SUPERVALU Inc. F2Q10 (Qtr End 09/12/09) Earnings Call Transcript

Oct.20.09 | About: SUPERVALU Inc. (SVU)

SUPERVALU Inc. (NYSE:SVU)

F2Q10 Earnings Call

October 20, 2009 10:00 am ET

Executives

David Oliver – Vice President of Investor Relations

Craig Herkert – President and Chief Executive Officer

Pamela K. Knous – Executive Vice President and Chief Financial Officer

Analysts

Deborah Weinswig - Citigroup

John Heinbockel - Goldman Sachs

Meredith Adler - Barclays Capital

Edward Kelly - Credit Suisse

Karen Short - BMO Capital Markets

Scott Mushkin - Jefferies & Co.

Mark Wiltamuth - Morgan Stanley

Neil Currie - UBS

Charles Grom - J.P. Morgan

Operator

Good morning. My name is [Whitney] and I will be your conference operator today. At this time I would like to welcome everyone to the SUPERVALU second quarter earnings conference call. (Operator Instructions)

Now I would like to turn the call over to David Oliver, Vice President of Investor Relations. Sir you may begin.

David Oliver

Thank you and welcome everyone. SUPERVALU’s call today is webcast and will be available for replay on our website.

Today on the call are Craig Herkert, SUPERVALU’s Chief Executive Officer and President and Pam Knous, Executive Vice President and Chief Financial Officer.

As you know, the information presented and discussed today includes forward-looking statements which are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our fiscal 2009 10-K.

Craig will begin today’s call by discussing his vision for SUPERVALU. Pam will follow with comments on the quarter and Craig will return with his concluding remarks. After today’s prepared remarks, we will have a question-and-answer session. We are scheduled to run one hour on prepared remarks and one-half hour on Q&A. As in prior quarters, I will be available after the call for additional questions.

I will now turn the call over to Craig.

Craig Herkert

Good morning. Let me begin today’s call by discussing with you my vision for SUPERVALU. On the first quarter conference call I stated that I was confident that my vision would build upon the tremendous assets that make up SUPERVALU’s businesses; specifically, energized associates and outstanding retail store base, highly successful independent retailers and sophisticated supply chain operations. So you will not be surprised if the vision I’m sharing with you today takes full advantage of this very strong base, capitalizing on our many strengths and competitive advantages.

In my first five months I have conducted a comprehensive review of the company, which has included visiting SUPERVALU’s retail stores and supply chain operations as well as talking with employees, independent retailers, vendors and the board. I have also taken stock of the competitive environment and the economic headwinds that the industry and our company face. All of this has helped me develop a new vision for SUPERVALU that will unlock shareholder value and enable us to realize our full potential.

One of my first steps was to engage with my executive time to articulate exactly who we are. This focused us on the unique strengths we possess and formed the basis for our efforts to identify how best to leverage these strengths. So, who are we? SUPERVALU is a uniquely positioned grocery and pharmacy company serving a wide range of customers in neighborhoods nationwide through stores ranging from hard discount to traditional and premium grocery formats. SUPERVALU reaches millions of families with products and services they need through owned, licensed, franchised and affiliated stores.

Today we’ll be post updating SUPERVALU.com where you will find a map that shows the broad range of our newly defined, diverse store network. Each clearly has its strengths. 4,300 stores, both owned and supplied, serving varied neighborhoods across America. This extensive network includes approximately 3,100 traditional and premium stores and 1,200 discount locations. From a longstanding customer base to well differentiated and trusted brands across the country, we have a unique, diverse store network and footprint that can be leveraged for future growth.

We will be America’s neighborhood grocer and the diversity of our 4,300 store network will be at the heart of our strengths. This concept of who we are represents a departure from how the company has viewed itself in the past. Historically SUPERVALU’s focus has been on individual parts which often resulted in others viewing us as multiple businesses. It was easy to reach this conclusion when you looked at our individual components. A dozen retail banners, hard discount Sav-A-Lot operations and/or supply chain reasons serving approximately 1,900 independent retailers. That is not the way we’re looking at SUPERVALU today. We’re on a different path.

The review of our business confirmed that the greatest potential lies in operating not as multiple or distinct businesses but as a wholly integrated entity, a company that sells groceries and reaches its consumers through a diverse network of owned and supplied stores. So what does this mean in terms of how we will move forward? First it means we will leverage our unique strengths to grow by emphasizing geography over banner and ownership, using both owned and supply store formats to grow market share in those markets where we already have relevant share or believe we can build a significant presence.

Looking at the business in this way and operating as an integrated company enables us to choose the format that best serves a given neighborhood, be it a SUPERVALU banner store or one operated by a business partner. Rather than speak in the abstract, let’s look at a real growth opportunity we have in Chicago through this integrated approach. Jewel-Osco, located in the third largest metropolitan area in the United States, operates 185 stores and holds a 36% market share. While this format is a real hometown favorite, it may not be the most appropriate banner to serve all residents that make up Chicago. By thinking of our business both holistically and geographically, rather than by banner and ownership, we will now look broadly at how best to deploy all our formats to meet the unique customer preferences in each part of the city. For example, certain consumers may find that our hard discount offering, Sav-A-Lot, to be more relevant in compelling offerings than Jewel-Osco, in which case we will seek sites that allow us to meet the needs of these neighborhoods.

In our submarkets our affiliated business partners such as Moo & Oink, who already do an outstanding job serving their specific customers, may have the best format. To those of you who may not be familiar with Moo & Oink, they’re a fabulous, multi-store retailer operating stores in Chicago’s south and west sides. These folks have a rich heritage, deep roots in the community and a truly unique vibe that make them a staple to many in Chicago. We are privileged to work with innovative retailers like Moo & Oink and I envision SUPERVALU partnering with them to find new locations to support them in their growth plans.

As you can visualize, this integrated point of view will dramatically change how we grow. As another point of comparison, under previous strategic plans we would have built on Jewel-Osco’s success by driving sales in existing stores and adding new square footage each year. These activities will continue, but our integrative planning efforts will now incorporate an accelerated number of Sav-A-Lots that will serve more areas suited to that format. Other neighborhoods may be more appropriately served by one of our independents as we fully address all submarkets in this geography.

With Chicago as an example, you can see that this integrated approach calls for us to utilize the various formats available to us to drive growth and to increase our total aggregate market share. This focus on key geographies will drive all capital allocation decisions.

Another strength of who we are is the tremendous opportunity we have to fully leverage the size of our diverse store network to achieve best in class product cost by acting as one integrated company that can pass these savings on to our customers, business partners and associates and shareholders. Let me illustrate this potential with a recent success. Recently we completed across the total store network the realignment of a small grocery subcategory, where 65% of the sales were from our own brands line and the balance was spread over three national brands. Historically vendor negotiations for this subcategory did not include the purchasing power achievable by acting as one integrated company. Frankly, many procurement decisions didn’t include all of our own banners, Sav-A-Lot or many of our affiliated locations.

You will not be surprised that in this instance we concluded that we did not need three national brands. In fact, duplication in this subcategory only made shopping more difficult for customers. So we consolidated all of the volume with one of the national brand players, which was also selected to be our own brands provider. We entered into a long term contract, leveraging the category realignment into annual savings in the high seven digits. And by the way, we will also achieve savings on store labor, inventory and distribution. I know we have countless opportunities to repeat this process across a broad range of categories.

And as a final strength we will do everything possible to optimize performance of the three components of our store network. I will address each of these, owned traditional banners, Sav-A-Lot, our hard discount format and affiliated retail stores. First we must leverage the brand value of our own retail banners. I clearly recognize that each of our banners is a powerful brand in and of itself and we will work hard to protect and nurture the unique identities of each banner. As we move forward, I will stress that our traditional banners will be inviting stores that are well merchandised, priced right and run by friendly associates. I also want to emphasize that we will not change how we go to market. High-low banners will remain high-low banners and those attributes that have made our specialty retail banners successful will be zealously guarded.

