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Winn-Dixie Stores, Inc. (NASDAQ:WINN)

F2Q09 (Qtr End 01/07/09) Earnings Call Transcript

February 12, 2009 10:00 am ET

Executives

Sheila Reinken – VP of Finance and Treasurer

Peter Lynch – Chairman, CEO and President

Bennett Nussbaum – SVP and CFO

Analysts

Karen Short – FBR Capital Markets

Alex Bisson – FTN Midwest Equity

Karen Howland – Barclays Capital

Jonathan Chin [ph] – Private Management Group [ph]

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2009 Winn-Dixie Stores Earnings Conference Call. My name is Fab and I will be your coordinator for today. (Operator instructions) I would now like to turn the presentation over to your host for today’s call Sheila Reinken, Vice President of Finance. Please proceed.

Sheila Reinken

Good morning everyone and thank you for joining us to discuss Winn-Dixie's financial results for the second quarter of fiscal 2009. I’m Sheila Reinken, Vice President of Finance and Treasurer. Joining me this morning are Peter Lynch, Chairman, CEO, and President; Bennett Nussbaum, Senior Vice President and Chief Financial Officer; and Eric Harris, Director of Investor Relations.

Before we begin, let me remind you that the information presented and discussed today includes forward looking statements 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 SEC filings.

Today’s call also will include a discussion of adjusted EBITDA which is a non-GAAP financial measure. A reconciliation of adjusted EBITDA to GAAP financial measures can be found on the back of the press release we issued yesterday, which is available on the investor relations section of our website www.WinnDixie.com. Today’s call is being recorded and a transcript will be archived. A replay of the call will also be available on the investor relations section of our website later today.

Peter and Bennett will begin with some prepared remarks and afterward we will open up the call for your questions. Now it is my pleasure to turn the call over to Peter Lynch.

Peter Lynch

Thank you, Sheila, and good morning everyone. As you saw from our press release, we succeeded in generating higher levels of profitability in the second quarter. Adjusted EBITDA was $35.5 million for fiscal 2009 second quarter, which is an increase of 65% compared to last year. For the first half of fiscal 2009, adjusted EBITDA was $62.5 million, which is an increase of 52% compared to the first half of last year. The improvement in adjusted EBITDA was driven primarily by higher gross margin.

As a percentage of net sales, gross margin was 28.1% during the quarter, an increase of 140 basis points from the same period last year. For the first half of the year, gross margin was 28%, an increase of 100 basis points compared to the first half of fiscal 2008. The key factor in our gross margin improvement was the merchandising and marketing strategy we are reducing to drive more profitable sales through the holidays.

As you know, the holiday season falls during our second fiscal quarter. In the past, we experienced lower gross margin in the second quarter caused in part by heavy holiday promotions. We have worked hard to refine our holiday promotional activity and deliver margins more consistent with the rest of the fiscal year.

In last year's second quarter, we made progress towards that goal by increasing gross margin by approximately 100 basis points over the prior year period. This year we built upon last year's improvement and successfully eliminated the sequential decline in our gross margin through a combination of product sales mix, less overall investment in promotional activity, and additional focus on our corporate brands. We are very pleased to have normalized our second-quarter margins and I want to recognize the team for a very good job during the second quarter.

Moving on to sales, during the second quarter, identical store sales increased 20 basis points compared to the prior year period. Identical stores sales were driven by an increase in basket size of 2.8%, offset by a decrease in transaction count of 2.5%. Consumers continue to economize in their purchasing behavior during the quarter, which affected basket size growth and ID sales. Identical store sales during the quarter continued to be affected by the mix shift in pharmacy sales from branded to generic drugs. This had a negative impact of approximately 80 basis points in the second quarter.

In addition, I should also note that increased private-label sales negatively impacted identical store sales by approximately 30 basis points, however, as I mentioned earlier increased penetration of our corporate brands program is accretive to gross margin.

