targeted in the second quarter. The strong cash flow performance enabled us to pay down $75.8 million of long-term debt during the second quarter. The continued paydown of debt balances also resulted in favorable interest expense compared to last year's second quarter. During the quarter, the company declared $7.1 million in cash dividends, equal to 20 cents per common share. We also repurchased 265,000 shares during the quarter at an average price of about $20 per share. Our second quarter adjusted EBITDA was $54.4 million compared to $59.2 million in the prior year quarter. Combined with the reduction in our long-term debt balance, our leverage ratio decreased to 1.9 times compared to two times at the end of fiscal 2020. As covered in yesterday afternoon's press release, we are raising the low end of our 2021 profitability guidance range as we continue our momentum into the second half. Earnings per share is now expected to range from 156 to 169 per diluted share on a reported basis, while adjusted EPS is expected to range from $1.70 to $1.80 per diluted share. Adjusted EBITDA is now expected to range from $200 to $210 million. This update to our profitability range recognizes the strong performance trends in the retail segment, but is tempered by headwinds we continue to feel in our military business and supply chain. These include the continued impact of the availability and cost of labor we have felt most sharply in our supply chain, as well as domestic military commissary trends. We've also made investments in wages across the supply chain, similar to what we already executed within the retail business and discussed in our first quarter earnings call. In addition, the guidance now includes the impact of investments and expected earnings gains related to the previously announced supply chain transformation initiative, which we expect to be modestly dilutive on a net basis for 2021. As Tony mentioned, we will continue to update you regularly on this exciting initiative as it progresses throughout the balance of this year. We are affirming our 2021 guidance as it relates to consolidated net sales. However, we do expect a shift in the segment performance from a sales perspective. With the continuation of positive results in the retail segment, we now expect that retail comparable sales will be down from 2 to 5%, an increase of 2 to 3% from our previous expectations. Military sales are now expected to decline between 9 and 13% from last year, a further decline from our previous expectations. We continue to expect that food distribution sales will be down 1 to 3% from last year, These updates reflect both the trends observed in the quarter as well as our updated expectations for the remainder of the year.
spk10: And now, I'd like to turn the call back over to Tony. Thank you, Jason.
spk05: In summary, we are very pleased with our overall financial performance and the progress we have made this year, but we're not yet satisfied. We will work diligently to deliver upon our KPIs that will position us for success regardless of the industry backdrop. With that, I'd like to turn the call back over to the operator and open it up for your questions.
spk09: Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 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 2.
spk08: And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Peter Sillay with BTIG.
spk09: Please go ahead, sir.
spk02: Great. Thank you. Jason, could you just elaborate on the supply chain transformation? I think there was a margin benefit that Tony mentioned, 15 to 30 basis points. When should we start to see that? Is that second half of the year? I believe he mentioned that was ongoing. So just some more details around that. And does that also include some of the inventory work that you guys have done this quarter? Thank you.
spk11: Good morning, Pete. Thanks for the question and great to have you here this morning. We're super excited about this supply chain transformation program and where it's going to take us. A few headlines to build on what Tony talked about just a few moments ago. The program itself has started with a blueprinting, just as a reminder, the blueprinting that we talked about and announced last quarter. That blueprinting completed within the quarter and we've then laid out a specific transformation program and begun work on that program. As you can imagine, the changes for that can range from very quick to very long ranging. What we're expecting is that the seeds of those improvements will begin late this year, early next year. And what we've included in our guidance is a small amount of benefit within this year with an expectation that we'll be building towards a run rate into 2022. And we'd love to give you more color on that as the year progresses, and we'll share more detail about the program and how it's progressing at the investor day that Tony talked about as well.
spk02: Great. And then just on the inventory, the $60 million, I guess, benefit you guys saw this quarter, can you just give us a little bit more color on, you know, should we expect that to continue into the back end of the year, or is that more of a one-time in nature? Just details there would be really helpful. Thank you.
spk11: Sure. Sure. Thanks, Pete. The inventory was strategically targeted. So the way I would suggest you think about it is that – We had built more inventory than we needed in Q1, and then we also took a step back and assessed what inventory we needed and what locations and began work on that program. That effort concluded with a reduction in inventory in the quarter. The way I think about that is it's partially a catch-up or a recovery from carrying a little too much out of the first quarter, and I would expect that our inventory levels will stay relatively close to where we are through the remainder of the year However, they will vacillate up and down based on forward buy opportunities and the potential to create value on that front. So I think about this as a base from which there will be some variability up and down, but generally I'd expect to keep the working capital in check.
