Great Atlantic and Pacific Tea F2Q09 (Qtr End 9/12/09) Earnings Call Transcript

Oct.20.09 | About: The Great (GAP)

Great Atlantic and Pacific Tea (GAP) F2Q09 Earnings Call October 20, 2009 11:30 AM ET

Executives

William Moss - Vice President, Treasurer

Christian Wilhelm Erich Haub - Executive Chairman of the Board

Brenda M. Galgano - Chief Financial Officer, Senior Vice President

Analysts

John Heinbockel - Goldman Sachs

Karen Short - BMO Capital Markets

Bob Summers - Pali Capital

Reed Kim - Banc of America

Operator

Good morning and welcome to the Great Atlantic & Pacific Tea Company’s conference call. (Operator Instructions) Chairing today’s call will be Christian Haub, Executive Chairman. Also participating on today’s call will be Brenda Galgano, Senior Vice President and Chief Financial Officer. I would now like to introduce Mr. Bill Moss, Vice President and Treasurer, who will read A&P’s Safe Harbor disclaimer. Mr. Moss.

William Moss

Thank you. Good morning, everyone. This morning’s presentation may contain forward looking statements about the future performance of the company and is based on management's assumptions and beliefs in light of information currently available. The company assumes no obligation to update this information. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements, including but not limited to competitive practices and pricing in the food industry and particularly in the company's principle markets; the company's relationship with its employees; the terms of future collective bargaining agreements; the costs and other effects of lawsuits and administrative proceedings; the nature and extent of consolidation in the food industry; changes in the financial markets which may affect the company's cost of capital or the ability to access capital; supply or quality-control problems with the company's vendors; and changes in economic conditions which may affect the buying patterns of the company's customers.

I will now turn the call over to our Executive Chairman, Christian Haub.

Christian Wilhelm Erich Haub

Thank you, Bill. Hello, everyone and welcome to our first live conference call since our new financing closed in early August. As you can tell from our press release, we again had an important development in addition to our quarterly results but let me assure you we are not planning for this to become a regular event.

Let me start this morning with our management change. We announced the departure of our CEO, Eric Claus. The company’s performance has not met our expectations and based on these results, the company felt a change in leadership was warranted and appropriate.

I would like to thank Eric for his contributions during his tenure with A&P and wish him well in his future endeavors. We have commenced a search for a permanent successor and in the interim, I will re-assume the responsibilities of the Chief Executive Officer.

In my role as executive chairman, I have stayed close to the business and I am familiar with our strategy and initiatives and I intend to drive forward with the plans we have put in place.

Before I get into the second quarter performance review, let me briefly talk about the new financing we secured for A&P since the last time we spoke. As you’ll remember, in late July we announced the execution of two investment agreements with Yucaipa and Tengelmann for $175 million of convertible preferred stock, as well as the launch of a high-yield debt offering. In early August, we closed on all these transactions and raised gross proceeds of $435 million, representing a significant strengthening of the company’s balance sheet.

Both Yucaipa and Tengelmann believe that investing these funds in A&P in combination with the senior secured notes has put the company in a great position to pursue its format strategy and strengthen its strategic position in the Northeast while at the same time addressing its near-term financing needs and reducing its overall leverage. Both Yucaipa and Tengelmann strongly believe in the strategic value of the company following the acquisition of Pathmark and while the company is not yet performing at its full potential, we have agreed on a plan to driver performance and create shareholder value.

Our working relationship with Yucaipa is off to a great start as we continue to look at ways to improve our overall business strategy. We’ve begun working on projects in labor relations and marketing and we are planning further projects in such areas as pricing and store operations, as an example. I am intending to take full advantage of their knowledge and expertise, especially in these challenging times.

Let me now turn to the second quarter, and share with you my views of the company’s most recent performance. While sales have been very difficult to come by in this extremely challenging economic environment for our industry, our gross margin expense management have enabled us to realize respectable operating earnings and EBITDA. Our legacy businesses, namely our fresh, gourmet, and discount operations continue to improve their EBITDA results despite softer sales, which I believe is quite encouraging.

Our price impact on Pathmark business is not performing at the level it should but we are working very hard to implement the necessary changes to return this business to a better level of performance. To that end, we have made significant price investments in that business, which has hurt results in the quarter.

