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Spartan Stores (NASDAQ:SPTN)
Q2 2018 Earnings Conference Call
Aug. 16, 2018 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the SpartanNash Company's second-quarter 2018 earnings conference call. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Katie Turner. Ms. Turner, please go ahead.

Katie Turner -- Investor Relations

Thank you. Good morning, and welcome to SpartanNash Company's second-quarter fiscal 2018 earnings conference call. On the call today from the company are Dave Staples, president and chief executive officer; and Mark Shamber, executive vice president and chief financial officer. By now, everyone should have access to the earnings release, which was issued yesterday at approximately 4:05 p.m.

Eastern time. For a copy of the release, please visit SpartanNash's website at www.spartannash.com\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, among others, competitive pressures among food, retail, and distribution companies; the uncertainties inherent in implementing strategic plans and integrating operations, and general economic and market conditions. Additional information about the risk factors and uncertainties associated with SpartanNash's forward-looking statements can be found in the company's second-quarter earnings release 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 any forward-looking statement. SpartanNash 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 measure and other information as required by Regulation G is included in the company's earnings release.And it's now my pleasure to turn the call over to Dave.

Dave Staples -- President and Chief Executive Officer

Thank you, Katie. Good morning, everyone, and thank you for joining us today. The format of today's call will include my brief overview of the second quarter as well as an update on our business. Mark will then provide additional detail on our operating and financial results before we open the call for your questions.

I'd like to begin my comments today by reemphasizing my remarks about the company's continued progress toward implementing our long-term strategic objective of becoming a growth company focused on developing a national highly efficient distribution platform that serves a diverse customer base and is known for solving unique and complex logistical issues. Our business growth will be driven by an efficient and versatile supply chain that services our highly complementary business unit of food distribution, military distribution, and retail. We have been consistently advancing this strategy and now sell food and related grocery items throughout the United States and overseas. Today, we are helping our customers grow no matter as we work to accomplish more with the assets we have, implement unique distribution models, and develop partnerships in areas where it is more efficient than investing in additional bricks and mortar.

I believe the continued sales growth in our distribution business and the improving retail sales trend are a testament to this progress. While the current operating environment may have its challenges, I'm excited by the customer base we are serving and the growth we are experiencing as a result. I expect our sales momentum to continue as we ramp up a significant program launched late in the second quarter. We also remain focused on growing and improving profitability of our freshly produced offerings and will continue to develop the products and services that our existing and future customers need to meet the growing, healthy, and fresh demand of today's consumer.

Our key objectives over the next few quarters will center on straining more of this growth to the bottom line. We are currently implementing plans to overcome some of the incremental transportation and warehousing costs we experience due to the rapid growth in certain of our regions and to generate more volume in our fresh processing operations while improving their overall productivity. We also expect to benefit from growing programs such as the private brand offering at our military group and sales from some of our unique distribution solutions that are in the ramp-up phase. In addition to the performance objectives just noted, we remain committed to providing returns to our shareholders through cash dividend and share repurchases, which have totaled $33 million year to date, and reducing our long-term debt, which is down nearly $40 million, so far, this year.

Now let's take a look at our results and the strategic initiatives across the operating segment. In food distribution, we delivered overall sales growth of 4.3%, as we saw strong retention in our core customer base and expanded business with key customers. As I previously mentioned, late in the quarter, we launched a significant program with an existing customer and will realize strong contributions to sale in the second half of 2018 as this program gains traction. Annualized volume estimates for this business range from $100 million to $175 million.

While we expect substantial upside going forward, there will be some short-term pressure on profitability due to initial costs to accommodate the expansion of our supply chain network. We are proud of our ability to grow our existing business. The strong growth in our traditional distribution business, which was 5.3% in quarter one, 6.2% in quarter 2, and is expected to further accelerate in quarters three and four, speaks to the strength of our customer base, the innovativeness of our team, and the quality of our products and network. As a result, we continue to be optimistic about our perspective opportunity.As previously disclosed in June, we issued a voluntary product recall at Caito, which temporarily disrupted this business' growing momentum.

In early June, at the start of peak summer demand for produce and as we were generating record sales volumes in our fresh operation, Caito voluntarily recalled all its fresh-cut melon product over a multiple week period due to potential contamination with salmonella. As soon as we became aware of the potential issue, we immediately stopped production of fresh-cut melon products and took decisive action to look out for the safety of the consumers of our product. These actions included performing tests of our production facility and manufacturing processes by both third-party food safety experts and representatives of the FDA. In total, over 500 tests were performed among these parties.

Despite none of these tests showing salmonella contamination, we did not restart production until we were confident that our facility was not the source of the issue. Fresh food offerings remain a key strategic priority to us and are critical to today's consumer. While the recall has delayed our progress in growing the top line and driving the efficiencies we believe to be there, we continue to see great opportunity with our fresh offering and are focused on innovating new products, developing our sales pipeline, and continuing to serve our existing customers with exceptional fresh offers. Turning to our military segment.

We achieved continued sales growth in the second quarter as we benefited from a combination of the business obtained in the Southwest and the ongoing expansion of DeCA's private brand program. While the commissary business remains challenged, we are encouraged by our partnerships with DeCA, AAFES, and NEXCOM, and the vendor community that supports them, which has allowed us to consistently come up with new offerings and new ways to serve our military heroes. We continue to make progress on the rollout of private brand products with DeCA, although at a slower than originally anticipated pace, and we have been pleased with the customer reception to the program. During the second quarter, DeCA introduced approximately 100 new private brand products ending the latest period with over 600 products in the system.