Now, let me update you on our store remodeling program. This multi-year initiative, which commenced in the second half of fiscal 2007 continued to move forward during the quarter. The remodeling program is a vital part of our long-term plan. Customers at our remodel locations now have a vastly different shopping experience, which is built around two key components of our long-term strategy, fresh and local.

Each store showcases colorful arrays of fresh produce and other perishables, as well as expanded and more varied selections of products in a cleaner, modern, and more attractive setting. The remodels are also neighborhood specific and cater to the needs of customers in five specific formats, Hispanic, urban, affluent, resort, and kosher.

We have now successfully completed phase 1 of the remodel program. In this phase, we strategically remodeled stores located in the majority of our markets across our five state footprint and in all of our five formats.

During this time, we also tested the design of the program and refined it as appropriate, to ensure that we were meeting the unique shopping needs of all of our customers.

In total, we remodeled 112 stores or approximately 20% of our store base. Our plan is to have a total of 170 stores remodeled by the end of fiscal 2009, which represents about one-third of our footprint. We will complete roughly half of the chain by the end of fiscal 2010 and substantially all of our stores by fiscal 2013.

Of our 112 remodels, 74 are still within their first year of operation, 54 of these 74 first-year story models are considered offensive. For the first half of fiscal 2009, our 54 first-year offensive remodel stores had a 9.7% weighted average sales increase compared to the same period in the prior fiscal year excluding the grand reopening phase.

This sales increase resulted from increases in transaction account, and basket size of 3.3% and 6.1% respectively compared to the prior year period. On a sequential basis, however, the rate of growth in basket size both in the remodels and across the chain experienced a decline as consumers continued to modify their typical shopping patterns by trading down to private-label brands and purchasing fewer items.

As a result, the sales lift at year-one stores is slightly below our 10% annual target for offensive year-one remodels. That said, the stores are still generating very positive results and resonating very well with our customers. We continue to believe that a 10% annual sales lift is the appropriate target for the year-one offensive remodels. We are currently conducting store-by-store reviews and implementing operational and merchandise initiatives to improve sales of these stores. And I remain very confident that we can achieve our annual sales lift objectives for the year.

As of the close of the quarter, we are still in the very early stages of collecting data on the performance of our year 2 remodels. Those stores have remained offensive remodels for both the first and second years are generating slightly positive ID sales in year two. This sales lift is in addition to the approximate 11% sales lift that these stores generated in the first year. Given the state of the economy as well as our decision to be less promotional in the second quarter, we are generally pleased with this performance. I would caution, however, that this is a very small sampling of data collected from a short period of time and does not necessarily indicate of what these stores can deliver over the longer term.

In the second half of fiscal 2009, we are embarking on phase 2 of the remodel program. With 112 stores already completed and tested, we now have a strong base from which to build out the program. In phase 2, we will primarily employ a market-by-market strategy where we will remodel all of the stores in a Winn-Dixie market before moving on.

This approach will also help us target our advertising efforts and leverage our brand more effectively as we draw new customers to the store, we will be confident these customers will be visiting stores that reflect the improved fresh and local shopping experience that we want them to associate with the Winn-Dixie brand.

Moving on to our corporate brands program, as you know, our program is designed to offer customers a wide variety of products to give them flexibility to stretch their food dollars, without sacrificing quality. In the current economy, this program is especially important, and as I mentioned earlier it is an important contributor to our margin improvement this quarter.

Our customers are continuing to migrate to Winn-Dixie brand products from national brands. For the second quarter of fiscal 2009, we improved our penetration rate to 22.2%, which is an increase of 130 basis points compared to the second quarter of last year on the categories that we measure.

The program continues to evolve as we conduct customer research and gear our brands to promotional activities to match customer needs. Although clearly the economy is having an impact, we also believe the popularity of our brands reflects the improvements we have made in quality, appearance, and selection including our decision to add more products in the fresh departments.

To date the company has completed 2000 packaging and label redesigns. We remain on track with our plan to have substantially all of the company's private-label products, which consists of approximately 3000 items on the shelf with redesigned packaging by the end of calendar 2009.