However, my vision is to instill a common operating approach and philosophy across the country as it relates to the majority of in-store decisions surrounding category assortments, promotional displays and labor management. We will be customer focused while operating with greater uniformity where appropriate.

Regarding Sav-A-Lot, our hard discount banner and highest returning asset, I am genuinely excited about the opportunity to grow this format. Today, SUPERVALU is America’s only national grocer that has a successful hard discount format in its arsenal and our 1,200 stores are a great base from which we will build. Let me elaborate on the immense potential I see for broadly growing the Sav-A-Lot brand. First, Sav-A-Lot is an extremely relevant format for customers motivated by price with our target customer having household incomes of less than $45,000 a year. This group make up nearly half of all American households, meaning we have a large population segment that we can attract. Second, our new vision insures we address geography and format first, meaning Sav-A-Lot will be more top-of-mind as we look to maximize market share. In support of this new mission, the Sav-A-Lot store development team now reports into our corporate group, which allows us to leverage more resources and better aligns our enterprise real estate development process. Third, we have listened to our licensees, heard their comments and addressed their concerns. And finally, the existing Sav-A-Lot distribution network has capacity that we intend to utilize.

I want to assure you that we will grow this format and we have already put in place a number of changes to insure this will happen. First, we’re lowering the capital requirements for Sav-A-Lot by 15% to 30% through redesigning the store layout, reducing the leasehold and fixing requirements and greater utilization of used equipment. Second, based on feedback from our licensees we are simplifying our operating model by revising the licensee agreement, modifying but clearly not eliminating restrictions on product assortment and pricing as well as service departments and in many cases, eliminating non-critical compliance requirements. In addition we will drive improved thought profitability for our licensees by achieving lower product costs through more efficient procurement across the entire SUPERVALU organization as well as more highly optimized pricing strategy. We will also consider additional incentives to promote growth in certain geographies.

By allowing licensees to be more customer centric in running their day-to-day operations, limiting upfront capital requirements and reducing cost of goods, the Sav-A-Lot format will be even more financial opportunity for existing licensees. In addition, we will take full advantage of this powerful format to attract and affiliate new operators. Their growth will further leverage our investment in the Sav-A-Lot distribution network. My expectations are that we will roughly double the size of the hard discount network over the next five years or so.

While we presently are anticipating opening 50 new Sav-A-Lot stores this year, we will have over 100 projects in the pipeline for next year. These projects have been preliminarily approved and are in various stages of due diligence, lease negotiations, permitting and construction. We are working with potential licensees on more than half of these stores. Clearly, we will be looking at ways to enhance our business model to accelerate Sav-A-Lot growth in the coming years as this will be critical to achieving the store count increases I envision. I will talk about how we plan to fund this in a moment. I can assure you that [inaudible] to Sav-A-Lot growth opportunity with a new and heightened sense of urgency and I am personally committed to getting this done.

Third and finally, SUPERVALU is proud to be affiliated with some of the country’s finest retailers and believe that our vast and efficient distribution network, combined with our broad list of retail services, has contributed to their growth and success. Many of these entrepreneurs operate innovative stores that we feel have immense growth opportunities. We will now take the step of including them in our assessment of market potential. We recognize we are dependent on one another for success, which creates a strong incentive to work together toward a common goal of increased market share.

Their success is our success, as we all benefit from greater leverage of our capital investment in supply chain. What does this mean in terms of our consolidated financial expectations? I think it is realistic that over the long term we can generate a top line annual growth rate of approximately 4%, along with an annual 8% improvement in EBIT while delivering 10% annual bottom line improvement as we continue to leverage our scale, lower our overall cost structure and de-lever our balance sheet through strong and predictable operating cash flows. We are committed to achieving a 15% return on invested capital.

To summarize what I have previewed with you today, my vision is to maximize the strength inherent in our diversity of formats, to more effectively leverage our size and scale, to nurture and distinguish the unique brands we possess so that we create a sustainable, competitive advantage that is relevant, differentiated and compelling for our customers and will deliver financial results indicative of a growth company. To date we have started a number of work streams that are essential to achieving this vision. As these work streams unfold over the next few years, they will redefine how SUPERVALU conducts business and what you should expect from us.

It is important to note that the hard work the company has done to date to centralize various aspects of the business is an important first step in what we are trying to accomplish. Today I can confidently describe for you who we’ll be in the future. First, SUPERVALU will be a customer focused company. We will return to the principles on which Joe Albertson, Sam Skaggs founded their businesses. Know your customer and make sure everything you do addresses their needs. These were truly hometown grocers and their spirit is today personified by many of our leading independent retailers. The shopping experience of our traditional stores will include great bakeries; fresh meat and seafood departments; locally grown produce; well merchandised grocery and general merchandise products that will include a wide assortment of items to meet the ever increasing health and wellness needs of our shoppers; friendly pharmacies and employees who fully understand and are committed to satisfy the need of our customers. We have spoken before about our internal store level customer satisfaction surveys and we will improve our scores as we turn our focus to the customer.

Let me share some of the result with you, metrics that we report on each quarter. Customer scores on our overall price competitiveness have improved by 8% since the end of second quarter a year ago. The courtesy and friendliness of our checkers is up 4%. The quality and freshness of our perishables is up nearly 6%. And finally the number of shoppers who tell us they would return to our stores and recommend us to others is up 5%. Again, these are metrics that we have historically used internally to gauge how we are doing and we plan to share this with you each quarter. Needless to say, identical store sales will always remain a key indicator of how well we are meeting the needs of our customers.

Second, we will be America’s neighborhood grocer. As I outlined earlier, we will approach our business both holistically and geographically rather than by banner and ownership. This will allow us to look broadly at how to maximize market share by deploying the formats that best meet the unique customer preferences in each subsection of a market. Our share improvements will be realized by optimizing our investment opportunities in each high priority geography.

We will measure results with market share and store count growth. We are now identifying the markets and defining the base line that will serve as the benchmark for future market share growth. This measure will include our corporate retail stores, all Sav-A-Lot locations and independent stores where we are the primary supplier. We expect to update you at least semiannually on the performance of our top 90 DMA’s. Each of these designated marketing areas has at least 10 stores.

Third, we will have made the necessary investments in price. We know that today this is a priority for our customers and we need to respond to that priority. Our traditional retail banners will have every day pricing that consumers believe to be fair in addition to our strong reputation for promotions, which means it will be acceptable for customers to place every day priced items in the basket. Let me assure you, we continually monitor our pricing against all major competitors in our markets and we will take those steps necessary to insure that our pricing is competitive.

Our most recent results are showing some traction here, as our latest survey points out that our price position has improved in a majority of our banners. Our ability to be competitive on prices will be a large determinant of our success. And again, same store sales and customer counts will be the best measure here. These price investments will be partially funded by changes in our behavior as we become smarter merchants. We will not be offering 26 different varieties of fresh Artisan bread each day, but may carry five to eight on a rotating basis. Production will be more efficient and shrink will be reduced. We will, on the other hand, be talking to customers about value, placing our own brand alternative in more prominent positions on the shelf to increase movement to margin. These are both good examples of things we can do internally to partially fund our investments in price which we’ve balanced between every day shelf prices and our promotional offerings.

Next, our roots in wholesale and distribution will continue to nurture our organization and provide avenues for growth. We will assist our independent retailers in growing market share by providing them with the information, products, tools and services they need to be relevant to the customers and successful in their operation. My vision is that SUPERVALU will be recognized for partnering with our independents and providing the grocery needs of our broadly defined customer base in addition to our logistics expertise, technological innovation and status as the low cost wholesale distributor.