We will continue to collaborate with DeCA on the release of additional products throughout the remainder of 2018 and still expect a significant number of new items be launched in 2019. We expect this growth to partially offset the cycling of the expanded business in the Southwest, which began in the third quarter of 2017. Additionally, we are focused on building our sales pipeline, developing relationships with the exchange businesses and working to mitigate warehousing and transportation headwinds. In the retail segment, despite a highly competitive environment, we achieved another quarter of sequential improvement in comparable store sales.

Areas that provided challenges in the current quarter related to the pricing environment and margin within our pharmacy business due to the significant increase in direct and indirect remuneration or DIR fees. While this is an issue facing virtually all sellers of pharmacy products, we are currently working to offset the impact due to warehousing of generic medication and ensuring our benefit follow-up programs are generating all the potential income available. We remain very pleased with our new family fare brand positioning. Executing key elements of our brand redesign in some test stores, as discussed last quarter, we have seen a very positive response to our efforts.

In our latest customer survey, overall customer satisfaction scores have improved significantly. With four remodels in process and scheduled to open in the second half of the year, we are excited to continue our-- roll out our brand positioning and leverage it to drive continued improvement in our retail trends. Additionally, we continue to expand Fast Lane, our online ordering and pickup service, as well as other click-and-collect services. Online ordering for delivery and curbside pickups are now available at approximately 55% of our retail locations, and we are continuing to expand the reach of these services to provide convenience for our customers.

And with that, I will now turn the call over to Mark. Mark?

Mark Shamber -- Executive Vice President and Chief Financial Officer

Thanks, Dave, and good morning to everyone listening on the conference call and the webcast. Net sales for the second quarter of fiscal 2018 increased to $1.9 billion, an increase of $39.8 million, or 2.1% over 2017 second-quarter sales of $1.86 billion. For fiscal 2018 year to date, net sales totaled $4.28 billion, an increase of 1.7% over fiscal 2017's year to date net sales of $4.21 billion. Adjusted diluted EPS for the second quarter of fiscal 2018 came at $0.50 per diluted share, which includes approximately $2.9 million through the end of the second quarter, or $0.06 per diluted share, and estimated losses associated with Caito's voluntary product recall, which have not been adjusted.

This compares to adjusted diluted EPS of $0.60 in fiscal 2017 second quarter. On a GAAP basis, company earned $0.50 per diluted share in the quarter, compared to diluted EPS of $0.56 per share in the second quarter of fiscal 2017.In our business segment, net sales in our food distribution segment increased by $38.6 million, or 4.3% to $941.7 million in the second quarter of fiscal 2018, driven primarily by increased sales through existing customers. As Dave mentioned, sales growth at our legacy food distribution business, which includes Caito, increased sequentially to approximately 6.2% in the second quarter of fiscal 2018, compared to 5.3% in the first quarter. We experienced inflation of 34 basis points in food distribution during the quarter, a sequential decline of 63 basis points from Q1 and a 4 basis point increase from fiscal 2017 second quarter.

From a department perspective, a flip from inflation to deflation within the meat category is almost entirely behind the sequential decline as most categories were relatively flat to slightly less inflationary. Second-quarter operating earnings for food distribution declined to $18.7 million, largely due to costs associated with the Caito recall, losses at Caito's Fresh Kitchen, higher healthcare expenses and higher supply chain costs. Adjusted operating income totaled $19.8 million in the quarter versus the prior year's second-quarter adjusted operating income of $25.8 million as a result of the previously mentioned items as well as merger/acquisition and integration costs. Military net sales of $489.7 million in the second quarter increased by $18.6 million, or 3.9%, compared to $471.1 million in revenues in the prior year second quarter.

Consistent with our commentary in the last couple of quarterly earnings conference calls, increased sales in private brands and additional sales volumes from new commissary business obtained in the Southwest more than offset sales declines in commissary locations we serve. Operating earnings in military in the second quarter increased to $3.1 million, compared to earnings of $2.5 million in the second quarter of fiscal 2017. A gain on the sale of a real estate asset lifted the improvement, while incremental sales volume from our acquired Southwest commissary business and private brands and better margins were nearly offset by higher transportation and healthcare costs. On an adjusted basis, the military segment's operating income were $2.3 million for the second quarter of fiscal 2018, compared to $2.5 million in 2017 second quarter, when excluding the $0.8 million real estate gain.Finally, our retail segment's net sales came in at $464.6 million for the quarter versus $482 million for the same period last year.

Approximately $15.5 million of sales decline related to the sale of closure of retail stores while the balance is driven by increase in comparable sales-- comparable store sales of 1.9%, excluding fuel. Higher year-over-year sales serve to partially offset these funds. We finished the second quarter with 140 stores after selling one store to a customer and closing enough. The retail segment reported GAAP operating earnings of $8 million for the second quarter of 2018, compared to $13.2 million in the prior year's second quarter due to previously disclosed investments in tax savings in margin and in store labor and lower comparable store sales.

We are also seeing continued pressure from the increase in DIR fees in the pharmacy, which is having an approximately $1.2 million margin impact quarterly. DIR fees are a growing issue within the pharmacy industry generating Congressional attention, and a number of bills have been proposed to address or eliminate retroactive pharmacy DIR fees. We expect to continue to feel this impact in the second half of the fiscal year. Second-quarter adjusted operating earnings in retail totaled $7.7 million, compared to $13.1 million in 2017 second quarter.

