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SuperValu, Inc. (NYSE:SVU)

F3Q09 Earnings Call

January 7, 2009 10:00 am ET

Executives

David Oliver - Investor Relations

Jeffrey Noddle - Chairman of the Board, Chief Executive Officer

Pamela K. Knous - Chief Financial Officer, Executive Vice President

Bob Johnson – Vice President, Investor Relations

Analysts

Deborah Weinswig - Citigroup

John Heinbockel – Goldman Sachs

Mark Wiltamuth – Morgan Stanley

Edward Kelly - Credit Suisse

Meredith Adler - Barclays

Scott Mushkin - Jefferies & Co.

Karen Short – Friedman, Billings, Ramsey

Operator

Welcome to the Q3 fiscal 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. David Oliver. Sir, you may begin your conference.

David Oliver

Welcome everyone. SuperValu’s call today is web cast and will be available for replay on our website. Today on the call are Jeff Noddle, SuperValu’s Chairman and CEO and Pam Knous, Corporate Executive Vice President and CFO. Also joining us on the call today is Bob Johnson, who is now on board as SuperValu’s Vice President of Investor Relations, a role I have held on an interim basis. Prior to joining SuperValu Bob held various financial roles at JCPenney including most recently Vice President of Investor Relations. Please join me in welcoming Bob to SuperValu.

I will be working with Bob through the year-end release tentatively scheduled for April 23.

As you know, the information presented and discussed today includes forward-looking statements which are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our fiscal 2008 10K. After today’s prepared remarks, we will have a question and answer session. Bob and I will be available after the call for additional questions.

I will now turn the call over to Jeff.

Jeffrey Noddle

Thank you David and thank you for your service during this interim and we welcome Bob to the SuperValu team. We are very pleased to have you here. Good morning to everyone joining us today. I will start by providing some brief comments on the quarter and then provide some preliminary comments on our fiscal 2010 outlook. Pam will provide additional detail on the quarter after which I will make some closing remarks.

This morning we reported a loss of $13.95 per diluted share which included the impact of non-cash impairment charges in the amount of $14.57 per diluted share. Excluding the impairment charge, I am pleased to report for the third quarter despite cautious consumer spending, that we were able to deliver adjusted diluted earnings per share of $0.62 in line with our expectations, $0.02 above First Call consensus and also cycling a record quarter in the prior year.

First I’d like to comment on the $3.3 billion pre-tax non-cash impairment charges that were recorded in the third quarter. These charges were driven by FAS 142 which requires a reconciliation of a company’s current stock price when assessing the recoverable value of goodwill and other intangible assets. In these unprecedented economic and financial times and environment we do not believe that our stock price which was approximately $12 at quarter end is an appropriate measure of the long-term value of our company.

However, simply stated FAS 142 requires the charges and absent the requirement of FAS 142 to reconcile to a current stock price the company would not be recording any impairment charges. Again I want to stress these are non-cash impairment charges and are in no way an indicator of our business outlook and strategy to build long-term shareholder value or does it have any effect on our all important cash flows now or in the future.

Now I will briefly discuss some specifics on the quarter. The economy has been officially declared in recession and it is certainly one of the worst we have seen. With that as a backdrop we continue to take the action to improve the performance of this company both short-term and long-term.

First, we are making smarter, more effective price investments and promotional offers which have resulted in improved gross margins. Second, we are seeing more efficient labor utilization and enhanced productivity as this has become an area of company wide focus.

We finished the third quarter at negative 50 basis points ID sales. This year the week following Thanksgiving, typically a very soft sales week, fell into the fourth quarter compared to last year when it fell in the third quarter. We estimate this calendar shift benefited third quarter ID sales approximately 80 basis points, meaning we were at essentially the same basic flat run rate compared to the second quarter.

While we are always going to be disappointed with current, negative ID sales performance, certainly in this environment we think going forward it will be prudent to be accelerating our actions to stimulate sales and gain traction with consumers. We, like all retailers are seeing ID sales impacted by consumers continuing to trade down.

Our internal measurement of the trading down impact continues to approximate at least 100 basis points, consistent with the level of goods in the first and second quarters. We also saw declines in discretionary spending in the third quarter. Some examples of this would be in the floral area and coffee bar sales. These small categories alone had a negative 10 basis point impact on total ID sales. In addition we experienced approximately 20 basis point ID sales reduction from increased owned brand sales as well as a 10 basis point decline from growth in generic drugs in the pharmacy area.

We did continue to see approximately 1/3 of our stores with ID sales of at least 2% or better. Many of these stores are offensive remodels delivering an average of 6% ID sales lift. Although the positive ID sales trends of remodels and merchandising and marketing initiatives have been muted somewhat by consumers trading down and other competitor activity, we know it is the right strategy for our long-term growth.

Let me now turn to fiscal 2010. Today I will share with you certain priorities and specific actions we are executing to deliver results in fiscal 2010. We are not today providing fiscal 2010 earnings guidance. That will occur early next fiscal year once we have finalized our plan with the board. However, I will say as we look at the First Call estimates for fiscal 2010 we believe the current analyst consensus of $2.69 per diluted share would probably be at the bottom end of our fiscal 2010 earnings guidance range.

Pam will also comment further on the analyst consensus cash flow estimate.

While we are still in the early phases of our budgeting process I will share with you the five specific action areas that are the drivers to improve this performance in fiscal 2010 and beyond.

One, creating value for our customers through accelerated, strategic price investments. Two, using research and analytics to focus customer centric marketing. Three, improving ID sales through merchandising innovation and our remodel program. Four, reducing our cost structure. Five, lowering capital spending and paying down additional debt.

So how do we make this happen? Let me add a little bit of color. First, we will increase our price investment efforts. We know that price has become a key criteria for consumers when choosing where to shop. In today’s challenging environment it is even more frequently becoming the number one criteria.