Turning to capital, we have already begun to better focus our investments in key markets and more specifically submarkets, where we can effectively compete and make meaningful progress on gaining share. We will target markets where we have a relevant market share or can build it and capital will be ruthlessly prioritized to insure that we achieve the maximum returns on our investment. As part of this, we will continue to share the ID sales performance of remodeled stores as we track our progress.

For assets potentially deemed non-strategic, divestiture decisions will be driven by prospects in a given market, the cash flows generated by the assets and the benefits derived from using sales proceeds elsewhere. This is a process we are continually engaged in as we better refine our market share analysis and goals. We will look at the hard economics when making these decisions.

The SUPERVALU of tomorrow will be a company that maintains local relevance while gaining greater leverage through its national scale. Ongoing centralization of decision making and administrative functions is one way we’re already doing this as centralization lowers our expenses by eliminating redundancies in the organization, removing the need for excessive collaboration and creating greater uniformity in how we operate. Cascading this approach broadly through the organization will allow us to further reduce our cost structure. We will also have common, best in class systems that will allow us to more effectively manage our retail and supply chain businesses. Today we are encumbered with manual workarounds that add time and cost and these will be eliminated as we complete our new merchandising system and standardize the last remaining distribution center.

The success of our efforts will be evident in the form of lower selling and administrative costs as a percent of sales. I would fully expect to see a 50 basis point improvement in selling and administrative costs as a percent of sales when we return to a more normalized environment in which we are better able to leverage our expense reduction efforts. This does, as a point of clarification, assume an ordinary level of pension costs. I would also add that we will be disciplined enough to keep these costs out of the business in the future and we will meticulously track our progress on many initiatives that we have defined.

One of my clear imperatives is to become a company that is much easier to do business with. We have centralized our merchandising function in Eden Prairie and our national vendors are realizing that this team is responsible for merchandising across the enterprise and they only need to speak with us in Minneapolis. We fully expect this will lead to more promotional dollars and better pricing flowing our way, benefiting margins, supporting price investments and driving same-store sales. We will also embrace simplicity in every aspect of our business. We want to be the neighborhood grocer that keeps things simple for our customers and don’t want their grocery shopping to be a struggle. We know customers will appreciate a store that offers convenience and makes shopping easy by providing everything in one place, grocery and pharmacy; best check-out; friendly employees nearby to provide assistance; a wide selection of national brands; convenient grab-and-go options; clean facilities; and honest and straightforward prices that are easily understood.

Let me share with you an example of something that is clearly less than easy. We recently ran a Salty snack display with a signage stating, “3 for $5.” I would tell you that this demonstrates three points we are working to eliminate. First, the customer has to do the math to figure out that one item sells for only $1.67. Second, the sign implies that you need to buy three to get this price and I can assure you that not many people want to buy three of this item at one time. And finally, the price the consumer sees is $5 which does not scream value in today’s economy.

Another area of opportunity for us is reducing the number of items in our stores. Having an excessive number of SKUs only adds to store inventory, increases store labor, creates confusion for our customers and leads to higher levels of shrink. As a result, we will rationalize SKUs where appropriate and we are already making meaningful progress on this initiative. We have initially sorted all center store categories into five groupings to help organize and prioritize our focus. These are categories in which we will either invest, optimize, support, maintain or exit. For the first 12 center store grocery categories that we have addressed, which came from the support and maintain groupings, SKUs will soon be reduced by 15% to 20%.

We will complete all remaining categories by the end of next year and we will keep you updated on our progress. We expect a total SKU reduction of approximately 10% to 20%. This will not only simplify the shopping experience but will also allow us to have better holding power on the shelf for items that do sell, driving ID sales as well as lowering store labor costs. These benefits are incorporated into the measures already discussed.

In addition to being a company that is easy to do business with, we are committed to improving SUPERVALU’s capital structure while continuing to invest in our business. This commitment is evidenced in our announcement this morning that we are reducing our common stock dividend. The new dividend payout is more appropriate for our industry sector and better aligns our capital allocation with our strategic growth objectives. We recognize the importance of our dividend to our stockholders. However, we believe the additional financial flexibility resulting from the revised dividend policy will allow us to drive greater growth in our greatest, highest returning business, namely Sav-A-Lot, contributing to enhanced shareholder returns over time.

We also know that the importance of reducing debt levels and returning to investment grade. Although existing debt levels and covenants are manageable, our leverage has resulted in higher cost of capital compared to our peers and has negatively impacted our equity valuation. The good news is that by leveraging our diverse store network, lowering our costs, maintaining a rigorous discipline about capital spending and divesting assets in markets where appropriate, we will be in a position to further reduce debt levels while still investing in the business, be it price or capital.

Our balance sheet will be a measure of our success as we meet our annual debt reduction targets communicated with our annual guidance. We will embrace diversity in the workplace and in our supplier relationships. Our associates and suppliers will be reflective of our customer base. We will honor our pledge as environmental stewards by minimizing our carbon footprint and promoting sustainable operations. Our store design and development teams will continue to innovate and incorporate new technologies that enhance the shopping experience and reduce our consumption of energy. We will continually work to use energy more efficiently and reduce waste, and we invite our customers and our associates to join with us in our commitment to protect the environment through responsible use of natural resources.

The opening of our new Shaw’s Chestnut Hill store later this month is an example of this environmental commitment. The store, located in Newton, Massachusetts will be one of the first stores in the nation to use all LED lighting. It will be largely powered by an on-site fuel cell that will generate heat and power for the store, thereby reducing the burden on the power grid. The store will also use nontoxic, ozone friendly refrigeration systems and is the first store in the nation to be recognized with the EPA Green Chill Award at the Platinum level.

And lastly but of vital importance, SUPERVALU will operate with a culture where there is greater clarity in roles and responsibilities, a more highly developed feedback loop to share market level information and focus on speed of execution. Our compensation programs will be aligned with our vision and our commitment to creating shareholder value. With the full support of the board, we have already begun the next phase of our efforts, putting in place the detailed plans necessary to deliver on this vision. And we are determined to succeed. I plan to provide additional details and commentary around our plans at future quarterly calls in addition to an investor day that we are planning to host sometime next spring.

Implementing this vision won’t change the trajectory of our top line or bottom lines overnight. This will be a multi-year revitalization effort that will be complicated by the unpredictability and pressures of these unprecedented economic times. We will continue to respond to competitive activities and address our customers’ rigorous focus on price and value. I’m being realistic when I say there’s much need for improvement in our every day execution and this will be a near term imperative as we work on getting the basics right.

In many cases, our people will need to learn new skills and tactics to meet this new vision. In addition, it will take time to meet with all of our vendors and decide upon assortment and pricing strategies. Further organizational changes will be forthcoming as we move to better align ourselves with our vision.

The executive team has signed on to this decision and is committed to doing what we must to get done to improve our near term performance and setting the foundation from which to execute on this vision. We will emerge from this challenging environment more agile and more competitive. Over time I believe that this vision and execution of the strategic plan to achieve the vision will enable us to make a compelling, differentiated offering to our consumers, thereby driving traffic and higher margins and improving financial performance. In combination with a lower mixture and better utilization of capital available to us, we will be positioned to deliver meaningful value to our shareholders.

As I stated on the first quarter call, I’m excited about SUPERVALU’s potential. I am honored to be here and thank the board for entrusting me to lead this company. I am confident SUPERVALU can realize significant performance improvement and achieve its long term growth objectives.

Pam will now take a few moments to comment on the second quarter.

Pamela K. Knous

Thank you Craig and good morning everyone. Quarter 2 ended on September 12 and covered a period where the economy, although providing some signs of encouragement, remained weak by any standard.

The Consumer Confidence Index, after bottoming out in February, has risen slightly in recent months but remains at historical lows. Inflation continues its rollercoaster ride as the CPI Food and Home Index has fallen steadily this year and turned to deflation the past three months.