Finally before turning the call over to Bennett, I will comment on our financial guidance for the remainder of the year. As you know, we announced our financial guidance for fiscal 2009 last July; the economic environment was dramatically different. While food retailing may be less vulnerable to a recession than some other industries, we are certainly not immune to the economic hardships facing many of our customers.

As you would expect, consumers are tightening their belts and trading down to private-label brands and generic pharmaceutical products. Given this environment, our year-to-date performance is a testament to the solid execution by the team here and by our associates across the chain. We are working hard to ensure that we offer our customers better quality, service, and value for the shopping dollars.

As we look out over the balance of fiscal 2009, I expect the economy will continue to present us with extraordinary challenges and this makes forecasting especially difficult. However, our year-to-date results put us on track for the year and gives us added confidence that we will meet our financial objectives for fiscal 2009. Therefore, we are maintaining our previously issued guidance range of $1.10 to $1.25 in adjusted EBITDA for the year.

Now, I know many of you have questions about the pricing environment and what I can tell you is that as I sit here today pricing has remained rational in all of the markets that Winn-Dixie operates in. As far as Winn-Dixie is concerned, we will continue to be strategic and price competitive. We will also employ a targeted approach with respect to our promotional activity. We will not over invest in promotions simply to chase sales.

I have said many times, our top opportunity is to drive sustainable and profitable sales growth across the chain over the long term. And we will remain intently focused on our initiatives that will position us to achieve this goal. We will continue to be flexible in our approach in the second half of the year as we balance sales and margins.

And now I would like to turn it over to Bennett to review the financial results in more detail. Bennett.

Bennett Nussbaum

Thank you, Peter, and good morning everyone. Before we open up the call for Q&A, I’ll briefly run through a few key items for the quarter. The first item I'd like to discuss is liquidity. As of the end of the second quarter, Winn-Dixie had approximately $632 million of liquidity consisting of approximately $487 million of borrowing availability under our credit agreement and approximately $145 million of cash and cash equivalents.

All of our cash investments are invested in money funds consisting solely of US Government obligations. We have no borrowings under our credit facility and the only usage under the facility is for letters of credit related primarily to our workers compensation self insurance programs.

For fiscal 2009, we expect capital expenditures to total approximately $250 million of which approximately $150 million is budgeted for our store remodeling program and approximately $100 million is budgeted for maintenance and other store related projects, information technology projects, new stores, back up generators, and logistics projects. We believe our fiscal 2009 capital spending program is prudent for the company, particularly our continued investment in store remodeling program, and we don't intend to make any significant changes to our CapEx in the fiscal 2009 year, which ends June 24, 2009.

As we look forward to fiscal 2010, we remain committed to conducting an additional 75 remodels. That said, we remain very cash conscious and we will continue to monitor the economic conditions as we consider our other capital spending needs for fiscal 2010. We will provide details on our fiscal 2010 CapEx program when we announce our fourth quarter and year-end results in August.

Moving on to other operating and administrative expenses, the company’s other operating and administrative expenses for the second quarter were approximately $28.7 million higher compared to the same period last year. As a percentage of net sales, other operating and administrative expenses were 27.5% in the second quarter compared to 26.4% in the year ago period. In the second quarter of fiscal 2009, O&A included the benefit of $8.6 million due to an adjustment in our self-insurance reserve due to favorable claims development in prior year's claims reserves. This adjustment to the company's self-insurance reserves was primarily related to workers compensation claims based on independent actuarial studies conducted during the quarter.

When making year-over-year comparisons, you should note that O&A in the same period last year also had a similar adjustment to our self-insurance reserves. This resulted in a benefit of $15.5 million for O&A in the second quarter of fiscal 2008. Excluding these adjustments in both fiscal years, other operating and administrative expenses for the second quarter were $21.7 million higher than the prior year period. Several items contributed to this increase including the following; higher compensation and related expenses of $13.5 million due primarily to retail payroll, higher depreciation and amortization of $4.6 million related primarily to our store remodeling program and increased utility costs of $3.9 million due entirely to higher rates.