We know improving our price perception ultimately leads to increased trips and basket size. I am pleased to report that in the third quarter in 10 of 11 major markets in which we operate our price position either improved or remained the same relative to our traditional competitors.

An example of one of our recent merchandising successes is the conversion of certain of our high velocity categories, once commonly perceived as value items to a more everyday low price offering rather than the historic high/low with a continued heavy focus on promotion. Soup and coffee would be two examples we have taken in our key markets. These actions are resonating with our customers as our pricing perception scores have improved based upon our recent survey work. So both our extensive price comparison analysis and the customer surveys confirm the improvement in our pricing position during the quarter.

I would add that we will continue working with our vendors to ensure appropriate pricing especially in light of the current fall in commodity prices and fuel costs. We will also continue to refine our go-to-market pricing strategy for the remainder of this year and into fiscal 2010. For competitive reasons I am not going to provide specifics on our price investment plan. However, I do want to share with you some recent successes that are delivering real value to our customers.

In fiscal 2010 not only will merchandising and marketing teams be at a full force run rate but we will have the benefit of activities we have tested beginning in fiscal 2009 such as targeted loyalty mailings, company wide branding message and a full line of owned brand quality offerings including home meal replacements. All of these have been well tested this year and will be fully deployed as key components of our value proposition as we look to 2010.

Second, I would like to provide some specifics in our customer centric marketing program launched in the third quarter and the implications for fiscal 2010. To date we have sent three targeted mailings to customers with the most recent going out as of yesterday. These target mailings went to more than 2 million households and these are in our Acme, Jewel-Osco and our Albertson’s banners. With each mailing we have increased the relevancy of the targeted offers based on redemption rates of the previous mailing. These mailings are designed to increase traffic and basket size.

Without giving specific results I will tell you redemption rates from the initial mailing exceeded our expectations by more than 20% on average and the redemption rates for the second mailing exceeded the first. I look forward to updating you more on this program in the months ahead but we are very excited to have this capability as it will become a mainstream weapon in our arsenal in fiscal 2010.

We believe the effectiveness of these type mailings is in large part due to our new customer centric marketing organization which now accumulates customer data to drive analytic decision making capabilities across the organization. This data is used to understand customer behaviors and types and transactions that can be used to increase the effectiveness of all the promotions, assortments and pricing we offer.

Believe me, this has not been a small undertaking. Over the past year we have hired a Chief Marketing Officer, built a centralized data analytic group, invested in merchandising and marketing systems and most recently partnered with a third party data analytics provider. This partnership will accelerate our ability to convert the learning’s from the data we gather into meaningful, executable marketing initiatives that truly leverage our local expertise, our market share position and our owned brands.

Third, we have committed to merchandising innovation and driving sales through our remodel program. Examples of our merchandising innovation include the Wild Harvest organic line of products and Culinary Circle, our solution for restaurant-quality meals at home. These are recent additions to our owned brands offerings with sales that continue to exceed our expectations. Today I am pleased to report that owned brands finished the third quarter at approximately 17.3% of retail sales, surpassing our previous goal of 17% by the end of fiscal 2009. We don’t see this momentum slowing any time soon as our owned brand offerings are exception value building customer loyalty and making us a preferred shopping destination.

We now expect owned brands to reach 18.5% of sales by the end of fiscal 2010. The success of owned brands is just one example of the success of our central merchandising efforts which will have even a greater reach and impact in fiscal 2010 as we complete the final transition to center-led merchandising.

Certainly equally important in fiscal 2010 is the ID sales benefit that we will receive from the nearly 300 remodels completed in the past two years. In addition our fiscal 2010 remodel program will add 85-95 major remodels and 40-45 minor remodels with heavy emphasis in our Chicago and West Coast stores.

Fourth, we are continuing to take active steps to reduce costs in all areas of the company. In the second quarter this year we announced cost mitigation initiatives that benefit the company in this fiscal year 2009 and beyond. Additional actions now are being taken in the fourth quarter and fiscal 2010 which will help fund the further investments in price as we have just discussed. Whether it is the closure of nonproductive stores or a reduction in shrink and administrative overhead or improved labor productivity we are taking positive, active steps in this difficult economic environment to benefit fiscal 2010 operating results and more importantly position the company for the future.

Finally, looking at fiscal 2010 we expect to invest approximately $850 million in capital spending in contrast to the approximate $1.2 billion for fiscal 2009. As you may recall, we quickly determined upon the close of the acquisition that heavier spending would be required in the initial years because of the significant, historical, underinvestment in the Albertson’s properties. Now after 2.5 years and $1.2 billion of investment in the acquired properties we have made excellent progress in updating our store fleet and are adjusting our spending to a more normalized run rate which will be approximately 2.5% of retail sales. In fact at the end of fiscal 2009 both Shaws and Jewel will be basically at our 80% target for new or newly remodeled in the past seven years.

The majority of the reduction in capital spending in contrast to fiscal 2009 reflects first fewer new stores. We will be going from about 14 in fiscal 2009 to just 4 in fiscal 2010. Fewer major remodels and mostly the higher priority remodel projects have been completed and reduced investment in technology spending as system migration activities are completed during fiscal 2010.

Also given due consideration certainly to the current financial environment and the economy we believe it is prudent to be more selective with our capital spending anyway allowing for additional debt reduction of at least $200 million and increasing our goal for debt reduction to be at least $600 million in fiscal 2010. This simply provides additional financial flexibility given these uncertain capital markets.

I will now be happy to turn the call over to Pam and then I will come back with a few closing comments.

Pam Knous

Thanks Jeff. Good morning everyone. Today I will be covering third quarter results, outlook for the fourth quarter and financial conditions. Before I comment on our third quarter results I would like to make some observations about recent trends.