Unemployment, which has continually risen over the past 12 months, hit 9.8% in September, a 26 year high while median household income fell 3.6% compared to last year, its steepest decline in 40 years. Finally, consumers continue to save at historically high levels, with recent saving rates in the 7% range as household debt decreased for the first time since the 1950’s. Overall, these are difficult times. Unemployment in five of our top ten DMA’s exceeds 10%, being well over the national average. In Las Vegas where we have more than 30 stores, unemployment is in the low teens while home values have fallen by over 30% this past year. In Detroit, localized unemployment of 30%, coupled with a housing market not unlike Las Vegas has dramatically impacted independent retailers serviced by our supply chain. The timing of government provided entitlement payments is the driving force as to why, in many areas, 70% of retail sales occur in the first two weeks of the calendar month.

With that as a backdrop, this morning we reported earnings per diluted share of $0.35. This compares to first call consensus of $0.33 per diluted share as the $0.61 in last year’s second quarter after adding back a penny in one time costs. Identical store sales were negative 4.8% in the quarter compared to negative 3.2% in the first quarter.

In the second quarter, our customer counts, down approximately 70 basis points, tracked modestly better than we have seen over the past two quarters as we are pleased to say store traffic levels have generally held up. The majority of our identical store sales performance was attributable to a decline in average transaction size, driven by several factors. First and foremost, the number of items per transaction was down by almost one-half item over last year, which accounted for over a 2% impact to ID sales. Consumers are clearly adhering to their shopping lists and are reluctant to add additional, often discretionary purchases to their cart. Second, customer trade down persists as higher priced items are replaced by lower priced alternatives. This includes the increase in units sold of our own owned brand, although deflation kept the sales penetration rate, measured in dollars, flat in the mid-70% range. Our overall estimate is that trade down impacted ID sales by approximately 100 basis points in the second quarter.

Finally, our second quarter was impacted by a lack of inflation which as we measure it internally was actually a net deflation of approximately 80 basis points, including our pricing initiatives. Although these results were not what we would like, they were in line with our expectations. Compared to Quarter 1, the clear driving force to the change in identical store sales was the decrease we saw in inflation.

Second quarter net sales were $9.5 billion compared to last year’s $10.2 billion, a decline of 7.5%. This decline was primarily driven by a negative 4.8% identical store sales performance, previously announced store closures and the ongoing transition of Target to self distribution in supply chain services.

Total operating earnings for the quarter were $245 million or 2.6% of net sales. Last year’s total operating earnings were $342 million or 3.3% of net sales. In the retail food segment, operating earnings were 2.5% of sales this year compared to 3.6% of sales last year.

Supply chain services operating earnings as a percent of sales was 3% this year compared to 3.4% last year. Let me provide some insight, starting with retail food. The 110 basis point variance in retail food operating earnings as a percent of sales reflects an approximately 50 basis point decrease in gross margin and a 60 basis point increase in selling and administrative expenses. The three key drivers of the increase in second quarter gross margin were first, the percent of items purchased on promotion increased 450 basis points over last year and continues to reflect consumers opting out of discretionary purchases and relentlessly seeking value in what they buy. Second, our price investments in the second quarter, including the big release in Chicago, So Cal and Spokane, Washington impacted the margin rate. And third, as I alluded to earlier, the number of items per basket remained down by roughly one-half item compared to last year and this lost item has often been more discretionary in nature.

Higher margin purchases such as flowers, premium varieties of meat and cut fruit are not making it through what Informational Resources, Inc., a leading provider of market information refers to as the lens of affordability. I do want to add, however, that we believe our pricing efforts are beginning to be noticed by our customers. The Big Relief Price Cut was introduced in Chicago and Southern California this past spring and we remain encouraged by the early results. Fifteen additional stores in the Spokane, Washington market joined the Big Relief program in August with initial outcomes exceeding both Chicago and Southern California. One interesting observation I would share with you is that we have seen better results from those stores that are geographically the closest to price competitors relative to stores further away. This tells us that customers want to shop our stores if we remove price as a barrier to doing so.

To reiterate what Craig stated earlier, our internal surveys across a majority of our banners show that our pricing initiatives have made us more competitive. We still expect margins to remain under pressure in the back half of the year.

On the expense side, I am pleased that our cost reduction initiatives are on track in delivering the anticipated benefits. We did see selling and administrative expenses increase by approximately 50 basis point in the quarter, predominantly reflecting the de-leveraging of fixed expenses due to soft sales. I can assure you that SUPERVALU remains focused on aggressively managing expenses. Recent actions include our retail operations team looking into further opportunities to increase the overall productivity of store labor while not adversely impacting our critical customer touch point.

Real estate and store development plans that are now in place to lower our utility and store maintenance costs and consistent with the vision of reducing our selling and administrative expenses by 50 basis points, since the beginning of the year we have begun to right-size certain administrative departments in light of our current sales levels and includes the reduction of over 40 vice president and director level positions.

Moving to our supply chain services segment, operating earnings were 3.0% of sales for the second quarter compared to 3.4% of sales last year. The change in operating margin was primarily driven by the decline in supply chain sales, predominantly due to the loss of the Target business which de-leveraged the fixed expenses. From a supply chain operations perspective, this past quarter saw two significant accomplishments from our supply chain team.

One milestone was the standardization of our Melrose Park Distribution Center, which supplies the Jewel banner in Chicago. Thanks to the great teamwork between supply chain and their counterparts at Jewel-Osco, I’m happy to say the standardization, being one of our largest, went as smooth as any we have done. In addition, supply chain is also working to complete the rationalization of our East Coast distribution network. By the end of the second quarter, we had shifted all product other than grocery out of our Harrisburg warehouse into our Lancaster facility and we expect to have the grocery migration complete by the middle of our third quarter, at which time we will no longer be shipping out of Harrisburg. Both of these supply chain initiatives represent ways we are lowering our retail infrastructure cost by using common systems and consolidating volumes where possible.

Now turning to our financial condition, we reduced total outstanding debt by approximately $220 million in the quarter, bringing our year-to-date total to $340 million which primarily reflects reduced capital spending. In the next several weeks we expect to close on the previously announced store sale in the Salt Lake City market and will use the approximately $150 million in proceeds to reduce debt. Accordingly, we are on track to hit our stated targets of paying down $700 million by the end of this fiscal year. We remain in compliance with our two existing debt covenants at both the current as well as more restrictive levels that will be affected when these reset at calendar year end with trailing 12 month EBIT, excluding impairments and other non-operating charges of approximately $1.4 billion, depreciation and amortization expense of $1.0 billion, net rent expense of $0.4 billion and total debt of $8.1 billion.

In terms of liquidity, we finished the second quarter with approximately $1.6 billion in total borrowing capacity under our revolving credit and securitized AR facilities, an amount we deem more than adequate to fund our business needs for the foreseeable future. Total maturities from now until the end of next fiscal year, roughly 16 months, is approximately $1.1 billion. Of this, only $400 million comes due in calendar 2010.

Moving to capital spending, this quarter we opened one new traditional store and completed 27 major store remodels, which keeps us on track to complete the 65 to 70 major remodels included in our guidance. At the end of the second quarter, approximately 70% of our stores were either new or newly remodeled within the past seven years and we expect to finish the year at roughly the same percentage. Although we have stated that our goal is to move this metric closer to 80%, we have consciously deferred a number of projects that would simply not generate an adequate return in today’s economic environment.

Regarding the performance of our store investments, the offensive remodels which we have completed within the past 12 months are generating a lift of approximately 3%. Those that have cycled their one year opening reflect a slightly negative in their second year. As Craig has previously stated, we have not generated acceptable returns on our remodels and are taking actions designed to lower capital costs and better showcase our merchandising initiatives. This will result in capital deployment decisions that are more tailored to the customer base of each store and geared towards sales driving elements.

