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Executives

Ken Levy – VP, IR

Craig Herkert – President and CEO

Pam Knous – EVP and CFO

Analysts

Meredith Adler – Barclays Capital

Mark Wiltamuth – Morgan Stanley

Ed Kelly – Credit Suisse

Radina Russell – JP Morgan

Susan Andersen [ph] – Deby [ph]

Karen Short – BMO Capital

SUPERVALU INC. (SVU) F4Q10 (Qtr End 2/27/10) Earnings Call Transcript April 20, 2010 10:00 AM ET

Operator

Good morning. My name is Adrian and I will be your conference operator today. At this time, I would like to welcome everyone to the SUPERVALU fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I would now like to turn the call over to Mr. Ken Levy, Vice President of Investor Relations. Sir, you may begin your conference.

Ken Levy

Good morning, and thank you for joining us to discuss SUPERVALU's fourth quarter and year-end results for fiscal 2010. With me on today's call are Craig Herkert, SUPERVALU's Chief Executive Officer and President; and Pam Knous, Executive Vice President and Chief Financial Officer. Following prepared remarks, we will open up the call for a question-and-answer session.

As you know, the information presented and discussed today includes forward-looking statements, which are made under the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our most recent 10-K filing. Today's call will be available for replay on our Web site at supervalu.com. I will also be available after today's call for additional questions.

With that, I will now turn the call over to Craig Herkert.

Craig Herkert

Thanks, Ken, and good morning. As you read in this morning's release, SUPERVALU reported earnings per share of $0.62 in the fourth quarter before one-time items, and $2.03 for the full year. All in all, I'm pleased with our fourth quarter results, and would say that we've accomplished a lot, not the least of which was delivering on the earnings and beating the debt reduction guidance provided at the end of the first quarter shortly after I joined the company.

I want to start the call by emphasizing that we're making steady progress, streamlining operations, taking expenses out of the business, and meeting our financial plans despite a challenging economic and competitive environment. Consumer spending and buying habits are changing due to the prolonged economic recovery. Today, the majority of my prepared remarks will focus on the strategic actions that SUPERVALU is taking in fiscal '11 to become a more effective retailer, more intently focused on meeting the needs of our customers, and positioned for a long term financial success.

I'd like to briefly recap the significant accomplishments of the fourth quarter as strategically it was an important time for us. First, we've completely redesigned the role of our store leadership to fully reflect that our store directors, more than anyone else, have the ability to positively influence the shopping experience. In the past, too much of the store director's time was spent on administrative task.

Second, we've also refined and aligned our marketing and merchandising organizations. The lion's share of our better merchant and marketing teams representing nearly 75% of our sales no matter where they reside physically now report to our centralized leadership team here in Minneapolis.

Third, we optimized 10 major center store categories across all of our traditional retail stores. In doing so, we moved with pace, completing these resets in record time. On average, we've removed about 20% of the FTUs from each category. We also exited 26 general merchandise categories that were not core to our customer focus, items such as fragrances, automotive accessories, and everyday electronics. These efforts contributed to lower year-end inventory levels.

Fourth, in private brands, we corrected pricing and imposed new shelf placement disciplines company-wide.

Fifth, we've opened 22 new Save-A-Lot stores during the quarter, and will accelerate this growth rate with 100 new locations planned for fiscal '11.

Sixth, during the quarter, we sold 15 Shaw stores in Connecticut, most recently, announced our exit from the Cincinnati market. A great family operated grocer, Remke Markets, who has been in the food business for over a century, agreed to purchase seven of our bigg's locations. As part of this deal, SUPERVALU will continue to supply the bigg's stores that Remke operates, and will supply Remke's existing seven stores. All told, this is a great example of SUPERVALU leveraging its relationship and expertise to execute as America's neighborhood grocer.

Seventh, we paid down $545 million in debt during the quarter, exceeding our debt reduction goal by nearly $150 million for the year.

Eighth, we launched the replacement of our credit facility, which was successfully completed earlier this month. This milestone should remove any questions about our financial flexibility.

Lastly, but of critical importance, I have filled out my management team. I now have the right people in the right jobs, each with a clear understanding of their roles and responsibilities. On our last earnings call, I shared with you the addition of Steve Jungmann, EVP of merchandising. Steve's drive and leadership have already been felt throughout the organization. And we are reshaping the way that we work with our suppliers as well as with our vendors. He's been working in partnership with our vendors to bring value to customers and improve return of investment for all parties.

Julie Dexter Berg, our chief marketing officer has been on board for four weeks. She is a true marketer, and has a long career forging strong customer connections, improving brand help, and driving improvements in operations performance. During the course of the year, I look forward to sharing with you Julie's impact and the accomplishments of her team.

Finally, earlier this month, we announced the hiring of our chief information officer. Wayne Shurts will join SUPERVALU next week, and will lead us through the full integration of our corporate systems. Most recently, Wayne served as the global CIO for Cadbury. His contributions will allow SUPERVALU to gain the functionality of state of the art marketing and merchandising systems, and move us to a fully centralized technology platform. I can't tell you how pleased I am to have been able to assemble an executive team with professionals I have confidence in, who share my vision for this company's future, and I know will get the job done.