Interest expense of $7 million represented an increase of approximately $1.3 million in the second quarter of fiscal 2018 due to a combination of higher interest rates and higher average debt levels during the same period last year. We generated consolidated operating cash flows of $104.3 million in the first half of 2018, compared to $38.4 million during the first half of 2017. The higher operating cash flows were primarily due to reductions in working capital in 2018 versus significant investments in working capital in 2017. We generated $30.4 million of free cash in the second quarter and $69.7 million during the first half of fiscal 2018, compared to $30.3 million in the second quarter of fiscal 2017 and $0.6 million in the first half of last year.

During the first half of fiscal 2018, we paid $13 million to shareholders in the form of cash dividend of $0.18 per share per quarter. Additionally, we repurchased approximately 952,000 shares of our common stock for $20 million, all during the first quarter at an average price of $21.01 per share. Our total net long-term debt increased by $39.5 million in the quarter to $694.7 million, compared to $734.3 million at the end of fiscal 2017. With the reduction in inventory levels being partially offset by lower accounts payable higher accounts receivable in the share repurchases as noted.

Our net long-term debt to adjusted EBITDA ratio was 3.1:1, a slight increase from the first quarter of 2018 due to the year-over-year decline in second quarter adjusted EBITDA. As covered in yesterday's press release, we are updating our fiscal-- updating our guidance for fiscal 2018 due to a combination of the product recall at Caito and slower anticipated sales growth and productivity improvements at our food processing operation. Additionally, the slower-than-anticipated introduction of new private brand product within our military segment, the slower ramp up of a significant customer program within our food distribution segment presents additional headwind. We continue to anticipate year-over-year sales growth in the food distribution segment.

And as Dave covered, we expect that growth to further accelerate sequentially in the third and fourth quarters to mid-single digits, due primarily by sales to existing customers and the continued ramp up of our significant customer program. In the military segment, we anticipate year-over-year sales growth to be relatively flat as the slower expansion of the private brand program and the cycling of a prior-year commissary business acquired in the Southwest in 2017's third quarter will be nearly offset by lower comparable sale. Within our retail segment, we expect comparable sales to improve up to 50 basis points sequentially despite headwinds associated with a number of remodels and store closures in the prior year's third quarter. We now expect 2018 adjusted earnings per share from continuing operations to be approximately $1.96 per diluted share to $2.08 per diluted share, excluding adjusted expenses and gains, but including the $0.06 associated with the product recall.

This excludes the expenses covered in Table 6 of yesterday's press release, most of which have been incurred in the first half of fiscal 2018. From a GAAP perspective, we expect the reported earnings from continuing operations to be in the range of $1.69 to $1.84 per diluted share in comparison to a loss from continuing operations of $1.41 in fiscal 2017. We have updated our capital expenditure guidance for fiscal '18 to be in the range of $64 million to $70 million, and we now believe that depreciation and amortization will range from approximately $82 million to $86 million. We expect interest expense will be in the range of $28.5 million to $29.5 million.

Finally, we expect our recorded effective tax rate to range from 22% to 23%, while our adjusted guidance reflects an expectation of effective tax rate of 23% to 24%. And at this point, I'll turn the call back over to Dave.

Dave Staples -- President and Chief Executive Officer

Thank you, Mark. In closing, we remain committed to our long-term strategy, which we believe will deliver on our objective of increasing shareholder value. We remain focused on continuing our growth through incremental sales with new and existing customers, exploring new avenues for our network and continuing to work with our partners at DeCA to bring the private brand program to its full potential. All while straining more of this growth to the bottom line.

With that, I'd like to turn the call back over to the operator and open it up for any of your questions. 

Questions and Answers:

Operator

Thank you. [Operator instructions] First question today comes from Ryan Gilligan with Barclays. Please go ahead.

Ryan Gilligan -- Barclays -- Analyst

Hi. Good morning. Thanks for taking the question. On guidance, can you just talk about what gets you to the high and low end of your range for the second half?

Dave Staples -- President and Chief Executive Officer

Yes. I mean, I think, Ryan, we highlighted some of the items that are coming into play that cause us to adjust our guidance. And I think really where those-- where the range comes from beyond that is how well we view reducing the expenses or ramping up the customer program, or as I referenced with regard to the retail segment being able to mitigate the negative impact of the retroactive DIR fee. So I would say that those are probably the three primary areas.

Within the military segment, I'm not sure that we're going to see any sort of acceleration of private brand introductions, but that's certainly would be something that would be a positive and help push us toward the higher end as well, or if we have some successes in winning other business that we don't currently have. But I think that within the segment that we control some of that, it really comes to taking the expenses out as we ramp up that customer program, seeing acceleration in the sales and/or mitigating some of the expenses that we are seeing that are headwinds, like I just referenced on the DIR fee. So does that help?

Ryan Gilligan -- Barclays -- Analyst

Yes, definitely. And, I guess, just following up on that new program with the existing customer. I mean, at this point what's your best guess for how long it will take to reach the full run rate and when you can get cost to normalize?

Dave Staples -- President and Chief Executive Officer

Well, I think there's two different questions there. So, I think as it regard to the sale ramp, we probably won't ramp to the ultimate level that is currently being forecasted until the back half of the fourth quarter. I mean, there's-- the glide path that we see sort of shows sequential increases week by week, but it's not a big step up in any given week. And so, it will continue to improve, but we're likely two months or so behind from our original projections on net sales.

