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Smart & Final Stores Inc  (NYSE:SFS)
Q1 2019 Earnings Call
May. 01, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Smart & Final Stores First quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Madeleine Myers, Investor Relations. Please go ahead.

Madeleine Myers -- Investor Relations

Thank you for joining us today as we discuss Smart & Final Stores' First Quarter 2019 Financial Results, which was a 12-week quarter ended March 24th, 2019. Participating on today's call will be Dave Hirz, Smart & Final's President and CEO and Rick Phegley, Smart & Final's EVP and CFO.

Before we begin, we want to remind you that comments made during this conference call and webcast contain forward-looking statements and are subject to risks and uncertainties. Our actual results could differ in a material manner from those expressed in such forward looking statements for any reason, including those listed in the Company's SEC filings. The Company assumes no obligation to update any such forward-looking statements. Please also note that past performance is not a guarantee of future results.

During this conference call, the Company will refer to certain non-GAAP financial measures, including adjusted net loss, adjusted net loss per diluted share and adjusted EBITDA. The Company uses these as measures of operating performance, not as measures of liquidity. These measures should not be considered in isolation from, or as a substitute for measures prepared in accordance with Generally Accepted Accounting Principles. In addition, these non-GAAP measures may not be comparable to similar measures used by other companies. Please refer to the Company's earnings release made available on its Investor Relations website for definitions and reconciliations of these measures to the most directly comparable GAAP measures.

Finally, as noted in today's press release, we will not be hosting a Q&A session following the prepared remarks in light of the pending transaction with funds affiliated with Apollo Global Management that we announced on April 16th.

Now, I will turn the call over to Dave Hirz, Smart & Final's President and CEO.

David G. Hirz -- President and Chief Executive Officer

Thanks, Madeleine and good morning, everyone. We had very solid first quarter results despite some challenges in weather affecting both of our banners. Both comparable store sales and adjusted EBITDA were above the high-end of the guidance for the quarter. Before reviewing the results in detail, I'd like to mention that we're constrained in what we can discuss in this call regarding the pending transaction with funds managed by affiliates of Apollo Global Management that was announced on April 16th. The company and purchaser and entity owned by funds managed by Apollo, will be filing tender offer documents with the SEC that will contain more information regarding the pending transaction, which we encourage you to read.

Now turning to our first quarter 2019 results. We had a strong start to the year. Total Company sales in the first quarter grew by 2.8% year-over-year and a 2.2% comparable store sales growth rate. As mentioned, comparable store sales exceeded our first quarter guidance range of 1.75% to 2% and represents our highest comp store sales rate since the fourth quarter of fiscal 2017. Adjusted EBITDA of $29.6 million was also higher than our Q1 guidance range of $25 million to $28 million and grew by approximately 4% year-over-year.

We achieved these results despite ongoing challenges from a low inflation rate environment in one of the coldest and wettest winners in many of our markets in decades. In both store banners, we continued to emphasize our strong value proposition and unique product assortment that appealed to business and household customers alike.

The first quarter inflation rate was 1.1%, comprised of 1% inflation in the Smart & Final banner and 1.5% inflation in the Smart Foodservice banner. While this represents a significant improvement from the 0.2% inflation in the fourth quarter of 2018, inflation was lower than the 1.4% level we experienced in the same period a year ago. And it remained significantly below the 2% inflation rate we believe is necessary to leverage operating costs in our business.

As I highlighted on our fourth quarter 2018 earnings call, managing an environment with low rates of product cost inflation against a backdrop of rising operating costs in all areas of our business remains a headwind to earnings growth. In this environment, we remain focused on our strategic plan of building on our core strength and value pricing and dynamic merchandising, improving our customers' experience whether in-store or online, and evolving with the market through targeted investment in digital commerce and infrastructure. Our product offering and shopping experience continues to resonate with our customers in both of our store banners.