As a percentage of net sales, other operating and administrative expenses were 27.7% for the first of the fiscal year, an increase of 80 basis points compared to the same period in the prior fiscal year. As you know, our second quarter is a 16-week period, whereas our other quarters are 12-week periods. When you adjust for the extra weeks in the second quarter, O&A is up about $6 million on a sequential basis or about 1.2%.

Before discussing net income, I will briefly comment on our interest expense and income taxes. Our net interest expense is primarily amortization of financing fees and interest on capital leases offset by interest income. The increase in interest expense for the quarter and year-to-date was primarily related to lower investment income as compared to the same periods in the prior fiscal year as interest rates have declined significantly.

Our financial statement effective tax rate of 52.4% and 56.1% for fiscal 2009 and fiscal 2008 respectively differs from our statuary rates, primarily due to permanent items and the impact of our prior year tax return to a provision adjustment recorded in the second quarter of fiscal 2009. Of course, we are not a cash tax payer due to a large NOL, which I will discuss in a moment.

Moving on to net income, for the second quarter of fiscal 2009, the company reported net income of $16.1 million or $0.30 per diluted share compared to net income of $4.1 million or $0.08 cents per diluted share in the second quarter of fiscal 2008. Net income for the fiscal 2009 second quarter included a gain of $22.4 million, which is $13.8 million net of tax or $0.25 per diluted share from resolution of the company's insurance claims related to hurricanes that occurred in fiscal 2006.

Net income for fiscal 2009 second quarter also included a benefit of $9.2 million, which is $5.6 million net of tax or $0.10 per diluted share and is due to an adjustment to the company's self-insurance reserves that I also mentioned earlier. Net income for the same period last year was also impacted by a similar adjustment to our self-insurance reserves. As a result, the second quarter of fiscal 2008 included a benefit of $18.3 million, which is $11.3 million net of tax or $0.21 per diluted share.

For the first half of fiscal year, net income was $13.8 million or $0.25 per diluted share compared to net income of $3.3 million or $0.6 per diluted share in the same period last year. Net income for the first half of fiscal 2009 included the benefits we just discussed. The $22.4 million gain related to the settlement of claims surrounding the fiscal 2006 hurricanes and the $9.2 million benefit from the adjustment in the company’s self-insurance reserves.

Net income for the first-half of fiscal 2008 also included the benefit of $18.3 million related to the adjustments of the company’s self-insurance reserves I mentioned a few minutes ago.

Now let me comment on our operating loss carry forward for federal income tax purposes or NOLs. As of January 7, 2009, the two-year period during which IRC section 382 (l) (5) would be applicable through a subsequent ownership change expired. Our NOL carry forward’s for federal income tax purposes of approximately $550 million have no current limitations. We continue to expect that our NOLs will increase as we settle the remaining outstanding bankruptcy claims and distribute approximately $7.4 million shares held in reserve by the dispersing agent to satisfy remaining disputed unsecured claims. The amount of the increase will determine based on the then current market value of our stock at the time these additional shares are distributed. As we have noted previously, these 7.4 million shares are included in the 54 million shares we had outstanding as of January 7, 2009. We filed our 2007 federal tax return in March 2008 and made an election that will allow us to utilize fully our NOLs to offset our taxable income for the next several years as we generate it. Finally, before I turn it back to Peter one quick note about our expected third-quarter results. The timing of the Easter holiday will be different this year as Easter falls later in the calendar. Accordingly, the benefit of the Easter holiday on our financial results will be felt in this year's fourth quarter unlike last year where it fell in our third-quarter. Now let me hand it back to Peter. Peter.

Peter Lynch

Thanks, Bennett. I again want to commend the team on a very good quarter and first-half of the fiscal year. We do have strong results on the bottom line and we are continuing to make progress with our strategic initiatives. Obviously, we have significant challenges ahead with the slumping economy and much work left to do in our multi-year turnaround program, but I'm very pleased with how the company has performed in fiscal 2009, and I remain very confident in the team and what we can achieve this year and over the longer term. I want to thank you all again for joining us this morning and for your interest and your support. Thank you. Operator, we are now ready for the Q&A session.