It takes time to get credit from the consumer for these price reductions but we are seeing some promising early signs, such as increased traffic and item counts, although they are not enough yet to pay for the overall investment.

We also increased our marketing spend in the quarter to make our customers more aware of our improved pricing and again we believe it will take some time before this message has fully registered with consumers.

When it comes to describing the overall environment we are operating in, I can certainly say that the external headwinds has clearly become worse during the second quarter and the first part of our third quarter. Unemployment keeps rising, consumers continue to trade down, price competition is heating up in our markets, and now we are also experiencing significant deflation across our entire business. It is fair to say that we are currently going through one of the worst environments I have ever experienced in my career in the supermarket industry.

Against this challenging external backdrop, we continue to implement our business optimization initiatives and while we are already realizing some of the anticipated benefits in the areas of labor productivity, supply logistics, and energy management, some of them have been eaten up by the effects of the worsening environment.

We still have a lot of work ahead of us and areas such as stock losses have not yet accomplished the level of improvements we would like to see. But the worsening economy and now deflation are creating additional challenges affecting our shrink experience. Our private label penetration, however, continues to make progress, especially in our Pathmark business. And our most recent addition of a natural and organic line called Green Wave has had tremendous success.

Looking ahead, I am realistic about the short-term, especially considering the pressure deflation is putting on results. I do believe, however, that the headwind from deflation won't be around for long, since many commodities have already bounced off their lows and I expect for inflation to return next calendar year.

I am more concerned with rising unemployment and its dampening impact on consumer spending in our sector, despite the economic recovery gaining traction. Therefore we have to be realistic about sales expectations and consider our cost structure accordingly. We will have to work extra hard to generate offsets to these negative factors but this company has faced many challenges before and I am confident we will continue to find solutions for these problems.

Longer term, I am confident that with a much stronger balance sheet and the support of Yucaipa, we will be able to accelerate the performance improvements we are working on, add new business improvement initiatives, and drive our format strategy to the next level.

Considering the different consumer mindset we are experiencing today, I see tremendous potential for our price impact and discount formats, which should thrive in the new, more frugal consumer environment which the recession has created and which will most likely continue even when the economy recovers.

My focus over the next few months will be on securing our strong cash position, producing respectable EBITDA results and generating reasonable revenues, and of course recruiting a top notch CEO to take our company forward and realize the tremendous potential A&P has.

That concludes my opening remarks and I will now turn it over to Brenda and I will be back to summarize before we go to Q&A. With that, Brenda.

Brenda M. Galgano

Thank you, Christian and good morning, today we reported second quarter sales of $2.1 billion and a loss from continuing operations of $62 million, which includes a $50 million increase in non-cash mark-to-market adjustments related to the financial liabilities. Comparable store sales were negative 3.8% in the quarter. Deflation in increased promotional activity had a larger impact on our second quarter results. We continue to experience negative sales trends during the first several weeks of the third quarter. Deflation has accelerated into the third quarter; however, unit or tonnage trends are improving and are positive to date in our third quarter.

Excluding non-operating items of $15 million this quarter, adjusted EBITDA was $64 million versus $67 million last year. Schedules 3 and 4 of the press release detail the non-operating items for both years.

I would also point out that the current quarter’s EBITDA includes approximately $3 million in higher, non-cash pension expense than in the prior year due to changes in actuarial assumptions.

Second quarter ongoing gross margin excluding LIFO provisions increased 33 basis points to 30.23%. Gross margins were positively impacted by improvements in our fresh business and partially offset by lower margins in our price impact business due to more promotional sales and price investments.

Second quarter adjusted SG&A increased 32 basis points from 29.62% to 29.94%, driven by lower sales leverage on fixed costs, mainly labor, and $3 million of higher non-cash pension expense.

Non-cash stock comp expense for the second quarter was $1.2 million this year versus $2.2 million last year.

Second quarter interest expense includes a non-cash adjustment for our GHI liability of $7.6 million. Capital spending totaled $23 million. Depreciation expense was $58 million. This compares to $30 million of capital expenditure during last year’s second quarter, with depreciation of $61 million.

During the quarter, we completed two new price impact stores, one fresh conversion, one discount conversion, and one liquor store remodel.

