Safeway Q1 2009 Earnings Call Transcript

Apr.30.09 | About: Safeway Inc. (SWY)

Safeway Inc. (NYSE:SWY)

Q1 2009 Earnings Call

April 30, 2009 11:00 AM ET

Executives

Melissa C. Plaisance - Senior Vice President, Finance and Investor Relations

Steven A. Burd - Chairman, President and Chief Executive Officer

Robert L. Edwards - Executive Vice President and Chief Financial Officer

Analysts

John Heinbockel - Goldman Sachs

Neil Currie - UBS

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Mark Wiltamuth - Morgan Stanley

Edward Kelly - Credit Suisse

Meredith Adler - Barclays Capital

Deborah Weinswig - Citigroup

Bob Summers - Pali Capital

Scott Mushkin - Jefferies & Co.

Operator

Welcome to the Safeway First Quarter 2009 Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions) I will now turn the call over to Ms. Melissa Plaisance, Safeway's Senior Vice President of Finance. Please go ahead.

Melissa C. Plaisance

Good morning everyone and thank you for joining us for Safeway's first quarter 2009 earnings conference call. With me this morning is Steve Burd, Safeway's Chairman, President and CEO and Robert Edwards, Safeway's Executive Vice President and Chief Financial Officer.

Before we begin, let me remind you that this conference call may contain forward-looking statements. Such statements may relate to topics such as sales, margins, earnings, earnings growth, operating improvements, cost reductions, capital spending, debt financing, dividends, free cash flow, growth of Blackhawk, depreciation, product development, lifestyle stores, additional growth vehicles, guidance and other related subjects. These statements are based on Safeway's current plans and expectations and are subject to risks and uncertainties that could cause actual events and results to vary significantly from those implied by such statements. Please refer to Safeway's reports and filings with the SEC for a further discussion of these risks and uncertainties.

And with that, let me turn the call over to Steve Burd.

Steven A. Burd

Thank you, Melissa. Let me begin with net income. Net income for the quarter was $144.2 million. This compares with $193.4 million from the same quarter a year ago.

Expressed in earnings per share, we made $0.34 this quarter as contrasted with $0.44 one year ago. The earnings per share decline of $0.10 from last year's quarter is only a nudge below our internal expectations.

You may recall from our last earnings call when the consciences estimates stood at $0.46 a share, albeit there were only four analysts that had supported it at that point, stood at $0.46 for Q1. We guided everyone on the call to a Q1 number that logically would have brought you to kind of the mid 30s. I specifically called out three items that were worth about $0.08 a share and then I identified three other items and encouraged you to quantify those on your own.

The specific differences from last year's $0.44 a share starting with the callout from the fourth quarter earnings call are as follows. The holiday shift, which is largely an Easter event, occurring this year in quarter two when last year's heavy shopping occurred in quarter one shifts about $0.04 a share. So that... it takes it away from this year's first quarter, but, as you can appreciate, it puts it into this year's second quarter. So that's merely a shift. And as I think many of you know, we stand alone among the publicly traded supermarkets in how our quarters are designed. So we always get this shift and nobody else really does. But it's really just a shift from one quarter to the next.

Currency exchange, which also makes us unique, at least among the top three, we had a currency exchange difference which we highlighted on the fourth quarter call which in fact came to fruition of about $0.02 a share.

Now, that $0.02 is going to repeat itself in all likelihood in quarter two and three, but it will be greatly moderated in the fourth quarter because that's when the big event took place. Now what I just said kind of assumes that currency kind of remains at about the current level.

And then fuel margins, when we announced our fourth quarter earnings, we were deep enough into the first quarter that we could see that fuel margins were going to be down and affected to the tune of about $0.02 share.

Now I might just tell you on the fuel margin issue, we've been in the fuel business for five or six years now on a significant level. And what we've learned about the fuel business is when you finally get to the end of the year and you add up all the numbers, I don't think we've had more than one penny a gallon difference in margins. So I don't think you can assume that that fuel different is a continuing phenomenon. But I can't predict to you when that will get offset. But again, over the course of time, it has tended to be a pretty constant margin. So that works out to about $0.08 of that $0.10 difference.

And then not specifically called out on the call either because we just didn't call it out or because we weren't exactly sure how all elements of the quarter would play out, we had a pension increase which we in fact teed up in our investor conference in December. And that is about $0.02 a share. Now that pension number will be an ongoing number throughout the rest of the year. And of course, some of you recall from that fourth quarter... or not the fourth quarter, but the investor conference and we made some very significant changes in our own pension plan to really moderate what would have been a much larger effect.

And then I'm going to talk extensively about gross margin. But if you just look at the gross margin implications for the quarter, that would have been an $0.08 effect were it not for some offsets. And we had a tax benefit which is pretty common for us, a reduction in taxes in the quarter. It was just the opposite of what happened last year. So we had a $0.04 tax benefit, but last year we had a $0.01 tax pickup. And so that equated to about $0.05. And then we had a whole series of other offsetting factors which worked out to about $0.03. And then that reconciles you to the $0.44.

So some of these things are ongoing and some of them are not and I'll get into the details of that as I go through the balance of my remarks.

In terms of how we view the quarter, we're disappointed in our EPS results, but we understand it. The EPS disappointment was entirely from gross margin where we consciously made some aggressive promotional investments in the middle of the period in and around Super Bowl that we thought was worth the risk. We felt a little flush on the earnings side. So we spent some money and didn't get the kind of return that we expected to get.

On a more positive note, very encouraged by what we see on transaction volume. I think I said this last time that sales increases really begin with transactional increase. And our transaction volume improved dramatically in the quarter. And even beyond that, if I look at the number of unique households that are shopping Safeway, that is up even more than the transaction.

And then market share grew also in the quarter. We were on a declining trend where we still have a little bit of a decline, but we're almost flat. So that's a marked changed from the last three quarters.

Turning first to the sales component. Total sales declined 7.6% from last year's first quarter. The sales decline was the result of three major factors. First of all, lower fuel sales, due largely to lower retail. Now keep in mind that last year at this time, retailers were not the $4. I mean they... that happens in the middle of the summer. So you will continue to see a decline we think in fuel sales as we play out the balance of the year. We also had a decline in sales as a result of that dropdown in the U.S. Canadian exchange rates and then of course the shift in Easter holiday.

In terms of ID sales, the first number I will give you is ID sales for the full quarter including Easter declined 0.7%. But when you adjust for Easter, which we think is the fair way to look at the quarter and we've always done that, whether the adjustment is positive or negative, excluding Easter, our ID sales were a positive 0.2%. Well the 0.2% is slightly lower than our ID sales experienced in quarters three and four of last year. As I said briefly earlier, we're encouraged by the result.

To give you a little more specifics on the transactional data, the transactions had been negative for four consecutive quarters and then turned solidly positive in the fourth quarter, increasing over the fourth quarter almost 200 basis points. And if we look at our transactions during the first four weeks of this quarter, transactions remain quite strong. So that continues.