Question-and-Answer Session

Operator

(Operator instructions) And your first question will come from the line of Karen Short from FBR Capital Markets. Please proceed.

Karen Short – FBR Capital Markets

Hi everyone, congratulations.

Peter Lynch

Thanks Karen.

Karen Short – FBR Capital Markets

I have a couple of questions on, I guess housekeeping a little bit. First of all, I was wondering if you could just give us some color on the timing of the remodels in the second or the third and fourth quarter and then I don’t know if you could maybe give a little bit of an update on what you think that remodels may contribute to EBITDA in the back half because I know, you have kind of given a number previously and obviously things have changed a little bit.

Peter Lynch

Okay Karen, regarding the remodels we will have about – 17 will be completed in the third quarter and 41 will be completed in the fourth quarter, giving us a total of 75 to the year in 170 for the total company, which is very good number for us.

Karen Short – FBR Capital Markets

Okay, and what about – what are you thinking in terms of the EBITDA lift?

Peter Lynch

Well, obviously there is more coming towards the second half of the year because we have not done a whole lot in the first-half of the year. I don't have that number in the top of my head. I'll have Eric get back to you with exactly what that list is going to be.

Karen Short – FBR Capital Markets

Okay. And then looking just at markets in general, I guess are you – you must be fairly close to having completed all the remodels in the Jacksonville market. Is that right?

Peter Lynch

No. There are still quite a few to be done in the Jacksonville market, but what we have said in the call was one, we want to get out there and test all, most of the markets that we are in that we put remodels towards all of those markets, all those DMAs and then we want to make sure we had representatives of the different types of stores we wanted to do it be kosher or Hispanic et cetera, et cetera. We have done that. We have tested them. We tested the consumers, and that was the point we fine tune them. They were going to go back in on a market-by-market predominantly, okay. Complete a market. Really go after the brand in that market and then move on to the next, and I'm not announcing today what the next market is. I don't want to give my competitors a little bit of advantage but as we get one down we will obviously bring you guys up to speed and take you through the numbers, but at this point in time a lot of our focus here at Winn-Dixie is really now focusing on building the brand and putting all of our energies behind telling the great story that is going on here at Winn-Dixie. You know, we have 170 stores at the end of the year. I think that now gives us a base as we go market-by-market. I think we've got a great opportunity to talk about the new Winn-Dixie and where we're taking the company, and I think this is going to give us a real nice push as we move into next year.

Karen Short – FBR Capital Markets

So at this point is it still a little too early to comment on what the sales was just like in the market where you have almost finished the entire store base and –

Peter Lynch

Yes. We would still be too soon because we really haven't finished one in total, although my expectation is, you know, it ought to be better because we are going to put more power behind this thing.

Karen Short – FBR Capital Markets

Okay. And then just on LIFO, kind of wondering what you're thinking on the total LIFO charge for the full year and what that implies in terms of inflation and then follow-up, I am just wondering why you guys don't add the LIFO back to EBITDA.

Peter Lynch

Okay. Ben, why don’t you take that one?

Bennett Nussbaum

Karen first of all with regard to LIFO, we saw a tremendous increase in prices in the first quarter and as we expected we saw an increase in our second quarter but at a somewhat reduced rate. We have continued that somewhat reduced rate in our forecasting for the full year, which will put us out at about a 5.4% LIFO charge for the full year. We really haven't seen big price decreases or increases so far in the third quarter but we are only a short way into it. With regard to the other reason, there are very few supermarkets that really report adjusted EBITDA. I think A&P is probably the only company that does report – does take LIFO out of adjusted EBITDA, you know, we try to be more conservative and adjust just as few things as we can and as we set this up initially we came out of bankruptcy. We thought that was a more prudent and conservative way to do it.

