Katie M. Turner - Managing Director of Healthy Living, Packaged Food, Supermarket & Food Distribution Companies Dennis Eidson - Chief Executive Officer, President and Director David M.

Staples - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Scott Andrew Mushkin - Wolfe Research, LLC Karen F. Short - Deutsche Bank AG, Research Division Charles Edward Cerankosky - Northcoast Research Benjamin Brownlow - Raymond James & Associates, Inc., Research Division

Thank you. Good morning, and welcome to Spartan Stores Second Quarter Fiscal Year 2014 Earnings Conference Call.

By now, everyone should have access to the earnings release for the second quarter ended September 14, 2013. For a copy of the release, please visit Spartan Stores' website at www.spartanstores.com under For 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'd like to remind everyone, comments made by management during today's call will contain forward-looking statements.

These forward-looking statements discuss plans, expectations, estimates and projections that might 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, among others: competitive pressures among food, retail and distribution companies; the uncertainties inherent in implementing strategic plans; and general economic and market conditions. Additional information about risk factors and uncertainties associated with Spartan Stores' forward-looking statements can be found in the company's second quarter earnings release, fiscal and 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 forward-looking statements. Spartan disclaims any intention or obligation to update or revise any forward-looking statement.

This presentation includes certain non-GAAP metrics 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 measures and the other information required by Regulation G is included in the company's earnings release, which was issued after market closed yesterday.

And it's now my pleasure to introduce Mr. Dennis Eidson, President and CEO of Spartan Stores, for opening remarks.

Thanks, Katie. Good morning, and thank you for joining our second quarter fiscal year 2014 earnings conference call.

With me this morning are members of our team, including our EVP and Chief Financial Officer, Dave Staples; our EVP of Retail Operations, Ted Adornato; and our EVP, General Counsel and Secretary, Alex DeYonker. Today, I'll begin by providing you with a brief overview of our business and the highlights of our financial performance for the second quarter, as well as the status of our merger with Nash Finch.

Then Dave will share some additional detail about the second quarter financial results and our outlook for the remainder of fiscal 2014. Finally, I'll provide some closing remarks and we'll open up the call and take some questions.

We're very pleased to report second quarter earnings that exceeded the guidance we provided during our last call in early August. Our better-than-expected results were driven by sales gains in both divisions and an improvement in our fuel margins.

These results enabled us to generate approximately $27 million in cash flow from operations year-to-date, and reduced net debt by $11.1 million, or 7.5% from the prior-year second quarter. Now I'll review our distribution segment results.

Sales increased 4.7% for the quarter due to the combination of organic growth and new business gains. These were partially offset by the elimination of sales related to our acquisition of an existing retail customer's store in the third quarter of fiscal 2013, as well as lower pharmacy sales.

Our distribution team continues to focus on increasing our sales penetration with existing distribution customers, seeking new independent customers and further improving the efficiency of our distribution operations. From an efficiency perspective, we are making further progress on our warehouse automation plans.

The new high low robots began performing meaningful work in August. However, it will take several months to fully implement all of the functions.

They are currently operating at 40% of their design capacity, and we expect that all functionality will be 100% operational by the end of the year. Net sales in our retail segment increased 4.4%, due to the sales contribution of the grocery store and fuel center we acquired in the third quarter of fiscal '13, new Valu Land store openings and positive comp store sales.

These benefits were slightly offset by a decrease in the fuel price per gallon when compared to last year. We continue to refine our YES Rewards program and leverage our pharmacy and fuel offerings as value-added rewards for our consumers.

Even though the program was fully rolled out to all of our stores over a year ago, we continue to register new households in the program and the number of active households increased over 1% from the same period last year. On the product side, we are driving both distribution and retail sales through the expansion of our private brand program.

During the quarter, we launched over 100 net new private brand items, for a total of more than 270 new items year-to-date. We ended the quarter with approximately 4,600 items, and are on track to introduce a total of 300 to 350 private brand items for the year.

Our private brand unit penetration at retail was approximately 23.3% in the fiscal year-to-date period. Moving on to our capital plan during the second quarter, we completed 5 minor remodels and store rebanners of Glen's locations to our Family Fare brand.