Part of it, as we talked about in the first-quarter earnings call, is that the program we originally envisioned that would start in May and then it didn't start until June. And so, that was one element. But then the second element, this customer was previously handling those sales themselves and as they worked on their DCs, I think we knew that they had inventory to work through. But I think we maybe underestimated how long we take them to work through that.

So, that's kind of where we end up almost two months behind. And so as I said, I don't think that we would get to sort of the steady level that we start to comp again until probably late in the fourth quarter. And then-- I'm sorry. I think I spent too much into the first part of your question.

The second part of the question was?

Ryan Gilligan -- Barclays -- Analyst

Just taking cost out for when you can get margin to normalize with that business?

Dave Staples -- President and Chief Executive Officer

Yes. I mean, we've got programs in place that we would expect to start to see improvements in this quarter. But again, I think part of that comes from getting additional squeeze on the truck so that the trucks are-- we're really leveraging some of those base expenses and/or better leveraging some of the variable expenses a bit better. And so, they probably won't get to the ideal run rate until we get to the sales volume because at that point, we'll be fully squeezing out the trucks and the orders to the level that we thought when we built the model.

So, we'll see a sequential improvement in Q3 and Q4, but we likely won't hit there until the middle of the quarter to the end of the fourth quarter.

Ryan Gilligan -- Barclays -- Analyst

That's really helpful. Thanks.

Operator

The next question comes from Scott Mushkin with Wolfe Research.

Scott Mushkin -- Wolfe Research

Hey, guys. Thanks for taking my question. Thanks for all the detail. I guess, I was hoping and at least I did get some amount of detail, but I was hoping you could kind of just frame the reduction in guidance between the kind of company-specific things that you went through and then maybe the industry conditions may perhaps being a little bit tougher than what's originally expected in the back half? And then I did have a follow-up.

Dave Staples -- President and Chief Executive Officer

Well, Scott, I guess, as we thought through that. I think the number of the items, I guess, as you try to bucket them between industry and business specific, timing of rollouts, the Caito business as we continue to-- I think generate great interest in our operation, new program, those are things we control. I think we can work and we can stay focused on that. I mean, we're really excited about the opportunities at Caito, A, the recall put us back a few of periods on that, yes.

But we've got great interest in what we're offering there, strategically it's right down the fairway, what the world wants today between healthier food and fresher food. And so, we're highly focused on that and I think we begin to bring those efficiencies back online at Caito when we continue to roll that business. And we'll continue to move that forward as we progress through the back of the year and going forward. On the private brand side, it's a great program.

I think DeCA likes the products we're putting in. I think they like how it's working. They're committed to it. They believe in it.

But they have to roll it out at the pace they choose to roll it out at, and we're very supportive of that. And we're excited about it and we see that rollout continuing to ramp up as we go through the rest of this year and into next year, just not at the original pace we thought. So, we're excited about that and we'll keep moving forward. As well as timing of rollouts and things like that, I mean, hey, that's how things like this go.

They're big projects. They're important to the customer. They're important to us. We're all about making sure that we're delivering the highest quality service to these customers as we can as we bring them innovative solutions.

So, that will roll out at this quarter goes on. And as far as then the industry factors that could impact things like transportation rates and the others, this happens in our industry all the time. I mean, rates go up, rates come down. We're nimble about that though.

And so, while we look at may be in the past when customers would have rapid expansion, we would use third parties, we would do other things. And today, we'll use our own fleet as we move forward. So, I think some of the pressures that came with rapid growth are due to what, I guess you would term now as industry factors, and those are things we're putting plans in place to address, and I think we can do that. We can do more with our own fleet.

We can do more with just how we typically stream through our operation. Costs that are related to initial start-ups go away once you are up and running in the program. So, I think we have a handle on that. On the retail segment, the DIR fees and other things like that, we have counterbalances to that.

We're going to begin where we've begun warehousing our own generic drug, and we'll begin to distribute that product over time. We believe that will generate significant margin as we move forward, and we expect that over time to offset some of this type of pressure. We also in the pharmacy world can provide counseling and services to our patients on how they should and properly can use their medication. And we have a program in place that we're continuing to ramp up and we believe that will bring revenues that we hope can offset that.

So, I think it's a mixed bag of all those types of things, and I think we have a strong action plans in place to address whether it's an industry event or whether it's a timing and a rollout type of event.

Scott Mushkin -- Wolfe Research

So, I appreciate the detail. And then my second question just goes to you're seeing incredibly strong organic growth in your distribution business. And it's interesting because you take some of the other larger public companies that some of the smaller guys that you're distributing to compete with. And what you hear from them is like, "Oh, you have a business to consolidate.

Any smaller chain, these independent companies are in really bad shape compared to us. We can make the investments. We're in better shape. The industry is going to see a lot of people go out of business and we're going to benefit." But then I look at your numbers and I'm saying, "Well, wait a second.

Spartan's got a lot of those types of customers and they're growing their sales so rapidly." So, I was hoping you could give us your thoughts on your customer base and how they are positioned competitively in this new world.

Dave Staples -- President and Chief Executive Officer

Yes. I mean, Scott, as you look at our customer base, we have a great variety of customers, right? And our customers, they have made their way in this world by serving niches that they serve better than anyone else, and they're focused on that local niche. And so, as you think about the trends that are going forth and urges people to want to buy local. They want to know the people they're buying from.