In the Smart & Final banner, first quarter comp store sales grew 2.4% year-over-year, led by a 1.7% increase in ticket and a 0.6% growth in transaction count. Importantly, this was the second consecutive quarter of positive ticket and transaction count growth in the Smart & Final banner. Our focus on improving customer service, in-stock levels in front-end wait times, continued to contribute positive results. Key to growing sales at the Smart & Final banner is the engagement of our business customers composed of small businesses, restaurants, clubs and organizations. These customers appreciate our unique assortment, including our strong private label and warehouse club pack items offered without a membership fee at everyday low prices.

Sales to our business customers remained solid, representing over 28% of total Smart & Final banner sales in the first quarter. Private label sales were also strong and continued to support our merchandise margin. Private label comp sales accelerated to 2.2% with a 28% penetration rate. These offerings are popular among our customers due to their high-quality and strong value proposition.

In the first quarter, we achieved sales growth, while simultaneously improving our merchandise gross margin rate. Increasing margin, while maintaining our pricing gaps to competitors, is a key accomplishment realized through improving our sales mix and other merchandising and pricing initiatives.

And now, turning to the Smart Foodservice banner. In the first quarter, comparable store sales growth was 1.5%, comprised of a strong 3.1% growth in average ticket, partially offset by a 1.5% decline in transactions, which include the traffic depressing effects of weather. You know we normally don't call our weather as a factor in our operating results, but we believe traffic in Smart Foodservice was impacted by record snowfall and rain experienced in the Pacific Northwest. The practical effect was softer food away from home sales, which in turn impacted our core restaurant customers.

Notably, we were able to maintain a strong merchandise margin in the banner despite the sales challenges. During the first quarter, we opened a new Smart Foodservice store in the Northeast (ph) Portland market with solid early results. We're also continuing to selectively invest in e-commerce sales in both of our store banners. Our goal is to support the evolving shopping preferences of both existing customers and potential customers who have now visited our physical stores. Our e-commerce platform allows us to maintain relevance with existing customers and also represents a great opportunity to introduce our compelling product offering and value pricing to customers who discover us online.

While e-commerce sales growth is off a small base, sales of both of our banners continue to gain traction. In the Smart & Final banner, we recorded a 48% increase in e-commerce sales during the first quarter with average orders of approximately $78, more than double the average of our in-store sale and with a higher margin. In the Smart Foodservice banner, we saw over 150% growth in e-commerce sales. Our Smart Foodservice average e-commerce transaction is now nearly 3 times the average in-store sale with a similar higher margin. In April, we expanded our Smart & Final banner e-commerce presence with online ordering and delivery through shipt.com providing yet another option for convenience. Our customers can now order product through shop.smartandfinal.com as well as on the Shipt and Instacart marketplaces.

Later this year, we'll further expand our customer-facing profile to include our own in-house e-commerce ordering site for both banners, providing us direct customer interaction, enhanced cost controls and the opportunity to work more directly with key vendors to improve economics for both our customers and the Company.

I'll now hand the call over to Rick to discuss our first quarter results in more detail.

Richard N. Phegley -- Executive Vice President and Chief Financial Officer

Thank you Dave, and good morning everyone. As noted in today's release, consolidated net sales in the first quarter were $1.04 billion , up 2.8% versus the first quarter of 2018. Net sales growth was driven by the sales contribution of stores that opened over the last 12 months, as well as consolidated comparable store sales growth of 2.2%. Both the net sales and comparable store sales growth were well in excess of the underlying product inflation rate and were supported by strong average ticket growth in both store banners.

In the Smart & Final banner, sales increased by 2.6% over the prior year, including the contribution from new stores. As Dave reviewed, average ticket in the first quarter increased by 1.7% with an underlying estimated inflation rate of 1%. Store traffic increased by 0.6%.