Along with the store rebannering, our remodels include updating our décor and signage programs and replacing the fixture -- fixturing where required. During the third quarter, we anticipate continuing our rebannering program by completing 4 minor remodels and 1 major remodel.

We expect to fully rebanner all Glen's locations to the Family Fare brand by the end of next year. The results from these efforts appear to be favorably received by the consumer as the trend in comp store sales at these locations since conversion have experienced meaningful improvement.

We also acquired a pharmacy during the second quarter in our continued effort to provide both convenience and value to our customers. Before I turn the call over to Dave, I'd like to provide a quick update on the status of our merger with Nash Finch.

We continue to make progress on the merger and recently, passed several key milestones. First, we were pleased to see that the Hart-Scott-Rodino waiting period expired in September with no action by the Federal Trade Commission or the Department of Justice.

Second, we have internally communicated the composition of our senior leadership team. And most recently, our S-4 registration statement was declared effective on October 15.

While we are now awaiting shareholder approval, we are moving forward with finalizing our integration plans including everything from back-office functions to the announcement of our new organizational structure. As you can read in the prospective -- prospectus, the shareholder meetings for each company have been scheduled for November 18 and assuming a positive outcome, we expect the closing of the transaction will be within a day of the vote.

With that overview, I'll turn the call over to Dave for more details on the second quarter financial results and an outlook for the remainder of fiscal '14. Dave?

Thanks, Dennis, and good morning everyone. Consolidated net sales for the second quarter increased 4.5% to $649.5 million compared to $621.6 million in the year-ago quarter due to organic growth and contributions from our recent acquisition in the retail segment and new customers in the distribution segment.

Distribution and fuel sales represented 41.8% and 7.5%, respectively, of consolidated net sales compared to 41.7% and 7.6%, respectively, in the last year second quarter. The consolidated gross profit margin for the second quarter was comparable to the prior year at 21%.

Second quarter adjusted operating expenses were $114.6 million, or 17.6% of net sales compared to $110.9 million, or 17.8% of net sales last year. The decrease in the rate was due to expense leverage on increased sales, partially offset by higher incentive compensation and depreciation and amortization expense.

These results exclude $3.6 million in expenses related to the merger with Nash Finch in fiscal 2014, and a $400,000 asset impairment charge in fiscal 2013. Adjusted EBITDA for the second quarter was $31.9 million, or 4.9% of net sales compared to $29 million, or 4.7% of net sales last year.

Adjusted earnings from continuing operations for the second quarter were $12.1 million, or $0.55 per diluted share compared to $10.2 million or $0.47 per diluted share last year. These results exclude expenses related to the merger of $0.10 per diluted share and a tax benefit of $0.01 per diluted share in fiscal 2014.

Turning to our operating segments. Second quarter net sales for the distribution segment were $271.4 million compared to $259.2 million in the year-ago quarter.

The increase in sales is primarily due to organic growth and new business gains, partially offset by the elimination of sales related to the acquisition of a customer's store in the third quarter of fiscal 2013 and lower pharmacy sales. Second quarter operating earnings for the distribution segment were $11.6 million when adjusted to exclude $3.6 million in expenses related to the merger versus $10.8 million last year.

In our retail segment, second quarter net sales were $378.1 million compared to $362.3 million last year. The increase in sales was largely driven by incremental sales from our recent grocery store and fuel center acquisition, new Valu Land store openings last year and positive comparable store sales.

Comparable store sales excluding fuel increased 0.2% in the quarter. Retail segment operating earnings for the quarter were $10.1 million compared to $8.5 million last year when adjusted to exclude last year's noncash pretax asset impairment charge of $400,000.

The improvement in adjusted operating earnings was due to the higher sales volume and improved profitability at our fuel centers, partially offset by higher depreciation and amortization expenses and higher health care cost. From a cash flow perspective, our year-to-date operating cash flow was $26.9 million at end of the second quarter of fiscal 2014 compared to $900,000 for the same period last year.