They want to feel that that retailer is part of their community and involved, and we then bring scale behind that. We bring purchasing scale. As we talked about our strategy, right, in building out this network that allows it to be highly efficient and versatile, we're able to bring value and scale to all different types of customers out there. And by the fact that our businesses are so complementary between retail and distribution, we bring a partnership with CPGs as well to that mix.

So, we bring scale and the ability to purchase through our highly efficient network and then by being involved in the retail world, we bring execution efficiency, and partnering capabilities to the CPG world that they value. And when we put those two things together, we're able to bring to that independent or other customer base we serve unique ideas, strong pricing and the ability to execute their strategy to serve their niche that they've done better than the chains all these years. I mean, that's not really new news, right. These strong independents, they connect better with their communities than the chains, they offer more uniqueness than the chain, they quite frequently have better location than the chain.

And so, that's why they survive and that's why they continue to survive. And I think the other key components are our customer base is not in the major metropolitan markets for the most part, and that's where you see some of the current pressures more focused. Our customers are not also necessarily in the core markets that all of your large conventional chains are focused on. Certainly some are, but not all of them.

So, like I say, we serve, I think, niches that continue to be there and continue to offer opportunity, our customer's flexibility and nimbleness and understanding their market, our efficient network, our relationships with the CPG and our ability to bring creative retail thoughts compared to the distribution network whether that's in the military platform or able to help them with the private brand because of our experiences and then distribute that to the world because of our distribution network and our partnerships or whether that's with the independent customer, where we're working with them, they continue to try to provide programs to them to take advantage of the key areas of growth in their customer base. So, we feel good about our customer base. I think like anything, we've got some that are just doing exceptionally well, others that are doing really well and others that are probably having some problem with this environment like everybody else. But on balance, I think, we feel good about our customer base.

I think we got a lot of great independents and other types of customers.

Scott Mushkin -- Wolfe Research

Thanks, guys.

Operator

The next question comes from Chris Mandeville with Jefferies. Please go ahead.

Unidentified speaker

Hey. Good morning, guys. This is Jeff on for Chris. Thanks for taking our question.

First one is I do wanted to-- curious to know about the retail environment, especially with the grocery, and how groceries are handling the deflation in certain category? And then in general, what are you guys seeing from the likes of maybe your primary competition on overall pricing aggression? Are the Walmarts and Aldis of the world doing anything particularly different these days versus prior quarters?

Dave Staples -- President and Chief Executive Officer

I think as we look at the overall competitive environment, I think one thing you can be guaranteed in retail, it will be-- it will stay competitive. It always has been. It always will be. I think in some of our markets, as everybody knows, we experienced some significant pricing moves by Walmart and Aldi.

And I think we're responding to those, I think, with our new positioning, which I think really takes that head on and allows us to be differentiated yet close enough in value that the customers has buoyed for all this uniqueness. I really enjoy this store. I don't need to go anywhere else. And I think our customers are doing the same kinds of things.

And so while the pressure is certainly there and the pricing in certain categories is more aggressive than it has been, we've actually seen it moderate little bit in some markets and a little bit in some players. Other players may be at work to catch up to that pricing that was set, but I think the low bar that was set, I think, we've seen moderate little bit, which we take that as a positive. And we think as we go out, personalization, talking more directly to our customers in addition to the positioning we're putting in play, and I think our customers to the same extent as they execute and they deliver on what makes them different. I think we've been able to see traction and improving trends in our retail business.

And I think we'll continue to see those as we go forward and we roll out more of our positioning to the four stores we're talking about. This year we're really excited to see if that keeps driving the momentum we're seeing in the test stores so far. And if it does, we'll be excited to move this out to more stores on a faster pace next year.

Unidentified speaker

Got it. Thanks for that. And then secondly, what's driving the slowdown in the private brand for DeCA? And then what seems to be the issue with the-- your business development at Caito in Fresh Kitchen? And did the recall any concern from Caito customers?

Dave Staples -- President and Chief Executive Officer

Let me start with DeCa. The slowdown is more just-- there were initial expectations, I think, that they had. They had a change in leadership since those were published. I think they still remain very excited about private brand.

I think they remain very excited about what they're seeing it do. I think it's really just an executional philosophy. As they do category reviews, that's how they want to roll this out as opposed to maybe more of a rapid rollout and plug and play. I think they determined they just want to be much more, I guess, how I would say, diligent about the process.

They do category reviews on a regular basis, and they decided that's how they should really roll it out, which is a different understanding than we had initially. This is their business. They need to roll it out in the way they see fit. We continue to think this is the kind of offering that will help them drive more footsteps into the commissary.

We believe this is the type of offering that can float the boat for not just what they want to accomplish, but also their CPG partners. And so we really see this as a win, win, win all the way around between DeCA and their CPG partners and the consumers. And I think some tangential evidence suggests that where they're putting that in in the categories that have been in service, they're seeing increased foot traffic in the commissaries while their competition is seeing declining foot traffic in those categories. So, it's allowing them to serve their benefit purpose to more and more military families.

So, I think it's just more of a strategic play on their part on how they want to manage and make sure they roll it out as best as possible for their customers. And so, like I said, I think we'll see big increases again next year and for the years after till we get to the point where I think it can be. I still think it can be 3,000 to 4,000 items if they choose to get there. And that's a real big opportunity for them and us.

The second part of your question?

Unidentified speaker

On the Caito?

Dave Staples -- President and Chief Executive Officer

On the Caito plan, I guess, I'm not-- I don't see it as a problem. What I see happen is we are making great progress with Caito, and we had a recall. And these things happen. We don't ever want them to happen.