Karen Short – FBR Capital Markets

Okay. And then just lastly, can you maybe give us some color on the cadence of sales in the second quarter. Obviously, I mean, it seems to be obviously tolerated but, maybe some comments on sales trends in the third quarter so far.

Peter Lynch

Okay. I think it is way too early to jump into this third quarter right now. However, I will tell you that the second quarter, the very beginning was influenced by some of that rollover from the hurricanes. We still had some of the government's funds out there and people had a few extra dollars and really helped us in the early quarters. But as we got into the mainstream holiday period time that is when, you now, we really put together our strategy of not over promoting for the holiday and quite frankly I think that hurt us a little bit on sales. However, our focus was to go after the profitable sales. So beginning of the quarter, we had some better sales lift; toward the holiday period there was less sales lift in there. So –

Karen Short – FBR Capital Markets

Okay, great. Thanks very much.

Peter Lynch

Thank you.

Operator

Your next question will come from the line of Alex Bisson from FTN Midwest Equity. Please proceed.

Alex Bisson – FTN Midwest Equity

Good morning everybody.

Peter Lynch

Good morning.

Bennett Nussbaum

Good morning.

Alex Bisson – FTN Midwest Equity

Just a couple of questions for you, Peter over the last couple of weeks it looks like you had some pretty – pretty positive news from a competitive front, number of stores closing and a competitor going bankrupt. You know, how well prepared are you guys to take advantage of that and can you retool your remodel program to take advantage of it faster. I mean, will you look at those markets as a focus of your remodel program to maybe accelerate those markets.

Peter Lynch

Well Alex, I think you're right on point. With my numbers, I calculate somewhere it is north of 20 store closings that have been announced between, you know, potential Bruno's, Sweetbay, and some of the Albertsons out there. So there are opportunities there. You should know that we move very, very quickly. An example would be when Publix and Albertsons announced, Publix buying a number of their stores. We moved immediately and we remodeled a number of stores that we were going to be competing against the new Publix. So, we have got the ability to move very, very quickly and complete remodels before, in some cases the new acquirer has a chance to even get the stores open. So, you know, we are also very much aware of what is happening in each one of those markets. So, we will take a very hard look with these opportunities, we will move quickly and smartly. But at the end of the day what this really is, this is the continued rationalization of the markets that we operate in. When I first got here I talked about these markets would continue to rationalize. They are. This is good news for Winn-Dixie, and where the opportunities exist will take up, we will have a better day. Okay.

Alex Bisson – FTN Midwest Equity

All right. So, it sounds like, it makes sense to be very aggressive where you can be offensive, if you will, and maybe delay just a little bit in areas where you need to be more defensive given that the current environment.

Peter Lynch

But what I'm saying is we are very much aware of what is going on with our competitors. Where there is an opportunity that makes sense, okay. We will do the appropriate things to move customers into our stores and better develop our brands in those areas. So we are watching it. I can tell you, I'm out in the markets two days a week. We are kicking the tires. We know what is going on, and we will move appropriately.

Alex Bisson – FTN Midwest Equity

All right. Peter, as you look at the second half of the year, what are your thoughts on gross margin relative to where it was last year, you know, thinking about things like, you know, promotion, store reopenings and certainly I think in the fourth quarter you will see probably a little bit of a gross margin benefit. So, can you stay flat, is it going to be down or up or is that tough to say.

Peter Lynch

It is obviously, you know, little tough for the environment out there but my expectation to meet the numbers that we got last year.

Alex Bisson – FTN Midwest Equity

From gross margin perspective?

Peter Lynch

That is correct.

Alex Bisson – FTN Midwest Equity

Okay. And you look at the private-label sales obviously that has been doing very, very well for you guys and industry-wide. Can you talk just a little bit about how the – your three tiers were doing on a relative basis. Are you seeing strength, pronounced strength maybe in the quality sphere or in the value sphere or how is the growth look there on a relative basis?

