Stater Bros. Eyes Debt Reduction, Investments

ELLIOT ZWIEBACH

SAN BERNARDINO, Calif. — Stater Bros. Markets here said it is considering using some of the free cash it expects to generate this year to reduce debt or else possibly to buy some empty department stores sites for future supermarket locations.

Analysts told SN they expect the company to generate free cash flow of $15 million to $25 million this year now that the large expenses the company invested in building a new warehouse and distribution center are behind it.

Phil Smith, executive vice president and chief financial and administrative officer, said Stater wants “to look at reducing debt down the line, and when the time is right, we would consider buying bonds back.”

Jack Brown, chairman and chief executive officer, added that there are several former sites of Mervyn's Department Stores in Stater's operating area “that several [supermarket companies] have looked at, and that's another reason we want to maintain higher cash levels.”

The two executives made their remarks during a conference call with analysts to discuss financial results for the fourth quarter and fiscal year that ended Sept. 28 — a 13-week quarter and 52-week year compared with a 14-week quarter and 53-week year in fiscal 2007.

Net income for the quarter fell 30.8% to $7.2 million, while sales declined 5.4% to $940.2 million. Adjusted for the extra week, during which management said the company generated sales of $65.1 million, sales were up 1.7% in the quarter and comparable-store sales rose 1.1%.

Smith said first-quarter comps are running at levels similar to the fourth quarter.

For the year, net income fell 17.8% to $40.6 million, while sales increased 1.8% to $3.74 billion, a record level. Adjusted for the extra week, sales were up 3.8% and comps grew 2.4%.

Gross margin for the quarter rose to 26.4% of sales, compared with 25.6%, “due to increased rebates from some vendors and our ability to recoup some impact of inflation,” Smith said.

“However, the full impact of inflation was not fully passed on as we reduced prices on certain items to grow sales. That situation was isolated to the quarter, and we expect gross margin to fluctuate, depending on the competitive situation, through this year.

“Our marching orders are to continue to protect our customer base with low margins.”

Brown said financial results were impacted by the downturn in the economy and efforts by Stater Bros. to maintain its low-pricing position in Southern California. “2008 was a challenging year from the company, and 2009 will be even more challenging,” he said.

One challenge Stater had to deal with last year, Brown said, was deflation in state-controlled milk prices that affected all California retailers. “The price of milk this year fell $1 per gallon, which amounted to $400,000 a week — the equivalent of losing a complete store for a year,” he pointed out.

He said there has been little change in competitive merchandising in the last six months. “Everyone is working to reduce expenses and hold onto customers, though we feel we've done a better job by running a lot of ‘lowest price of the year’ promotions.”

Asked what categories are underperforming, Brown mentioned wine, floral “and a little slowdown in health and beauty care. But corporate brands are strong.”

Traffic is up, with customer counts in the fourth quarter increasing by 355,000 over the third quarter, Brown said, while basket sizes are smaller.

Unemployment in Southern California is running at about 9% — above the U.S. rate of 6.7%, Brown pointed out — “and with the construction industry shutting down, it really hurts us. But the good news is, we think [construction] will be back up by the end of 2009.”

Capital expenditures this year will drop to $73 million, compared with $170.6 million in 2008 and $193.6 million in 2007, with most of the money the last two years spent on building the new distribution center and office complex. All new warehouses are operating except the bakery facility, which is scheduled to open in April, Brown said.

Stater plans to open four new stores this fiscal year — two of which have already opened, with another due in February and one more likely to open later in the year.

Q4 RESULTS

*FISCAL 2008 WAS 52 WEEKS, WITH A 13-WEEK FOURTH QUARTER, COMPARED WITH 53 WEEKS AND 14 WEEKS, RESPECTIVELY, IN FISCAL 2007. COMP-STORE SALES FOR BOTH PERIODS ARE ADJUSTED FOR THE EXTRA WEEK.