In terms of market share, which I said had declined, and it actually declined sequentially in the last three quarters. It improved to the point where we are in a near flat position. But of course, the next step is to be positive, which we were at one point for 12 consecutive quarters.

So we think our efforts to invest in price and we think our marketing programs are in fact working. We like everybody else are being saddled with a pretty tough economic climate.

Our ID sales were also negatively impacted by some unprecedented deflation in two very large categories. I mean you had two categories comprise close to 20% of your sales, you got the dairy category which has a lot of deflation and then you've got the produce category.

In produce, an item can easily carry a lower cost in the previous year or a higher cost depending upon the crop. But in all the years I've been here, I've never seen an across the board effect like we have seen. We start seeing it in the fourth quarter. It was more pronounced here in the first quarter. As we look forward, we think that deflation will be strong and yet, the second quarter really begin to wind down significantly in the third quarter. And then supply and demand has a tendency to come back into balance.

We think we'll be back in balance on produce before we are back in balance on dairy. And that takes a bit longer.

Were it not for this deflation, ID sales would have been 0.9. So it would have been our best quarter in four quarters were it not for that deflation, which I think is reinforcing the transactional and market share data I discussed earlier.

In addition to deflation, just to complete the picture, ID sales continue to be negatively effected by several other factors. First is the shift to branded... from branded drugs to generic, which has been with us now for over two years. And I'd just remind everybody that that is... that's positive to earnings. So no one should really worry about that. And then we continue to have very strong market share gains. For several quarters now, our corporate brands have outpaced the growth of national brands anywhere from 800 to 1000 basis points.

And frankly, we don't see any let up in that. We are seeing more trade dollars coming from national brand vendors. But still, this is... corporate brand items carry great price points and in this kind of economy, consumers are turning increasingly to those brands.

We also... it has an effect on sales, obviously, making investments at price (ph). And you'll recall that our dominant strategy is to give our consumers a better everyday value. So when they talk about investments and price, but for what I commented earlier, our price investments are largely about everyday investments. And the challenge with that is to bring those to be attention of the consumer. And it's probably a little easier to do that in better times than it is soft times. But it takes a little time and we're confident that what we're doing is working.

Turning to gross margin. Our total gross margin rate declined 7 basis points from last year. That's the all-in number that includes fuel. When you exclude fuel sales, our gross margin declined 86 basis points, which, on the surface, sounds a little bit scary. The 86 basis points decline is an off-trend number and is not the level of gross margin decline that we expect as we move forward. There are several reasons for that.

One is a one-time spend that we attempted in the quarter and the other... if you go back and look at our gross margin investments, you get a feel for it; you don't get a crystal clear feel. But we really started stepping up our investments in the third and fourth quarter of last year and of course will be rounding those kinds of numbers.

If I try to break down the 86 basis points for you, 38 basis points of the decline reflects this one-time promotional spend which was intended to spark sales growth during the four-week period that began with Super Bowl. We thought if there was a time to really bring new customers in and spark sales, that would be a good effort. And we had some success with it, but not the success that we planned. Nine basis points of the decline is the result of a change in the U.S. Canadian exchange rate. And as I said, that's expected to continue until we get to the fourth quarter. But it's not... you can't put that in the same vein as normal price investments.

And then we had 7 basis points of decline that reflects either a reclassification of an expense item or some operational changes that we made that caused gross margin to really come down. But there is an equal offset on O&A expenses. And so another way of looking at it is gross margin is impacted, but income is not. And so you can't just translate every gross margin decline into a necessary income because we find opportunities, for example, to bring products into our bakery or deli at a different state of readiness which shrinks our gross margin, but lowers the labor content in the store. And you will us continue to do that kind of thing.

The remaining 32 basis points of decline reflects an ongoing effort to lower everyday prices and includes some offsets, as we always have, that enhance gross margins either in the area of advertising, distributions; the Blackhawk income gets booked here; LIFO charges, as you noticed, have come down. And then more often than not, we have an improvement in shrink which also saw some of that effect (ph).

In terms of O&A expenses, O&A expenses increased 90 basis points from last year's first quarter. And again, that increase is largely due to the decline in the average retail fuel sales. When you exclude fuel sales, which is the way I think most of us look at these numbers, the O&A expense ratio, it did increase on the quarter. For those of you that are keeping track, we had eight consecutive quarters of an O&A expense decline. But in this quarter, when you exclude fuel, we had 16 basis points of increase versus last year. And again, 9 basis points of that increase is the result of the change in currency. And so if you look at the balance of that in terms of the 7 basis points, the Easter holiday contributed more than 7 basis points. So had Easter been in the same quarter, absent currency exchange, this would have been a positive number. And then also, we were not able to overcome the negative effect of pension expense, which was also affecting the quarter.

So, all in all, we're actually very pleased with our O&A expense for the quarter. As you know, we've put some very aggressive targets out there to achieve O&A reductions. Our number on the year is 50% higher than it was last year, which was a strong year for us on O&A cost reduction. And we are slightly ahead of where we plan to be in the first quarter on that O&A reduction.

And as large as that cost reduction effort is, given everything that's going on in the economy, we'll be adding to that effort as we move through the balance of the year.

Turning to interest expense. Interest expense declined $6.3 million, which is essentially about a penny a share, largely as a result of lower debt outstanding. But we also had a small drop in the interest rate from 6.2% to just under 6.1%. Part of what helps there is our strong balance sheet which gives us access to low-cost money in the commercial paper market.

In terms of capital expenditures, we completed one Lifestyle new store and then did 10 Lifestyle remodels. And our total cash capital spend, which of course includes more of the store investments, was just under $244 million. By contrast, last year, we completed one new store, remodeled 22 stores and the all-in cash capital spend was $373 million.

Maybe commenting on some other notable events in the quarter. We purchased 3.5 million shares of stock at an average price of $18.40 for a total spend of just under $65 million. We also secured favorable tax benefits that reduced taxes by $16 million, contributing $0.04 per share to earnings. Now, again, I think I commented on this earlier. This contrasted with the $0.01 increase in... that resulted from a tax increase last year.

While not a first quarter event, the tax benefits that we've been calling out in our 10-K has now been finalized, and we now know it to be a second quarter event. So I can quantify that for you.

First of all, it will positively affect earnings per share by $0.11 in the second quarter. And when combined with the tax benefits from the first quarter, the 2009 taxes in total will be reduced by some $66 million. And in addition to that, the cash implication of this effort is $160 million.

So, again, this is something that we work very hard to do, we have been very successful at. We engage both internal and external tax, accounting and legal staff to minimize our taxes. And if you look at our track record, I was going to say it's second to none. I just haven't looked across the universe, but it's very, very good.

