Fairway Net, Sales Continue To Plummet; Loss Is $13.9 Billion

Stock in Fairway Group Holdings (Fairway Market) dipped sharply following the company’s release of quarterly losses and sales declines that were more severe than had been expected. When the earnings announcement was made on August 5, shares dropped 20 percent to a yearly low of $2.13 per share and when we went to press on August 12, Fairway’s stock had gained only marginally to $2.35 per share.

The 15 store Manhattan-based retailer posted a $13.9 million loss in its second quarter ended June 27. Sales were $198.3 million, down 2.3 percent from the same period last year, and comps dropped 5.3 percent.

Jack Murphy, Fairway Market’s CEO said, “I am pleased with our performance this quarter in a number of important operational areas including our gross margin which was driven by better selling margins and improved shrink. We also performed well on expenses with progress in labor management and other expense categories. Importantly, we also strategically invested approximately $2.8 million to launch advertising, promotional and customer acquisition campaigns that we believe will eventually benefit our top line.”

However, after the release and during his conference call with financial analysts, Murphy acknowledged that the results were not good. Moreover, he revealed that his plan to recapture top-line sales would show results in the long term, while conceding that this progress would come at the expense of earnings for the next few quarters. He also noted that a positive ID sales turnaround could take 12-18 months.

“The top line will take time and it will require investment that may impact these short-term results, but management is here to build a long-term strategy, and we believe this will ultimately produce value to the investors, the former Earth Fare CEO declared.

Murphy once again affirmed plans to proceed with smaller, less costly new stores beginning next spring with a new store in Brooklyn at the site of a Waldbaums currently operating in the Mill Basin area (Ralph Ave.). Another newer, but smaller Fairway Market is scheduled to be built in Staten Island. Murphy added that the company’s unit in New York’s Tribeca neighborhood would be smaller than initially envisioned. A plan to build a new Fairway in the huge Hudson Yards mixed-use development on the west side of Manhattan was potentially scrapped earlier this year (Fairway had expected to open that store in late calendar 2015 or early calendar 2016. In connection with the lease termination, the retailer has negotiated a limited, conditional right of first negotiation if the developer determines to include a supermarket in the second phase of the Hudson Yards development. Fairway paid the landlord a total of $3.5 million in connection with the lease termination).

As for other new stores, Murphy told the analysts, “…we are focused on growth. As Edward (Arditte, president and CFO) said in the past, we have a number of leases already in process and we are looking very diligently at other opportunities in the tri-state area.”

Murphy laid out several promotions that Fairway has put in place to grow sales. During the first quarter, the retailer invested $2.8 million in promotions and coupons, he told analysts. The program included a mobile number acquisition program that offers customer discounts in exchange for their phone numbers, which has thus far allowed the retailer to grow its text message database to 100,000 numbers – up from 6,000 before the program started.

Murphy said the text messaging effort is resulting in high conversion rates and increases in trips and items per basket, particularly at its stores in suburban Pelham, NY and Douglaston, NY. Fairway’s seven  units in New York City – particularly an Upper East Side unit (E. 86^th St) whose volume has declined by approximately 15 percent as a result of a competitive Whole Foods opening – are still sliding.

“You could say to me, ‘Well, Jack, you don’t seem to have gotten much of a sales boost from this initial foray.’ On the basis of the short-term numbers, you are right,” Murphy disclosed. “But we are beginning to see the beginnings of some very good returns in some of our suburban stores, and we are building this program and this strategy for the long-term. So it’s not about buying quick sales, it’s not about boosting margins irresponsibly. It’s about a long-term commitment to responsibly build a really great company.”

As for the actual numbers, the downward trend of the past two years continued. Gross profit for the first quarter of fiscal 2016 was $60.9 million compared to $61.4 million in the same period of the prior year. The gross margin increased approximately 50 basis points to 31.5 percent from 31.0 percent in the prior year. The increase in gross margin was driven by a higher merchandise margin as a result of improved shrink management and price optimization, partially offset by an increase in occupancy costs, as a percentage of sales.