First, food inflation rates are holding at approximately 6%. We do expect to see some inflation relief in fiscal 2010 as recent declines in commodities including fuel work their way into food prices. Second, as Jeff mentioned, we continue to see evidence of consumers trading down. It is no surprise that in today’s economy customers are looking for the best prices, comparing promotions and altering buying preferences getting the most from their grocery dollars. We are seeing this trading down activity impact sales mix and margins. A measurable example can be seen in the meat category.

In the quarter, grilling steaks were down 6% with the majority of sales switching from the higher price point T-bone, rib eye and New York strips to lower price value cuts like chucks and rounds. We have also seen ground beef sales increase year-over-year as a percent of total meat sales which is another indicator of consumers seeking value.

A third area would be an update on our market share position. Market share trends are another data point which allow us to determine if our actions are resonating with customers. As you know, in most of our major markets we hold a number one or number two market share position and have maintained these positions since the acquisition. We continue to monitor this data and have seen no meaningful changes in fiscal 2009.

Another trend I wanted to update you on relates to Wal Mart’s entry into the Chicago markets, a topic we have discussed on previous calls. The impact of these openings has resulted in some market share loss and has negatively impacted total company ID sales by approximately 30 basis points per quarter this year. The good news is we are just beginning to cycle some of the first openings and expect ID sales trends in a majority of the impacted stores to improve over the next year. As an aside, at the time of the Albertson’s acquisition we knew Wal Mart had plans to enter the Chicago market and this would result in some market share loss. After all, we hold the number one share position in this market by a very wide margin. Our goal since day one has been to differentiate Jewel-Osco in the Chicago market by delivering an exceptional shopping experience to our customers.

To this end our remodel program has been aggressive in Chicago improving the Jewel-Osco store base to 78% new or newly remodeled in seven years reaching our company wide goal. We are not stopping there. In fiscal 2010 we have 25 major remodels planned in the Chicago market in addition to the 26 major remodels completed this year.

My final trend observation relates to trip consolidation by consumers. The U.S. Department of Transportation recently reported that Americans drove 100 billion fewer miles in the 12 month period ended October 2008 compared to the prior year. This reduction in miles translates into fewer shopping trips at our stores and an increase in the average ticket. However, fewer trips ultimately translates into fewer discretionary purchases and lower sales. We believe given today’s economy and outlook for calendar 2009 many of these trends will continue for the foreseeable future as consumers have adjusted their behaviors and established new shopping habits.

So let’s turn to the third quarter starting with our retail food operating results. In the third quarter retail operating earnings excluding the impairment charges were $309 million or 3.9% of sales in contrast to our record prior-year of $342 million or 4.4% of sales. This 50 basis point decline in operating earnings reflects a 10 basis point improvement in retail gross profit, offset by a 60 basis point increase in selling and administrative expenses.

The 10 basis point improvement in gross margin reflects a number of items. On the positive side the benefit from merchandising initiatives including higher penetration of owned brands, the contribution from our premium fresh and healthy remodels and lower shrink, one of our cost reduction efforts, all of which improved gross margins more than offset price investment in the quarter. We also benefited from higher retail fuel margins but continued food inflation resulted in higher LIFO charges which reduced gross margins.

I am pleased to note that fuel costs in the third quarter returned to prior year levels.

Retail selling and administrative expenses in the third quarter ran 60 basis points unfavorable to the prior year third quarter yet a slight improvement over the second quarter. While we are making improvements in labor productivity we continue to incur higher employee related costs as we maintain duplicative merchandising and marketing staff during the transition to a center-led merchandising and marketing organization. These costs will go away by the end of fiscal 2010 as we complete the transition.

In addition we have also experienced reduced leverage of fixed costs in this soft sales environment. Let me assure you we are not satisfied with the cost reductions achieved to date and we are aggressively pursuing additional areas which I will discuss in a moment. As a reminder, in addition to labor productivity we are also addressing overhead costs, maintenance and utilities as part of this initiative which we outlined in our second quarter call. We expect these efforts to gain traction benefiting this year’s fourth quarter and beyond.

I am pleased to report that our supply chain services business turned in another strong performance reporting operating earnings of $69 million or 3% of sales in the quarter compared to 2.9% of sales last year. This improvement in operating earnings reflects the benefits of many initiatives taken throughout supply chains to increase efficiency and reduce costs. Our supply chain businesses also benefited from the pass through food inflation, new business growth and lower customer attrition which offset the operating earnings impact of target transitions to self-distribution this year in two geographic regions of the country.

Turning to the fourth quarter, at this point we anticipate the ID sales run rate in the fourth quarter will be comparable with that seen in the second and third quarters. As noted in our release we have modified our full-year 2009 earnings guidance in light of the persistent weakness in the consumer environment and our continued investments in price. Our new range is $2.80 to $2.90 per share before charges compared to our previous range of $2.90 to $3.00 per share.

Accordingly, our fourth quarter guidance is $0.78 to $0.88 per diluted share including an estimated $0.06 benefit of the 53 week and of course before any charges. This compares to $0.69 last year which was a record quarter. This is a wider range than we would normally provide this late in the fiscal year but given the uncertain economic environment we believe it is prudent. I will add that our range does fall within the current analyst range of $0.65 to $0.89 per diluted share and is in line with the consensus of $0.80 per diluted share.

Also in our release this morning we gave guidance on anticipated charges in the fourth quarter for closing certain, non-strategic store locations and other cost mitigation efforts. Although we are not providing specific details today we estimate fourth quarter charges in the range of $150-200 million pre-tax that are predominately non-cash. These charges principally relate to the closure of approximately 50 stores across the entire store network as well as administrative reductions company wide that affect a very small portion of the total workforce.