Ending with the second quarter of 2009, we will have lowered our taxes, if I want to use 38% as a standard, 18 of 22 quarters. So not only have been good at this, we've been quite consistent. And we have routinely said that taxes to us are like labor and benefit and every other expense we have in the business.

Our average tax rate over the last five years, for those of you that are curious, is 33%. And if we look at this entire tax reduction effort that we've been focused on now for 10 years, we've generated more than $1 billion of cash over that 10-year period. And of course, we've used some of that to buy back stock, we've used some of that to reduce debt. So I know some people don't like to look kindly on tax reductions, but we frankly look very kindly on tax reductions.

In our December investor conference and in our fourth quarter earnings call, in those two separate events, we suggested that we might use some or all of our expected tax benefits to accelerate our price investments. Most of you that follow the company believe it's a good thing for us to invest in price. We think that's a good thing and we have been sort of teeing up that this might be a good use of any windfall income or tax benefits. We now believe, particularly in the current economic environment, that it would be a great use of these benefits.

As you might expect, the price investments that we have been making, we have been very thoughtful. We've tried to pick items that were really sensitive to consumers where we could get an immediate demand response. And if I take you back to the investor conference, we showed you some categories. We may not have told you what the categories were, but you saw that we were getting a very quick response.

As we complete what we think is the necessary set of price investments, we get into those categories that are not purchased as frequently and for which it's not as easy to convey to consumers that we've made this price reduction. And therefore, you don't get the demand response that you get with the first group. So if you look at the balance of price work (ph) remaining, as we see it, it's going to take more time for the consumer to respond. Stated differently, the percent price reduction initially exceeds the sales increase. And sometimes those are negative to earnings events.

The tax benefits permit us to do the necessary price investments, accepting a slower consumer demand response and essentially achieve, what I'm going to describe in a minute, is today's earnings guidance. So we think that's a very good thing and we think it's a great use of these benefits.

But once the everyday price changes are well understood, and sometimes it takes four weeks, sometimes it takes eight weeks, sometime it takes 12, we believe the sales and earnings response will be both positive; in fact, sustaining. So I think one of the concerns people have about tax benefits is you've got to against those the following year. But given that this is pump priming exercise and given our experience with price reductions, we're confident that we will get sustainable earnings growth.

Switching gears, and this is in the press release, our Board of Directors approved a 21% increase in our quarterly dividend, which will be effective July 16th, bringing our quarterly dividend to $0.10 per share.

Moving on to Blackhawk, everybody likes to get a quick update on Blackhawk. You'll recall that last year we saw the demand for gift cards begin to fade a little bit as we moved into October. And that continued to occur as we moved into the biggest effort of the year, which is in the last eight weeks. So actually, our sales in the last eight weeks for Blackhawk, and I am looking at the face value of gift cards, what we partner cards, whether it's the open loop or the closed loop, it was actually lower the last eight weeks of year than it was for the entire quarter.

Well good news for everybody is that when I look at Blackhawk card sales and because Easter has an effect, I will adjust out Easter. Those sales increased a full 30%, which not only exceeds the fourth quarter run rate, but significantly exceeds the run rate of the last eight weeks of the quarter. So I think if you are sitting there concerned about retail in general and how that plays out with Blackhawk, Blackhawk continues to have a very different experience. Again, I think this is a preferred way to buy this kind of product. And so the Blackhawk growth story remains very strong despite a very soft economy.

Now let me turn to guidance. And our original guidance, which, as you know, was provided in mid-December 2008, people challenged this on the fourth quarter because we didn't change that guidance; we wanted to get a little experience under us when we announced our fourth quarter earnings. And so now we have four months under our belt and we think, given everything we see in the economy and in our own business, we believe it's time to kind of reset that guidance.

I don't think anybody on this call believes the economy has gotten any better. In fact, I am kind of a numbers guy, so when I saw the 6.1% decline in GDP, I was curious. And we have been keeping quarterly GDP numbers since 1947. And for those of you that like trivia, the two quarters, quarter four and quarter one, represents the two worst quarters in the 62 years that these numbers have been collected. And so I think that suggests that the economy has gotten a bit better. I know also I have seen some data that consumer spend was up in the first quarter. At the same time, unemployment is up and savings rates are up.

And so we didn't expect the economy to necessarily get better when we announced our guidance in December of '08. But we didn't necessarily expect it to get worse. And so the consumers we think have accelerated their efforts to trade down because what you see is an economic decline here that has really been elongated. I think most of us are confident and we've probably already reached the point where this is longer than a normal recession. I think consumers have really kind of hunkered down as a result of that. And then we are having to manage an unprecedented level of deflation.

So where does that leave us? We think the smart thing to do is to adjust our earnings range from a range of $2.10 to $2.30 a share.

Also, I will point out, given what I just described as our intended use of a good portion of these tax benefits, you should assume that that $2.10 to $2.30 incorporates those tax benefit, which amount to about $0.15 per share.

Turning to sales. While sales absent deflation in produce and dairy are the strongest they have been in four quarters, I don't think any of us are in a particularly good position to forecast the economic activity. And we are genuinely concerned about when that deflation will depart us in those two categories. As a result, we have softened our sales guidance to 0.5 to 1.5.

Now we'll cover the EPS implications of this change in ID sales by simultaneously stepping up what I referred to earlier as a very strong cost reduction effort.

On the capital expenditure side, as you know, we cut back capital in our original plan of 2009 from a level of about $1.7 billion to $1.2 billion. And just a reminder for everybody, we were at $1.7 billion because we were essentially trying to compact 10 years of capital spending to six and now have a very strong base of Lifestyle stores, common look and feel and all of those benefits.

As we look around us, our competition has cut back on its capital. We are seeing the smallest competitive new stores program against us I have seen in 17 years. And we think it's a good thing for us to back off of our capital just a bit. And so we're going to reduce our capital spend to $1 billion.

In terms of free cash flow, good news there. Our old guidance was $1 billion to $1.2 billion, and we now believe we will be in the $1.1 billion to $1.3 billion range. So we are actually increasing our guidance on free cash flow.

Now the uses of free cash flow for the balance of this year will be focused on a combination of some debt reduction. Obviously, dividend payment was a bit of an increase here and then stock repurchases. And we did a filing a couple of months back indicating that we might be doing that, and of course we did the stock repurchase in the quarter. But I think given where our stock trades, given the strength of our balance sheet, given our access to the capital market, it makes a great deal of sense to buy the stock, which is selling at historic lows. So that's the change in certainly the guidance that we've provided the last time we were able to talk to people publicly.

In terms of... I want to make one final comment. It's not an earnings guidance, but it might affect all of you modelers out there. We couldn't help but notice that when we look at the details of some of the models that have been done and forecasts as well that we've got a lot of folks that are anticipating 2009 sales that are high, and high by a large amount. And they don't seem to incorporate some fundamental changes that have occurred. And so I'm going to try to help you out with some of those numbers.