spk02: Thank you very much. Very helpful.
spk09: Thanks, Pete. The next question will come from Scott Mushkin with R5 Capital. Please go ahead.
spk06: Hey, guys. Thanks for taking my questions. So I think I want to focus a little bit short term. And you guys alluded to some forward buying opportunities. And I was just wondering, as you look through the rest of the year and the inflation outlook, how are you thinking about it? And do you think there's going to be a lot more opportunities, a potential upside to the guidance? And then the other question has just around when we're seeing COVID surge a little bit. Are you guys seeing any, you know, uptick in sales because of that?
spk11: Sure. Hi, Scott. Good morning. Nice to have you here. Let's maybe start with inflation. Inflation overall, as I spoke about earlier, it was relatively modest within the quarter, but there's kind of the story within the story that I want to share a little bit. with the group here. Just as a reminder, food at home inflation from a CPI standpoint was running about 1.4% in the second quarter. And when you kind of step back and we look at our wholesale business, for us, our inflation ran at relatively modest levels, kind of half a percent-ish for the quarter. However, there was a pretty big acceleration throughout the quarter from beginning to end. And there was also an impact from the year-over-year impact of lapping the huge protein inflation spike in Q2 of 2020. So you've got a little bit of noise in the data there. Importantly, by the end of the quarter, our inflation in the food distribution business was running around 3%. And that increase was really split between two kind of primary areas. The grocery business was running... close to the CPI rate, the CPI food at home rate that's publicly available through BLS, with meat running kind of high single digits. As you know, the meat protein and produce itself is much more variable and runs on a much shorter cycle, so you're going to see more ups and downs in that piece of the business. You obviously also see less forward buy opportunity because of the short cycle inventory. So kind of stepping back on inflation, We saw inflation look similar to publicly available data with some variability on proteins, also impacted by the big spike in meat prices last year, Q2. So what does that mean for forward buy? We continue to set ourselves up to be successful for forward buy. One of the goals of our inventory correction was ensuring we had the right space and the right ability to capitalize on forward buy should products be available. As you know, it's not a push-button exercise, and obviously there are some products that there isn't availability, and that's part of what's driving the price increase from the vendors themselves. So we will continue to pursue opportunities for forward buy and for capitalizing on that price change, but I wouldn't build a ton of upside into the back half of the year. We're seeing a big bulge in inventory now and into the third quarter. It remains to be seen what that will look like into the fourth quarter, and we continue to hold to an inflation rate of 2% to 3% for the year. I'd like to maybe hand it over to Tony to talk a little bit about the broader inflation environment because this is a different cycle where it's not just food but getting into a big change in the labor market.
spk05: Yeah, I think – hey, Scott, this is Tony. Yeah. Just a couple of comments. I'll get to your COVID question as well. So on the inflation piece, one discussion we've been having here is around the historical implications of inflation versus the current inflation we're experiencing and our forecasting. And historically, you know, we have been pretty efficient at passing through inflation, particularly in our wholesale business. And so there are benefits there. I think we will pass that through very efficiently in this case as well. And we believe that between the wholesalers and a retail business that the elasticity will be relatively low on that inflation. So I think that's positive. The one thing I just want to note is that the causal for the inflation is more significantly just base labor than it has been in some of the last couple of inflationary cycles. And we are also subject to those base labor inflationary elements. So While we have the advent of inflation coming from our suppliers that will pass through and then we'll find some efficiency in that, we also are subject to the costs, the same costs that they have, and that will offset some of those upsides. And so that's just a pragmatic reality. And for, I'm sure, other questions I'll have today, we'll talk more about labor. It has been a very, very big topic for us and for other businesses in this environment. On the COVID, you know, I think it's probably a little early to say what the implications of the current surge are. We saw our retail business taking some really positive gains ahead of sort of the discussion about the Delta variant and other things, kind of in the early part of the summer holiday season. And that continues. I am certain some of that is mixed with some concerns about the resurgence. But our business started really picking up, I think, on the strength of some sticky habits. And people want to get out and do some of their summer things that they couldn't do this year and maybe couldn't do last year. So we're being very, very vigilant. There's obviously a lot going on in that space. And for our own policy and our own team, as well as how that affects consumers, You know, we stay vigilant on that, but we believe there will likely be some benefits from the current behaviors as well as the most recent government action to extend SNAP benefits. So all mixed in there, I think there will be some upside.