We expect the balance of fiscal ’10 will be challenging, but the entire SUPERVALU team remains committed to taking the actions necessary to position the company for future success including intently focusing our efforts on the consumer, appropriately balancing our price and promotional needs, aggressively managing costs and prudently investing capital in the business.

I will now turn the call back to Craig.

Craig Herkert

Thanks Pam. Yes these times are tough and our second quarter results were below the prior year, but we cannot and will not use the overall economy as an excuse. SUPERVALU must transform itself into a business that is customer focused, dynamic and agile enough to meet the evolving needs of its customers, whatever the environment. And clearly we have not done that recently.

In fact, our identical store sales have softened during the first five weeks of the third quarter. Average transaction size continues to be influenced by the same items we discussed today, specifically a decline in total units sold. As a result of our outlook in the back half of the year, we now believe that full year ID’s will finish at approximately negative 4%.

We further expect consumer purchasing behavior, deflationary pressures as well as our decision to take price investments will pressure both sales and margins for the remainder of the year. Accordingly, we have narrowed our fiscal ’10 EPS guidance to $1.95 to $2.05 per diluted share on a GAAP basis and $2.01 to $2.11 per share when adjusted for store closures.

As I’ve stated earlier, we are not in a position where a quick fix will work. However, we have started to stabilize the business through a number of actions. First, our store associates are working hard on satisfying customers each and every time they shop with us, making sure our stores and offerings are relevant for today. And this is a crucial step on building loyalty and basket size. Second, our marketing and merchandising teams are making our stores simpler to shop by optimizing our assortments to reducing numbers of items that we carry. Third, the analytics group is engaging with our merchants to better understand customers and more effectively deliver acceptable pricing that balances every day shelf prices with promotional spends. And finally, we are reducing our cost structure through a number of initiatives throughout the company as we look for more efficient ways to run the business and take out excess dollars.

I remain confident that we have the physical assets and people to deliver long term shareholder value and that we are nearing an inflection point from which we will begin to grow this company.

With that, we will now open the phone lines for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig - Citigroup

You’ve laid your vision for Sav-A-Lot. Can you elaborate in terms of the unit potential in the U.S.? And is that geographically skewed at all or how should we think about that?

Craig Herkert

Well, what we’re looking at today, Deborah is doubling over the next five years our store count. So if we start at 1,200, which is our base today, it’s fairly simple math. Where we can go from there we haven’t laid out at this plan. We do know that there is a broad opportunity in this country, given the demographics of the United States of America. We’re looking right now at the next five years and we think there’s an opportunity to double it.

We have a detailed geographic plan that Bill Shaner and his team have put together. I do not want to share that with you today, but I will tell you there is a very thoughtful, detailed plan that encompasses both the parts of the country where we are very strong today and it would include many smaller markets, some rural areas. Importantly it would be growing in some of the markets where we have existing retail stores, which is something that’s a bit new for us. Where we’ve had a presence for example in Chicago we think that there’s an opportunity for a much more significant presence than we’ve had historically.

Deborah Weinswig – Citigroup

And then what are you doing to drive traffic to the stores which I think has been in positive territory at most of your competitors. What do you think the real key is there?

Craig Herkert

Well interestingly enough, traffic across most of our banners is either flat to slightly up, across most of our traditional retail banners. Our real challenge, Deborah, has been converting those customers who are in our stores to putting everything that we want them to put in their basket. There’s been certainly deflationary pressures, we’ve all heard about, it affects the whole industry primarily in milk and dairy. But there’s also been a fairly notable drop in the number of items that the customer are putting in their basket.

We think there’s a couple of reasons for that. One is certainly the economic [inaudible] are just meeting customers more value focused. They’re being more thoughtful on their spend. But quite frankly some of its been self directed. That is we’ve allowed as I’ve said before our regular retails to get too out of whack with what a customer thinks is a fair price. We’ve taken a lot of actions specifically with Big Relief to try to address that, but as I said in my statements this morning we’re looking beyond Big Relief, category by category, brand by brand, item by item in some cases, to look at how we more accurately spend the dollars that we have between regular pricing and promotional pricing.

We will remain a promotional merchant. Our consumers like us for our promotions. So we will not stop doing that. We just need to get those regular prices more in line. And frankly that’s a long term effort. That’s what we think is going to help us get our basket size back to where we think we should have it.

Deborah Weinswig – Citigroup

And Pam you alluded to, but can you expand on what additional opportunities exist on the expense side?

Pamela K. Knous

Well as I said there are a lot of them focused from the store ops tea, just continually looking across the banners. Clearly with Pete Van Helden heading up that area he has the ability to look across all banners, identify best practices and move towards a more standard operating model which will bring great efficiencies to us in the future. I did comment on the actions of our real estate team, clearly looking to reduce the capital spend, you know simplify the requirements of the stores, be energy efficient, you know all of those things are going to have great benefit for us. And then as we commented in the vision we have actively started on looking to reduce administrative costs across the company. That’s an action that we started at the beginning of the year and have accelerated it now as the vision has been finalized and we’re looking to align ourselves with the vision.

So every aspect of being efficient, appropriate spend control, just a very, very thoughtful review of our actions around the appropriateness of the infrastructure for the size of our company.

Operator

Your next question comes from John Heinbockel - Goldman Sachs.

John Heinbockel - Goldman Sachs

Craig, can you talk about the possible organizational structure you’d like to have and sort of the challenges of this holistic approach? You know for example do you need someone to own and be responsible, accountable for Chicago as a whole you know as opposed to the different banners, someone to be accountable for Southern California? How do you bring that together where you get all the different parties on the same page and someone is accountable for that market?

Craig Herkert

Yes. Great questions, John. We are not there to answer that today. So what I tried to lay out today was a vision for what we want to be. And to be honest with you we’ve got a lot of organizational work to do to bring this vision to life. I don’t know that I can answer that question specifically. I know that we have engaged leaders across our enterprise who like this idea. But clearly as I said in the statements, there will be design changes that we’ll have to address as we bring this thing to fruition. So sorry I’m going to dodge your question a little bit, only because I don’t have the answer yet today.

John Heinbockel - Goldman Sachs

As a follow up, do you think it will be more that the guys who run Sav-A-Lot a Jewel and wholesale sit together and strategic plan once or twice a year and then go back and run their banners? Or do you think there will actually be someone who will have kind of a Chicago P&L if you will or geographic P&L? Which one do you think it might be?

Craig Herkert

Well one thing I know that I want to protect, John, very, very clearly is the uniquenesses of the, let’s not talk about the banners for a moment. Let’s talk about the format. The thing that I think is very [inaudible] for us is to protect our traditional banners and to protect our discount banner, Sav-A-Lot. And we will leverage the back office things. We’ve already made enormous changes to our structure to leverage what we talked about already with regards to some of the procurement opportunities and certainly things like real estate development. What we don’t want to do is to change the ownership. For example, a Sav-A-Lot, that that team led by Bill Shaner will continue to own that format across the country and will drive the very important customer understanding and customer relevance. And we don’t want to mix that up so that we end up blending the formats where they sort of become hybrids of each other, if that makes any sense.

So A, we want to keep the formats very, very distinct. And then we think there is this opportunity in particularly the major markets for how you have a relevance in the major market. That we have to work through. We’ve got great leaders out all across the country today. We intend to keep those great leaders across the country today. How we make sure that this all kind of flows together is a process we’ll have to work through.

John Heinbockel - Goldman Sachs

And then finally just on a more short term basis, so if I look at your guidance it looks like the sales environment is not going to get that much different. You have a negative 4 comp in the first half so it looks like a negative 4 in the second, yet the implied EBIT margin looks to be a much better performance. What’s the driver of that? You know is that something on the cost side, mix, you know is there something you could comp through so EBIT margin will be you know a lot better in the back half of the year?