We are seeing sales numbers in the 44 billion range, and let me tell you what that misses. It misses the fact that the Canadian exchange rate is going to have an effect on sales if it stays where it is of about $900 million. But keep in mind, that doesn't translate into some big income number because the costs also get affected. And so when I suggested to you something in the 6, maybe 7% range, Robert, on... if the exchange rate stays where it is, that's the income effect of that. But again, I don't know how you build your models. But you are 900 million strong there for those of you that haven't accounted for that.

And then fuel retails. Fuel retails were down 38% in the first quarter. Again, costs are down. So this is not a big income issue, but fuel retails are down 38%. We still haven't gone against the big $4 gallon prices last year. And so we try to make kind of a basic forecast of what we thought, how it might play out. And we think that relative to last year, it could affect us by about $1.2 billion in terms of reported sales.

And then the last thing I would just remind everybody of, every six to seven years, we get a 53 week year. And if you haven't accounted for that, that's about $800 million.

So, again, those numbers in total add to close to $3 billion. And so again, if you are trying to model your income projections to Safeway and it particularly affects calculations to gross margin and O&A.

So with that, I'm ready to turn it over to questions.

Question-and-Answer Session

Operator

Thank you. At this time, we're ready to begin the question and answer session. (Operator Instructions) Our first question comes from John Heinbockel. You may ask your question, please state your company name.

John Heinbockel - Goldman Sachs

Yes, Goldman Sachs. Steve, why didn't the Super Bowl promotion work? Did you expect you to spend the 38 basis points? And you guys have good technology and good history. Do these things... often times, they don't work if you spend... if you overspend. I guess we don't hear about the ones that do work. But how do you guard against having some bad ROIs on this type of activity, particularly in this economy?

Steven Burd

I think this was a conscious effort. The senior team sat around the table, we decided on an amount of money we thought we could risk. We contemplated a sales result that we might get from that. Again, we felt a little flushed on the earnings side. And so we thought these were really unprecedented times and so old models may not apply. And so we put an effort in. It didn't get the result that we expected. We remain very pleased with what we're getting on an everyday price investment. And in general, our promotional program has been very good.

We tried a little something extraordinary. And if you saw... if you had insight into our gross margin activity in the first four weeks, very different gross margins than we had in the experimental period and then things return to normal in the third four weeks of the period. So we thought it was worth a shot. We are always experimenting. We took more risks here than would be normal and it worked. So I think that was a learning experience. But we knew what we were risking. We felt we can do much better on sales.

John Heinbockel - Goldman Sachs

So it didn't work. The impact was more... not that you spent more than you thought you were going to, but you didn't get the sales response?

Steven Burd

That's exactly right. We spent exactly what we intended to spend.

John Heinbockel - Goldman Sachs

And you didn't get the sales response because you think the program itself wasn't structured right or the economy or competitive response or what?

Steven Burd

It wasn't a competitive response. It was... I think the bottom line is consumers are not... they are not inventorying product, not just for us. I mean transactions are up as they are with a few other retailers. Items per basket are down. And I think we were going to try to put more items in that basket, and it just didn't happen. I mean we got some response, but not what we counted on. We knew exactly what we had to get to repay the investment and we didn't get it.

John Heinbockel - Goldman Sachs

So, secondly, if I hear you right, the $ 0.11 for the second quarter, that will be more everyday shelf pricing, not promotions, and the idea is you take the gross margin hit, but the demand will just take much longer to build and pick up?

Steven Burd

Yes, it's not just second quarter. I think you will see the second, third and fourth quarter. It's very interesting, when we look at our data, unlike maybe... keep in mind, historically, we have been quite promotional, more promotional than anybody else. And as you invest in everyday price, you have to begin to promote with less frequency and the depth of promotion relative to your new price point becomes less. That activity will continue.

Our everyday price, this will surprise you I think, that we're selling less on promotion than we were a year ago, whereas most people are selling more on promotions, which I think confirms that the everyday price investments we've made are in fact getting the attention of consumers. And now we go into that pile which is less demand responsive. And so there is going to be a little more pump priming there and that's how we think we should use our newfound money.

John Heinbockel - Goldman Sachs

But just from a modeling standpoint, it sounds like the, I was going to say, is the idea that the $0.11 is neutral in the second quarter? It sounds like it is a net benefit in the second quarter, maybe not for the year, as you spread the investment out.

Steven Burd

That's correct.

John Heinbockel - Goldman Sachs

But you're not going to spend $0.11 in the second quarter it sounds like.

Steven Burd

You're absolutely right. You could not spend it that fast wisely.

John Heinbockel - Goldman Sachs

Alright. Then finally deflation in produce and dairy, that was... you said it... comp would have been 0.9 excluding that?

Steven Burd

Correct.

John Heinbockel - Goldman Sachs

That's 0.9 versus the negative 0.7 or the positive 0.2?

Steven Burd

It would be 0.9. It would add 0.7 to the Easter adjusted 0.2.

John Heinbockel - Goldman Sachs

So the deflation hurt you by 70 BPs. And what would that have been in the fourth quarter?

Robert Edwards

10 basis points, John.

John Heinbockel - Goldman Sachs

10?

Robert Edwards

Yes.

Steven Burd

Yes.

John Heinbockel - Goldman Sachs

Okay. Alright, thanks.

Steven Burd

Hey, John, just to give you a little color on that. If you look at retail and milk, we're reflecting cost reductions. We're down 28%, egg down 29%, butter down 29%. I mean these are big numbers.

John Heinbockel - Goldman Sachs

And do you still think they get back to maybe zero by the end of the year?

Steven Burd

By the fourth quarter, for sure, it will flow (ph) around it. But we actually think it begins to soften. I think the second quarter will look very similar to the first quarter, and the third quarter, we see softening. And then we see it almost gone in the fourth quarter.

John Heinbockel - Goldman Sachs

Okay. Thank you.

Operator

Thank you. Our next question comes from Neil Currie. You may ask your question and please state your company name.

Neil Currie - UBS

Hi, UBS. I just wanted to follow on on the deflation issue because it's quite clear that milk and eggs and butter prices are down 29, 30%. But it also seems that the cost of those products are down similarly, if not more. And I was wondering what the growth... whether it's similar to private label and generic drugs, whereby the impact of deflation is negative on the top line, but not necessarily negative; it's either neutral or positive on the gross profit dollars that you're generating from these products.

Steven Burd

Here is what I would say. In general, you are correct. Where we have felt compelled to make some price investment, we have actually squeezed our margin. But you are, in general, you are absolutely correct that it's not a bad thing for income. Also, just to clarify, I'm not saying that there is no inflation. If you look at things like price per item, despite the trade down either to private label or a cheaper wine, you still have some modest increase there overall. And what I am commenting on is the extraordinary outright deflation that happened in almost 20% of our business.

Neil Currie - UBS

So if you take a base weighted basket rather than a current weighted basket, there is inflation, but it's just a bit moderated than what it was.