spk08: Perfect, guys. Thank you very much. The next question will come from Greg Budishkanian with Wolf Research.
spk09: Please go ahead.
spk07: Good morning. This is Spencer Hannes on for Greg. I think you mentioned that you're going to be building to a run rate in 2022 for supply chain savings. What are the biggest factors driving that timeline, and could you see an improvement sooner? And then I guess, is there a scenario where margins can get back to 20 to 2018 levels?
spk05: Great question. I'll take a crack at that and turn it over to Jason for the details. This project is a very comprehensive project. There are five key components of it and it involves a fair amount of detail in terms of training and process optimization and new tools. That process work will take place over the course of about a year. We will see, as Jason mentioned earlier, we'll see some benefits coming in kind of toward the end of this year and more of the benefits coming in next year as we really refine those processes across our network. So, we'll have that spread, but the work so far, it's early work, but the work so far, it looks terrific and I think we'll start seeing some of those benefits toward the end of this year. As far as getting back to 2018, It's certainly our objective to make this a continuous improvement idea that continues to build on itself. Once the project is through, we will also establish additional processes to continue to sharpen that saw. I think that will likely involve more technology and more process improvements that come from technological implications in years to come. It's certainly our objective to get back to that place. There are some mixed implications that have changed our numbers there, but our biggest focus is getting the organization in the supply chain world to be as efficient and effective as possible, and that's not just a one-year project.
spk11: Yes, Spencer, building on Tony's comments, a couple of things I'd highlight just for reference here. We've made great progress on the gross margin side in the food distribution business. Our gross margins are up in the second quarter by about 100 basis points from where they were two years ago, so pre-COVID. Now, to be fair, the supply chain expense has largely swamped that margin improvement, and that's why we're tackling supply chain. And kind of the first phase of that supply chain improvement is 15 to 30 basis points. And we expect that to be kind of phase one of multiple phases to continue to build back and capture that margin enhancement and push it to the bottom line.
spk08: Got it. That's helpful.
spk07: If I could switch to military for a second, what do you think needs to happen at DECA for them to win back customers? And at what point do you think it's time to potentially explore some strategic alternatives there and just refocus your time on retail and food distribution? that is just a little bit more in your control?
spk05: Sure. Well, I think it's a very complicated circumstance that DECA is facing. And I have a lot of – they are very desirous of making progress. They have a lot of confidence in the team there. And I think they have a big chore ahead of them, right? They've got the base closures – And closures and openings and closures and openings that happened in the last year and a half I think has moved some folks who might have been loyal commissary shoppers to other alternatives. And I think those habits have been sticky as well, and we're seeing some of that in the numbers. So they've got their work cut out for them to claw that back. I know they've got a lot of ideas that they're working on. From our perspective, I think a couple things. One is we think we can actually help. We are fully engaged in partnering with them on ideas and what they can do to bring those customers back. Fundamentally, there's a need and a customer out there that can be certain that there's room for better profitability for all the players involved in that supply chain. We remain confident that there's better profitability in that world. Our team's working hard on that. Everything from how we think about mix and how we think about products and certainly Related to that is the supply chain work we just mentioned. There's a lot of cost opportunity in supply chain specific to MDV as that network has changed. We have the opportunity to change our network to better serve what is now a different business than it was just a few years ago. Our job, one, is to figure out how to make that business work and make it profitable. That's our primary focus.
spk07: Got it. And then I just wanted to follow up on the labor commentary that you guys have made. You mentioned a few times about stepping up wages. How should we think about the size of those investments that you guys made in distribution this quarter? And then for the investments that you made in retail last quarter, are you seeing signs of better retention there yet, or is it still sort of too early to know?
spk05: Yeah, great question. So it's probably a wee bit too early yet. It's been about a couple months in retail and just a month in supply chain. We're seeing better applicant flow. We're seeing what we believe to be better candidates that have come from that. I can't really mention the numbers, but the entry-level wage increases were north of 10%, so pretty sizable increases by our measure. I believe we're going to come back even this year and make some additional adjustments in retail and some selective increases as well, as we believe we need to strengthen that number even better. But the early anecdotal components are, hey, we're getting better applicants, we're getting a little better stickability with applicants, so we're confident that this work is actually going to get us get us that place. I think importantly also, because the labor environment has been so challenging, and the costs associated with that have been pretty extraordinary, everything from the amount of overtime that we've had to experience because people are working longer shifts to cover for openings. In some cases, we have third-party contractors working, and they're also costly. I think we have room to make increases in our base pay that actually have a payback as it gets stabilized. So we feel bullish on being thoughtful but aggressive in pay and using that as a tool to help win this war on talent.