Turning to our balance sheet, I am very pleased with our recent capital raise, which consisted of $260 million of 11.375% senior secured notes due 2015 and $175 million in 8% cumulative convertible preferred shares. These finances have certainly bolstered our liquidity and provide flexibility to address our short and mid-term financing needs, including our outstanding convertible notes. We continue to evaluate alternatives in this regard and we will communicate the use of funds at the appropriate time.

I would like to make a few additional comments on the preferred shares. Based on applicable securities laws, on the date of issue approximately one-third of the preferred shares are convertible within one year of their issue date. In accordance with GAAP, and until such time that shareholder approval is obtained, approximately two-thirds of the preferred shares, or $117 million, has been classified as a preferred stock liability on our balance sheet.

Upon shareholder approval, which is expected by early December, the preferred stock liability will be reclassified from liabilities and included with the other preferred shares on our balance sheet.

A final point -- from an enterprise value perspective, our total outstanding share count is approximately 90 million shares. This represents the current 58 million shares outstanding plus 35 million in convertible preferred shares, plus another 2 million for the in-the-money stock compensation, less 5 million of shares to be returned under the share lending agreement. Excluding the preferred stock liability, we ended the quarter with net debt of $1.217 billion, which includes capital leases and real estate liabilities, and is net of $256 million in restricted cash and short-term investments.

For the quarter, free cash flow was $15 million, consisting of adjusted EBITDA of $64 million, net cash interest paid of $24 million, taxes of $2 million, and CapEx of $23 million. The $140 million decrease in net debt from last quarter resulted from the following -- the free cash flow of $15 million, real estate proceeds of $1 million, and proceeds from the preferred stock issuance of $175 million. This was offset by total financing fees of $23 million, payments against dark store liability of approximately $15 million, and working capital changes and other of $4 million.

Liquidity at the end of the quarter was $483 million, comprised of borrowing base availability of $232 million, and short-term investments of $251 million. Outstanding loans totaled $132.9 million, and letters of credit totaling $199.6 million.

As of the end of the quarter, we had a net tax operating loss carry-forward of $549 million to offset future tax profits, including operating profits and capital gains. Our closed store reserve was $205 million, which increased $16 million from the first quarter, related primarily to an increase of $13 million from the closure of four stores and $14 million for changes in estimates on existing liabilities, offset by payments during the quarter.

Given the slow real estate market, we have changed our estimates on the length of time to sub-lease dark locations and decrease the amount of estimated sub-leasing counts.

In conclusion, I would like to make the following comments -- the quarter was a challenge, with increased deflation and competition, as well as rising unemployment putting more pressure on the top line. Our fresh, gourmet, and discount formats continue to experience improvement in margin and segment income. While price impact continues to be a challenge, our pricing investments, as well as our optimization initiatives, are aimed to better position the business to compete in the long-term.

We don’t expect much improvement in the short-term; however, we continue to be focused on generating net positive cash flow for the year and are planning to mitigate lower EBITDA earnings with other cash generating initiatives, including working capital management.

I will now turn it back to Christian.

Christian Wilhelm Erich Haub

Thank you, Brenda. I want to close with a brief summary of what you have heard today. We have made a leadership change and the interim transition should be relatively seamless. More importantly, I am confident we will attract a top-notch CEO to lead the company going forward. With the investments by Tengelmann and Yucaipa, the company has made a major step towards improving its balance sheet, securing additional liquidity, and addressing its financing needs. Now A&P will be able to focus on improving its operations and realizing the benefits of its many optimization opportunities and driving its format strategy.

A&P remains in a very strong strategic position and believes that with the support of Yucaipa it will successfully manage through the current major recession and emerge a much stronger player in the Northeast supermarket industry once the economy recovers. While the operating environment continues to deteriorate, in the short-term we are determined to take whatever actions are necessary to stem the negative performance but at the same time stay focused on the longer term opportunities we have identified.

I am today more confident about A&P's future and look forward to realizing the full potential of the company and working together with Ron Burkle and Yucaipa to create significant shareholder value in the next several years.

This concludes our presentation part and we are now ready to take your questions, so Operator, if you could start that process.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Heinbockel with Goldman Sachs.

John Heinbockel - Goldman Sachs

So Christian, a couple of things -- what are the qualifications you are looking for in the new CEO? And how long do you think that process will take -- you know, likely to be -- I imagine it’s going to be fairly lengthy, so we’re not talking until maybe early next year at the earliest but what are your thoughts on that?