Now that I shared some of the more recent accomplishment, you can see that the fourth quarter was a very productive period for SUPERVALU. We made significant headway in refocusing on the costumer, streamlining functions throughout the organization, assessing our market position, on-boarding new leadership, and improving our balance sheet. As I look forward to fiscal '11, my executive team will have a handful of priorities. In discussing these, I'd like to underscore the deliberate actions we are taking to improve operations and become a more relevant retailer.

The broadest initiative and the one that I am most excited about is what we call Project SHE, which stands simply for Simplify Her Experience. The SHE initiative has many components, will evolve several years, and will fundamentally alter the shopping experience for our customers. Consistent with my vision, Project SHE will allow us to improve our relevance to our customers in their neighborhoods by leveraging our brand equity while maintaining all the advantage of our national scale.

We are in the first stages of this multi-year initiative, all focused on dramatically enhancing the shopability of our stores, not only making them customer friendly, but also simplifying the retail experience. Activities in this past year have many facets and include SKU rationalization of creative displays, compelling product adjacencies, and clear signage. All will heighten our focus on customer engagement and bolster our local relevance. We will be more effective in capital spending as we redefine the in-store experience and redesign it with her in mind.

Our fiscal '11 capital plan contemplates rolling out initial basis of SHE to approximately 300 stores. Needless to say, you'll hear more detail on this in the coming months as we touch and learn from early implementations and roll these out across our retail network.

Now you remain a top of mind to today's drift conscious consumer. SUPERVALU will continue to invest in price, call out value, and promote its private brands. While internal metrics in third party surveys confirmed that we are competitively priced relative to traditional retail peers, this does not mean that we will stop pursuing opportunities to lower price for a good retailer price investment never ends.

As I previously commented, the vast majority of our marketing and merchandising functions at the banner level have been centralized with our enterprise team in Minneapolis. This step creates a single unified touch point between SUPERVALU and the vendor community, which enables us to capture the benefits of national scale while maintaining the flexibility to tailor our approach at the local level. We already know that this alignment eliminated many of the complexities and extra costs that vendors incurred in servicing our company. This improvements, combined with our purchasing clout, will reduce the cost of goods, which as I see it is the single largest opportunity for SUPERVALU to bring greater value to its customers.

The merchandising team under Steve's leadership is already moving aggressively on this front. These efforts will give us more flexibility to invest in price and provide even greater value to our customers. With this new structure, we'll also see more effective promotional programs as well as more consistent store-level execution across our banners. As a company, our goal is to simplify how we go to market for our customers, vendors, and employees. I firmly believe our ability to deliver our programs, facilitate strategic objectives, and drive sales will fundamentally change the way our vendors and partners view us.

In fact, later this quarter, we will leverage the strength of our 4,300 store network to execute multiple national sales events with our vendor partners. Our network of stores is larger than any traditional grocer. This is a big deal for us and an indication of things to come. Our near term goal is to make our product offering more relevant for our customers and deliver on the value proposition in service they expect. The good news here is that our marketing, merchandising, operating teams are coordinated and focused. A good partnership has been established among Steve, Julie, Pete, and Janel. And their organizations are moving with a sense of urgency and speed capitalizing on early wins and incorporating learnings as we continue to test, refine, and roll out new operational initiatives.

SUPERVALU's private brand offering is another unrealized opportunity for the company. We have aggressively negotiated new company-wide sourcing agreements to achieve cost reductions. For example, in a popular beverage category, we've realized savings in the mid-single-digit millions, which will lower the base price of this product and improve our margin.

Already in the first quarter, we're aggressively promoting the marketing and value of our private brands to shoppers. We have in-source spender negotiations as well as research and analysis with the objective of developing and maintaining a direct relationship with our private brand vendors. And just last week, we embedded private brand personnel within the category teams, which I believe is critical to the success of overall category management. I believe these changes will place a more appropriate emphasis on our private brands and allow us to better control our destiny. I challenge our merchandising team to increase private brand sales penetration by more then 200 basis points in fiscal '11. This puts our year-end sales mix target at just over 20%.

Reducing shrink and improving workforce productivity remained focal points for SUPERVALU. In fiscal '11, we plan to make further improvements to simplify shelf stocking, minimize backroom inventory, and reduce the frequency with which product is handled. Each of these activities will ultimately drive improvements in shrink.

We've also began a series of initiatives that will adjust hours of operation, improve staffing levels in service department during peak hours, and reallocate store personnel to customer phasing activities. As I stated before, our goal is to reduce corporate S&A cost by at least 50 basis points. In fiscal '10, our progress towards this goal was masked by soft sales that we put many of the necessary disciplines in place. As of now, we expect to get to a run rate in fiscal '13 that meets our target.

Our expansion in Save-A-Lot is well on track. With100 stores in this year's pipeline, we are developing the internal expertise and skills to ramp up to a pace that will allow us to more than double in five years. Our newest Save-A-Lot stores are doing quite well, with sales averaging 10% above our internal projections, and initial capital costs 10% below our best spend rate. The Save-A-Lot team has had good success controlling capital by utilizing existing storing periods, aggressively negotiating construction bids, and leveraging internal architectural and engineering expertise.