The increase was primarily due to the timing of seasonal working capital requirements, lower income tax payments and prior-year first quarter payments related to new customer supply agreements. Total net long-term debt was down $11.1 million to $136.4 million as of September 14, 2013, versus $147.5 million at the end of the second quarter last year, primarily due to the timing of working capital requirements.

I will now provide further detail on our outlook for the remainder of fiscal year 2014. While we've been encouraged by our recent performance, we will face progressively challenging year-over-year comparisons in the third and fourth quarters as we begin to cycle the retail store acquisition and new distribution customer, and are likely to experience lower fuel profit contribution than in the first half of this year.

In addition, we believe that the expected lack of inflation will have a negative effect on our sales and earnings for the second half of the year. As a result, we expect comparable store sales for the second half of fiscal 2014, adjusted for the Easter calendar shift, to be slightly negative to flat.

Additionally, adjusted earnings from continuing operations are expected to be flat in the second half of the year when compared to the prior year. On a full year basis, we continue to expect fiscal 2014 net consolidated sales and adjusted earnings from continuing operations to exceed our fiscal 2013 results, excluding any one-time expenses including those related to the merger with Nash Finch.

We expect the capital expenditures for fiscal 2014 will be in the range of $39 million to $42 million with depreciation and amortization in the range of $41 million to $43 million, and total interest expense to be in the range of $9.5 million to $10.5 million. This concludes our financial discussion, and I will now turn the call back to Dennis for his closing remarks.

Dennis?

Thanks, Dave. In conclusion, we're certainly encouraged by our performance in the first half of fiscal '14, as well as our transformative agreement to merge with Nash Finch.

It was a busy 6 months and continues to be so, as we move forward with plans to complete the merger and begin to integrate the 2 companies before the end of the calendar year. While the second half the year will prove more challenging, we will continue to invest in the consumer experience and focus on delivering the best value and quality to our distribution and retail customers.

We remain enthusiastic about the opportunities that lie ahead and our prospects for increasing shareholder value. And with that, we'll open up the call if there are any questions.

So I had a couple of things here. Number one is, it seems like your outlook for the back half, and you articulated this a little bit, is a little less robust than what we saw in the current quarter.

And I was just wondering specifically on the comps in the back half, are they really kind of, I think you said flat to slightly down. Is that below where you thought they would be, let's say, 3 or 4 months ago?

No, I think when we had the call, the last call, I don't know if it was August, I guess it was. It maybe a bit softer, but really not much, Scott, than we guided this quarter that we just completed and the comps was going to be slightly negative to slightly positive and that's really where we came in.

I would say the revenue really in both segments was not really a big surprise to us in the quarter and the outlook hasn't significantly changed.

Okay. And then, can you talk about the pricing climate?

Obviously, inflation is very low, on the producer side, was coming into your warehouses. But I also want to talk about the pricing climate at retail.

How is that looking and is that kind of coming in a little as well? And is that part of why the outlook maybe is a little bit more subdued?

I don't think there's a material difference in the pricing climate as you led the wholesale inflation number that we track pretty aggressively. Well it's showing really, no life.

It was about 1% inflation in the distribution segment for us. Now if you went back a couple of quarters, we were at like 1.9%, a quarter before we were at like 1.6%, and now we're down to 1%.

So you're seeing this negative trend in inflation. So we're still inflationary, but very modestly so.

At retail, we're basically seeing no inflation. And I'd say the pricing climate hasn't changed significantly.

I think everybody is in the same boat, trying to chase volume that in some instances just isn't there in our marketplace. But I don't think there's been any irrational behavior in pricing or promotion, nor do I think there's been any change.

Okay, that's good. I still have a lot of questions around there I could follow up but I'll just have one more and I'll open it up to other people.

The commissary business of Nash, a lot of articles has been written lately about the shrinking military, really pulling back the number of people, active-duty military. I think there's going to be another cut off like 22,000, 23,000 coming and then next year, I think I've seen estimates as much as 50,000 to 75,000.

Can you talk about the commissary business in relation to a shrinking military. How did it look back, I guess the last time we went through something like this was in the early '90s?