Our guidance is a range as we are still filing estimates of the cost of real estate [inaudible] which will be completed during the fourth quarter. These actions will positively impact fiscal 2010, operating earnings, cash flow and ID sales and are necessary steps to build a stronger SuperValu and better position us for success in fiscal 2010 and beyond.

Let me now turn to the balance sheet.

First and foremost I want to assure you the impairment charges we took in the third quarter did not impact any of our financial covenants, access to our credit facility or our ability to finance our operations. Our cash flows remain strong. Through 40 weeks of fiscal 2009 our net cash flows provided by operating activities were approximately $1.1 billion compared to $1 billion last year.

In terms of our debt profile let me assure you that debt reduction is a priority and we are committed to reducing our borrowing levels by at least $400 million this fiscal year. At the end of the third quarter total debt including capital leases was $8.9 billion reflecting seasonal peak borrowing. Debt reduction from prior year-end through January 6 was $222 million placing us on track for reaching our target of at least $400 million reduction by this fiscal year end.

At the end of fiscal 2009 we expect to have approximately $1.5 billion available under our revolving credit facility. Further, with the planned reduction in capital spending as just stated we have increased our debt reduction target to at least $600 million annually which equates to $1.2 billion over the next two years. This $2.7 billion of liquidity clearly exceeds the cash flow needed to service the $2 billion of debt maturing through February 2011 with nearly 40% of the $2 billion maturing in February 2011 over two years from today.

While our revolving credit facility is an available option for refinancing debt maturities, we are ready, willing and able to access the credit markets when acceptable terms and pricing are available. I believe what I have laid out for you today clearly demonstrates our strong cash flows and our ability to fund any debt requirements we have over the next two years while continuing to invest approximately $1.7 billion in our business.

We remain well within the metrics prescribed by our debt covenants including the two financial covenants in our credit facility. Again, these are not impacted by the impairment charges taken in the third quarter. As a reminder, our covenants require a leverage ratio of no more than 4.25 times and an interest coverage ratio of no less than 2.2 times. For those of you tracking these covenants, during the trailing 12 months we have $1.6 billion of EBIT excluding impairment charges and one-time acquisition related costs, $1.1 billion in depreciation and amortization expense and $0.4 billion in net rev expense.

In summary, we are focused on the key priorities that will position us for success in fiscal 2010. We are reducing costs, investing in price, delivering value to our customers and being prudent with our capital spending in this environment to ensure debt reduction targets are met and financial flexibility is maintained.

Thank you and I’ll now turn the call back over to Jeff.

Jeffrey Noddle

Thanks Pam. In recent months obviously the turmoil in the financial markets and the difficult economy has resulted in investor uncertainty and it has led to a decline in stock prices for many companies. While we are operating in a very challenging economic environment the SuperValu team is taking the right steps to succeed and the grocery business, as we tell our associates, is still a great place to be in this economy.

Today our business and 2009 projected cash flows are strong, funding $1.2 billion in capital spending, $400 million in debt reduction and $105 million in dividends. Perhaps of equal or greater importance, as I have outlined today, we expect to be better positioned in fiscal 2010 to meet the current market challenges. Our priorities for cash flow continues to be investing our stores, reducing debt and paying dividends and we believe that as the economy improves and consumer confidence starts to return SuperValu will be a stronger retailer positioned for growth.

In closing I am proud of what we have been able to accomplish in the 2.5 years since the acquisition, the commitment and engagement from all levels of associates has been nothing short of excellent.

Thanks for your time. We are now happy to open it up for questions.

Question-and-answer Session

Operator

(Operator Instructions) The first question comes from the line of Deborah Weinswig – Citigroup.

Deborah Weinswig - Citigroup

In terms of, I appreciate all the details, but in terms of the decrease in the cost structure and the price business what do you think will be the biggest buckets if you will?

Jeffrey Noddle

There is a number of buckets. We’ll be giving more clarity to this as we give our guidance for fiscal 2010 but administrative cost is certainly one of the large buckets. Cost of goods is certainly going to be another cost bucket that is leveraging our scale as we finish our merchandising transition.

Deborah Weinswig - Citigroup

Will these buckets run continued improvements in labor productivity?

Jeffrey Noddle

The shrink in labor productivity are ones that we have well started this year. I was thinking more of those that are going to be next year. We are certainly going to enhance those but we are going to be much more aggressive on the administrative side and we mentioned the store closing this morning. These are non-strategic stores. Those of course will improve our ID sales going forward but clearly they have an impact on the bottom line going forward next year and we intend to reinvest some of that or all of that into price initiatives.

Deborah Weinswig - Citigroup

In terms of the change in the capEx outlook for 2010, it sounds like the technology spending is coming down anyways. Can you maybe provide some additional color on the remodels and new store activity as well?

Pam Knous

Sure. I think as Jeff said we were spending at a very high rate post Albertsons transaction. Once we got our hands around the level of understanding on some of the key properties for Albertsons and have now, as we stated, feel we can get to a more normal run rate. I would say to you just the reduction in new stores alone counts for about ½ of that year-over-year decrease. Then we also did call out the change in IT because if you recall one of our big initiatives was as we brought these two companies together we were migrating many systems into common systems and the majority of that activity will be completed in fiscal 2010 and therefore that will reduce the capital spending in that area.

Jeffrey Noddle

I will add one thing. We also in the major remodels worked very hard over the last six months to deliver all the primary benefits of the major remodels at a lower cost. Certainly we have more negotiating possibilities in terms of materials, supplies and labor but in addition to that we have been able to get smarter as we have moved along in these remodels and we can accomplish most of those now at a lower cost rate than we did initially. That is reflected as well. Of course we also have ended up closing more stores than we thought which obviously don’t require remodeling. So, all those things have kind of added into that bucket.

Deborah Weinswig - Citigroup

I was fortunate to recently visit Urban [Fresh] and I was very impressed with the format. At what point in the game might we hear more from you in terms of additional stores of that format?