Looking into fiscal '11, we plan to open around 15 stores in the first quarter, slightly more than that in the second and the balance of the stores in the back half of the year. I'm also excited about the prospects for our supply chain business. We've had new business coming on board this year, including over 50 new affiliations with independent customers, representing 126 total stores that joined us in the past year. Janel and her team are committed to growing our independent customer base and are actively pursuing new affiliations while they work with existing customers to grow their market relevance and share.

And finally, we continue to weave analytical discipline into our corporate DNA. Each initiative I laid out today is data driven, quantified, and time bound, and will generate considerable savings and sales growth for this company. We have also adjusted our compensation programs to appropriately align management incentives with these priorities. I'm proud of the 150,000 associates who have rededicated themselves to focus on the customer.

On that note, let me turn the call over to Pam for a discussion of our financial performance and outlook.

Pam Knous

Thank you, Craig, and good morning, everyone. Today, I will be covering our fourth quarter operating results, the company's financial condition, and lastly giving some color to our fiscal '11 guidance.

As Craig alluded, the economy has not changed much since we reported our quarter three results in January. Although hooded [ph] home deflation appears to have bottomed out and unemployment as reported by the federal government is not getting worse, consumer confidence still remains low. The value-seeking shopper of 2009 used 27% more coupons than in 2008, the first yearly increase since 1992. In addition, small businesses and consumers are finding credit more difficult to obtain. And finally, the housing market remains uneasy, at best.

This morning, we reported net sales for our fourth quarter for $9.2 billion, compared to $10.8 billion last year, a decrease of 14.9%. The change in year-over-year sales is predominantly the result of four items. First, the loss of last year's 53rd week, which we disclosed was approximately $800 million or approximately 50% of the decline; second, identical store sales of negative 6.8%, in line with our expectations and similar to the third quarter run rate; third, the impact from the F'09 previously announced store closures in addition to the third quarter exit from the Salt Lake City retail market; and finally, the completion of Target's previously announced plan to transition certain volumes to self-distribution.

The identical store sales of negative 6.8% reflected a 3% decrease in customer count and a 3.8% decrease in average basket size. The customer count decrease represents a slight decline from the third quarter run rate and one of Julie's top priorities is to address customer traffic. Average basket size, which did show a slight improvement of 70 basis points from a negative 4.5% third quarter figure, was influenced by factors we have talked about before, namely trade down, deflation and a number of items per order.

We estimate trade down at approximately 70 basis point in the quarter, which when combined with last year's fourth quarter and quarter four of fiscal '08, puts the three year stat at close to 300 basis points and includes higher private brands penetration, which reached nearly 80% of sales for the quarter and accounted for approximately 21% of units sold. Inflation ran at approximately negative 80 basis points. This was the third consecutive quarter that we have seen falling price levels, a reflection of both product cost deflation and our own price investment activity. The balance of the basket size decline was attributable to customers buying fewer items per visit, which again was down by roughly one-half item per order.

Moving to operating earnings, despite weak top-line sales, we delivered retail food operating earnings of 3.1% net sales, which included charges triggered by the quarter one fiscal '11 sale of our Connecticut Shaw's stores and our Cincinnati bigg's locations. Prior to these charges, operating earnings were 3.8% of net sales compared to 4.5% last year. This change was driven by loss of sales leverage on six expenses as growth margins, benefiting from a favorable LIFO credit compared to a LIFO charge last year, were up modestly.

Despite continued investment in price, gross margin reflects a slight decline in promotional mix. We had actually seen a reduction in overall units sold on promotion with an offsetting increase in units sold at the everyday retail. It is great to see our progress in fixing these pricing in balances, where we had high shelf prices on some great everyday items and therefore sold the vast majority of units on promotion.

It's good to no longer have to repeat Craig's example of a national brand of cookie that he talked about when he first arrived. I would also add that we absorbed another $0.01 in cost related to the Salt Lake City retail market exit, which brought the full year net benefit from these transactions to a positive $0.01.

Our supply chain services segment had another solid quarter. Operating earnings were 4.5% of net sales, which included these received from the early termination of our supply agreement with Ukrop. Excluding these items, operating earnings were 3.8% of net sales for the quarter, compared to 3.2% of net sales last year, and reflected both the LIFO credit and careful expense management in light of softer sales.

Turning to our financial condition, we finished the year with total outstanding debt of $7.6 billion, which represented an aggregate fiscal '10 debt reduction of approximately $850 million, exceeding our guidance by $150 million. Our FIFO inventory levels declined by over $300 million, compared to the end of fiscal '09, reflecting the initial benefit of SKU rationalization across both our retail and distribution networks and a heightened focus on managing working capital company-wide. Our inventory days supply was the lowest since we bought Albertsons in 2006.

Our debt-to-total capital ratio declined by approximately 400 basis points as we finished the year with debt, representing 73% of total capital, compared to 77% a year earlier. At year-end, we were in compliance with our debt covenants, with a trailing 12-month EBIT of $1.3 billion, excluding impairment and other non-operating charges. Depreciation and amortization for the year was $1.0 billion, and rent was $0.4 billion.

Earlier this month, we announced that we had successfully amended and extended our existing credit facility or agreement. Our agreement includes a $1.5 billion revolver with a five-year term, extends the term on $500 million of term loan B, and resets covenant levels. With this transaction, we have insured our liquidity for the coming five years.