Peter Lynch

Alex, you know, Winn & Lovett is our premium brand, and we got the Thrifty Maid at the lower end. We are seeing growth in all of these, now quite frankly Winn & Lovett is new. So you are naturally going to see growth there but we are very pleased with the sales. Our everyday Winn-Dixie brand, we feel unbelievably good about and in this economy you see some people treading down into the very lower brand. So, all three are doing very well and we feel very good about where we are moving and we're going to continue look at these lines. As I talked about before we've got packaging being completed on all of them, and now we are looking very hard at bringing in some new items, so we can even expand the offerings to consumers as we move forward. But clearly the customers have recognized that the quality of these products is very good, they love the packaging that we are doing, and they continue to trade into our private-label brand, as you know that is very accretive to our gross margin for the company.

Alex Bisson – FTN Midwest Equity

And maybe just one final one. This I think is for Bennett. You talked about the IRS section 382, meaning will make your NOLs have unlimited access. Will that also hold true if there was a change in control? If there was a change in control, could the acquirer still use those NOLs?

Bennett Nussbaum

Before the two-year period expired, an acquirer could have lost all the NOLs. Now with this election an acquirer would still be able to use the NOLs as you would in any acquisition across-the-board. So, what it does is it puts it back on a level playing field and there is an IRS formula for the percentage of the NOLs that can be taken in any one year by an acquirer and would follow that. But there is no more danger that we believe that it will be lost.

Alex Bisson – FTN Midwest Equity

All right. Thank you very much.

Bennett Nussbaum

Thank you.

Operator

Your next question will come from a line of Karen Howland from Barclays Capital.

Karen Howland – Barclays Capital

Good morning.

Peter Lynch

Hi, Karen.

Karen Howland – Barclays Capital

Hi. You know, the first question is for you. I understand of course the desire to get some profitable sales, but isn't it going to make the story work that you are going to have to drive sales per square foot improvement to get long-term EBITDA margin improvement?

Peter Lynch

Yes Karen. You got to have a combination of both. I think in the script I used the word balance several times. We clearly here are watching the balance I think between the profitable sales and sales per square foot, but the last quarter was clearly trying to level the playing field during this holiday period where in prior years, I mean I think I told you this one. When I first came here the company gave away free turkeys during the holidays. We needed to get out of that. We needed to get into a more balanced approach. We've done that now. Okay. So there is probably, you know, more direction toward profitable sales in that quarter and you probably see a more balanced approach going forward here on out towards achieving that balance between growing sales per square foot and growing profitable sales.

Karen Howland – Barclays Capital

So, it makes your understanding like this quarter perfectly little bit more conservative on our promotionals and make sure you were in line. Going forward, could expect a little bit perhaps, a little bit more promotion to try to drive incremental sales and this seems given that in the significant remodel program that you're doing, not be getting any sort of increase in – or the basket size decelerate is a concern.

Peter Lynch

Karen, we are very, very focused on that again. It is a balanced approach that we’re taking you know, thinking about the environment in, the things that we are going to be doing the drive sales, we got a great CapEx program that we're going to continue to push and now with the next move face to face is go market by market, and I think that is going to give us more upward mobility. We're going to continue to expand that private label offering, which consumers love during this time period. We're going to expand the use of our loyalty card. We've got it, our competitors don't, and talking to the consumers during these difficult times I think is a big deal and we are going to use more that. We're going to continue to focus on value. You know, a lot of people keep on talking about price, price, price but consumers are looking for value during these difficult times. They are looking for a supermarket they can trust. They've lost their trust in the banks and Wall Street and the politicians. The supermarket is a place where they can find trust again and we are going to be focusing on that value and we're going to continue to improve our customer service. So that is where we are moving. It is all about improving our brand and I think we're very well positioned in the second half of the year to do that.

Karen Howland – Barclays Capital

Okay. And then just to clarify, I think you had mentioned that you expect the gross profit to be at a similar level in the second half of the year to what it was last year, does that include – I know in the fourth quarter the gross margin was under considerable pressure last year. So, I just wanted to make sure I understood that correctly.

Peter Lynch

The individual asked me would it be equal to the gross margin in second half of last year, and I said my expectations will be equal to that of the second half of the year.