Jeffrey Noddle

It is a little early to comment on what our further plans might be. I would expect next year in 2010 that we would comment going forward. I appreciate your business. I’m going to hold that. If we were to expand we certainly would look initially in Chicago most likely and not move out of that geography. Other than that I’m going to hold comments until we get into next year.

Operator

The next question comes from John Heinbockel – Goldman Sachs.

John Heinbockel – Goldman Sachs

In terms of food inflation moderating, what is your sense in terms of timing? Because if it does look like manufacturers are being slow to pass that through timing, the form that it takes, would be more trade spend or list price reductions and then how big of a benefit do you think that would be for you?

Jeffrey Noddle

I think the second half of the year next year will have noticeably lower inflation rate. I think the first half of the year is going to be a battle ground to get that accomplished. I do think you will see efforts made by vendors to cut back on promotion and trade spending but as I look at the macro environment I don’t think they are going to be able to hold that very long. I think they are going to be forced initially into more trade spending and then ultimately bringing prices down. So I look at the first six months as being a battle ground and it will be more noticeable in the second half.

I have said for a long time, and you and I have talked about this many times, I think the sweet spot of inflation in our industry is somewhere around 2%. I am hopeful that late next year we can get to that kind of number. I think that is a manageable number both on a cost and margin side and I think anything substantially below that or substantially above that is a more difficult operating environment.

John Heinbockel – Goldman Sachs

Do you think trade spends is at a low end historically or is about where it has been historically?

Jeffrey Noddle

I think it depends on what they call it. They call it Ted or Fred and they used to call it something else. I think it is less than it used to be. I think they also have systems that make them smarter on where they put their money and how they invest it. They want to invest it more on what goes through completely to the consumer and I think the industry does on balance a much better job of getting those trade spends into the hands of the consumer and driving sales with it. My guess is on balance it is less than it used to be but I’m not sure it is noticeable to the consumers that it is less.

John Heinbockel – Goldman Sachs

If you look at the 50 stores you are closing I assume as a group they are unprofitable. Is that fair?

Jeffrey Noddle

For the most part that is true. Also we look at it very strategically too. I am not telling you every store that is closing isn’t producing some slight benefit for recovering some fixed cost structure but the majority are not profitable. But they are strategic decisions as well. We don’t just lop off the bottom performers because some might be in a growing area, a new market or a new store and we are pretty selective in that regard.

John Heinbockel – Goldman Sachs

Do you think if you look at the 50 that would be any material amount in aggregate or not really? It is just kind of more of a rounding?

Jeffrey Noddle

I would say it is significant because normally I think a normal course for a chain of our size looking at just our traditional super markets with numbers around the thousand or so. That is leaving Sav-A-Lot out. I would say on a normal run rate we are going to close 20-25 stores a year. So I think this is somewhat of an exceptional look in the sense we looked at the total economic environment, we looked by market, we said lets be a little more aggressive in thinking about where we can deliver value to customers and some of those stores have both nearby stores as well. So I think this is not just our typical annual cadence. I think this is something beyond that.

John Heinbockel – Goldman Sachs

It sounds like you are pretty comfortable the 850 will cover what you need to do next year. You don’t really have that pent up demand for capital like you might have had. Is that fair? Then has there been any more thought of are there non-strategic assets that you could sell to raise proceeds to accelerate or keep spending in the core business at a higher level?

Jeffrey Noddle

The 850 is the level, as you stated, we are comfortable with. We think again we are a lot smarter now about the amount of money. We can get more remodel per dollar now than we did at the beginning. Also because we are looking market by market and because of the economic situation in certain markets that look certainly difficult next year that changes our thinking about whether to remodel stores. The market, for example, in the west that were so heavily dependent on housing look differently today because the population growth isn’t there. So whereas you would have staked your claim in a new store, for example, or a remodel store in some of those out markets you can defer that and that is the right decision in this environment. So that level of capital is really influenced very strategically in that regard.

As far as non-core assets we always have those options available to us. Our board is certainly well aware of that with diligent review of those periodically and whatever point in time in the future we have something to say about that we will. But we review those as part of our financial structure and our strategic plan going forward on a continuous basis.

John Heinbockel – Goldman Sachs

I guess this is not a good environment to sell assets anyway.

Jeffrey Noddle

I would just make a general comment not relative to SuperValu. I think anything of that type we are going to have a different credit market than available to us than is currently but I don’t think anybody can predict the credit market 30 days from now let alone six months from now.

Operator

The next question comes from Mark Wiltamuth – Morgan Stanley.

Mark Wiltamuth – Morgan Stanley

I wanted to dig in a little bit on the target transition. Are there any further step downs on the target areas we should be watching for?

Jeffrey Noddle

There will be a minor step down early in the fiscal year and a major one late in the fiscal year when they bring online a northern Iowa distribution center.

Mark Wiltamuth – Morgan Stanley

That is late in fiscal 2010?

Jeffrey Noddle

That is right.

Mark Wiltamuth – Morgan Stanley

Do you anticipate an earnings to claim from that segment for the year for fiscal 2010?

Jeffrey Noddle

I’m not ready to give that kind of guidance for 2010 and I’m certainly not ready to hold our supply chain people not accountable for improved earnings. So, at this point my answer would be we have not updated that but we will have comments on that as the year unfolds. We plan on giving guidance early next fiscal year.

Mark Wiltamuth – Morgan Stanley

The other grocers are all talking about making price investments as well. Are you feeling that and are you feeling it in any regional areas heavier than others?