Let me move on to provide several other disclosures. First I want to speak to SUPERVALU's market share. At our second quarter call, we committed to provide color of our top 90 DMAs or designated marketing areas. These are markets in which we generally have at least 10 stores. The market share figures that we track reflect a combined market share that includes our traditional retail stores, all stable lot locations; and, independent stores, where we are the primary supplier.

As of February, on a year-over-year basis, we either gained or held share in nearly 40% of these 90 DMAs, and lost market share in the balance. For the top 20 DMAs, which accounts for approximately two-thirds of our sales volumes, the cumulative total share loss was approximately 60 basis points. These figures capture both our ID sales performance and planned store closures, which has reduced square footage by 6.2% over the last 12 months.

Next, let me comment on our most recent store level customer satisfaction surveys, which again rose over the prior quarter. Scores for price competitiveness, staff courtesy and friendliness of our checkers, the likelihood of customers' willingness to return or recommended to others, and the quality and freshness of our perishables, all increased by approximately 100 basis points to 400 basis points. It goes without saying that we are pleased with these results. It describes the rival last spring and our company's renewed focus on the customer, shopper's responses on all four items have improved at least 400 basis points. Our perishable scores, which have been a real focus, are up nearly 900 basis points. Clearly, we are moving in the right direction and making meaningful progress toward meeting customer expectations and improving the overall shopping experience.

And last, an update on the performance of our remodels. Our first year remodel shows an average lift in the fourth quarter of about 1.5% when compared to other stores in their respective markets. Those stores that have cycled their one-year opening were up an additional 100 basis points in their second year.

Moving to the new fiscal year, we have built our plans around the expectation that the economy will continue to pressure consumer spending. This morning, we introduced fiscal '11 GAAP earnings per share guidance in the range of $1.65 to $1.85 per diluted share. This includes $0.10 of one-time costs primarily related to the fiscal '11 quarter one retail market exit in Connecticut and Cincinnati. Prior to these charges, earnings per share is forecasted to be in the range of $1.75 to $1.95 per diluted share, a decline from the $2.03 adjusted EPS we reported for fiscal '10.

I would like to spend some time commenting on our guidance and headwinds we are facing. First, all markets exited in F'10 and '11 as well as the target in Ukrop's business, were positive contributors to earnings and cash flow. Next, our new revolving credit agreement reflects the current market rate environment, which I can tell you is not as attractive as when we closed on the Albertsons deal. However, we are pleased that the pricing achieved reflects our strong cash-generating capabilities even though any borrowings will cost us roughly 60 basis points more than our previous facility.

Our plans also call for a higher LIFO charge this year if we believe inflation, albeit at a moderate rate, assumes at 1.5%, will return by the end of fiscal '11. And finally, pension expense, the company's defined benefit pension plan will increase this year compared to fiscal '10 as the implications of the financial market, having not yet fully recovered, will impact our annual expense. Therefore, the many initiatives that Craig just shared with you around sales margin and cost reduction will, collectively, almost offset these items.

How do we see fiscal '11 unfolding? We expect the identical store sales run rate to improve across fiscal '11. It still will be approximately negative 2% for the full year. By the fourth quarter, we believe total company IDs will be flat to slightly positive as our marketing, merchandising, and operational initiatives build throughout the year. Included in total company IDs is our assumption for positive ID sales from our corporately-owned Save-A-Lot stores.

From a total sales perspective, keep in mind that fiscal '10 sales included bigg's, the Connecticut Shaw's stores, and Ukrop's business for the entire year as well as Salt Lake City sales through the third quarter, and the Target volume for approximately half the year. As well, we also expect ID licensee pool purchases which we call pools from our Save-A-Lot warehouses to be positive, and ID wholesale pool for our independent customers to be flat for the year. We expect to have additional gross profit dollars available to us as we negotiate better costs of goods, run more effective promotions, increase private brand penetration, and further reduce shrink. This will give us added flexibility to invest in price and bring greater value to our costumers as we look to effectively manage the balance between sales and margin.

Our fiscal '11 capital plan of $700 million, with an emphasis on remodels and in-store merchandising initiatives focused on driving sales. We are also excited with the growth initiative at Save-A-Lot, which totals 100 net new stores. We finished fiscal '10 with about 66% of our stores either new or newly remodelled within the past seven years. And we plan to remodel approximately 90 to 115 stores this year in addition to touching 300 stores with in-store merchandising initiatives.

Going forward, we will place less emphasis on this metric as we touch more stores with more (inaudible) that would not meet our remodel threshold of $500,000. We believe these customer facing capital investments will better drive sales and at the same time, we will not allow the physical condition of our facilities to deteriorate. With this capital plan, depreciation and amortization will be largely unchanged from the current run rate.

In the coming year, despite slightly lower earnings, we will again generate free cash flow to further reduce debt through prudent capital investment decisions and aggressive management of working capital. Our total debt reduction target for this year is $600 million, which when combined with the $850 million pay down we achieved in F'10, will allow us to exceed the $1.3 billion two-year expectation I spoke to at this time last year, well exceeding the debt-reduction target set as part of the Albertsons transaction. This will result in debt-to-total capital of approximately 68% by year-end

Fiscal '11 maturities total approximately $975 million. After fiscal '11, debt maturities average about $175 million over each of the next five years with the highest single year being fiscal '13 when approximately $800 million comes due. We expect the first half of fiscal '11 to be considerably more challenging than the second half based on our view of the economy and the build of our marketing, merchandising, and operational initiatives that Craig reviewed earlier. The first quarter will also be – will also include the negative impact of approximately $0.10 worth of charges, primarily related to the completion of retail market exit in Connecticut and Cincinnati.