Craig Herkert

Yes. We’re starting to get frankly control of our spend. I think I mentioned in our Q1 call, John, that we had spent money pretty much across the enterprise trying to drive customer behavior. And it really didn’t change customer behavior but it did spend a lot of money we didn’t have. I am very pleased with the efforts of [inaudible] across the country that we’ve begun to get control over that. And so yes I have confidence that with a lot of work we can in fact have the appropriate returns that our shareholders need, which is why we updated our guidance as we did this morning.

Operator

Your next question comes from Meredith Adler - Barclays Capital.

Meredith Adler - Barclays Capital

When you talk about looking at the individual opportunities in markets and what’s right for the local neighborhood, would you consider taking an existing store and converting it to a new banner or selling a store to an independent customer?

Craig Herkert

I guess the short answer is yes. The approach we have is to look exactly at these markets and say what is the right store for that community? And quite frankly one of the things we see across the country is communities change over time. And certainly if we look at our business now as a portfolio of banners and ownership models, we think there is that opportunity. So yes.

Meredith Adler - Barclays Capital

And you’ve obviously tying yourself closely to your wholesale customers, many of whom are very innovative and do a great job. But is there any way to actually tie them in? Because the big fear is you sell a store to an independent and then they find another wholesaler sometime down the road.

Craig Herkert

Well I might turn it over to Janelle to give you some color, but I think what our approach is here is to make sure that our offering in our supply chain business is compelling enough that we don’t need to tie them to it, but rather that what we do is we’re a compelling enough operator that they choose to be with us. And that’s really our approach, is to make it so that they don’t desire to leave us.

Meredith Adler - Barclays Capital

Is Janelle going to say anything?

Craig Herkert

No, I think that’s it.

Meredith Adler - Barclays Capital

And then my final question is just about the centralization process. I have to be honest that on you know my conversations with vendors are saying that there’s been some technology issues and that maybe one of the most important things is for the folks out in the region to execute whatever promotion is signed at corporate. You know, if it’s building an end cap or whatever and that there’s somehow a breakdown either in the communication or whatever. So culture has always been an issue in terms of finding the balance between centralized and decentralized. Where do you stand on that?

Craig Herkert

Well as I said I think in Q1 I’m crystal clear and I think this entire management team is crystal clear that we will centralize, we will centralize the decision making for the national brands. That is not a debate at SUPERVALU. Clearly there is work to be done to clarify exactly how. We do have as I said earlier work rounds we have to have right now on the system side, but quite frankly I think we can get it done. And we’ve had some success right now getting that done. I do not believe that it is dependent on the complete implementation of all of our systems which are still a year-and-a-half or so away. We can do this today.

What we do know though, Meredith, is that we’ve had to learn more about being responsive to our customers and to our banners, and make sure that we are putting the right things in the ads and the right things on the end caps. We’re making changes which quite frankly we’re seeing some positive things on it. There’s a lot of people at this company having to learn new skills. That doesn’t mean we’re not going to do it but it does mean we need to do it thoughtfully and plan fully. And we have programs in place to make sure that we are in fact being responsive to our customer needs and getting the right things out there.

Operator

Your next question comes from Edward Kelly - Credit Suisse.

Edward Kelly - Credit Suisse

Craig, if I were to sort of sit back and try to take an honest assessment of the SUPERVALU supermarket business it seems to me like you know one of the bigger challenges that if I look at you know the markets where you are, and you’ve got you know you’re number one or number two in a lot of these regions, but your absolute share in those regions you know sort of if you take out kind of Jewel for instance, you know its sort of around the 20% range. And if I was to do that for a Kroger for instance I think you’d see you know north of 30%, which to me indicates that those markets you know I think are still very competitive. So you know how big of a challenge is this generally for you longer term?

And then as I think about you know this strategy, it seems like there’s a greater reliance on third parties, probably more than what supermarket investors are used to. You know, what’s the challenges of you know better leveraging and independence for instance? Is that independence going to compete with some of your stores? Could you maybe speak to all of that?

Craig Herkert

Sure. Well first of all you know one of the things we do is we get on the geography side, we’ve really taken a more granular approach than a lot of people. And we would look at say Southern California and not look at Southern California in aggregate, but look at particular markets of Southern California which if they were anywhere else in the country they would be markets in and of themselves. We just happen to call them Southern California. But if you look at it more granularly, you’ll see that we actually have a much more compelling share than if you look at it in total.

And likewise that you could look at the Intermountain West that way, where we have outstanding market share in many markets in the Intermountain West. And so we’re actually doing a process right now where we’re going market by market and being very granular. The other thing we’re doing, Ed, is as I said today for the first time we’re looking at all that we offer in a market and how that totals up to market share and gives us leverage, leverage that’s you know really important when you look at distribution for example. So we would look at Philadelphia as a market. Let’s talk about Philly for a moment where we have Acme but we also have a very strong Sav-A-Lot presence and we have an opportunity to even grow with our independent network.

The way we look at it would be not that they would compete with each other, but rather that they would complement one another. And so one of the reasons we wanted to highlight Moo & Oink this morning in Chicago is that you know realistically yes, there would be some overlap with what we would do at a Jewel-Osco and what we would do at a Sav-A-Lot. But mostly what we look at when we look at these things is that they complement one another. And that in fact customers may choose to shop all of them on any given day.

When you talked about how we compete or what we look like relative to others, there is one of our independent retailers who I won’t name but a great independent retailer in a fairly sizable market in this country, and their experience has been putting a traditional supermarket literally in the same plaza, in the same strip mall as a Sav-A-Lot store has been very, very successful for them because they attract either different customers or sometimes they attract different customers who might have different needs on a given day. And so that’s been a successful tack. We think there’s an opportunity for us to behave that way and we think it is compelling and unique because we have the strength of formats that our competitors frankly don’t have or at least not on a national scale.

Finally to address the independent, I have had a chance over the last five months to meet with many of our independents and I am serious when I talked about the fact that these independents represent what I think you know the original founders of the grocery industry were like. I never had the opportunity to meet Joe Albertson or Sam Skaggs. Certainly I’ve heard all the stores. But I think our independents, whether they own one, three or 30 stores, they operate on this hyper-local idea that they really do take care of their customers. And I think there’s an opportunity for them to grow. And some of that is because they have dominant positions in particular towns, where we don’t operate owned stores. And in other cases it’s because they have great positions in towns where we have owned stores but they have unique and differentiated formats that actually complements us.

Edward Kelly - Credit Suisse

And then a second question for you, how important with this you know this whole strategy is price going to be from where you are today? You’ve clearly made some big price investments this year but where does it stand in terms of how much more in terms of, you know what needs to be done incrementally?

Craig Herkert

Oh it’s really important, Ed, you know and not just because of the economy today. I think its important going forward. I think I mentioned before my sense is the American consumers’ shopping habits have changed probably forever or certainly for a long time. I don’t think you know somehow we’re going to wake up in a few months and everybody’s going to be back to 2006. So we have to make sure we get our pricing right. And quite frankly I think it took us a long time, many, many years to get out of whack. And by out of whack what I mean is we measured this really diligently six times a year so we know where we stand. If you look at our shopping basket across most of our traditional banners, and you look at the promoted price, that is the net price after promotions versus what you can shop at, whether it be a traditional competitors or discount competitors, we actually feel pretty good about where we sit.

What we got out of whack with is our regular retail. And in too many cases we’ve allowed our shelf prices to be so out of line with both traditional competitors and with discounters that the customer only wants to buy those products when they’re on promotion. It is a long term effort for us to get that in line. And as I said in my comments this morning, there’s no single pill we get to take to get this right. It literally is vendor by vendor, category by category, looking at how we’re spending our money, how we’re negotiating with the vendor. I’m getting this more in [inaudible] and to be clear it is not about becoming an every day low price operator. That’s what Sav-A-Lot is for. We will be promotional.