Jeffrey Noddle

Yes we do see some areas where we see evidence of that. We see other areas where there have been a lot of noise about price investments but as of yet they don’t seem to show up that clearly to us on our comparisons. But yes there are some markets where we see those clearly. I don’t want to comment specifically by market. One market I will comment because we have done it continuously is in New England. We certainly have seen price investments by competitors there. That is a market where we have also taken steps in that regard. As you know from my comment earlier we intend to accelerate our price investments and those will certainly be incorporated into our financial plan for next year when we give specific guidance in that regard. We are going to pretty much pick our spots. People tend to forget that we also operate a chain called Sav-A-Lot. Sav-A-Lot is as well positioned in this economy as any competitor on the landscape in my view and again we are having very, very good solid results in Sav-A-Lot and we hope that will also entice some of our licensees to grow faster and we are working certainly hard in that regard in addition to looking for corporate opportunities.

So when we talk about price investments we have a piece of our business that is in Sav-A-Lot. We have a piece of our business that we have banners and chains that are very much every day low price leaders in their market such as Cub in the Twin Cities and Shop-N-Save in St. Louis and Shoppers Food and Drug in Washington/Baltimore just to name a few. So we look at our situation somewhat bifurcated but it is in the more traditional super markets where the price investments we have always said are going to be needed. To our plan we are just going to have to accelerate them in this environment sooner and that is the proper thing to do because that is where our consumers go.

Mark Wiltamuth – Morgan Stanley

A follow-up on the inflation debate, we had inflation levels of 6% for a couple of quarters now but the comp is certainly not running near 6% because of the various trading down factors you have talked about. If we do see inflation cool to 3% how much do you think the same store sales could slow down?

Jeffrey Noddle

Our expectation would not be to see any sales decline if there was a decline in inflation. I think anything that helps the consumer today will help us get people into the store and to sell more to them when they are in the store. We certainly have worked over the last 2.5 years and put enough initiatives together that we feel fiscal 2010 is going to bear fruit. We have not yet given our guidance on sales for next year yet but I would not expect on the lowering of inflation I think would be positive on our sales, not negative.

Operator

The next question comes from Edward Kelly - Credit Suisse.

Edward Kelly - Credit Suisse

You are going to be under spending your depreciation next year by about 20% and your spending as a percentage of your retail sales will be below even Safeway even though you have only been doing the remodel program for 2.5 years. Why is that not somewhat of a concern in thinking about it in the longer term and is that really the longer term level of capital spending you are projecting for this?

Jeffrey Noddle

The 2.5% we think falls in average over a long period of time and to us that number is not that far off. Some of the spending that is coming off is in IT and other places as well and in supply chain. So you can take the whole number and look at it. But in retail the 2.5% the thing I would say about this is we have completed those we think were certainly the most important. We will do more remodels now with less dollars, as I said, per unit we can do it somewhat more efficiently and more cheaply. But I think the thing that is prudent for us to do is recognizing this year we are in a difficult macro environment. Frankly returns are just harder to get for capital investment and I think that is true in our industry. I think that is true probably broadly across American business beyond the food business. Capital returns are just harder to get in this environment so we think it is prudent in this environment to take a little bit of a step back and be more selective. We are closing more stores. We are being more selective now by market.

We said from the beginning it was very important for us to go and touch a number of different banners and areas because we certainly wanted at least our people to understand we are willing to invest in their markets. So we didn’t do it market by market. We purposely went across the enterprise and picked the best opportunities to invest in. Now I think we are at a point where we can be a little more selective and we can carefully select our markets. We talked about Chicago. We talked about West Coast specifically today. We can now concentrate. We have done some major remodels and we have got flagship remodels in these major markets and now we can kind of go back and finish, if you will, key markets and I think you are going to see us more do that over the next few years than broadly across the enterprise.

So that does bring down our capital spend some. I think it is prudent in this environment and it is prudent for us from financial planning to have that financial flexibility. If we begin to see macro trends change and we continue to be satisfied with our cash flow we could make a decision to accelerate those at any time. It only takes a few months to accelerate remodels and enhance that program and we will continue to monitor that. I think this is a prudent rate for us this year.

Edward Kelly - Credit Suisse

As you look out and you mentioned you are going to be doing less major remodels, inflation is clearly going to slow and there is probably a very good case to be made it might be zero by the end of next year, and everyone is talking about investing in price. How hard is it going to be to drive positive ID’s next year?

Jeffrey Noddle

Well I think it is certainly a harder environment than any of us would have predicted two years ago on driving ID. But I have every reason to believe and we are continuing in this company to try to plan towards all the various initiatives, and I won’t go through them again as we have broken them down very specifically, and we actually have it by line item what sales contribution is going to come from every single marketing and merchandising effort we have in this company identified and exactly how many basis points of sales that is and what the dollars are. We are going to hold our people accountable and no matter what the environment is we think we are in a position as we improve our pricing, our marketing and leveraging our scale that we have upside, maybe more than other people do. I think if inflation starts to cool and if the economy begins to improve in the second half of fiscal 2010 I think people will maybe migrate somewhat back from the super center trips they are making today more frequently.

So, nothing stays static and we are positioning ourselves to where we think the consumer is and is going. We think things like the meal replacements are going to continue to be important and more important. I think it is a tough environment and when we give guidance we will give some very deep thought to what we think the right number for us to target is next year. I certainly am not holding anybody in the company not accountable for the fact we expect positive comps for fiscal 2010.

Edward Kelly - Credit Suisse

You are clearly focused on cutting costs. As I look at SG&A next year is it possible that SG&A is flat in terms of growth, potentially even down, or is that too aggressive?

Jeffrey Noddle

I just don’t know yet. Again you have to adjust for some of the store closings and some of the volume loss there and some of those kinds of things. I don’t want to give you a number if I’m not yet comfortable with it but I would certainly say that is something we would target toward and see if we can accomplish.

Pam Knous

We will provide color on that when we give guidance.

Jeffrey Noddle

We will probably give guidance in early March.

Operator

The next question comes from Meredith Adler – Barclays.