I will now turn the call back over to Craig.

Craig Herkert

Thanks, Pam. In summary, I'm looking forward to fiscal '11. My team's in place. We know what has to get done. And we will execute. Yes, there are headwinds that Pam discussed. But fiscal '11 will deliver solid earnings, meaningful debt reduction, and the necessary platform from which to execute our vision of becoming America's neighborhood grocer. Our renewed focus on consumers, strengthen merchandising and marketing capabilities, strict capital discipline, and an unrelenting focus on cost reduction are the priorities for fiscal '11 that will position us for growth at fiscal '12 and beyond.

Prior to opening up the call for questions and answers, I'd like to touch upon this morning's announcement regarding the Board. After a deliberative review, the Board is making changes to its size and compositions. Actions include reducing current membership from 15 to 12 directors, adding new directors to bring perspectives – new perspectives to the Board's oversight of the company and naming a non-executive chairman. The Board believes these actions are consistent with high standards of corporate governance.

With that, I'd like to open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Meredith Adler with Barclays Capital.

Meredith Adler – Barclays Capital

Thanks for taking my question. I was wondering if you could talk a little bit about what you're seeing in terms of sales as the last – as the fourth quarter ended and what you're seeing now? Because it seems like you're going to have to show a pretty big improvement to get to minus 2% for the year.

Craig Herkert

Yes, we're looking at the first part – first off, good morning, Meredith. But we're looking at the first part this year at a similar run rate to where we ended last year. And we look to see that improvement as the year progresses I guess for a couple of reasons. The key one to me would be the fact that the steam that we've assembled really just got here. Steve spent here all of 11 weeks. Julie spent here all of four weeks. And so, as we put this team together and all the initiatives that they're working on and we start to roll these things out, we look to see them really hit our business impact as the year progresses.

Meredith Adler – Barclays Capital

And then I have another question about several quarters ago where you talked about feeling a need to do a better job balancing shelf prices and promoted prices. And today, you talked about the fact that the mix you – shifting back more towards full price. Is that a function of your behavior or is that just what the consumer's doing now?

Craig Herkert

No, I think it's really a function of our behavior. We have very specific examples. As Steve has really come on board and have been very aggressive about thinking granularly regarding our pricing proposition, including branded products and, Meredith, even fresh food products as we repositioned some things to where we have a fair everyday price. And we'll still promote many of these items that we have a fair everyday price. We've seen a significant shift, a very positive significant shift in consumer behavior to where she feels like she can buy those items everyday in our store and not simply wait for them to be on sale.

We had an item I may have talked about in the past in the bakery department. It's just a great item for us. But we had gotten (inaudible) price to be so out of whack that something in excess of 85% of our sales were only occurring when the item was on sale. We made a dramatic shift in that item. We love what we're learning from that. And we're beginning to roll that out across the various categories. But it will be a long term process, a multi-year process because we want to be thoughtful as we do it. As I said in the past, work with our vendor partners as we think about how we're costing products and how we bring value to our customers. I want to be careful that I don't make you believe that somehow because we're learning good things that we're going to change the proposition of all the items in our stores over night. This will be a thoughtful multi-year process as we make these changes.

Meredith Adler – Barclays Capital

And then I guess one more question about technology, you have stated as a goal is to be merchandised to the local neighborhood and you have to take advantage of your scale. Where is the state of your technology now? And is it fair to assume that you're going to be able to do – accomplish both those goals this year.

Craig Herkert

Great question on technology, so let me first state that technology is – we're still mid-stream on technology. We have some great solutions coming. And no, those solutions are not this year. That said, we actually have the capability with the current technology we have to do some great local things. I'll tell you, Meredith, as we travel across our company and visit our great independent retailers as well as many of our owned vendors, we see amazing things happening. What Pete, and Janel, and Steve, and Julie are really working towards is capturing the Best Practices of what we already do, and do that more broadly.

And it's not dependent on system solutions. System solutions would be nice when they come. But being focused on our local customer is not dependent on a systems solution, it's dependent on having the store director be able to make the right decisions for his or her community, which I mentioned earlier I think Pete has done, is requiring that Steve and his team to build the capability to get the leverage that we have as a $40 billion retail. And we're talking to the national brand of suppliers, but at the same time making sure that the local products can be sourced locally, and that we give the opportunity to our local merchants to in fact take care of those local items.

The fact that those local merchants report into Steve's group here is, I think, very consequential. But it doesn't mean that all stores across the country are going to carry only national branded items. Our goal is to continue to be great local retailers, whether that's lost in Philadelphia or Idaho Falls.

Meredith Adler – Barclays Capital

Great. Thank you very much.

Craig Herkert

Sure.

Operator

Your next question comes from the line of Mark Wiltamuth with Morgan Stanley.

Mark Wiltamuth – Morgan Stanley

Hi. Good morning, and greetings from London.