Christian Wilhelm Erich Haub

Well, I really don’t want to put a time estimate on how long the process is going to take but saying a few words about the type of candidate we are looking for, it is clearly somebody who has a good amount of experience in the food retail industry but I think we look at this industry and defining it larger than just supermarkets. You know, we today compete in a world where we compete with warehouse clubs and discounters and [inaudible] discounters and different formats, and I think that is something very important for me for the next CEO to understand and how we successfully compete in an environment like that. You know, we’ve been working on a transformation strategy with some very good success in the past but also with some challenges and we need to further transform the business, so I think the next leader has to share in that vision that success will not come from actually just tinkering with what is existing but thinking in more radical ways of better position and transforming this organization.

John Heinbockel - Goldman Sachs

Is it likely to be -- do you think it is likely to be someone with a prior relationship with Yucaipa, or it doesn’t have to be -- that’s not the path this likely goes down?

Christian Wilhelm Erich Haub

I think we have agreement that we are looking for the best possible candidate and we are not limiting ourselves to anything here, and I am looking forward for Yucaipa’s involvement, since they have a pretty major stake in this decision and I think this is going to be a very collaborative process with specific members of our board that will be engaged, as well as myself.

John Heinbockel - Goldman Sachs

Just touching on Pathmark then, you made the point that the business should be doing better in this economy. I guess you are seeing some signs in terms of tonnage that things are getting a little bit better but how long do you think it will take to change price perception and I guess it’s likely that you need to make some greater changes to the look of the store but that -- how quickly do you think that is going to happen, Pathmark?

Christian Wilhelm Erich Haub

Well, I think it is good that we are seeing some signs and we are all trying to figure out how much is the economic headwinds kind of masking the real progress that might be going on and you know, customer perception is something that we know from experience doesn’t turn overnight and we have to keep working on this and do what is necessary. The consumer is clearly in a massive trading down spirit right now and our sales and promotions are significantly up over a year ago and consumers are clearly navigating the stores to find the best values that they are looking for. There’s great discipline in terms of shopping lists. People are holding back on making any kind of impulse or discretionary purchases when it comes to -- when they walk through our store, so a lot of kind of the old merchandising techniques are just not as successful today as they used to be. But you also have to be careful that we are not trying to steer the customer to only buy what is on promotion and what is reduced in price. I think we have to really focus on getting them an overall basket that is competitive and our price investments were necessary and have put us into a much more competitive situation and there’s clearly reaction by competition. Everybody is investing in price and everybody is investing in promotion, so there’s really a flurry of activity out there and have kind of break through to the consumer in a meaningful way is clearly more challenging but with time and with further actions that we need to take, and we will see some progress there. I mean, Pathmark had a good price reputation and has a good position there and I think reinforcing that and bringing the customer back to that is -- is going to take time but it’s going to work.

John Heinbockel - Goldman Sachs

Do you think -- and I don’t know about you guys, but do you think that competitors in general, people out there are making some un-smart decisions, un-smart investments because of what we are seeing with deflation? That made people a little less disciplined and as inflation comes back, you see some of those programs, efforts cease or no?

Christian Wilhelm Erich Haub

Well, I think we’re probably not the only industry that in times of recession become desperate for top line and make irrational decisions and irrational promotions. I think that’s natural. You know, we have to assess ourselves in that and I think that’s what we have to look at, and we can't chase every promotion that is being run by other competitors out there. Then we are only going to contribute and drive greater irrational behavior but I think we are clearly at the depths of this very, very difficult environment.

And deflation only adds to that, it doesn’t make it better. But I think deflation is hopefully going to be a relatively short-term phenomenon. All indicators from the commodities markets and conversations we are having with suppliers seems to be pointing towards a return to some moderate inflation, which is typically the best environment to operate in and I think moderate inflation in hopefully an environment where the consumer at least feels stable and not trying to save more money and trading down even further could be beneficial.

John Heinbockel - Goldman Sachs

All right, and then finally, I know there are some opportunities on the supply chain, you know, some stuff that P&S can do, can any of that be moved up or accelerated or is that still -- some of that still 18 months down the road?

Christian Wilhelm Erich Haub

Some of it will be structural but I think there is always opportunities in the short-term for improvements, for efficiencies, for just looking at how we can work together more effectively, so I think as -- probably as much short-term than there is longer term and we have seen some progress in our supply and logistics costs in the quarter and that’s -- the frustrating thing right now is just that all the progress we are seeing in a lot of these initiatives are eaten up by the declining sales and the tough margin environment.