Steven Burd

Yeah, quite moderated. And on last earnings call, someone asked me where I thought inflation would sort out for the year. And I thought... and I am thinking about what our LIFO charge is likely to be. I am thinking we're going to be between zero and one, which is sort of back to normalcy.

Neil Currie - UBS

And just philosophically, obviously, you've taken advantage of some of these cost reductions in dairy to maybe sharpen your prices. But philosophically, would you say that a deflationary environment is a little bit easier to manage than the massive inflationary environment we had a couple of years ago where it was more difficult to pass through price increases?

Steven Burd

I think --

Neil Currie - UBS

And neither are great, but --

Steven Burd

Yes. No, I would say neither are great. I think what's great is modesty, modest movements. I think that when you have extraordinary declines or extraordinary increases, they are hard to manage.

Neil Currie - UBS

Okay. Thanks very much.

Steven Burd

Sure.

Operator

Thank you. Our next question comes from Karen Short. You may ask your question and please state your company name.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Hi, FBR Capital Markets. Thanks. Just a couple of questions. I wanted to clarify a little housekeeping. What is your tax rate guidance going to be for the third and fourth quarter, or your expectations for the tax rate, just normalized 37%, kind of range?

Robert Edwards

Karen, for the year, I will just give you the annual number. We are looking at just under 32% for the year.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Okay.

Steven Burd

Just a tick below the average.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Okay. And then LIFO charge, is the first quarter run rate a good proxy because I've got... maybe to about (ph) $6 million for the year for a LIFO charge?

Robert Edwards

Yeah, that sounds... it's in a reasonable range.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Okay. And I just wanted to turn to Canada for a second, because we've been seeing out of some of the Canadian retailers some pretty strong comps just because of what's happening with inflation rates in Canada. I was wondering, I mean if I kind of figure, you guys have similar comp trends to what Metro and Loblaws are seeing. At Canada, about 14 or 15% of sales, it would tell me that your U.S. comps are running kind of minus 1.1. Can you kind of confirm if that about right and maybe could you talk a little bit about what's going on in the market in Canada?

Steven Burd

We don't typically comment on geographies. I think we've probably said in the past, I mean what you observe in terms of people that might report publicly there, Canada is a strong market for us, we have strong market shares and the economy has been stronger than in the U.S. But beyond that, I am not really going to try to isolate things in Canada.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Okay. And then I don't know if you could maybe help us there just sort of modeling in fuel going forward, if you have handy your average price of fuel in the quarters last year.

Steven Burd

Yes, don't have it with us. I think, Robert, correct me on this if I am wrong, but I think last year was probably a tad stronger than normal. But normally, there is about a one penny difference in margin if you look over the course of a five or six year period. So I would still think that this year would be normal. I am not predicting it would be particularly abnormal on margins.

Robert Edwards

Karen, you are just referring to retail prices?

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

I am taking about price per gallon, just because that was... obviously, people are modeling fuel off of... well, maybe, they aren't modeling fuel. But if knew what your average... pardon me?

Steven Burd

What I would suggest, I think you could... I think the number I would suggest using is the number I gave that might be missing in some of these sales forecasts, which, if I can find it here, I gave it earlier. Yes, I gave 1.2 billion.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Yes.

Steven Burd

So I think that's the number I would use to model, and I don't know what that translate into retail per gallon. But we looked at the retailers of the first quarter. Obviously, we are looking into a crystal ball here. And if we were perfect at this, we would be in a different business. But I think that that is reasonable. Melissa just showed me a number. In the first quarter, our retail averaged 194 versus a year ago, 314. And so if it stays in that $1.94, kind of $2 range, when we get to the $4 numbers that we've had last year, that will create an even bigger spread. And I don't think anybody is forecasting we'll return to $4.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Great, okay. And then lastly, I guess just looking at the number of SKUs on EDLP, I don't know if you said this, I didn't catch it. How many SKUs do you have on EDLP now and can you give us kind of some sense of what the range is, or what your goal is in terms of the range of SKUs? And then do you have a sense of the timeframe you plan to get there?

Steven Burd

I don't think I want to give you sort of the SKUs. We made a lot of progress and think that we'll be able to make a lot more progress through the balance of the year. And we think that will fuel sales growth as that becomes increasingly known to consumers. And part of that is what you do in the store and part of that is how you communicate your message. And sometimes, you're a little bit compromised on your message until you get a little bit further along. One thing you don't want to do as a retailer is over promise. So we're very careful about how we communicate what we have done.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Okay. And then just, sorry, last question. Do you have any property gain assumptions in your guidance, or maybe did you previously, now you've kind of... the market's changed, that's not going to be included anymore if there was any change in that outlook, because you seem to always include some property gains?

Steven Burd

I mean, Karen, historically, we've done very well on property gains and there is some included in this forecast. Although you've got to assume that based on the current state of the commercial real estate markets, it might be less.

Karen Short - Friedman, Billings, Ramsey & Co., Inc.

Okay. Thanks very much.

Operator

Thank you. Our next question comes from Mark Wiltamuth. You may ask your question and please state your company name.

Mark Wiltamuth - Morgan Stanley

Hi, I'm just trying to get a gauge on how long the margin sacrifice could occur. Philosophically, are you thinking that you keep cutting prices until the comp improves, or do you think you'd cut the price until you get to into appropriate price point relative to your peers?

Steven Burd

Well, when you look at the comparison to peers, it's always who are you pacing yourself against. And that varies by market. So there is not single market where we're not lower than two or three players today, all right. And it's just that what you're trying to do and you're trying to do this with the skill of a surgeon, you're trying to surgically adjust prices by category and ultimately by item that you think is going to create the best value for consumers and keep them loyal to Safeway.

And so we have said for sometime, I think all the way back to 2004, that our desire was to become less promotional. And I said earlier in the call that we're selling less on promotion; well, that's working. And to have a better everyday value so you don't always have to look in the ad to see where you're going to shop that week. And so we believe we have more price work to do. We believe that in an elongated recession, it's important to get there quickly.

I think that absent this elongated recession, we'd probably pace that out over a longer period of time. And if you just look at our numbers over the last couple of quarters, we've really picked that pace up. The tax benefits now allow us to further pick that up. I don't want to give you a finish line, although I will commit that when we believe we have reached the finish line, we will convey that. And I think it's better to do it when we are there. And we think that we are in a unique position to be able to do this because our balance sheet is so strong, our cash flow is so strong. And we compete with a lot of folks that are not in the same basic position as all too often, I think people think that we compete with two other publicly traded companies in that bit. But I could go market by market where we don't even have one of those two publicly traded companies in those markets.

And so there is a lot of share to take out there. And often times, it comes from people that are not as well capitalized, maybe over leverage (ph), didn't anticipate this kind of economic climate. And then keep in mind on the gross margin investment, we are very aggressive on cost reduction. A lot of that's getting booked on the gross margin line, which actually softens the reported gross margin effect.