Craig Herkert

Good morning.

Mark Wiltamuth – Morgan Stanley

I wanted to ask a little bit about the new Save-A-Lot stores. You got 100 in the pipeline. How many of those are corporate versus licensees? And how are you doing on signing up new licensees for this bigger roll-out.

Craig Herkert

Well, first of all, let me talk about, just a little bit more, the ones that we've opened the last quarter. I cannot tell you how proud I am of both the corporate team in working to reduce the cost of these. And I talked about this before. But also the Save-A-Lot team in getting the right locations and the right proposition. Every one of these new stores that we've opened is doing better than our expectations. And that's true for both our corporate stores and our independent stores.

We're not releasing the numbers on the exact – which ones are corporate, which ones are licensees as we look at the 100 stores going forward. I have visited, Mark, with a lot of our Save-A-Lot independents. There is a strong desire – a strong desire for us – for them to grow. And we're getting some nice traction. And we'll tell you, however, there are opportunities out there in America today for small businesses to get loans. And we're working with our small retailers to help them with our incentives and to encourage them to grow.

It's a lot of enthusiasm for what this business is bringing them. We have a lot of excitement out there. There continues to be stress on small businesses getting financing.

Mark Wiltamuth – Morgan Stanley

And what is the capital cost now down to? I know you're working on being a little more flexible on store resets and things like that before you went into a new location.

Craig Herkert

Yes. We're much more flexible. I think all-in, including getting out and inventory, we're about $1 million for a Save-A-Lot store. So it's significantly lower than it was, and significant new flexibility, which I can tell you has been widely well-received by our independent retailers.

Mark Wiltamuth – Morgan Stanley

Okay. And what was the capital cost before or I guess the all-in cost before?

Craig Herkert

Yes, I think it's about 30% less, so somewhere between $1.2 million, $1.3 million, Mark.

Mark Wiltamuth – Morgan Stanley

Okay. And I have a question for Pam, with these market exits you've done in Connecticut and Cincinnati, how much margin boost do you get from that? And is there a big opportunity for more margin boost as you exit more markets?

Pam Knous

Well, as we said in my comments, these stores were all positive contributors. Clearly, though, these were markets that we view that we should exit. And so, the margin that remains then, you could draw some conclusion that will blend to a different number. But the fact of the matter is the gross margin dollars are gone from the mix as are the sales.

Craig Herkert

I would say, maybe another way to approach that market, these are strategic decisions, not tactical decisions. As we look to make sure – as I've said in the past, we talked about our sub-market reviews that we're embarking on, and we haven't embarked on. And it is to make sure that we're positioning ourselves for growth. And so, where we see opportunities, we may exit. But these are not tactical decisions. These are strategic decisions.

Mark Wiltamuth – Morgan Stanley

Okay. But I would think those are the lower margin stores versus the base. Wouldn't they blend to a higher margin?

Pam Knous

I think that would be safe for you to draw that conclusion.

Mark Wiltamuth – Morgan Stanley

Okay. Thank you very much.

Pam Knous

Sure.

Operator

Your next question comes from the line of Ed Kelly with Credit Suisse.

Ed Kelly – Credit Suisse

Good morning, Craig and Pamela. How are you?

Craig Herkert

Good morning. We're great.

Ed Kelly – Credit Suisse

Wow, thank you. So my question relates to SKU rationalization. A lot of – not a lot, but some of your competitors have gone after SKU rationalization. They have seen some negative impact on sales. So I was hoping you could maybe speak a little bit more about what you're doing here. Does this explain some of the sales weakness that you're seeing now?

Craig Herkert

First of all, great question. And no, it does not explain any of the sales weakness we're seeing now. We've actually been diligent about measuring the impact in – I mentioned we had 10 categories that we've rolled out, a couple of them quite big categories. And frankly, the stuff we took out still positions us to be a leader in assortment and variety. So we were simply – I think I may have mentioned this before. And we're simply so over assorted before.

The 20% of skews that we've taken out in some of these categories still allows us to be an assortment leader. There may have been a handful of items that we've had to respond to consumer request for. But it's been very, very small. And frankly, the improved in-stock that we're seeing is that we're actually improving sales. The other thing we're able to do, and I'm thinking of one particular food category, is because we took out 20% of the skews. In addition to improving in-stock, we're able to position our private brands much better than we were before.

We have a great private brand program. We've got a team here that has delivered beautiful products. But we were hiding them, quite frankly, because we were over sorted, it was very difficult for our consumers to find these products. So I mentioned we instilled disciplines today about positioning, placement, and pricing for these private brands, which I think are very, very important for our consumers who I think you all know continue to look for value. And as I've said, I think it's a new normal. I think consumers will – they changed their habits. And many consumers have learned that they liked private brands. And we want to be a great place for them to come and buy our private brand.

And finally, I think the thing that's been really good and we have just begun to see this is the efficiencies of the SKU rationalization in some of these categories where the Q of the products was quite large. We were in a situation where virtually – maybe of many years, a third to half of the items in the category, you couldn't fit a case on the shelf at a time. So that meant that every time the store ordered product, some of that product is going to the back room. That clearly is not an efficiency move for us. And we're working diligently to undue that behavior so that we can get our cost structures in mind.