We're totally committed to food safety, and we'll take very decisive actions to ensure that we're doing everything we can to be that safe food provider. And so we closed the operation in the fresh-cut melon for a few weeks for that reason. It's just put us back. I think what that kind of an activity does to us, to everybody is AFFO gets 100% on that and it slows down on another things.

Our customers are happy. I think the product we produce is fantastic. My understanding is we are one of the largest single-point producers of this kind of product amount in one facility and the quality is great and the product is great and there is a lot of interest in what we do. I mean, we have a very exciting line of unique opportunities.

It's just because some of these are pretty unique-- I mean, some of these even involve new technologies and new processes. They seem to be taking probably longer than we originally anticipated to get them to fruition. So I don't feel like it's a lack of opportunities or that any opportunities have dwindled or gone away. I just think the runway, as we learned the kitchen side of the business especially, it's sometimes longer to launch these products than we would have expected combined now with the delay driven by the recall and we're just seeing a little bit longer timeline to get these products online.

The efficiencies feel like we're getting back on track there now, and I feel as optimistic as ever and excited as ever about where this can go. I certainly would love it to get there faster as I'm sure all of you wants as well.

Mark Shamber -- Executive Vice President and Chief Financial Officer

Jeff, what I would just add is some of it on the Fresh Kitchen is that a potential customer may come in with a formulation for a particular product, particular meal, and looking to hit a price point. And so, there may be multiple iterations in order to hit that price point and ensure that the product still has the appropriate taste and quality of what they originally intended. And so to the point that Dave just made, I think that the inbound interest in working with the Fresh Kitchen and looking to do business with us remains robust and we continue to get more inbound inqury, but the sales cycle is probably a little bit longer than we had initially envisioned.

Unidentified speaker

Got it. Thank you.

Operator

The next question comes from Paul Trussell with Deutsche Bank.

Unidentified speaker

David [Inaudible] on for Paul.

Dave Staples -- President and Chief Executive Officer

Hi, Dave.

Unidentified speaker

Hey. How's it going, guys. Just a question around the retail operating margin. It looks like it's down around 100 basis points.

And I know DIR fees impact that around $1.2 million. Can you talk-- speak to the other headwinds affecting margin in the quarter and kind of what you expect going to the second half with those drivers?

Dave Staples -- President and Chief Executive Officer

Yes. I mean, I don't think I'll break them all, but I think we highlighted recently our prepared remarks, and I think it's also in the press release. But we had mentioned at the beginning of the year that we are going to make some investments in labor within the stores, and so we have done that. But in addition, we selectively made investments in margin.

And we're not going to discuss where and what category simply because we had some success in that area and we don't want to let the competition in on how we've been doing it. But I would say that that's where the other impacts are that are-- what you're seeing from a sequential or in a year-over-year standpoint.

Unidentified speaker

OK. Do you think those similar investments will move in the second half?

Dave Staples -- President and Chief Executive Officer

Yes. Yes. I mean, they were not one time. The labor investments were across the board.

And so those will continue on a rapid into next year because they didn't all go into effect on 01/01. On the margin, I mean, I think we'll continue in areas where we have success and in areas where it doesn't generate the sales lift or the incremental sales that we expect we may move between categories. But I would expect those investments to continue.

Unidentified speaker

OK. And then on Fast Lane, you say you're 5% of locations now. Do you have any data on how that's working from a basket margin profile compared to just the in-store customer? Just some color on that business?

Dave Staples -- President and Chief Executive Officer

Yes. I mean, it's pretty exciting when you look at the baskets. The basket is over $100. So that's great.

We're finding 50% of the business is incremental. So, with our existing customers, we're seeing that they are purchasing 20% to 30% more than they originally were. And what we really like to see is with the new and the existing customers, they're still shopping probably around 25% of the time in the store. So, we're not losing out of the store, which I think speaks to the convenience of our location and our operation.

So, it's really turning into a combination. You do some bulk shop online and whether you have that delivered to your home or whether you pick that up in your car, but you're also still consistently coming into the store because I think it's either there's things you want to pick up that you may not want to wait and get delivered or [Inaudible]. You use the store and you enjoy the experience and you find unique things in the store. So it's really been a nice win for us.

The margins probably are a little bit less, but they're big, full baskets. So, I think they're a little bit down on the margin, but I think as we refine our processes, our labor is going to continue to come down. And I think click-and-collect, there is a real avenue there for profitability over the longer-term as we continue to refine our processes. Delivery in a lot of our markets will be difficult.

As long as there is a fee associated with that, I think there is potential for profitability. But that's a tougher way to go in our markets when you think of-- we're not in those high dense urban areas, but it's an option. By far though people are choosing click-and-collect over delivery at least at this time.

Unidentified speaker

Thank you.

Operator

The next question comes from Ajay Jain with Pivotal Research.

Ajay Jain -- Pivotal Research Group -- Analyst

Yes, hi. Good morning. I think I wanted to follow up on some of the earlier questions about your guidance in the back half. So, I think excluding the impact of the product recall, I think your EBITDA was still down a couple digits by around 15% in the quarter.

And I guess, implicit in your second half outlook is some recovery. I think EBITDA outlook is supposed to improve to a mid-single digit rate range in the back half. So, I'm just trying to reconcile that recovery in the guidance with some of the incremental headwinds that you mentioned such as DIR fees in pharmacy and investments in labor, etc. So, apart from the product recall issues mostly going away, what's really driving the improvement that you're expecting in the back half when it seems like the range of challenges isn't necessarily coming down?