With energy costs coming down, that lowers distribution. We constantly find more efficient ways to spend our advertising dollars and we have a lot of money spent on advertising. Shrink has been a great source for moderating the reported gross margin effect. So there are all kinds of things that we are doing that will cause the gross margin rate to be moderated. But the price of this that's behind that will be quiet significantly.

Mark Wiltamuth - Morgan Stanley

Okay. And if you can just give us a little update on the private label versus brand battle in the quarter. Where is your sales mix on private label now and how much of a margin boost do you think you got out of it in the quarter?

Steven Burd

Well we've avoided giving specific penetration numbers and frankly, I have never found it particularly useful unless you know the book that people use and do they includes produce, what's in there. But we continue to make major share gains in private level. We have a very strong private level program as you know. And I think I commented earlier in the call; I'm not sure if you were on where we are outpacing the growth in national brands by 1000 basis points. And so that says a lot. And I don't see that dissipating. I don't expect that number to get... to be much different in quarters two, three and four. And I'm not sure it's going to be different in 2010.

Mark Wiltamuth - Morgan Stanley

And I think you had mentioned that you were seeing some promotional dollars coming back from the brands in response?

Steven Burd

We are. There have been some outright price reductions, but more often than not, we see some additional trade dollars coming our way. It allows a consumer packaged goods company to keep what they would consider their hard earned price increase, but to try to spend some money to get back up some share. And so I think that you will continue to see that happen. We don't... we basically are trying to provide value to our consumers. And if today that value is best seen in private brands, then we're going to shop (ph) those private brands, we're going to merchandise them and we're going to sell them. We're more than happy to take trade dollars and sell branded items because they still are the lion's share of what we sell. But we've got something to sell and create value for consumers regardless of what happens to price points of consumer packaged goods.

Mark Wiltamuth - Morgan Stanley

And then just lastly, how big are your external sales of private label now when you're selling to third parties and other grocers?

Steven Burd

I don't have a number, a current number on that. But we're making good progress. We've always sold to outsiders for more than 20 years. We've stepped that out with organic meeting right. So the numbers are growing, but I don't have a specific number for it.

Mark Wiltamuth - Morgan Stanley

Okay. Thank you.

Operator

Thank you. Our next question comes from Ed Kelly. You may ask your question and please state your company name.

Edward Kelly - Credit Suisse

Yes, credit Suisse. Steve, could you give us some color on how are you feeling about the consensus number for the next quarter? Typically, you comment on it; I didn't hear anything, particularly because you have the $0.11 tax benefit. It might be helpful.

Steven Burd

Well I think the consensus number that I saw yesterday was pretty much in the middle of the range that I just gave. So it's hard to really comment on that; it's right in the range.

Edward Kelly - Credit Suisse

All right. And then you've made a fair amount of progress obviously on SG&A, down 4% in dollars this quarter. How sustainable is that given that you're going to have some tougher comparisons over the next few quarters? I know you did mention that there was other opportunities you're working on. Maybe you could talk about those.

Steven Burd

Yeah, can you repeat the question? I didn't hear the front part of it.

Edward Kelly - Credit Suisse

Yeah, the question is on the SG&A and you've made great progress so far, down 4% this quarter, how sustainable is that over the next few quarters and you did mention that you have other opportunities. Can you maybe talk about that?

Steven Burd

I think that your... if you look at the ID sales guidance, we're challenged not getting a lot of leverage from sales. So, basically, any reduction in the percentage of O&A is going to driven, by our ability to drive down cost and I've commented in the past that this thing ramps up, just as it did last year, as they move in subsequent quarter because what you got is a lot of the stuff is operationally based. And so, it takes a little while to roll it out, it takes a little while to get it on hold and executed rates. And then you get more back, in the back half of the year. We are stepping that effort up. I'm a strong believer in that no matter how good you are at this, you can always think of new and better ways, I mean that's certainly been my career experience.

And so I think sometimes people are surprised at how we can constantly find new opportunities to create value on the O&A side. But keep in mind that when you have an organization this big with a lot of repetitive activity, you crack the code one place. If you are good executor, you can then execute that across the board. And if you lived in this organization, you might think that, I give on realistic time frames but how quickly I want something done. But the organization is pretty good at responding to that, I am getting a few shaking of heads around here.

So I feel very good about our cost reduction efforts. I said that we are slightly ahead of where we were in the first quarter. It ramps up. We have constant meetings. We focus on the things that we think we might struggle with. And if we conclude that we're not going to get the original number and we back fill it with a new opportunity. And then we are always periodically adding to those opportunities. So I think that that is one of absolute best parts of our game.

Edward Kelly - Credit Suisse

Okay. And then last question for you. Could you maybe help us understand how you are thinking about the model today as the consumer finally stabilizes whenever that may be? How do you see your IT growth and the level base, just given that you have now pretty much done with the lifestyle program, what is a more normalize type investments in price from a gross margin perspective and SG&A growth can't obviously go down 4% forever. So how do you think about that as we sort of cycle out of this recession?

Steven Burd

Sure. I actually think that SG&A growth can in fact be down forever. Now it's dependent upon... in the short term for us, it's dependent upon extraordinary cost reductions without compromising shopping experience. In the longer term, if you're generating percent 3 plus percent ID, it won't go down on its own without any extra effort on the cost reduction side.

So the way I look at it, we all are living through this tough economic climate. When you get into this kind of economic climate, price becomes a lot more important. And we think we have the perfect shopping vehicle, the perfect shopping experience for a normal business cycle. It creates a few issues when you get down into this kind of environment. And it's the reason we're sort of running hard on the price reduction side.

I've said this before. If you are a pure price operator and there is no one in the conventional supermarket business that is a pure price operator. But if you're a pure price operator, these are your best times. And when times return to normal, that which is a longer part of the business cycle, those are not your best times, because you don't have anything to offer but price. Whereas we have, I think most people would agree, a superb shopping experience. I know others are working on the customer interface and what people often call service. But we measure ourselves and everybody, we've been doing it for 13 years, and no one compares to our service levels. No one compares to our quality.

So I think that on the upside of this business cycle, we are extraordinarily well positioned to win and to win significantly. And we are making very, very subtle changes right now that will become a bit more evident as we get further along. It will further enhance that Lifestyle shopping experience in the stores. And so we're spending a lot of time understanding how we're going to win big so when the business cycle returns to normal.

And frankly, if you look at someone like ourselves that can have the kind of earnings increases that we've had over the last four and five years and then on a very soft sales environment, given the nature of your business model, you can sustain the earnings that you had in previous years while stepping up your cash flow 60% to 90%, that's a company I want to invest in.

So I think that we're doing well in this environment. I think we'll do very well when the business cycle returns to normal. And it will. And it's not to say that there won't be a residual or price sensitivity as consumers try to save more. But people really like our shopping experience.