John Heinbockel - Goldman Sachs

All right, thanks.

Operator

Your next question comes from the line of Karen Short with BMO Capital Markets.

Karen Short - BMO Capital Markets

Just digging into the comp a little bit, maybe could you just give a little more color on traffic versus basket in the second quarter and then you made comments on the third quarter and it sounds like the overall comp got worse but -- so units are better -- I mean, is traffic unchanged or -- how should I think about that?

Christian Wilhelm Erich Haub

Let me correct that -- the sales trend in the third quarter is not worse than it was in the second quarter, and clearly the main drivers of the comps is a reduction in the average transaction size, which is driven by the average item price declining, which is partially driven by real deflation, partially driven by our price actions, and it’s more pronounced in the price impact business than in our legacy businesses.

The customer count trends are, while still negative, have improved over our first quarter levels and similarly, the number of items in the basket are on an improving trend and now in the third quarter have really turned nicely positive but in the third quarter, we are seeing a much heavier impact of deflation now on the average item price.

Karen Short - BMO Capital Markets

Okay, and then -- okay, so if I look at the basket and you look at the percent of items purchased on promotion versus non-promotion --

Christian Wilhelm Erich Haub

It’s up.

Karen Short - BMO Capital Markets

But can you give us some direction -- like how, what percent of it now and where would it have been a year ago?

Christian Wilhelm Erich Haub

It’s up in the kind of mid-single-digits percentage wise, so that’s a --

Karen Short - BMO Capital Markets

It’s increased by mid-single-digits percent wise?

Christian Wilhelm Erich Haub

Yes.

Karen Short - BMO Capital Markets

But what percent of items would be on promotion versus non?

Christian Wilhelm Erich Haub

I don’t think we have the exact number but it’s in the 40% range.

Karen Short - BMO Capital Markets

Okay, and is that across all banners or more specifically Pathmark?

Christian Wilhelm Erich Haub

You would find a probably bigger jump in the Pathmark business, but in our -- our legacy business, it’s gone up across the board.

Karen Short - BMO Capital Markets

Okay, and then if I were to look at your segment data, I’m just wondering if you could give some color on the store count in the fresh versus the price impact year over year. Like what -- because I guess there would have been some conversion so you would have lost some stores in the fresh and gained some in the price impact, is that right?

Brenda M. Galgano

That’s correct. It’s -- using round numbers, Karen, it’s approximately 10 stores that would have come out of fresh and into the price impact segment.

Karen Short - BMO Capital Markets

Okay, so if I kind of back into weighted average, I mean, I’m getting a price impact comp. Obviously your sales declined 5.2% for price impact this quarter but the comp would have been significantly worse than that, given that you would have benefited from a change in, or an increase in units. Am I right on that?

Brenda M. Galgano

Well, at the same time, we did convert -- we did close some Pathmarks. One was later reopened as another format but during the quarter, we closed four Pathmark locations. So on a net basis, I would say it’s probably -- on a net basis, Karen, more like five stores that were added to the Pathmark segment.

Karen Short - BMO Capital Markets

Okay, got it. Okay, and I guess just wondering if you -- you know, you did -- you briefly touched on what your opportunities are, or that you have opportunities on the cost structure side, and I guess also working capital. Could you maybe just elaborate a little bit on what the cost structure opportunities?

Christian Wilhelm Erich Haub

I think it’s the same initiatives we have been working on and that we have identified over the longer term to drive positive contributions to the company and labor is one area, also the supply and logistics area. You know, energy management, which is utility costs, stock losses, which we probably made the least amount of progress so far. But we are continuously looking at the business and saying where can there be other opportunities to lower costs if it includes our customer/employee accidents, for example, or any kind of store expenses that we can look at. So it’s a continuous process of how do we lower costs because I think in this environment, I think the sales potential is more limited by everything that is going on externally and so the more we can take out of cost, the more we can offset these external headwinds and with the lower cost structure eventually going into an economic recovery that our industry will benefit as well, will lead to a greater acceleration of profit growth than if we don’t take costs out.