Ed Kelly – Credit Suisse

All right. And then you mentioned that sensualization has probably the biggest opportunity to the firm a potential gross margin benefit, can you help us size this opportunity and how long you think it's going to take to get? And then, what are you hearing from your vendors currently about the changes that you've made.

Craig Herkert

Sure. So to answer your first part, no I can't help you size it. It's too early for that. Duration, this is a multi-year process. We have in excess of 40,000 skews in our stores. And so, as I said, I think in Q2 or Q3, we are going to thoughtful and deliberative as we look to how we negotiate with our vendors, and make sure that our vendors come to us because they get a return. So we do view this as a partnership with our supplier partners. Our early resolve, I think, are quite positive. There certainly has been some challenge and discussions between that the merchants and the vendor partners as we've looked towards SKU rationalization.

But I will tell you, I've spoken personally to several of these CEOs of our large vendor partners, and they too would see the need for the SKU rationalization. They, too, see the benefit of having their strongest brand actually be in stock on the chef when the customers are in our stores, on one afternoon and fun day.

It's not been all that easy, but I think ultimately they liked that. The very fun thing I think is as I mentioned earlier, Steve has gotten on board and begun to work with all the Save-A-Lot team and the independent retailer that works with Janel, and leverages the scale of 4,300 stores. And actually, we now have a couple of events coming up this year already scheduled where we can put products in front of customers in the whole lot of grocery stores across this country, I think that's very exciting. And I think as we develop that skill set and prove to our vendor partners that we can be a place to sell products profitably, we'll see more and more benefit.

Ed Kelly – Credit Suisse

And then just last question for you, back to the ID trend. Your competitors have shown an improvement, or at least, maybe talked about an improvement and IDs. So far this year it doesn't seem like you're seeing any of that yet. I was just wondering what you think you attribute that to. And then secondly, if price is not a big button for you to push this year, what gives you the conviction that you're going to be able to actually get the comps to flatten out and maybe turn positive by the end of the year?

Craig Herkert

Well, it's a great question because we've done a lot of research. And our customers for a traditional grocery store – let's speak to our stores, whether that calibers and saw to that be a duel (inaudible). It's more than just about price at our traditional grocery stores. There is a value proposition our customers are looking for that includes the above local relevance – service that Pam spoke about. And I'm very, very proud of what our team has gotten done in the service component. While the importance to be a leader in fresh foods certainly prices a component to that, but so much more is involved in being a leader in fresh foods. And we've spoken about health and wellness.

So quite frankly, it's not just about price. Price is a component. We've talked about some of those initiatives that we will continue to work on, most importantly, private brands and some fair pricing initiatives. I don't want to leave you with the idea that we're not focusing on price this year. But we are focusing on the entire value proposition in our traditional retail stores. And then finally, with the addition of Julie Dexter Berg, we continue – we really aspire to continue to build on those great brands that have existed for so long and have relevance. And so I think there's more to this story than simply price.

Ed Kelly – Credit Suisse

Okay. Thank you.

Operator

Your next question comes from the line of Charles Grom with JP Morgan.

Radina Russell – JP Morgan

Good morning. It's Radina Russell [ph] here for Charles Grom. I wanted to dig in a little bit on the comp trend, if you will. First, you pointed to a slight improvement in the basket size. And I guess I'm wondering is that really being driven the lower amount of promotional sales? Or is there something else that we can infer from that?

Craig Herkert

Radina, just to confirm, and actually what an improvement in basket size is actually improvement in space.

Radina Russell – JP Morgan

Got you, got you. Okay. All right. Then turning to the traffic trend, that was down 300 basis points as I heard correctly. Turning to that, you – you keep speaking of these initiatives. And you alluded to them on the last quarter call as well. But you keep speaking to these initiatives that you're going to be rolling on the stores coming forward. And I guess, what – if you could give us a little bit of insight as to what exactly those are that are going to be able to really drive that turnaround in traffic. Because I think as we look across the competitors in the space, they're starting to really see the turn in that actual traffic trend. And so, I'm wondering what some of the initiatives are that might be able to jumpstart that.

Craig Herkert

Well, as I've said before and I believe I said today, this is a long term process for us. There is no one quarter fix. This is all of the pieces that I think I articulated this morning working together to drive relevance for our – our consumers to come to our stores. I would not want to leave you with the idea that there's a quick fix here. This is an opportunity to regain our relevance by doing things like Project SHE, "Simplify her experience", by upping the ante on the marketing relevance by taking care of our customers better, by improving our own brand penetration, and by skew rat. So quite frankly, Radina, there is no one easy answer to that question that you asked. It is all of the above, working in consorts that will improve our relevance, and it will take time.

Radina Russell – JP Morgan

Okay. I guess, the challenge that we have is obviously pointing to Meredith's – the earlier question. It's just how do you get down to 2% if we're looking at a lot of longer term initiatives on the top line. But moving down, you just mentioned – actually I believe it was Pam who mentioned that, as additional GPM dollars become available, you're going to look to invest that in price. Is that something that should assume that you're going to become more aggressive in terms of price investment? Or at we are at a run rate that we should expect to see going forward. I just wanted a little bit of clarification on that comment.