And how we should we think about as you buy the Nash business?

I think the comments about the Nash Finch business -- I want to be somewhat limited in that regard. Obviously, we don't -- we are not merged yet.

So that activity is to follow. I will say this, that as you look at the commissary spending, it is predominantly done through retirees in the military system.

And not necessarily the active-duty military. So I think we may have touched a little bit on this when we had the initial call announcing the merger.

But some of that, bringing back of the overseas military home, actually has a potential positive effect on the military business here domestically. Nash Finch is not involved the with feeding troops overseas.

It's not part of the business that they do. So in some respects that bringing that overseas military hero back home, has to be a helper to the volume.

Just wondering if you can comment a little bit more, maybe just to give a little bit more color on what you're seeing for -- what you will see this year in terms of competitive openings from supercenters and then what your expectations are for next year? Actually maybe, include supercenters and neighborhood markets this year and unfit supercenters neighborhood markets next year.

Well I think in this fiscal year that we have, that we're in now, I don't know that we're going to have any supercenter openings in our trade area. And the neighborhood markets have not made an appearance in our trade area.

So that's the answer to the first part. Going forward next year, there will be some supercenter activity in our trade area.

I think we're expecting at least 3 super Walmarts in next fiscal year. There could be a fourth one that creeps in there, which is a more robust number than we've had in the past several years.

Now since the recession, there was a -- all CapEx frankly in the space has really diminished quite a bit. So next year will be a little bit more formidable in terms of that type of activity.

And that seems like somewhat of a blip, right? I mean, that's how this has worked for us going forward?

Karen. Every once in a while, you have a year where you have a little blip and it seemed to settle back down.

I mean, we are a relatively saturated market for supercenters. I mean, we don't have stores that don't compete with supercenters.

I mean, it would be less than a handful that would not have 1, if not 2 supercenters they compete with currently. So nothing out of our historical past, nor do we necessarily see this is a new wave of competition.

Okay. And then, I don't know if you're prepared to give maybe a little bit of color on what you think your run rate on CapEx might be for the combined company.

Or is that a little too early?

You know what, probably at this point, we would prefer to hold off on guidance for the new co, until after the merger is complete. And then I think our expectation would be to provide guidance with our year-end release and help out with all that types of things you're going to be interested at that point.

Okay. And then just in terms of the composition of the comp going forward, I mean, I think, is it fair to say you probably will still be -- it'll be more basket skewed with traffic still a little softer.

And then I guess, maybe comment on what you think is contributing to the softer traffic or do you think it's just macro in general?

You know, if they're marginal in both directions, Karen, to be honest with you, so we're not seeing a lot of movement in either metric. But it has been the last several quarters a little bit softer and the traffic and a little bit more aggressive on the basket size.

And it's not materially significant in either direction, but that's what we've been seeing.

Okay. And then I haven't asked this question for a while, but where are you at in terms of attrition and distribution.

Are you seeing -- are you still seeing any net attrition or do you think your distribution customer base is pretty stable. And then I mean, obviously, growth, would be may be crude.

Like on your existing for that new customers that you're managing...

I mean, yes. We just have not experienced attrition in our distribution customer base.

It's de minimus. It doesn't even blip.

And we have -- we did call out reduced pharmacy sales in distribution segment. We have been an independent retailer that was operating 8 pharmacies and elected to get -- exit the pharmacy business.

He sold those script files, and we took some attrition on that. But I mean, retail, as we talked about this in the past, have been amazingly resilient.

And so, they've hung in there through the recession, and we just tend not to lose them to competition. It's just not in the DNA of the Spartan makeup here.

Dennis, if you're looking at the distribution business again, describe your ability to get new distribution customers in the past quarter and what it looks like over the next 6 months, especially as competitors change or get perhaps more aggressive in defending their turf.

We have, first of all, let me just say, changing wholesalers is a very significant event. Independent retailers don't do that without spending a lot of time and effort evaluating the reasons to do that.

We have been beneficiary over the past several years of being able to, I'd say, more methodically, add distribution customers to our portfolio. Maybe more effectively than some others in the geography.