Mark Shamber -- Executive Vice President and Chief Financial Officer

Well, I think as we highlighted, Ajay, I mean, I think, to the earlier question, I mean, where we fall within that range and where the improvement comes from to the extent that we're successful in driving out some of these third-party expenses that we're now intentionally incurring to avoid negatively impacting customers. I mean, as we bring that in in-house, we see an immediate drop in those expenses. We have programs in place to try to mitigate some of the impacts of the retroactive DIR fees, which Dave talked about having our own warehouse for generic. And then we continue to expect the ramp of that customer program, and we-- given that we're a couple of months behind, we sort of adjusted declines accordingly, but should there be an acceleration there, that would be something that would help us.

I think we feel comfortable with where we're at now that if we were to see the two-month lag continue all the way through the year end, that that's reflected in the guidance. And so, I mean, I think that those are a few of the different items. I'm not going to answer and go through the whole laundry list, but this--

Dave Staples -- President and Chief Executive Officer

Well, it's accelerating sales, Mark. We're seeing our sales growth is going to get to continue to accelerate in the back half.

Mark Shamber -- Executive Vice President and Chief Financial Officer

Well, I presumed, he was asking beyond the sales side of it where-- but yes, I mean, the other-- I mean to David's point, the other part is we're saying that food distribution is going to accelerate in the back half beyond what we had in the first two quarters.

Ajay Jain -- Pivotal Research Group -- Analyst

OK. And I just had one follow-up kind of high-level question based on the SuperValu developments. I guess, that new company will have the ability to sell pretty much everything across the perimeter in the center of the store. So, I was just wondering if that puts you potentially to disadvantage in terms of how you're going to market with your distribution customers? I'm sure, you see some opportunity based on that situation, but could the lack of kind of a one-stop shop ability to sell a full range of natural and organic products, could that also be a potential challenge down the road?

Dave Staples -- President and Chief Executive Officer

No, I don't really think so. Their networks aren't intertwined, so they're going to have to cross out that product or do other things. They're not going to dual slot it. And so, there is other players in that space that people will have the ability to buy that from or that we could set across that programs with, if we felt that was an issue.

I think I feel there's much more opportunity for us than overall risk in this transaction.

Mark Shamber -- Executive Vice President and Chief Financial Officer

And, Ajay, I would add that we aren't carrying natural organic products, and we carry the faster movers and the unifies and the KDs and their brethren carry the slow movers that don't have the turns. And so, as the demand for natural organic or specialty picks up, we would continue to add those SKUs. And so, I don't know that we'd be disadvantaged at all. I think, if anything, we'd be avoiding carrying the long tail which comes with higher shrink and slower turns and takes up a lot of warehouse space.

So, I don't know that-- I'd view it as a disadvantage in that regard.

Ajay Jain -- Pivotal Research Group -- Analyst

OK. Thank you.

Operator

[Operator instructions] The next question comes from Kelly Bania with BMO Capital.

Kelly Bania -- BMO Capital Markets -- Analyst

Hi. Thanks for taking my question. So, in terms of just the retail business, so you called out the DIR fee. Other than that, is-- are things tracking in line with your expectations relative to your original guidance?

Mark Shamber -- Executive Vice President and Chief Financial Officer

Well, I would say, that the comparable sales have improved, but again, probably not at the rate that we had originally set. I mean, I think that our initial guidance talked about being flat to positive or barely positive for the full year. And we now think we'll kind of finish the year comp-wise by the positives. So, we'll probably be slightly negative or negative for the year.

So, I would say that the improvements have been there, but not necessarily at the rates thought. But I would say other than that, we've seen sequential improvements quarter to quarter just not as much as we were expecting. And a portion of that is the inflation hasn't-- that we had talked about at year end hasn't materialized. The other piece of it is just the competitive environment that remains out there.

Dave Staples -- President and Chief Executive Officer

But all in, I think at this point, we're not way off where we thought we'd be.

Mark Shamber -- Executive Vice President and Chief Financial Officer

No.

Dave Staples -- President and Chief Executive Officer

We're pretty much, I think, in line with our expectations other than a little bit of the sales.

Kelly Bania -- BMO Capital Markets -- Analyst

OK. And in terms of the distribution segment and the recall, can you just-- maybe just provide more specific quantification on the impact of that on the operating income for the quarter? And how much that has impacted the second half in terms of just the cost and the disruption versus the sales loss from that given dynamic?

Mark Shamber -- Executive Vice President and Chief Financial Officer

Yes. I mean, I-- well, I mean, I would say that it's probably in that $2.9 million that we're referencing, right? I mean, it's probably north of 80%, 85% were expenses versus any sales loss and margin contribution that we might have otherwise gotten. So, the vast majority of it were in the hard cost whether it's throwing away products or legal expenses or customer rebuilds for product that they had to throw away or-- and we kept our workforce during that time frame, so there are yet expenses where you're paying folks to-- you're shuffling people who aren't on the line and so you were inefficient, but you didn't let people go or reduce headcount because you were down for a couple of weeks on the line. So, I would say most of those were hard costs, Kelly.

And as it relates to the third quarter, I mean, we'll probably have some legal fees, but -- and then there may be some better estimates on a couple of the numbers. As folks come back and rebuild for maybe for different numbers than what they've initially given, they find it-- couple of things in there. And so, I mean, I would say that the impact in the third quarter is-- at this point, I'd be surprised if it's more than $0.25 million, but it will probably at least $80,000 to $100,000 in the third quarter.