Meredith Adler - Barclays

Can we just go back to the 50 stores you are talking about closing? Are there any markets you are actually going to be exiting or is this really spread everywhere?

Jeffrey Noddle

There are no major markets we will exit. There are a few markets that will be a little heavier weighted but no there are no exits of a market and they are spread throughout the enterprise.

Meredith Adler - Barclays

You made a comment when the discussion was about food inflation that the first half of calendar 2009 would be the battle ground. I was wondering if you could sort of elaborate on that. I think there is pressure on manufacturers but maybe you could talk more about that?

Jeffrey Noddle

I think as we stated the way the question was asked to me there is reluctance from manufacturers and that is what led me to a battle ground comment. I do think it will be a battle ground. We are going to put tremendous pressure, as I think other retailers are, on suppliers for relief in terms of those things driven by commodities and fuel and there is going to be reluctance. That is the battle ground that I foresee.

But then as I see the macro environment being so weak I think the manufacturers are going to see benefit in delivering more value either through more promotion or through a change in pricing. So yes, I see a little bit of battle in the early part of the year but I see us well aligned as the year goes on.

Meredith Adler - Barclays

So it will be fair to say that if private label penetration goes up really significantly across the board they are going to get religion on the value?

Jeffrey Noddle

One would think. There are certainly suppliers in good categories that maybe aren’t as affected as much and there are others who are affected more. If you just look at our own results in private label I think the beginning of the acquisition we are up over 200 basis points in private label penetration. Across the size of our enterprise that is a pretty big deal. Now, that has been driven by the consumer. It has also been driven by the fact we got our act together much more efficiently and now it is really a core strength for us. I am very excited about what we have done with our own brands. I don’t know how much belongs in which pocket but the end result is we are up 20-30% in distribution of our own brands. That is pretty significant.

Meredith Adler - Barclays

I have a question about marketing monies coming from vendors. Do you feel that you are getting your fair share both from big vendors and small vendors or is there more opportunity for you guys to get more?

Jeffrey Noddle

I see no reason to assume we are getting more than anybody else and I see only as a good strategy that we are not and hence we will work very hard to accomplish that. We recognize we have been a little more of a fragment. Both companies previously were more fragmented in those efforts. One of the reasons we have centralized our merchandising which now comes to fruition in reality every period this year we have more of that in place and not to say we haven’t leveraged that scale but now it is leverage to scale with simply the amount of commodity we buy but now we are able to leverage the scale for the marketing efforts and to us that is much more important. I think we have upside. I assume we have not yet achieved all of our fair share and we think as this year unfolds we will.

Meredith Adler - Barclays

Regarding labor, do you have any contracts coming up this coming year and what do you think the discussion with your employees will focus on? Will it be wages or benefits?

Jeffrey Noddle

I think the focus will be around benefits more than wages. I think it is going to be hard for the unions to press hard on the wage side. We do have contracts. We have 300 contracts in the company so we have about 100 that come up every year. Frankly this year we are going to drag some from calendar 2008 to calendar 2009 such as Philadelphia, for example, which is a very important one for us that comes up in February but is unresolved and frankly I think as the macro environment gets more difficult I think it is harder for the unions to some degree to complete their objectives completely with the more difficult environment.

But I think the battle will center more around the benefits of healthcare and pension.

Operator

The next question comes from Scott Mushkin - Jefferies & Co.

Scott Mushkin - Jefferies & Co.

Did gross margins in the retail segment excluding fuel go up or down in the quarter? I wasn’t clear when Pam ran through that.

Pam Knous

We gave the combination of items that were up and down. We didn’t segregate what any individual item was. Net/net gross margins for the quarter were up 10 basis points.

Jeffrey Noddle

Slightly. They were up slightly. There is always enough moving parts of that so 10 basis points frankly isn’t very significant.

Scott Mushkin - Jefferies & Co.

Your price investments in the quarter are we going to see a big ramp up as we get into fiscal year 2010? Or are you happy where you were in the third quarter?

Jeffrey Noddle

I think I made the comment we will accelerate some price investment which means we will move to maybe markets that we are currently not in and ramp some up. A lot of this will be incorporated into the guidance in early March that we will provide. We did make a comment we were comfortable with the current consensus for 2010 as a low side of it and that would take into account some acceleration in price investment.

We are going to respond to the environment. This is driven by the consumer and if called for what we see today we need to enhance our price investment because of where the consumer has taken themselves this past year and we will monitor that very closely.

Scott Mushkin - Jefferies & Co.

On the store closures I know there are 50 in the fourth quarter. How many have you done so far this year and then how many of the Albertsons stores have you closed since you made the acquisition?

Jeffrey Noddle

Prior to this announcement of these store closings we have closed about 120 of the Albertsons acquired stores out of the 1,150 we acquired. Not all of these 50 are Albertsons properties. The vast majority are. There are a few Sav-A-Lot stores. There are a few other stores. There are some non-Albertsons based stores as well. How many stores we closed this year, I am guessing 25 for the year. That did not include the 50.

Scott Mushkin - Jefferies & Co.

I don’t think anyone asked about traffic. With all the price investments you are making and the marketing initiatives I guess I am surprised you continue to see the comp decelerating further in the fourth quarter. Why are you not…

Jeffrey Noddle

I don’t know how you got we said it was decelerating further in the fourth quarter. We did talk about the one-week shift affecting it.

Scott Mushkin - Jefferies & Co.

So maybe you can give us some thoughts on the fourth quarter? My model shows a 1% comp, negative 1% which your guidance suggests a ratchet down to about a negative 1.5 rate in the fourth quarter.

Pam Knous

You have got to remember that includes the shift of the 80 basis points from the third quarter so our comments were that the run rate is going to be fairly consistent in Q4 with that we experienced in Q2 and Q3.