It's a lot of hard work and effort and it's not an event, Chuck, it really is a process. In so many of the instances that's conversations that have taken place, not over weeks and months, but really, over years.

And they come at a kind of a disparate pace. They come when they come.

Sometimes there's an inflection point with their existing wholesaler. Sometimes it's the contract that's expired.

They're really, really hard to predict. And for me to say, here's what I think is going to come in the near term, I think would really be a stretch.

I'm not trying to evade your question, it's just not an easy question to answer.

But you're ready and able as the opportunities are there.

Absolutely. There is not an independent retailer in our trade area, our generally reachable trade area that we haven't been knocking on their door for some time.

And they know who we are, they know what we can do. And at the right time, sometimes the magic occurs.

And like I said, we've been very fortunate to be able to pull some of those customers into the portfolio.

Switching gears a bit, after the Nash Finch deal closes, you'll be going to the new fiscal year, will you issue new guidance for the calendar '14 year?

Yes, Chuck that's our intention. So once the merger takes place, as we hope and assume it will, we'll provide with our year-end call, the forward-looking guidance that you're accustomed to.

We'll also try to do some other things to try help make the transition easier for all of the investment world to understand. So we're looking into the things we can do to do that.

But with change in year-end, our quarter structural change, we'll go to a 4, 3, 3, 3 quarter structure, instead of a 3, 3, 4, 3 structure. And so, we'll try to help in any way we can provide a path to understanding that.

David, we have announced that we're changing the fiscal year, right? I'm not sure we have that in the release

I could just spend a little more time on that. Yes, we did announced that publicly.

In conjunction with the merger, we would change our year-end to a Saturday closest to December 31, which in this year's case, would be December 28. So our year would end, that would make this quarter 1 week short of a full quarter.

And then, obviously, we'd start a new one on the 29th, with our normal 13-period type year. As I mentioned, however, a 4, 3, 3, 3 period quarter structure.

And that means in the new fiscal year, the first quarter will be 16 weeks, followed by 3 twelves?

Correct.

All right. Got that.

I'll try to keep that straight.

Good luck.

Every company got that 16-week quarter somewhere, different. Could you give us the dollar gas sales in the most recent quarter please?

Well, what I have would be total fuel centers. It's about $48.9 million.

I think the pure fuel component of that would probably be more in the mid-40s.

Could you guys comment on the rebranding from Glen's to Family Fare? Just the positive customer response in that improved same-store sales.

Can you give a little more color around that sales lift that you're seeing in the capital there?

Sure. One thing we're not short of is brands.

When you grow your retail portfolio, primarily through acquisition, you accumulate more brands than probably you need. And we've done this over time, in my 11 years here, where we've consolidated brands, we did some research around the brands, and the Family Fare brand that we operate here in Western Michigan has a strong brand franchise in the Glen's brand.

We tested moving Family Fare up there and it responded favorably. We're doing these remodels and refreshes and rebannerings and we're moving the comp trends in the 3%, maybe in some instances, it's a little better than that.

So it's not wildly explosive but the stores are getting refreshed at the same time. And we're doing some decor et ceteras as we discussed.

It will allow us to leverage our marketing spend because right now, I mean, we do a marketing campaign we have to do a whole separate campaign for Glen's versus Family Fare, and with cable TV and electronic media. It will be more efficient for us to have 1 brand.

All right, that's very helpful. And then switching over to the expense leverage in the quarter, which was really encouraging.

Did you leverage your expenses at retail? I know healthcare was obviously a headwind, but I mean, just some color around there, and how are you thinking about leverage in the second half given your top line outlook?

Yes. I mean, I think we've consistently leveraged our expenses at retail.

We've done that through a lot of different things. We're very focused on energy consumption.

We're very focused on rent structures, we're very focused -- you could just go down the line, our operators consistently are working hard on how they manage the productivity of our labor and it's just -- it's really a way of life for us. So it's not any one new effort, it's just I think a continued culmination of the efforts we've put into place.

I think we look to continue to focus on those expense lines. Sometimes you're benefited by the seasonality and how winter takes place.

