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Safeway Inc. (NYSE:SWY)

Announcement of Sale of Canadian Operations Conference

June 12, 2013 4:30 pm ET

Executives

Melissa C. Plaisance - Senior Vice President of Finance & Investor Relations

Robert L. Edwards - Chief Executive Officer, President and Member of The Board of Directors

Analysts

Deborah L. Weinswig - Citigroup Inc, Research Division

Shane Higgins - Deutsche Bank AG, Research Division

Priya Ohri-Gupta - Barclays Capital, Research Division

Michael Aaron Prober - Clovis Capital Management, LP

DeAndre Parks

Andrew P. Wolf - BB&T Capital Markets, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

Damian Witkowski - Gabelli & Company, Inc.

Edward J. Kelly - Crédit Suisse AG, Research Division

Keith Howlett - Desjardins Securities Inc., Research Division

Operator

Welcome, and thank you for standing by. [Operator Instructions] I would now like to turn the meeting over to Ms. Melissa Plaisance. Go ahead, you may begin.

Melissa C. Plaisance

Good afternoon, everyone, and thank you for joining us on such short notice. With me today are Robert Edwards, our President and CEO; and Pete Bocian, our Executive Vice President and Chief Financial Officer. We've arranged this call to convey to you some of the details on the sale of our Canadian operations and to respond to your questions. We'd like to keep all the questions focused on today's announcement and, in the interest of fairness, would ask that each caller restrict themselves to one question. Questions will be restricted to analysts and investors.

We will report our second quarter earnings on July 18, and we will discuss our second quarter results at that time. I'd like to remind you that management will make statements during this call that includes forward-looking statements within the meaning of the federal securities laws. Forward-looking statements contain information about our future operating or financial performance. Forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. However, we undertake no obligation to update or revise such statements as a result of new information, future events or otherwise. For a list and description of those risks and uncertainties, please see our press release and our filings with the SEC.

And with that, I'd like to turn it over to Robert Edwards.

Robert L. Edwards

Thanks, Melissa. As you saw this afternoon, we announced that we have entered into an agreement to sell our Canadian operations through a sale of the net assets of Safeway Canada Limited to Sobeys Inc. for CAD 5.8 billion in cash. Total cash proceeds after taxes and expenses are currently estimated to be approximately CAD 4 billion. The proceeds are expected to be used to pay down $2 billion of debt to maintain our current debt ratings, with the majority of the remainder to be used to buy back stock. In addition, some of the proceeds may be used to invest in growth opportunities.

In the trailing 12 months ended March 23, 2013, Safeway Canada's revenues were CAD 6.7 billion. In addition, operating profit was CAD 428 million, and EBITDA was CAD 544 million, both adjusted for intercompany-related transactions. Our calculation of EBITDA includes CAD 31 million in gains from asset sales, which Sobeys does not use in their calculation of EBITDA. Canada Safeway will be accounted for as discontinued operations beginning in the second quarter of 2013.

We will remain responsible for Safeway Canada's $300 million of Canadian dollar debt, public debt due March 2014, and which is expected to be more than offset by cash and other receivables in Canada that also were not included in the transaction. This transaction allows us to realize the higher multiples attributed to Canadian supermarket companies and the premium attributed to our strong operations. The substantial cash proceeds in this transaction will allow us to create value for all Safeway stakeholders. The transaction has been approved by the Boards of Directors of both companies. The transaction is anticipated to close in the fourth quarter of 2013 and is subject to customary closing conditions, including approval under the Canadian Competition Act.

I am sure there are number of questions, and we will be happy to address them now. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Deborah Weinswig of Citigroup.

Deborah L. Weinswig - Citigroup Inc, Research Division

So 2 quick questions. Number one, can you talk about the timing of the transaction? And then secondly, in the past, you've done a great job in terms of repatriation of cash back to U.S., can you also talk about that as well?

Robert L. Edwards

Yes, we're -- thanks for those questions. We currently anticipate the transaction to close in the fourth quarter. And you're right, we have done a very good job at being able to repatriate cash from Canada. So included in the taxes that we've assumed were taxes associated with bringing the cash back to the states.

Operator

Our next question comes from Shane Higgins of Deutsche Bank.

Shane Higgins - Deutsche Bank AG, Research Division

Of the $2 billion that you guys plan to pay down on debt, which debt is that? And do you guys -- because -- pay some prepayment penalties on that?

Robert L. Edwards

Well, between now and August of 2014, we have about $2 billion in notes coming due. And so we believe there's adequate debt to pay down. And in addition to that, we have commercial paper outstanding now. So we believe there's sufficient debt available to be paid down. In terms of any fees or penalties, we've yet to have the opportunity since we haven't announced the transaction to discuss in detail any of the debt paydown. And so we'll have more to report on that as we move through the next couple of months, but we believe there's sufficient debt to pay down.

Shane Higgins - Deutsche Bank AG, Research Division

Okay. Just one more, if I can. On the buybacks, when do you guys plan to commence those buybacks?