The reported gross margin rate in the Smart & Final banner was 15.3%, up 60 basis points compared to the first quarter of 2018, reflecting the success of our merchandise mix and strategic pricing initiatives, partially offset by increased distribution and occupancy costs. Year-over-year for the first quarter, operating and administrative expenses as a percentage of sales in the Smart & Final banner was 14.3%, about 48 basis points higher than the year-ago quarter, reflecting steady increases in store level labor costs, due primarily to minimum wage rate growth.

In this Smart Foodservice banner, sales increased by 3.6% from the prior-year quarter with a comparable store sales growth of 1.5%. Average ticket in the first quarter increased by 3.1% with an underlying estimated inflation rate of 1.5%. Store traffic on a year-over-year basis decreased by 1.5% and was challenged by the adverse weather we experienced. Banner gross margin rate in the first quarter was 14.8%, 55 basis points higher than the prior year. Similar to the Smart & Final banner, merchandise margin accounted for most of the increase with distribution and occupancy expense rates fairly flat as a percentage of sales. Operating and administrative expenses as a percentage of sales in the Smart & Foodservice banner were 8.4% in the quarter, up from the prior-year quarter, including store labor costs.

Our first quarter is typically the lowest sales quarter of the fiscal year and represents a challenge in covering (ph) fixed costs, including interest expense and depreciation. On a GAAP basis, we recorded a first quarter net loss of $6.7 million and GAAP EPS of $0.09 loss per share based on about 74 million shares.

To better understand our operating performance, we focus on adjusted EBITDA, which by excluding unusual and certain other charges is more useful for comparison and analysis in conjunction with sales trends. In the first quarter, EBITDA was $29.6 million compared to $28.6 million in the prior-year quarter. This represents a 3.6% growth compared to the prior-year quarter.

Turning now to the balance sheet and cash flow statements. Before reviewing our balance sheet and cash flow numbers, I'd like to comment on changes to our balance sheet effective in the first quarter, based on the new lease accounting standards ASC 842. Historically, our leased properties were primarily accounted for as operating leases with limited related assets and liabilities recorded on our balance sheet.

Beginning in the first quarter of fiscal 2019, we adopted the new lease accounting standard, which requires lessees to put all leases on their balance sheet and recognize expenses on their income statement in a manner similar to the historical accounting. This change did not impact our cash flow related to store leases, but increased our asset and liability balances on our balance sheet by approximately $900 million.

We ended the quarter with cash and cash equivalents of $57.9 million as compared to $55.8 million in the year-ago quarter. Our working capital remains well controlled and in line with our expectations with investments in inventories of $286.9 million. Our debt balance was $653.7 million at the end of the first quarter. At the end of the first quarter, we had borrowed $35 million under our $200 million revolving credit facility.

Net debt to adjusted EBITDA at the end of the quarter was approximately 3.3 times in line with our expectations. On May 22nd, we'll have our annual meeting of stockholders as previously scheduled. And we expect that the pending transaction with funds managed by affiliates of Apollo, will be complete by the third quarter.

Finally, as noted in today's earnings release, we are no longer providing fiscal 2019 guidance due to the pending transaction.

And with that, I'll turn the call back to Dave for some concluding remarks.

David G. Hirz -- President and Chief Executive Officer

Thanks Rick. Our pending transaction with Apollo is a testament to the strength of our Smart & Final franchise, the quality of our store banners and the talent and expertise of our people. I'd like to express our gratitude to our 12,000 associates for their talent, expertise and their continued hard work and dedication. We're appreciative of all of our stockholders for their support, including our six-year partnership with the majority shareholder Ares Management.

In light of the pending transaction, we won't be taking questions on today's call. But I'd like to close by thanking our associates, suppliers, customers and shareholders for being our partners in our dynamic and differentiated retail business. We look forward to embarking on a new chapter in our almost 150-year history and continuing to evolve to meet the needs of both our business and household customers. Thank you.

Operator

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.

Duration: 16 minutes

Call participants:

Madeleine Myers -- Investor Relations

David G. Hirz -- President and Chief Executive Officer

Richard N. Phegley -- Executive Vice President and Chief Financial Officer

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