Kelly Bania -- BMO Capital Markets -- Analyst

OK. I'm just-- I guess, just trying to get a sense of given the continued strength in the distribution segment sales outside of, I guess, Caito, what is underlying profitability doing in that segment?

Mark Shamber -- Executive Vice President and Chief Financial Officer

Yes. I mean, I would say that the business-- as we talked about, we've in the past and for the new customer program, we incurred some costs to start that up, and we were using third parties versus using our own drivers and our own fleets. And so we've taken some heads-- or taken some headwinds associated with that, but I would say that the business has been growing from a profitability standpoint is yielding in general, in line with what we had historically if we are factoring out those items. So, I don't know if that's maybe getting to where you're going, or if I'm not understanding the question.

I think you're asking sort of are we still dropping to the bottom line other than the Caito and the new customer program.

Kelly Bania -- BMO Capital Markets -- Analyst

Yes.

Mark Shamber -- Executive Vice President and Chief Financial Officer

And I would say there hasn't been a major shift in the profitability of the legacy business, but when you factor in the customers that are experiencing the rapid growth in Caito, that's really where we've seen the headwind.

Kelly Bania -- BMO Capital Markets -- Analyst

OK. And I guess, in terms of the recall, I mean-- I guess, how do you avoid a situation like this? Or is this kind of just hard for the course in the fresh-cut business?

Dave Staples -- President and Chief Executive Officer

Well, I mean, you're never allowed to say it's hard for the course. It is a factor in life that salmonella and other types of things are in nature. And the products we're dealing with are in nature. And when you deal with fresh-cut items, you cannot cook that and heat is your biggest ally.

But there-- we have a lot of procedures in place to try to minimize this potential, and we'll continue to always work to put even more in place. And so, I think it's a natural event, but our job is to do the best we can to continue to think of ways to minimize the risk.

Kelly Bania -- BMO Capital Markets -- Analyst

Got it. And in terms of the delay in the military, it was going so well. I mean, I'm just not quite clear why there would be any hesitation in going forward with the original plan and slowing that down.

Dave Staples -- President and Chief Executive Officer

Well, I just think you had change in leadership, and I think it's process. And I think, while the leadership still is very engaged and desirous of the program, I think the organization is kind of determined that it wants to move at a different phase. It's an organization with its culture and the way it needs to operate and that may be different than a for-profit business. And so, I think they've chosen the path and we respect that.

And to really get any deeper than that, you'd have to talk to DeCA. But I mean, everything we've seen is they're happy with the program. Everything they told us is they're happy. All the results, I think, that have been presented would say it's working as planned.

I think it's just the pace they've chosen that fits, the methodology they want to use to roll it out, and I really can't tell you much more than that.

Kelly Bania -- BMO Capital Markets -- Analyst

Thank you.

Operator

The last question today is a follow up from Chris Mandeville with Jefferies. Please go ahead.

Chris Mandeville -- Jefferies -- Analyst

Hey, guys. Thanks for taking out quick follow up. Just briefly, I wanted to-- if you could speak to the rapid growth that you're seeing from customers from certain regions with distribution. Can you at all give any color as to kind of what channel they're coming from? And just broadly how this growth is actually affecting you from a logistics and expense standpoint?

Dave Staples -- President and Chief Executive Officer

Well, I mean, they're coming from multiple places, multiple customers. It's not any one customer, it's not any one thing. And so, I guess, I'm not going to give any specific color other than it's coming through our existing network. And it's multiple customers and it's multiple phased programs.

I think how it impacts our logistics is, I guess, a lot like we've just said before. I mean, we have DCs that are experiencing 10% 20%, 30-plus percent growth sometimes here because of some of the things we're launching. And what you have then is a need to expand your fleet, a need to expand your resources, a need to bring sometimes more product into the location, sometimes it's just incremental volume into the location. So, sometimes there is a need to rewrap and reset.

And so, those are the kind of costs we're dealing with. In the past, a number of those things were easily done by a third-party at a cost somewhat more than your base cost but not dramatically different. Today, given some of the pressures in some of the markets, those costs will be significantly more. What we can do to mitigate that is to bring more of those costs into our fleet and run them ourselves, and that's our plan.

It's just take some time to get the tractors, the trailers, everybody hired in the line. And so, as we shift our methodology for how we respond to this, we get those costs back in line. And so, I don't know if that answers your question fully but I think those-- that's really how it's flowing and how we're going to address it. And obviously, there's many, many other tactics we have in place but we feel confident we're going to-- all those costs come back in line as we get this up and running.

Chris Mandeville -- Jefferies -- Analyst

Got it. Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Dave Staples for any closing remarks.

Dave Staples -- President and Chief Executive Officer

Well, I just again like to thank all of you for participating today, and we look forward to speaking with you again at the end of next quarter. Have a good day.

Operator

[Operator signoff]

Duration: 61 minutes

Call Participants:

Katie Turner -- Investor Relations

Dave Staples -- President and Chief Executive Officer

Mark Shamber -- Executive Vice President and Chief Financial Officer

Ryan Gilligan -- Barclays -- Analyst

Scott Mushkin -- Wolfe Research -- Analyst

Ajay Jain -- Pivotal Research Group -- Analyst

Kelly Bania -- BMO Capital Markets -- Analyst

Chris Mandeville -- Jefferies -- Analyst

More SPTN analysis

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