spk08: Got it. Thank you. The next question will come from Matt Fishbein with Jefferies. Please go ahead.
spk01: Hey, good morning. Thanks for the questions. Just to follow up on the labor shortage situation, if you can kind of break out for us where you're seeing more pressure, whether it's retail versus wholesale, and also just on the wage pressure you're seeing, how is it, I guess, different relative to other instances of wage pressure that you've faced in your career as a CEO? Having battled this for a few months now, Are there any flag posts that you see in the future, like Labor Day, for example, that can create some type of catalyst for this to unwind a bit from a macro perspective? We'll start with that.
spk05: Yeah, so it seems like every day is Labor Day nowadays. So just first and foremost, I guess I would say we're seeing a little bit more pressure in our distribution centers. I think that if you think about retail turnover because of the nature of that work. A lot of part-time, a lot of young people getting their careers started. There's a fair amount of churn at the entry-level end. Historically, you would not be scared by 50% turnover in that business because that's just the nature of how people come on and come off seasonally in the retail space. We're seeing 60-ish percent turnover there. On the warehouse side of the business, the history in most of the business I've been in is that you'd see something more like 25% turnover in that business. You have slightly higher paying jobs. People are making careers and working in warehouses. We're actually experiencing about 70% turnover there. So we have worse turnover in a place, in a part of our business that historically would have had lower turnover. So I would say that's where we're seeing more of the pressure, is getting good, consistent talent into our distribution centers. And that's where we're taking some of the larger increases as well. You know, what's different is in the last couple of labor pinch points were driven almost exclusively by strong economy. And you think about one of the more acute ones we had right around the end of the 20th century when you had the dot-com phenomenon. Our economy was growing like gangbusters. And there was a lot of strain in getting people into jobs then as unemployment dropped down to 3% and lower in some neighborhoods. But it's based on the economy. So it's one of those kind of, as you think about it in a more comprehensive sense, sort of a good problem to have, right? Our economy is cranking and people are wanting to get in, but they just can't get in fast enough and we can't find people fast enough to keep the economy growing. This one has been significantly exacerbated by the government programs. And I think the practical reality is that that we have a latent economy that's pretty strong. There's a lot of growth potential. There's a lot of need for folks. And at the same time, there's very significant benefits for folks to not go into the labor market. In our states that we operate in, the sum total of the unemployment and other benefits from the federal government have an imputed value of about $23 per hour. And that's not much different than the national number. It's about the same. And so that is really different for us as now we have a new competitor in the mix. And as that gets stabilized more, I think we'll get on better footing, and this will look more like some of the other labor crunches of the past. But that wasn't particularly difficult, and we see that in the applicants who are, in a lot of cases, you know, if they're getting into the market, there's a little bit of a take it or leave it because they have a – they have a best alternative to working in a job that they may not favor. So anyway, that's what's different to answer your question. I think that component is new for us as a business society.
spk01: Thanks for all that, Cullen. It's really helpful. I just wanted to also ask maybe a longer-term, broader question on product mix in your food distribution segment. Relative to pre-pandemic, can you kind of walk us through the changes I guess you've seen through the pandemic, where you were from a product mix perspective prior to the pandemic, where did it shake out by the end of last year, and where are you now? And I guess, Tony, the bigger question here is, given your fresh distribution background, where should we expect that component to kind of shake out in terms of percent of sales or profit over the next few years?
spk05: Okay, great, great question. So as far as, I don't have the numbers handy on the mixed change versus pre-pandemic. Do you have that, Jason?
spk11: No, Matt, what I'd highlight is that there was naturally a cycle that moved towards kind of HPC-type products with the emphasis around cleaning and what I characterize as pantry stocking or hoarding of cleaning goods. And then there was a general decline in elements of the store that were fresh in nature and in part because delis were closing. So we saw kind of a downdraft there. What we've seen recently as kind of the recoveries come into place is a return to those fresh categories, both deli, bakery, and what I would characterize as value-add products. And you see this both in food distribution as well as in our retail business. And you didn't ask, but maybe just a little bit of color on the retail piece. We saw exceptional comps in Q2, really excellent results with a step forward sequentially in retail comps from kind of the mid-9% range to the mid-12s. And part of that was the value-added growth in bakery, deli, et cetera, as well as our promotional and retail execution. Now, we expect to continue to execute flawlessly going forward. But our outlook also reflects a step down in Q3 and Q4 from Q2 levels, not because of execution, but frankly more around uncertainty. We expect our Q3, Q4 to look more like a high single-digit growth on a comp basis, mid-nines in Q3. around 8% in Q4, so kind of a step down, but still very strong and really supported by some of the kind of the updraft of those mixed changes that you asked about in food, but then really flowed through our supermarket piece of the business.