Robert L. Edwards

Well, the -- again, the transaction, as we currently contemplated, is not expected to close until some time in the fourth quarter. So obviously, it would be after the transaction closes.

Shane Higgins - Deutsche Bank AG, Research Division

So probably early '14?

Robert L. Edwards

Well, it would be -- it depends obviously when the transaction closes, and then we have a number of choices as to how to actually execute the stock buyback. And we haven't reached any conclusions on those yet. But it could extend well into 2014, and it would obviously depend on market conditions as well.

Operator

Our next question comes from Priya Ohri-Gupta of Barclays.

Priya Ohri-Gupta - Barclays Capital, Research Division

I was wondering -- in your prepared remarks, you talked about the $2 billion of debt reduction, looked -- being sufficient to maintain your current debt ratings. What about the potential to use additional proceeds to pay down debt fees and further improve your ratings towards your mid-BBB target?

Robert L. Edwards

Well, as you just indicated, our ultimate objective is to achieve the mid-BBB ratings from all the agencies, and that's what we're working toward over the long term. And remember that there's about $700 million of free cash flow that we'll generate incremental to the $2 billion from the deal. That also is going towards the debt.

Priya Ohri-Gupta - Barclays Capital, Research Division

So we should see $2.7 billion of debt reduction versus where you ended last year, is that fair? By the end of 2013?

Robert L. Edwards

Yes, that's assuming the transaction closes as we scheduled.

Priya Ohri-Gupta - Barclays Capital, Research Division

Okay. So that'll be by year end, and assuming fourth quarter close.

Robert L. Edwards

It's our current expectation.

Operator

Our next question comes from Michael Prober of Clovis.

Michael Aaron Prober - Clovis Capital Management, LP

I just was wondering if you could give me some more information on the timing of the buyback in 2014. I didn't understand what your answer was to 2 questions ago. Is that going to be market dependent or you're going to set a time; 1 year, 2 years, 3 years? That will be helpful.

Robert L. Edwards

Well, it will depend on market conditions. But we haven't, since we're just announcing the transaction now and the cash isn't expected until the fourth quarter. But there are no specific conclusions about the timing. And given the size of the dollars involved here, if we have purposes there -- in open-market transaction, it would take some time. And as you may recall from our prior comments on stock buyback, we don't announce exactly -- our historical pattern is not to announce when we're going to buy back stock. But as we get closer to the close of the transaction, I think we'll probably have more to say about this.

Operator

Our next question comes from DeAndre Parks of Western Asset Management.

DeAndre Parks

Can you please have comment on, I guess, the timing of your intention to get back to a mid-investment grade? Kind of like, as I go back to my notes, I thought that was kind of like the primary priority when we last sat down and spoke. And it seems like you have an opportunity, and why not exercise it now?

Robert L. Edwards

Well, mainly, it -- clearly, it has been our objective, remains our objective to return to that. And our priorities for allocation of free cash flow this year, and that's excluding this transaction, have been to pay the dividend but primarily, to reduce debt.

Melissa C. Plaisance

And also, let me point out that the rating agencies go through an elaborate process in coming up with our ratings, and it's not all dependent on debt levels. They also look at the performance of the company and so forth. They will have time to look at that. It's not all by specific ratios, but we've done what we believe is appropriate here to earn our way back to mid-BBB with the 2 that don't have us there. And it's not all about the amount of debt.

DeAndre Parks

I understand, but I think...

Melissa C. Plaisance

We think we've allocated a sufficient amount to make a substantial progress towards that goal.

DeAndre Parks

But you also you thought that when you increase leverage, it would be sufficient to maintain a mid-BBB rating.

Melissa C. Plaisance

Right. We are not in control of the rating agencies, but we work very closely with them, and we get lots of feedback from them. And we have made it clear what our goal is, and we will continue to work closely with them as the months and years go by.

Operator

Our next question comes from Andrew Wolf of BB&T.

Andrew P. Wolf - BB&T Capital Markets, Research Division

In the release, and I guess you referenced it too, of the $2 billion that remains after you buy -- after you retire debt, there's a reference to growth opportunities. Could you help us understand what you might be thinking about there, particularly in regards to whether that refers more to some internal initiatives, the company talked about health care initiatives and maybe others that we don't know about? Or is that, in fact, more what's going on with the industry sort of accelerated the consolidation right now, especially in the U.S., where clearly multiples are -- for M&A are lower than what you just received?

Robert L. Edwards

Well, Andy, as we indicated in the release, the primary uses for the proceeds from the transaction will be paying down debt, and that we indicated the majority of the remainder would be used for stock buyback. But we felt it was appropriate to comment on our objective to grow the operating income of the core grocery business, which we are focused on. And so, it primarily refers to the internal initiatives that we have been working on and we've communicated and discussed with you and others as recent as the investor conference. But we have a strong focus on growing operating income of our core grocery business, and that's what that comment's addressed at.