If we have an incredibly brutal or nice winter, that will certainly affect our expense leverage as it works with utilities, right? And we did have a good summer.

We had a good summer last year, maybe not quite as hot, which probably helped our expense leverage a little bit. From an out-of-our-hands type perspective.

But it's really just the continued culmination of all the things we do. And I think we expect to hold the line, hold things in line through the rest of the year as well.

I had 2 follow ups. Number one is I wanted to get a Valu Land update, if you had one.

I know you mentioned a little bit on the call, but I didn't get -- I don't know if you had a further update. Are those still in test?

Is there kind of a planned rollout? What you could do more of them and kind of what you're seeing in the ones you have open?

That's 1. For the second thing, I just want to understand, did you guys see any impact on the government shutdown on all?

I'll take the second one first. We did not.

I don't know if we're unique in that, but we did not. Probably what we felt more was when the food stamps had that glitch with the technology there, a couple of Saturdays ago, and we felt bad for sure because that would have been a normal foodstamp distribution day in the state of Michigan and those foodstamps didn't get issued.

So felt that, but we got it back the next day. But nothing on the government shutdown.

As it relates to Valu Land, not a lot of different colors than I think provided last quarter. As you're aware, we're operating 8 stores today.

I think someone new on the call that have asked questions have been to some of those stores. We continue to be pleased with the comp performance in the stores that are in the comp mode.

We actually comped very nicely in the quarter end and there are 4 of those stores by the way. They comped at 6% positive, which is very encouraging.

But I would tell you even with the comping at 6%, we're not here to say, "Hey, we're ready to roll it out and we're going to have 20 stores operational in the year." The new market, Metro Detroit has been, as I discussed last quarter, a little bit more challenging for us.

There's a bit of a lumpiness in the performance of the stores over on the Eastern side of the state. So at this point in time, we have 8.

We are not going to open another 1. Do not plan to open another 1 in this fiscal year.

We're continuing to tweak and we consider it still at test mode. And there's still more work to be done.

Okay, perfect. And then just a couple of follow-ups on your original answer to my question about the government shutdown.

Behavior, as far as trading up, no difference really, nothing changed and then that's what I'm getting from you, but I just want to make sure, and then foodstamps. Are we going to cut November 1, I believe.

How do you guys thinking about that.

We're a little concerned about the foodstamp. I can tell you that.

That could be a meaningful event for us or we're going to have to wait-and-see. Foodstamps in the state of Michigan peaked in their distribution in March of 2011.

And subsequent to that period, we've had a continued reduction in the amount of foodstamps that the state has issued. And so, we've been seeing consequently a reduction in the number of foodstamps that are redeemed in correlation to the statewide reduction.

So a little concerned about them being reduced going forward. The other question was with regard to the consumer, I would say to you, consistently you know since I've been on these calls, the D&W brand, which is located in the more upscale areas of where we operate, continues to be pretty resilient and performs very well.

So I think we're still seeing that bifurcation. We have a portfolio of private brands and we have an entry-level brand, Valu Time.

We have a natural organic brand as well, Full Circle, and if you want to look at the results for the quarter, you'd see that Valu Time was a little bit softer than a year ago and Full Circle was a little bit improved versus a year ago. So maybe a little bit of positive sign there.

Dennis, when you rebanner a Glen store, in general, any store but specifically the Glen's right now, are they getting any kind of quickie remodel, anything like that inside the store to refresh them a bit as part of the program?

We are doing that, Chuck. It really is a pudgy fly variation.

There are some stores that we're doing a major remodel and then we're going -- we'd do a rebanner. And others where it's maybe a few cases and we do a rebanner in virtually every instance, unless we recently touched it with a decor package.

We're putting in the decor package that we have now is a standard fare in all of the stores that we open. I think you're at Metro Health store, that decor package, that color palette is what you will now find in the refreshed Glen stores.

Great. Well, thank you very much.

And that really concludes our second quarter conference call, and we appreciate everybody's interest in the company, and we look forward to speaking with everybody again next quarter. Thank you.