In the quarter, store expenses, excluding depreciation and amortization, increased $0.3 million to $41.3 million for the first quarter of fiscal 2016 from $40.9 million for the first quarter of fiscal 2015. The increase in store expenses was attributable to an increase in the number of stores in operation during the period. Store expenses for stores open in both periods decreased $1.5 million in the first quarter of fiscal 2016 compared to the first quarter of fiscal 2015, primarily due to continued improvements in labor productivity and enhanced cost discipline. Store expenses were 21.3 percent of sales for the first quarter of fiscal 2016 compared to 20.6 percent for the first quarter of fiscal 2015.

General and administrative expenses were $18.0 million for the first quarter of fiscal 2016, an increase of $2.7 million, or 17.7 percent, from $15.3 million for the first quarter of fiscal 2015. The increase in general and administrative expenses was due to $3.8 million in non-operating expenses, primarily attributable to costs related to the termination of the lease at  the Hudson Yards location. Excluding this cost, general and administrative expenses were $14.3 million for the first quarter of fiscal 2016, a decrease of $1.0 million, or 6.5 percent, from $15.3 million for the first quarter of fiscal 2015. The increase in general and administrative expenses was partially offset by lower severance, professional services, equity compensation and pre-opening advertising expenses. The portion of depreciation and amortization included in general and administrative expense was $0.8 million for the first quarter of fiscal 2016, a decrease of $0.2 million from $1.0 million for the first quarter of fiscal 2015. The Central Services component of general and administrative expenses increased $1.3 million for the first quarter of fiscal 2016 compared to the same period in the prior year.

Store opening costs were $1.3 million for the first quarter of fiscal 2016, a decrease of $0.4 million from $1.7 million for the first quarter of fiscal 2015. Approximately $0.5 million and $0.4 million of store opening costs for the first quarter of fiscal 2016 and the first quarter of fiscal 2015, respectively, did not require the expenditure of cash in the period due to deferred rent.

Start-up costs for the new production center in the Hunts Point area of the Bronx were $1.1 million for the first quarter of fiscal 2016, a decrease of $0.3 million from $1.4 million for the first quarter of fiscal 2015. Approximately $0.4 million of these costs for the first quarter of fiscal 2015 did not require the expenditure of cash in the period due to deferred rent.

The income tax provision was $2.2 million for the first quarter of fiscal 2016 compared to an income tax provision of $0.9 million for the first quarter of fiscal 2015. The income tax provision was recorded despite incurring a pre-tax loss because the retailer does not record any income tax benefit related to operating losses but recognizes income tax expense related to indefinite-lived intangibles assets. Fairway said its current expectation of the income tax provision for the full year is in the range of approximately $3.5 million to $4.0 million, which is expected to be primarily non-cash.

Fairway’s net loss of  $13.9 million for the first quarter of fiscal 2016, compared to a net loss of $9.7 million for the first quarter of fiscal 2015. The increase in the net loss was primarily attributable to an increase in general and administrative expenses related to the Hudson Yards transaction, promotional activities and income tax expense. The adjusted net loss was $3.9 million for the first quarter of fiscal 2016 compared to an adjusted net loss of $3.1 million for the first quarter of fiscal 2015.

In assessing Fairway’s unique merchandising assortment and overall persona, Murphy stated:

“We are hybrid, so we’re not going to emphasize or deemphasize, we are going to put the right products in the right place, at the right time. If you think about it for a second, at a Fairway store we are Whole Foods, Costco, Kroger, Trader Joe’s, and of course Fairway all in one place. I would call Fairway a unique hybrid in that we appeal to a vast spectrum of customers. We’re also going to be very, very careful about the analysis, we do so. I don’t know where we are going to emphasize or deemphasize but I know that when we do this we’re going to appeal to a very broad spectrum of customers from the foodie all the way to the person who is a budget conscious shopper because of our – our new circular that’s in the stores now the ‘Hot Sheet’s’ that we’re using and forms of advertising and promotion we are going to do. So I think that on all of those fronts, we have a unique opportunity not only to position and fine-tune the brand. But to drive the top line forward, I and the management team now are focused a 100 percent on driving that top line forward, because the other pieces not that we’re going to ignore are much more solidly in place now after nine months of very tough work by the operators and the merchants. Lots more to do, but lots of optimism.”