But it’s a long term project, Ed. I wish I could give you a timeline but let me say its multiple years of hard core efforts both on reducing our expense structure and changing our behavior with our vendors and frankly making sure that all of our merchants in the company understand what the right mix is that the consumer’s looking for today.

Operator

Your next question comes from Karen Short - BMO Capital Markets.

Karen Short - BMO Capital Markets

I have just a couple of follow ups on the Sav-A-Lot and also some other comments that you made. I guess the first question is, it sounds like you’re going to be pushing more the franchisee model versus company operated. Is that right?

Craig Herkert

Yes. Absolutely correct. We love the franchisee model at Sav-A-Lot and our goal will be to grow this business primarily through the use of the franchisee model. There will be corporately owned stores but our primary goal is to encourage the growth of our franchisee business at Sav-A-Lot.

Karen Short - BMO Capital Markets

So within the franchisee agreement are there barriers to you growing your own company operated Sav-A-Lots from an overlap perspective?

Craig Herkert

No. Well, there are barriers we want to be thoughtful. Certainly we don’t want to compete with our great franchisees. We like our franchisees so our goal is not to run them out of business by putting our own stores next to theirs. Our goal to be honest is to open with franchisee stores. Where I think you’ll see us open corporate stores would be areas where we maybe have not yet developed an independent franchisee and that we might take some time. We might open owned stores for example, built out a market and then actually sell those stores to a franchisee over time.

Karen Short - BMO Capital Markets

And then just turning to private label, could you maybe give us some color on what it’s looking like as a percent of units now and kind of [inaudible] been trending? And then on the basket follow up on that is, maybe talk a little bit about the basket in terms of percent of units bought on promotion versus non-promotion today, and maybe give us some timeframe on how that’s changed.

Pamela K. Knous

You know we did comment, Karen, that the deflationary impact of dairy, etc., is impacting the owned brand line. And so the sales penetration remained at about 17. From a unit perspective, we’re up in the 20s, 20 plus range as far as units sold. So we are seeing this there, that they’re going for the items that the deflation is impacting the top line.

Craig Herkert

Let me, just to be completely transparent with you guys, I think as I said earlier we have a really good own brands program. We have a really good own brands team. We have an unbelievable opportunity to show our customers those products in a better way than we’ve been doing it in our traditional retail banners.

Our team at Sav-A-Lot already does a great job. Love what they’re doing with the own brands. Many of our independents do a great job. We have not been as aggressive as I think we’ve liked to be in our own retail banners, showcasing the great products that we already have. So I would say to you we’re seeing some movement uptick. We’re not seeing the movement uptick I think we should see and I think that we will see as we look at showcasing these products better.

Karen Short - BMO Capital Markets

And then I guess last question is you had mentioned pension very briefly as it related to cost reduction opportunities excluding pension. Can you maybe talk a little bit about what you’re seeing from the multi-employer pension liability perspective? Do you have any data on where that’s trending and what the expense may be looking like?

Pamela K. Knous

Good question, Karen. I think that the reason that we wanted to call out pension is just because its an area that is potentially under reform, and clearly everyone is having to react to the fact that the investment portfolios that they had had been significantly impacted by the financial crisis from last fall. So at this point it’s difficult to know exactly how to project the go forward rates. There are actions going on actually in the legislature to look to provide some relief to companies. And clearly some of the multi-employer plans have gotten some relief on their funding requirements. So it was really called out more that it’s more unknown now, but that’s really driven by the significant decline in the portfolio that companies across America experienced. It wasn’t anything necessarily unique to SUPERVALU.

Karen Short - BMO Capital Markets

And then I guess the last question is just on corporate, that it was a pretty low number the $6 million. Is that a good run rate to use going forward from now on?

Pamela K. Knous

You know we don’t give guidance specifically on corporate, so I would say that we did have a lot of expense savings in the quarter. It was probably a little low from a run rate perspective but it’s all rolled up into our guidance.

Operator

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

Scott Mushkin - Jefferies & Co.

I just want to clarify a couple of points and then ask a question. Craig I want to make sure I heard you correctly that sales so far this quarter are actually worse than the negative 4.8%. The second thing I would like to clarify is it sounded like you said we need to make more price investments but we’re actually making less right now. Then the third clarification I would like to have is the distribution network. My understanding is that the Sav-A-Lot distribution and management structure is completely separate at this stage from the rest of SUPERVALU.

Craig Herkert

So let me see if I can get all three of those in. I might go backwards. On the distribution stuff, yes it historically has been. There are opportunities for us to look at that more holistically. Janelle is in charge of the supply chain for our whole company. She and her team are working in conjunction with the Sav-A-Lot team to look at where we may have opportunities to better leverage our entire network. So that’s that one.

On your second one, if I have it right, no, I didn’t say that. I hope I didn’t say that, that we’re pulling back on investing. We are staying the course on Big Relief. We like Big Relief. We’ve seen really nice results, primarily in a couple of markets but we like Big Relief. What we’re doing is actually adding to it by now looking at what we can do on adjusting how we spend our monies without having to reduce earnings. So it might be changing behavior. We’ll talk more about that as the quarters go on. I don’t really want to say what that is today, you know. But you know there might be even a banner initiative where we’re spending money on a particular program that wasn’t effective. We’ve got the research, we know it wasn’t effective and so we might choose to either stop spending that money or reallocate some of that money towards pricing. So what I was trying to get across, not that I’m pulling back, in fact we’re going full steam ahead but we’re really working towards trying to change our behavior and then put that into pricing.

And then the first question was Q3. Yes, Q3 the early parts of this quarter have been tough.

Scott Mushkin - Jefferies & Co.

So just to the last two, you’re obviously running somewhere in the negative 5’s and you said that you know you’re not spending less, you’re just trying to allocate it more appropriately. Actually you’re spending more. I don’t know how to actually square that to tell you the truth a little bit.

Craig Herkert

I’m not spending more. I’m reallocating. So there is a big difference between spending more. One of the things that we had done and I talked about this in Q1 and kind of flowed into the early parts of Q2, we were spending but we weren’t controlling what we were spending. I feel good that what we’re seeing now is the beginning of getting control over our spending. And where appropriate, investing the monies in promotions that actually are driving traffic and importantly trying to invest in fixing our regular shelf pricing. And again I wanted to be clear. There is no quick fix on fixing regular shelf pricing. It has taken us well over a decade to get to where we are in being out of whack. This is not a one quarter or two quarter initiative to get our regular shelf pricing in line. So the initiatives I spoke about regarding our behavioral changes are about trying to get our regular shelf prices on the items that our customers want in a place that are appropriate for a traditional grocer.

So it’s not pulling back. It’s not spending more. Its rethinking how we’re spending. To be honest with you, I feel good about the controls that the team has, that we’re starting to see some margin improvements as we move forward. We’ve seen it in the last few weeks where we’re getting control over our spending.

Scott Mushkin - Jefferies & Co.

Second I guess is more of a question from a shareholders perspective. A dividend cut, acceleration of growth which we have no insight into the business, Sav-A-Lot’s is not provided, with the rest of the business showing you know deceleration still into the third quarter, how is this shareholder friendly? I guess that’s a little blunt but I don’t get it to tell you the truth.

Craig Herkert

We look at the dividend opportunity as a strategic initiative to allow us to invest money into growing the business. We think it is appropriate given the industry that we’re in to right-size that dividend. But importantly we think that we can use that money to better grow the business. And as we have said, our best returning business is Sav-A-Lot. We think there’s a huge opportunity to grow that business, given the fact that it’s a high return and there’s growth opportunity. We thought it was the right decision for the long term shareholder value to make that change.

Scott Mushkin - Jefferies & Co.

Not to belabor this point a little bit but it seems like you’re still spending CapEx other places. Are we down so low on CapEx other places that you couldn’t allocate it from that CapEx budget over to Sav-A-Lot?