Operator

Our next question comes from Joe Feldman of Telsey Advisory Group.

Joseph I. Feldman - Telsey Advisory Group LLC

Was just curious if you could give a little more color as to the decision behind selling the entire Canadian asset, which is quite a strong asset from our vantage point versus -- there had been discussion of putting some of the assets into a REIT and breaking it apart or doing a spin-off. Or I guess, just why sell the whole thing? It is such a good asset. And also, if there was an auction process or this was just a straight-up negotiated deal.

Robert L. Edwards

The -- we're very, very proud of the assets. Our management team in Canada has done a great job in creating such a strong business, and an auction process was not run. And this was an unsolicited offer. And as we have thought about that offer on these assets and reflected about the interest that has been expressed in the assets over time, we believe that this was an extremely attractive offer and that it offered a substantial premium to the market multiples for U.S. retailers. And if you look at the multiple that we've received versus where we're currently trading, it's in excess of 2x what we are currently trading at now, so a significant premium. And so based on the analysis that we did, we believe that this transaction maximized the value of our Canadian assets. And that was the conclusion reached and therefore, pursued this transaction that we announced today.

Operator

Our next question comes from Damian Witkowski of Gabelli & Company.

Damian Witkowski - Gabelli & Company, Inc.

Question, what -- could you give us a better sense of what the store count now is? I know you have about 220 stores or so in Canada, but ownership of real estate in Canada was higher than the company average. So can you give us a sense of what the ownership is after this deal?

Robert L. Edwards

The ownership in Canada was about 52% of the assets. On average, for the corporation, it's about 42%. And so once the transaction is completed, the remaining store count will be approximately 1,415 stores and then about 20 manufacturing facilities in the U.S..

Damian Witkowski - Gabelli & Company, Inc.

Okay. And then anything in particular that made you go this route versus doing -- I know you've explored a REIT in Canada, and you think that, besides a nice multiple, that was more attractive going the -- out by sale route.

Robert L. Edwards

Yes. We've looked at a range of alternatives over time. And as I just indicated, we think that this transaction maximizes the value of our assets in Canada.

Operator

[Operator Instructions]

Melissa C. Plaisance

Okay. If there are no other questions, again, we appreciate you all responding on such short notice. Are there any other questions, Sharon, before we conclude?

Operator

We do have a question coming in from Mr. Edward Kelly of Crédit Suisse.

Edward J. Kelly - Crédit Suisse AG, Research Division

It's Ed Kelly. A couple of questions for you. One, could you just help us understand how this transaction -- how do you think about the core business now post this transaction and what type -- how it might actually change your strategy? Is there some investment and price component that we should think about? Does the strategy really change at all? And then second part of that is, what does the free cash flow of the business look like post the sale?

Robert L. Edwards

And all very good questions. The intent -- since we've just finalized the agreement and made the announcement, the focus of the call today was to address questions, specifically, to the transaction. Our earnings -- our next earnings release will be in about 5 weeks, I think on the 18th of July, and so -- and we'll be prepared at that point to comment on the business, excluding Canada, going forward and then respond to all the questions that you had. And so, in about 5 weeks, we'll provide further clarity on the business going forward and responses to those questions and related questions about the remaining company going forward.

Operator

Our next question comes from Keith Howlett of Desjardins Securities.

Keith Howlett - Desjardins Securities Inc., Research Division

Yes, I have a question about issues around the trademark of Safeway, whether there's a, I presume, a long-term licensing agreement. And then I was wondering what was happening with the Just for U loyalty program that I think you were planning to introduce in Canada this year.

Robert L. Edwards

Regarding Just for U is you're correct. The Just for U platform is not in Canada at this time. We've been working for some time to develop the technology to have Just for You in Canada. And so we plan to talk to Sobeys about the potential use of the tech -- of the Just for U technology as we move forward. And so part of the agreement does cover the Canada Safeway name and related trademarks, and so those names are part of the transaction and for potential use by Sobeys.

Operator

Our next question comes from Shane Higgins of Deutsche Bank.

Shane Higgins - Deutsche Bank AG, Research Division

A quick follow-up, Robert. What's the breakdown on the overhead? Is it pretty evenly -- is it mostly in the U.S.? Or is some of that going to go away with the Canadian assets? Or is it pretty pro rata split?

Robert L. Edwards

Well, most of the overhead costs, clearly for the corporation, are U.S. based, some in Canada. And so I think, in response to the questions that Ed had earlier, all the questions related to remaining co and related issues, which would include overhead, we'll address on the earnings call. We'll release our Q2 earnings in the middle of July.

Operator

And I am showing no further questions at this time.

Melissa C. Plaisance

Very good. Thank you, everyone, for joining us on such short notice. Christiane Pelz and I will be available to clarify any questions you might have remaining.

Operator

This concludes today's conference. Thank you for your participation. You may now disconnect.

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