Karen Short - BMO Capital Markets

Would you say there’s also some opportunities on the rent side of the equation? I mean, it seems like with your weaker -- well, weak sales relative to some of your competitors in this market, you may have some leverage on renegotiating.

Christian Wilhelm Erich Haub

We have done that continuously but I think our potential might be a little less, since many of our rents are below market and it’s much more difficult to get rent reductions or rent concessions if your rents are already significantly below market. But we have been successful in a number of cases but I don’t think that that’s going to have a very pronounced impact on the costs overall.

Karen Short - BMO Capital Markets

Okay, and then help me understand the GHI situation -- I noticed in your quarter, or your Q last quarter, you gave the new under-funded status of like $94 million and it looks like it has climbed to about $99 million. And I thought it was only kind of in the $40 million range pre the -- you acquiring, like at Pathmark before you acquired them. So I guess the first thing obviously that the market’s been terrible but can you explain what is going on with that? And also just explain what the cash impact is -- you said something about interest expense.

Brenda M. Galgano

Sure, right. When we first acquired the liability, we valued that liability at approximately $70 million. But since then, we have made changes in assumptions and we actually have to mark-to-market that liability every quarter, so this quarter we increased the liability by approximately $8 million and that’s due to a change in the discount rate. So it’s all -- it doesn’t affect our cash and it does flow through interest expense, so our interest expense this quarter is higher than the typical run-rate because of that non-cash adjustment.

Karen Short - BMO Capital Markets

Okay. And so if someone were to acquire you, would they have to make up that dollar amount? Like, what would have to happen to that under-funded component? Would it just stay --

Brenda M. Galgano

They would assume that liability but there would be -- that would be it. They wouldn’t have to come up with the cash. It’s a liability that’s paid over several years, as benefit payments are paid out.

Karen Short - BMO Capital Markets

Okay, and then just the last question and I’ll get back in the queue -- do you have any sense of where CapEx is going to be for this year? And if you said it, I didn’t catch it but this year and also next year?

Brenda M. Galgano

For this year, we still expect to be in the $100 million range. It will likely fall a bit lower than that. And then next year, that is still under review.

Karen Short - BMO Capital Markets

Okay, great. Thanks very much.

Operator

Your next question comes from the line of Bob Summers with Pali Capital.

Bob Summers - Pali Capital

Good morning. I wanted to try and get a little more granular on the expense side of the discussion. I think when the challenges first emerged with Pathmark two or three quarters ago, half of the issue was gross profit dollars contracting under a negative comp and the other half was related to the expense structure. If you could maybe talk about some of those items and update us on where we are in terms of fixing it?

Christian Wilhelm Erich Haub

I think there’s a lot underway, including all the areas we have touched upon -- labor, stock losses, distribution, on the expense side and probably a number of others that I can't recall at the moment but the pressure on the results is clearly coming from negative comps and the price investments that are pressuring the margin. And that impact is much more significant than the ability to make that up through these cost initiatives, some of which we’ve talked about are of a structural nature and will take some time to unfold, including particularly the supply and logistics area.

But we are taking this really from a longer term perspective because we know the current environment is not going to be kind of normal going forward and there will be some recovery in terms of sales and margin because of the ongoing price investment and consumers trading down, so as much as it is painful in the short-term, I don’t see that becoming kind of the new basis going forward. And so once that begins to recover and we will see cost reductions continuing to come through, you know, the business will improve significantly.

Bob Summers - Pali Capital

Okay, and I jumped on a little bit late -- did you talk about any synergy numbers at all, either in this quarter or the prior quarter?

Christian Wilhelm Erich Haub

No, actually we stopped talking about synergies a couple of quarters ago because we really felt that that work was completed at the end of the last fiscal year, so we are not really talking about that any further.

Bob Summers - Pali Capital

Okay, and then just on a broader basis with respect to competitive activity, I mean, are we seeing anything stabilize? Is it getting worse, getting better? And how does deflation play into that, which seems to be at the margin not bottoming like a lot of people had thought?

Christian Wilhelm Erich Haub

I think you are right about that but I believe -- and maybe that’s more hope than belief but I think there is a lot of data on the commodity side to indicate that deflation will bottom and will return to some form of inflation in the not-so-distant future but it’s clearly not helpful for the current environment and we are going into pretty important holiday selling season and it’s going to be interesting to see that’s going to become even more aggressive than what it has been since the summer, which typically you see a pick-up in activity as everybody is kind of vying to kind of grab the consumer that is coming back from the summer break and getting back into their more normal routines, and then that typically subsides to some degree as we go into the Halloween through Christmas period. So I think the next couple of months will be interesting from that perspective.