Edward Kelly - Credit Suisse

Thank you.

Operator

Thank you. Your next question comes from Meredith Adler. You may ask your question and please state your company name.

Meredith Adler - Barclays Capital

Meredith Adler from Barclays Capital. Thanks very much for taking my call. I was wondering, you have talked in the past and you talked a little bit today about getting a better balance between customer shopping, the everybody price, or shopping the promotion. Based on what's happening right now, do you believe that the switch is margin neutral, or is that part of what we're seeing in the gross margin?

Steven Burd

I think the switch to the everyday value, given the way we're trying to craft (ph) this should, when we are done with our price investments, be absolutely margin neutral. And I think you know that we will forever promote. And anybody who tells you their everyday price, even the classic everyday price guy out there is now running ads. So everybody is a bit promotional. It's just that we've been on the extreme end. And what that forces you to do is it forces your everyday retails to carry a higher value. So you have to bring your promotional spend down as you increase your spend on everyday price.

Meredith Adler - Barclays Capital

Okay. I was thinking of individual items and whether those individual items ended up being awash from a profit perspective.

Steven Burd

I think it's a mixed bag. I think there are some where we thought their sensitivity to consumers was so strong that we choose to be below most of our competitors, so you take a margin hit there. And then are other where that's simply not the case.

Meredith Adler - Barclays Capital

Okay. And then another question about this. When you think about who you are benchmarking yourself again, is it trying to match or be below the lowest conventional competitor, or do you also pay attention to where the pricing is of more discount-oriented retailers?

Steven Burd

I think we focus more on conventional retailers, but we do not ignore some of the price guys. And so... and it varies by market so that there could be clusters in a market where you might consider yourself to be going more against more of a price operator. But again, it doesn't mean you have to equal them on price because there are other elements in value that you bring to the table: your quality, your shopping experience, your ease of location. Something as simple as you have 350 parking stalls and they have 100; that's an advantage. And so...

But if you want a general answer, we are pricing predominantly against conventional competitors. And even within a defined geography, it's going to be a bit different, depending on the different elements of that geography. So there is no real one player that you would say in a certain market we go against. There are some competitors you pay more attention to in some markets than others. And you can't completely ignore the price operators. But often times, what you can do is you can take items that happen to be their floor set (ph) and you can be sharply priced on those. And that encourages people to shop more than they otherwise would.

Meredith Adler - Barclays Capital

And then as we look at the investments that you have been talking about making over the last few quarters, maybe even going back last year into '08, but even '07, because you did make some price investments, do you think that their balance was more towards hotter promotions and less... have you made... I guess what I am asking is if there have been a marked shift this quarter.

Steven Burd

No, I would tell you... well, the only thing is that 38 basis points, that's the only marked shift. If you go back, all the price investments that I've been talking about for the last couple of years and particularly the last three or four quarters, has been all about improving the everyday value position. And so when we talk about price investments, that's what we are talking about. We are not talking about... promotional spend is what we have done more of than anybody else. And so when we talk about investment price, it's about everyday price.

Meredith Adler - Barclays Capital

Okay. And then my final question is we are now past Easter. Can you comment on whether Easter sales, how they compared to last year's Easter? Were people willing to spend money?

Steven Burd

Our experience has been that people prepare for those holidays. I think they tighten the belt, the most of them (ph) and then when the holiday comes, they are determined to have a good holiday experience. That isn't true. Every holiday we've had since this recession began, and so I don't think this Easter was really any different.

Meredith Adler - Barclays Capital

Great. Thank you very much.

Operator

Thank you. Your next question comes from Deborah Weinswig. You may ask your question and please state your company name.

Deborah Weinswig - Citigroup

Citigroup. Good morning Steve. In terms of the cost reduction initiatives, which you guys have really done for us, can you talk about what the biggest divers of those initiatives are? And also can you talk about where you are regards to shrinking?

Steven Burd

Let me take the shrink one first. The shrink effort is going on for long time. We have consistently beaten our shrink target for the year. And after turning it a good strong number again last year we set ourselves to $50 million shrink target this year. I think we've got a good chance of achieving that number. I've got some ideas that might allow us to beat that number again. And the shrink performance that first quarter was softer than what we might have expected, but again it compared to an extraordinary result from the first quarter last year. So I think shrink efforts here are alive and well, I think we will have good performance and trade.

In terms of some of the cost savings, I think we have pointed out in our investor conference that it surprises some people, I think, but you still have opportunities that a single idea. In fact, we teed up about both projects that we said we worked about $15 million; it is about 19 projects it were $10 million to $15 million. And the way you had to think about these things, they often are operational in content. So it's not about squeezing the labor content in the store; it's about reexamining which gets done on the store. And trying to eliminate work or do the work differently. And I think it's sort of shooting a few sacred cows, if could you use that term, maybe it's not a good term these days. But often times, people in the organization think that well we've always it done it this way. And so no one would ever consider changing that. And what you have to do is you have to break that mindset, because we would in fact consider changing that.

Very simple thing. We have a cookie we're very proud of. It quickly moved from no sales to second in the company; it's called the Chocolate Chewy. It has the consistency and chewiness of a brownie, but is a real cookie. And we used to bring that cookie in and scoop it out with an ice-cream scoop and put it on a cookie tray. And now we actually bring that cookie in a different form. And so you remove that labor.

So there are literally dozens and dozens of things like that. And they are much more... they are easier to do in production departments. And even something as simple in the check stand where you've done a transaction in a certain way and you decide to do in differently and it takes a few seconds out. We're very prudent about rehiring people when somebody leaves, see if we can rejuggle the work. We've made a lot of changes in store operations, and so that's where a lot of this comes from.

Deborah Weinswig - Citigroup

Okay. And then with regards to the market share question, can you provide some additional details there? And then also as it relates to new customers, who do you think the incremental customer is and how, through marketing and advertising, can you drive even more new customers into your stores?

Steven Burd

Well I think what we see is, I commented on this earlier, we see a stronger growth in households than we actually see in transactions, which tells me that we're getting some new shoppers. And as they start shopping with us, they don't always start out giving us all their business. And so they might come in because they are attracted by an ad, they might come in because they have heard about our quality. And then our objective is to transform them from a casual shopper to a totally loyal shopper over time. And so we think that part of the way to do that is in your ads, part of it is your in-store communications as you get a reputation for certain items. And then how you communicate either through mailings or through email or through TV or radio, those are all ways to get people in. We think that we have materially improved the shopping experience over time and we have clearly improved our price position over time. And so we want to get people in there to experience that and trust that increasingly more of them will stay.

Deborah Weinswig - Citigroup

Just to sort of kind of finish off. So along those lines, it sounds like in this most recent quarter that there was an inflection point with regards to market share. What do you think drove that?