Karen Howland – Barclays Capital

So, not recovering from that gross profit, that gross margin decline?

Peter Lynch

There could be some upside from that decline in the fourth quarter. Okay. I guess the individual asked me, if it would be equal to, it will be equal to. Okay. But we're not going to have the same decline in the fourth quarter if that is your question.

Karen Howland – Barclays Capital

Okay. I guess there was nothing much that will it decline more, will it actually recover at all from this level?

Peter Lynch

I know, I think you can do the math, okay. We are not going to have the same decline in the fourth quarter.

Karen Howland – Barclays Capital

Okay. And then this question is more for Bennett. I'm just wondering, I know you got a target of 3 or 4 year cash-on-cash return for these remodels. What sort of top line growth do you need in the first year to get that?

Bennett Nussbaum

Depending on the investment in the store, because they do vary a little bit. We need a 10% to 12% per share growth to get our targeted return.

Karen Howland – Barclays Capital

All right. And if I could just –

Peter Lynch

Again Karen, that is dependent upon the investment in the store.

Karen Howland – Barclays Capital

Sure.

Peter Lynch

The typical one is about $2 million but you know, some of these we now decided that the appropriate investment might be $1 million too. And that could change that proposition.

Karen Howland – Barclays Capital

Right. And just I was kind of looking at more of the average but I think of course there is a lot of variability in that. And then I was wondering if you could talk a little bit about any change in the support you’re getting from your vendors, not necessarily you at Winn-Dixie, but I know, you see it in the industry overall, our vendors being providing additional allowances to try to be more promotional to try to pass through price savings to the customers or any changes there.

Peter Lynch

I know there has been a lot of things read lately about the vendors. We've got very good relationship with our vendors, as I said to you in the past, we have top to top meetings here every single week with the major vendors. We recently had I think about 16 meetings at FMI with our top to top vendors and our relationships are good. What we are currently seeing is, we are starting to see some of the costs go down but not a lot, but some okay. And that is a kind of change in what we are seeing from the first – from last year I guess, the end of last year and we're starting to see some more promotional opportunity in some of our vendors, however not a lot. So, we're starting to see some positive changes there. We've got great relationships and we are going to continue to work together, so we can drive more opportunities for the consumers and more opportunities for Winn-Dixie.

Karen Howland – Barclays Capital

Thanks very much.

Peter Lynch

Thank you.

Operator

(Operator instructions) And your next question will come from the line of Jonathan Chin [ph] with Private Management Group [ph]. Please proceed.

Jonathan Chin – Private Management Group

Hi, Peter, nice – congratulations on a great quarter.

Peter Lynch

Hi, Jonathan.

Jonathan Chin – Private Management Group

I wanted to ask you a question regarding your vendors and your suppliers. What types of conversations are you guys having regarding, you said that quarter one and quarter two, you guys had a large amount of cost inflation and as of moderating, are you guys able to reprice a contract. I was just curious how that conversation was kind of going.

Peter Lynch

Okay. You are correct that, you know, quarter one there was still lot of cost inflation, quarter two slowed down a little bit and the normal course of operations we meet as businesspeople with our vendors when contracts are up, we renegotiate those as a normalized process. Well, I don't want to give you the impression there is a lot of fighting going on around here because there is not. We're good businesspeople. They are good businesspeople, we understand there are opportunities and we sit down and we negotiate better contracts that are going to benefit the vendor and benefit us and in the end benefit the consumer. So, again very good relationships. We meet all the time. We’re businesspeople here with a lot of transparency into our business and we are finding ways to get some better costs and move forward.

Jonathan Chin – Private Management Group

Very good. Thanks a lot.

Peter Lynch

Okay.

Operator

There are no further questions at this time. I would now like to turn the call back over to Peter Lynch for closing comments.

Peter Lynch

Well thank you. And again thanks to everyone for joining the call today. We look forward to speaking with you again as we report our third-quarter results in May. Again, thanks for joining us and we appreciate your support. Bye.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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