Bob Summers - Pali Capital

Right, and then just conceptually, as we potentially move from the current deflationary environment into something that shows a little bit of inflation, can you talk about pass through a little bit? I mean, there’s been points in time within the industry where because of competitive situations or employment situations, there’s kind of a lag there. I mean, you think you see that this time around or because everybody is so desperate for margin and comp that you get an immediate pass-through?

Christian Wilhelm Erich Haub

I would say that any opportunity after this absolutely brutal environment to get some benefit back, that everybody is inclined to do that.

Bob Summers - Pali Capital

Okay, thanks.

Operator

We have time for one final question. Our next question comes from Reed Kim with Banc of America.

Reed Kim - Banc of America

Thanks. I just wanted to follow-up on the pricing question -- I was curious what fraction of, especially the Pathmark or price impact stores you’ve taken the pricing adjustments to. I think it was partial as of the summer and then related to that, are you seeing in the parts of the chain that have already taken prices lower, what sorts of reactions by competitors are you seeing?

Christian Wilhelm Erich Haub

We have adjusted pricing in those stores in those markets that we felt we had to really make those investments and we’ve clearly seen a trend change versus the baseline trend that those stores or markets had before we made those investments. Again, as I said, particularly in customer count and the item count that has gone up, you know, some of it will be kind of the early consumers who are kind of coming in and buying a lot of what we have on promotion that we then hope to convert to more regular customers with more diverse baskets and -- but it’s kind of following a relatively typical kind of trend and I think this time around, these things tend to take a little longer before they get traction but we are measuring various different elements of it to see how is our private label penetration improving and are these people shopping in the fresh departments, you know, is their basket more of a cherry picket basket or a broader basket and lots of other measures that is encouraging but not at the levels that we need to be for either being a real, more immediate pay-back on the investment but I think strategically these are absolutely the right things to do.

Reed Kim - Banc of America

And so it sounds like your competition is not coming back at you and really trying to react and taking things to the next level now.

Christian Wilhelm Erich Haub

We have changed our price position to a level that we believe we need to be at in terms of competitive versus all the key competitors we’ve identified and they have not come back and tried to kind of widen the gap again, or something like that. So from that perspective, we’ve accomplished an important part of that strategy.

Reed Kim - Banc of America

Okay, just two more -- quickly on the labor front, I guess your executive in charge of HR left a month ago. I was just curious if there were any updates on union relations in the quarter and whether the deeper presence by Yucaipa bringing anything else to that in these early days?

Christian Wilhelm Erich Haub

I think the transition there has been seamless and has not interrupted anything we’ve been working on and I think the integration of Yucaipa into some of these processes and projects is working well, as I mentioned during my presentation. So I’m not foreseeing any issues. I think there’s just plenty of opportunity.

Reed Kim - Banc of America

Okay, last one -- Brenda, the real estate related activity in the quarter, it would be $11.5 million. If you could just help me understand that a little bit more and maybe what we should expect that to be in the next quarter or two?

Brenda M. Galgano

Sure. There’s actually two pieces of it. Some of it is in real estate related activity and there’s a portion also in discontinued ops, but we did increase our -- well, first of all we closed four locations, so we did increase our reserve for the closure of those locations, our closed store reserves. In addition to that, given the slowing of the real estate market, we changed our estimate on existing [dark] locations whereby we increased the amount of time we believe it will take to sub-lease those locations, as well as the amount of estimated sub-leases that will come in once we do enter into sub-leases. So that’s what you are seeing flow through the real estate activity.

Going forward, what we have recorded today is our best estimate so we don’t expect that will have any further adjustments, so obviously this was something that we review every quarter to evaluate whether adjustments need to be made, whether they are a positive or a negative. And I will note that this is a non-cash adjustment, so it did not impact cash flow for the quarter.

Reed Kim - Banc of America

Okay, great. Thank you.

Christian Wilhelm Erich Haub

Great. I believe that concludes our Q&A for today. We thank you for participating and we will talk to you again at the third quarter conference call, which will be early next year. Thank you very much.

Operator

This concludes today’s conference. Thank you for your participation.

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