spk05: Yeah, and, of course, those are two-year numbers on the comps. Yes. And our focus going forward will be disproportionately on fresh. We think that's where, as people come back to some semblance of the new normal, I think that's one thing they'll really value. And we think we've got great opportunities for growth around the perimeter of the store. So there will be more bias and more focus there.
spk08: Great. Thank you very much. Again, if you have a question, please press star, then 1.
spk09: And our next question will come from Kelly Bania with BMO Capital. Please go ahead.
spk00: Hi, good morning. Thanks for taking our questions. I wanted to first follow up on the supply chain initiative. I believe last quarter there was a discussion of savings in the 25 to 50 basis point range, and now it sounds like 15 to 30. I was just curious if that's timing or if it's just the wage increases impacting that or any color you can help with there.
spk11: Yeah, it's $15 to $30 million. It's 25 to 50 basis points. It's the same as last quarter. It was reaffirmed, so if I misspoke, my apologies.
spk00: Got it. No, no problem. Another question, just in terms of the retail comps coming in better than expected, I guess I would have thought maybe distribution would maybe kind of follow suit. Maybe there's some mixed dynamics, but maybe just help us understand why that's not the case.
spk11: Yeah, and great question, Kelly. So if you kind of dig into the food distribution growth, We're seeing similar performance among what we characterize as our core independent customer to what we're seeing in our corporate retail business. Now, there's some underlying mix changes and pieces of the underlying business or the other food distribution business that behave differently than traditional grocery, and that's what we're seeing come out of the aggregate food distribution result.
spk00: Okay, and maybe can you just help us understand where service levels are today and where you're targeting them to reach under the new initiative?
spk05: Yeah, so the way we measure the service levels, we are probably about, I'd say about roughly 2,000 basis points lower than what we would normally have run two years ago, right? from the mid-'90s to kind of the mid-'70s in terms of our compliance to orders, so to speak. That was a number that was quite a bit lower a year ago, but we made progress in terms of our processes as well as additional gains from the manufacturing community as they improved their service to us. That sort of stalled out a few months ago. We've been getting about the same, actually a little bit worse, supply from the broader manufacturing community in the last three to four months. We will refine our process to be as efficient as possible in getting that product out to our customers and to our stores. But the headline is that the manufacturers are still not all the way back yet. They're also operating at a bigger delta versus their previous levels. That's the headline, the more complicating factor in service right now. As best we can tell as we survey what other people are experiencing, where we have side-by-side comparisons. We are outperforming other like services and we get pretty positive feedback from folks who actually get the chance to use multiple services. So we feel good about our internal process there. And the next chore is frankly to get stabilized with the manufacturing vendors and get their supply up.
spk00: Okay, that's very helpful. Just one more for me. You made the comment about gross margin up about 100 basis points versus two years ago, but maybe some of the costs eating into that gross margin upside. I'm just curious if you can unpack that gross margin strength for us and if you think you can sustain that going forward.
spk11: Yeah, I expect that we can sustain the gross margin going forward. And Kelly, I don't want to assume, but referring to the food distribution business, just to be clear. Yeah, I expect that we can sustain it. It's improved based on a combination of product mix and customer mix. And really, the key for us to get back to prior margin structures is to deliver on the supply chain piece, which has lagged. Frankly, the top line and profitability and gross margin improvements haven't fallen to the bottom line, in part due to some of the challenges that Tony referenced in everything from the fill rates to some of the challenges with the labor market, as well as our own operational practices, which we're addressing through that supply chain transformation.
spk08: Thank you.
spk09: This concludes our question and answer session. I would like to turn the conference back over to Tony Sarsom for any closing remarks. Please go ahead, sir.
spk05: All right. Thank you. And thank you all for your participation on today's call. We really look forward to speaking to you all again when we report out on our third quarter 2021 results in November. And we hope to see many of you in December for the Investors Day. We're really looking forward to that. So with that, we'll conclude this call and wish everybody a great day.
spk09: The conference has now concluded. Thank you for attending today's presentation.
spk05: You may now disconnect.
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