Scott Mushkin - Jefferies & Co.

But I thought on the last comments you guys said the run rate had improved about 80 basis points.

Jeffrey Noddle

It did. We reported 0.5 for the third quarter. Our actual number is 0.5 negative but in fairness for transparency we are showing that one week after Thanksgiving shift probably caused an 80 basis point shift. So that took us actually if you adjusted for that to the same number as the second quarter so if you are doing your planning I would just use those same numbers we are saying are kind of consistent.

With the environment people are trading down further and consumers are doing everything we expect them to do in this very difficult environment even regarding the fact that fuel has come off so much. We haven’t seen people change their habits because of fuel and there is no question it is a tougher environment. Look at the broad sales that are reportedly going to be reported for Christmas, talking non-food for the moment, those numbers are just astonishingly bad.

Scott Mushkin - Jefferies & Co.

I guess what I’m trying to understand why, and I think you are actually looking good, why aren’t they having any impact?

Jeffrey Noddle

That is a very long discussion, breaking things down. We are seeing impact. We saw 1/3 of our stores have 2% comps or better. We have got some markets where we are in a more competitive battle. But the biggest factor that affects our comp store sales at any time is how much new square footage is opened against us. Pam made reference to Chicago for example which is one of our highest share markets and certainly a big driver of our aggregate results. In Chicago Wal Mart is finishing their phase of opening and we are now starting to cycle that second year which usually is very positive for us. It is really the nuances of competitive openings that more often than not determine those. Some of those major ones, a lot of major retailers have announced fewer new stores including Wal Mart going forward. So we are getting the traction off these initiatives but the competitive situation really has driven the results in the near term.

Scott Mushkin - Jefferies & Co.

Is it safe to assume that Sav-A-Lot is contributing significantly to the comp number?

Jeffrey Noddle

Sav-A-Lot, as I said, you have to size Sav-A-Lot to our total but Sav-A-Lot as I said is a great environment for Sav-A-Lot. If you look at some of the performance of the dollar stores that public reports you can get a feel for what kind of performance Sav-A-Lot might be having this year. Keep in mind we only have about 300 corporate stores out of the 1,200. The rest of them are license. We monitor the like-store sales for the license but of course it is not reported as a part of our ID sales. So this doesn’t move the needle that much but we certainly are getting benefits from Sav-A-Lot and probably the best positioned retailer of any in this environment.

Operator

The final question comes from the line of Karen Short – Friedman, Billings, Ramsey.

Karen Short – Friedman, Billings, Ramsey

Looking at your capEx for next year, not to harp on this, but you reduced your capEx by $350 million but you only increased your debt pay down by $200 million. Can you maybe elaborate on the $150 million difference?

Pam Knous

A couple of things. I am pleased you asked a question on capEx because I was remiss in also not commenting that a big component of the decrease year-over-year is the fact that the majority of our investment in T squared in Lancaster is completed in fiscal 2009 so that is a fairly significant component of the decrease year-over-year. So if you look at that total decrease in the new stores, IT spend as well as substantially completing the T squared that accounts for over 60% of that year-over-year reduction and hopefully that will get people to get a sense that even though there is a slight reduction in the remodel count from investment at retail there is not that significant a different in F10 versus F09.

As far as an exact dollar per dollar match we are really just updating our guidance for something we see and feel comfortable with over the next couple of years. We will note we said at least $600 million and we will be monetizing assets as we close these stores through the end of the year and so we would hope to be updating that guidance further in early March.

Jeffrey Noddle

I think we have the opportunity to do better than that and some of it again depends on what the inflation rate is you would assume in our inventory so there is a lot of moving parts in terms of working capital as well.

Karen Short – Friedman, Billings, Ramsey

Could you just help me understand, if inflation were to come in at 2% next year what would that mean for your actual LIFO charge? Can you give us a sense of what the change would be in your LIFO charge?

Jeffrey Noddle

It would come down that is for sure.

Pam Knous

It is still an increase year-over-year. As long as you have inflation you have incremental LIFO. It would still be an increase. I would say go back to fiscal 2007 when we had about a 2% increase.

Jeffrey Noddle

Let me make one further comment on that. Be careful because not every category, it depends on where we have the inflation too because not every category is a LIFO category. For example fresh meat and fresh produce, those things are not LIFO categories. So for example if you had all the inflation in those and there was more zero in others then it would be different.

Karen Short – Friedman, Billings, Ramsey

Following up on Meredith’s question with the labor negotiations. You gave us Philadelphia but do you have any sense of what the status of the pension plan is looking like? Is there any chance you might have to increase pension contributions?

Pam Knous

As far as the union plans, as you know, the pension is negotiated along with all other items so that would clearly be a big focus for next year. Clearly the general decline in the stock market is impacting those plans fund to status but they do have the ability to amortize some of those losses over a period of time. So each plan is going to have to sit down and look at that on a case-by-case basis and make their assessment as to what they think the appropriate level of contributions to their plan should be.

Jeffrey Noddle

There also was legislative relief that came out of Congress that was signed by the President that dragged these losses out further so that will help some.

Pam Knous

Right. It will delay some of the funding.

Jeffrey Noddle

It will delay some of the funding and the non-union stuff incorporated into our plan will be some increase in our pension contribution but again when we give guidance we will give more specifics around that.

Karen Short – Friedman, Billings, Ramsey

Will there be any dark store lease liabilities associated with your 50 closures?

Jeffrey Noddle

Yes. Those are incorporated into the proposed charge we would take in the fourth quarter.

David Oliver

At the conclusion of the call today Bob and I will be available for questions so feel free to reach out to us in that regard.

Operator

This does conclude today’s conference call. You may now disconnect.

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Source: SuperValu, Inc. F3Q09 (Qtr End 11/28/08) Earnings Call Transcript
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