Craig Herkert

We are spending CapEx. We have said that we want to make sure that our store base, I think 70% of the store base needs to be remodeled. We have a significant asset base across the country. We clearly need to continue to invest in making sure that asset base is up to speed. We did also say that in those markets where we have market share that either is strong today and can grow or protect or places where we think we can grow market share, we will continue to invest. So you know we’re not saying that we’re only going to grow Sav-A-Lot. Where we have traditional grocery that continues to work, we want to invest in that as well. So I was very clear this morning. We will continue to invest in Jewel-Osco for example in Chicago. This is not an abandonment of traditional grocery. It is to accelerate Sav-A-Lot.

Operator

Your next question comes from Mark Wiltamuth - Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

If you look at your three buckets here, supply chain, Sav-A-Lot and core retail, it seems like you’re asking the supply chain and the Sav-A-Lot to really pick up their levels of growth. How much of that 8% EBIT number is really going to be coming out of those two buckets and how much will be coming out of the core retail? Because it seems like the Sav-A-Lot bucket is probably small in overall dollars right now.

Craig Herkert

Well we’re not actually talking about how we’re splitting that out at this point. The Sav-A-Lot bucket is relatively small and we think there’s a huge opportunity to grow it and it’s a great return. So you’re right on the fact that as a percent of the total, it’s certainly not a significant part. It’s a sizable business today to be sure, clearly one that we think has opportunity to be much more significant.

Mark Wiltamuth - Morgan Stanley

Well its low dollars on Sav-A-Lot right now, especially because it’s a franchise business model, but how much can the dollars grow in terms of EBIT growth over time? Is that a meaningful number, given that it is a franchise business?

Craig Herkert

Yes, well we expect to double the size of that business in the next five years.

Mark Wiltamuth - Morgan Stanley

So it sounds like most of the grocery here is just recovering core retail. That is still kind of the core.

Craig Herkert

Yes. We intend to focus on all parts of the business. Yes.

Mark Wiltamuth - Morgan Stanley

And what do you think a normalized growth rate for the supply chain could be once you’re done with the Target transitions?

Craig Herkert

I don’t think we’re going to break that out.

Operator

Your next question comes from Neil Currie – UBS.

Neil Currie – UBS

My main question centers around the core business. Obviously there are good opportunities on the supply chain side and in centralizing a lot of the functions. In terms of what the customer sees, we hear you talking about SKU rationalization, cutting prices, more customer focus, private label focus and being the store in the community. All those things are very valid and very important and the right thing to do, but we hear a lot of retailers talking about a similar strategy right now and many of them are also somewhat behind in addressing some of these issues. What do you feel once we come to the end of this process, what do you think will be the supermarket unique selling proposition that you have over your competitors?

And then secondly, this considerable investment that you’re making, will it be turned into an opportunity or will this be a cost of doing business in today’s environment?

Craig Herkert

I’m not sure I understand the second question. I’ll come back to that.

Neil Currie – UBS

I’m just wondering whether the investment’s a permanent cost and that your margins are basically going to be re-based here.

Craig Herkert

Oh, okay. I think I can get to that. On the [compellent] proposition, you know I’ve traveled the world as many of you know over the last number of years looking at supermarkets. I think there is a great opportunity just to be a compelling neighborhood grocery store. And I don’t want to over simplify it but I don’t also want to lead you to believe that this team has some magic sort of elixir that says other than being a compelling local, locally relevant store where you can buy your family’s groceries and health and beauty needs, I think that’s incredibly important and compelling.

What makes that better than competitors? A lot of it quite frankly, Neil, is execution. It is in fact being locally relevant and I like what our teams are doing today. I was in one of our stores in Cincinnati just late last week and saw some outstanding local relevance going on, really tied to the community. I want to protect that while at the same time getting this leverage by behaving like the size company that we are.

So I don’t want to over simplify it but it is a little bit kind of simple that doing the things that we need to do, I think you become compelling. And you have to be priced right. Over the longer term I think our focus on health and wellness is a very important play in today’s world, certainly in today’s America. We think we have an opportunity to leverage our existing strength with our pharmacist and our pharmacies, our health and beauty care departments, but frankly to begin thinking about the whole store differently, our Nutrition IQ program which our customers like, how they can think about buying fresh, locally grown produce. I wish there was a simple answer. There isn’t one. It’s a long term answer.

On the investment side, as we said when we talked about where we think our shareholder returns go going forward, we do think that there’s an opportunity for us to dramatically change the cost structure of this business and to improve the terms we get from our vendor partners because we will be easier to do business with. We’ll be a leaner organization and a simpler organization. So we don’t think we need to permanently sort of run at the existing earnings rate or the existing gross margin rate, if that answers your question.

Neil Currie – UBS

I’d also like to ask if possible in the markets where you’ve run Big Relief, could you give us some sense of what the traffic numbers are doing there and whether you’ve been able to stabilize the basket size?

Craig Herkert

Well I don’t know that there is a single answer because you know the markets are wildly diverse. As you know we’ve done Chicago, Southern California and a smaller market, the Intermountain West, Spokane. So I don’t know that there’s a single answer to that. I think as I said earlier in some markets we feel, well in all cases our customers tell us they like what’s happened and we’re comfortable that we made the right decision. In some cases, probably because of the macroeconomic situation, perhaps somewhat because of a competitive situation we’ve had better results than in others. But in all cases the results have been relatively in line with our expectations.

Neil Currie – UBS

In terms of your independent customers, how distressed are they right now compared to what they might have been six months ago? Is there a risk that many of your customers could fall into some trouble over the next six to eight months if we don’t see any improvements in the economy?

Craig Herkert

No, I don’t think we’re sensing any of that, Neil.

Operator

Your next question comes from Charles Grom - J.P. Morgan.

Charles Grom - J.P. Morgan

Just on the trends so far, quarter to date, I was wondering if you could give us a little bit of sense for where that’s coming from. Is it customer count? Is it trade down? Is it deflation getting worse? Any sense there would be helpful.

Pamela K. Knous

Yes, Charles, I did comment on that. Maybe I wasn’t clear, but its really in the units. It’s really you know kind of this half-item down, year-over-year, a little bit more than half-item down. That’s the biggest change from the run rate that we’re seeing in early Q3 versus Q2.

Charles Grom - J.P. Morgan

And then just to follow up to that, Safeway talked a little bit of color for us this quarter relative to last quarter on deflation trends in some of the higher turning categories. I was just wondering if you could give us a little bit of sense for what you’re seeing so far this quarter.

Craig Herkert

It’s relatively on track with where we’ve been. We haven’t seen any positive move. It’s on trend with where we were in Q1. Pretty aggressive yet in milk and dairy.

Pamela K. Knous

We don’t expect it to turn until later in the year.

Charles Grom - J.P. Morgan

And then on the last question on the 50 basis points of SG&A improvement longer term, I guess two questions there. One would be what’s the timeline or duration you expect to get that savings? And then two, is the goal to reinvest that 50 bips or is it the goal to let it fall to the bottom line?

Pamela K. Knous

Well as I said we are, you know we’re in the process of putting the work streams together that support this vision. Clearly at a later point in time we will be sharing more specific guidance around these items. And I think it’s a little bit of both. And so I think that you have the overall financial goals that we have, which is as Craig said that we’re going to accomplish this through better margins and through better S&A and better sales. So we will obviously have an infrastructure that we can better leverage as we get to a more normalized run rate. So those are some good questions and we’ll keep providing greater specifics on those probably next spring.

Craig Herkert

Operator?

Operator

Yes, sir?

David Oliver

Yes. We do have a hard stop at 10:30. For those on the call, I will be available today for additional Q&A. Probably in about 15 minutes we’ll get started there. But we would like to thank you for your calls today.

Craig Herkert

Thank you everyone for your time.

Pamela K. Knous

Thank you.

Operator

That concludes today’s SUPERVALU second quarter earnings conference call. You may now disconnect.

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