Steven Burd

I think transactions drove it. Households and transaction drove it because what worked against us was items per basket. And what declined was the price per item. So I don't think there is any question; it was transactions and households that drove the improvement in market share.

Deborah Weinswig - Citigroup

Great. Thanks so much and best of luck.

Steven Burd

Thank you.

Operator

Thank you. Our next question comes from Bob Summers. You may ask your question and please state your company name.

Bob Summers - Pali Capital

Pali Capital. I mean I guess I would like to leverage off the last two questions a little bit. In the past, you talked about, or like the idea that you had a variety of operators out in the market that were taking different paths to being successful with you guys choosing the route of differentiation. And now it seems that when you look at the conventionally landscape, the discounted landscape, everybody is talking about implementing more aggressive pricing approaches. How does this change how you view the business.

Steven Burd

I don't think it causes us to view the business any differently than we did in 2004 except we were trying to accelerate our everyday price position. I mean that was our view in 2004, become less promotional, have better everyday values, but remain really the sole player that has this form of differentiation. I am one of the few guys that has been around for 17 years and three business cycles. And so when you look at consumer research, what you find during, the business cycle typically runs about seven years. During normal business times, which would be five and a half years of that cycle, price occupies maybe anywhere between the third and the fifth position. And during that one and a half year typical business downturn, it moves for a large number of consumers to the number one position.

So I don't... I think the last thing we would want to do is to become a priced outlet (ph). We don't think that makes sense. And so we think that our differentiation will really carry the day when we return to normal business cycle. As it is, right now, we do better than most conventional players.

Bob Summers - Pali Capital

Right.

Steven Burd

Whether it's in cash flow, earnings or sales. And then we've got all the points of difference to carry the day and during good times. So I feel very good about where we've positioned ourselves.

Bob Summers - Pali Capital

You just talked about price per item being down. What's the right way to think about a split between what's being driven by disinflation and what's being driven by trading down?

Steven Burd

I think that, remember, the numbers aren't negative. It's a small positive number. But it's not the... the item increase was greater last year. I haven't tried to split this thing up. It is clearly a combination trade down. And it is also some of our price investments, and then it is also some overall key replacement or reduction in place. So, I think it's really a combination, I know others have slightly quantify the trade down effect is clearly material. But we have not really tried to quantify it.

Bob Summers - Pali Capital

And then two real quick questions. The flu pandemic, I mean any thoughts on the SoCal and Texas businesses, and how that might play out?

Steven Burd

Clearly, we haven't seen any effect of that. It's just too early to tell. What you are taking about is just in a supermarket like other places is a place where people gather. But right now, this thing is I think pretty early stage and no one really knows whether thing will explode into something greater. I heard the other day that normal flu kills 800 people a weak in this country, just the normal flu. And so that was put out there by somebody in the medical profession I think to get people to calm down a little bit, because we're not seeing extraordinary stuff right now.

Bob Summers - Pali Capital

Right. And then just one housekeeping item. Can you... and I'm not looking for specific numbers here, but mathematically, can you remind us how you create the consolidated ID?

Steven Burd

How we create the consolidated ID, in terms of how the exchange rate plays in it?

Bob Summers - Pali Capital

Right, because I think it's been in local currency.

Robert Edwards

Bob, we exclude any impacts from currency on ID.

Bob Summers - Pali Capital

And so it just mashed together based on the percent of the total pie?

Robert Edwards

Correct.

Bob Summers - Pali Capital

Okay. Thank you.

Melissa Plaisance

Time for one last question.

Operator

Thank you. Our last question comes from Scott Mushkin. You may ask your question and please state your company name.

Scott Mushkin - Jefferies & Co.

Yes, hi, it's Jefferies. Just quickly because I know we are getting long here. Going back to Karen Short's question, I guess sort of Bob just asked, and I know you guys are exposed to some of the biggest states that have had seen unemployment go up quite a bit. I mean are you guys positive or slightly positive in California and Oregon where you are seeing so much unemployment the rates jumps up there, or are things much worse in places that have much higher unemployment rates?

Steven Burd

Yeah, I think... we don't want talk about regions. I mean everybody is aware that unemployment in California is among the highest in the nation. I think what helps offset some of that... that doesn't translate into California by any means. What offsets that is very strong market position. That's also true in the Northwest. So I do think that it's more of an opportunity lost for us.

In other words, would our sales be better if we didn't have 11.5% unemployment in California, high foreclosure rates and all those things? I think the answer is there would be, because I think there is more belt tightening. But it would be jumping to conclusions to think that California is our worst market because it leads our geographies in unemployment and because we've such a strong presence here and we've been here a long time.

Scott Mushkin - Jefferies & Co.

And then just one follow up, if I could. The 32 basis points of true price investment in the quarter, how does that compare to the back half of last year? Was it similar or was it up a lot?

Steven Burd

I didn't hear the front part of the question.

Scott Mushkin - Jefferies & Co.

The true price when I think you brought down gross margin. I believe you said 32 basis points was kind of true price investment. How does that compare to the second half of last year? Was that level substantially above?

Steven Burd

I think it would be similar to first three and four. The reported growth was actually down more in those quarters. But again, you get all these offsetting factors and they are different each quarter.

We've been on the call a pretty extended period of time, which, I can understand. And Mike, if I could, I'm just going to spend two minutes here at the end because it's been a long call to kind of summarize what I think everybody should take away from the call.

No one is surprised here, not particularly strong economy. There is a lot of evidence, at least on the GDP front, that's it's getting worse. As a result of that, we've modified our sales guidance. We are continuing to ramp up. We still think we'll ramp up, but not ramp up to get us 2%, 3% by the end of the year. So we are saying 0.5% to 1.5%.

We are taking advantage of the fact that during a recession, price is kind, the cash is king in American business during these times. And are going to use those tax benefits to accelerate investments in price, which will have a little bit of a consumer lag response. We'll also fuel our earnings and try to get to the top end of our range by being very aggressive on the cost reduction without sacrificing the shopping experience.

We are encouraged on the transaction front. That continues into the second quarter. We're encouraged on the market share front. Our assets we think are in the best condition in the industry. We've been spending more on capital. We can afford to cut back. Others are cutting back, but not with a same capital history that we have. So we think that positions us well.

Free cash flow, which was fabulous last year, up 42%; we're now suggesting will be up 62% to 91%. We're going to share the benefits of that with our shareholders and buy back more stock, increase the dividend.

And we think when all the dust settles and everybody turns around and looks to 2009, Safeway is going to stand tall among American business. We think we'll stand tall among the Fortune 500, demonstrating our resilience and ability to perform in this environment. And frankly, we think we'll stand tall among retail and even quite tall among food retail. So we think relative to the rest of industry, 2009 is going to be a good year for Safeway.

Melissa Plaisance

Thank you everyone for participating in the call today. Christiane and I will be available if you've got any additional clarifying questions. Thanks a lot.

Operator

Thank you. And this does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!