Craig Herkert

We hope to be more thoughtful and deliberative as we look to how we invest in price so that we can both meet our earnings guidance and improve our relevance for our consumers.

Radina Russell – JP Morgan

Okay. And then one last question, just around your LIFO comment, then again, you would point it to a higher LIFO charge over the year I believe. Can you give us any color or what you're actually estimating there?

Pam Knous

Are you referring to the fourth quarter or to next year?

Radina Russell – JP Morgan

To next year.

Pam Knous

For next year, we are – assuming that inflation will be around 1%, 1.5%. So if you look back historically, that will be a charge of approximately $25 million or so million dollars.

Radina Russell – JP Morgan

Okay. Great. And then one final question, Pam, are there any buyback assumptions built into your guidance?

Pam Knous

There are not.

Radina Russell – JP Morgan

Okay. All right. Thank you.

Pam Knous

You're welcome.

Operator

Your next question comes from the line of Susan Andersen [ph] with Deby [ph].

Susan Andersen – Deby

Thanks for the great call. So just to follow-up really quick on Meredith's previous question, it sounds like you're maybe promoting less, such as promotions are just more effective in addition to better everyday pricing. And then also, how do you think the consumers have used SUPERVALU now since you increased or changed your promotions last year. Do you think you've won over more loyal customers now versus maybe the stray visitors in the early beginning of last year?

Ken Levy

This is Ken. I think I should say our promotional sales were actually down before. So we've seen this. This has actually seen an improvement in sales on the base price.

Pam Knous

On everyday items. So we've changed the mix a little bit from selling so much on promotion and not telling anything everyday. So that is the plan mix change.

Craig Herkert

And I will say we're early in that process, Susan, to better utilize the data that we have, again with this new team that we've assembled here, to better utilize the consumer insights that we have to make sure that the promotions we're putting forth are promotions that in fact drive the appropriate consumer behavior and don't simply spend money on against something that's not going to drive a different behavior. I would not tell you that we perfected that science yet, but we have a lot of great information. I think we have the team who will help continue to drive us to that.

Susan Andersen – Deby

Okay. Thanks. And then the third, another question. Can you maybe expand a little bit on these units? You think that – otherwise, this is going to be a merchandise transformation within the stores such as like SKU rationalization are better adjacencies? Or will often encompass some remodel attributes such as music chairs or flesh-offering areas. And then also, what's your expectation for the cost to soar this initiative, compared to a remodel.

Craig Herkert

While I think Pam touched on the cost per store. The good news is it's not a wildly costly event. We've actually done some of this already. We've been able to actually look at it, get real consumer feedback. And it is in fact, what you said, it's inclusive of all the above that is clearly it's about skews. It's about adjacencies. It's about signage. It's about our displays. It's about giving customers face. And I need fresh food, a little bit about picturing, although this is not a big picture expense program. What it is not is about completely redoing all the refrigeration in the stores and all those heavy capital intensive things that you do.

We will still do those types of remodels where it's a necessary. We have a robust remodel program. We will stay on that remodel process. But this allows us to touch far more stores in ways that really impact the customers. Pam said we'll talk about 300 stores this year. That's a significant, meaningful number of stores that will see changes that the customer will feel and will improve her experience in those stores.

Susan Andersen – Deby

Okay. Great. That's really helpful. And then this one last question on private label. It sounds like maybe you're thinking about passing on to sourcing savings in the form of lower prices and maybe that – part of the driver is that increased penetration in this next year. Or was it just a value proposition versus random products? Would you say that's correct? And then, also what do you think the other drivers have increased private label penetration will be this year?

Craig Herkert

Well, to answer your first part, in some categories, it will be Steve and his team will look category-by-category and perhaps item-by-item and determine what the appropriate pricing is for that item or that category, and work with vendor partners to make sure we have the cost appropriate to achieve that price. So I hate to send the message that says everything we do is going to be somehow passed along. This will be a very thoughtful and deliberative process to determine item-by-item and really starting with the consumer and what's relevant there for the consumer.

In addition to making sure we're priced right, as I said before, I love the fact that what this team is now doing, particularly in the 10 categories that we've already optimized, you'll see private brand positioning much, much better than it was before. Off times, it was maybe on the bottom shelf or the lower shelves, or as one phasing. We've now put those products – we're proud of those products, so we put them front and center. We put them at eye level. We put them where you can see them. And we've given them pacing that are appropriate so the consumer can make the choice. If she wants to buy the product, if she wants to buy a brand of product, we want her to be able to buy either of those at our stores. I think that's important.

And then I guess the final piece is we increasingly are putting the appropriate items in our promotional mix. So that when consumers come to our stores, she will now and again see those products on displays. We are, at the end of the day, in most of our traditional retail stores, we are promotional merchants. And customers love to come to our stores for promotion. Our private brands will be part of that mix.

Susan Andersen – Deby

Okay. Thanks so much, guys.

Ken Levy

And operator, I think we have time for one more question.

Operator

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

Karen Short – BMO Capital

Yes, thanks for taking my question. Two housekeeping, and then bigger picture, can you give us some sense of what the corporate expense dollars will be in '11 and also interest expense guidance?

Pamela Knous

Yes. Corporate expense will be relativity flattish year-over-year. And as far as the interest expense, we've given you the debt reduction goal and we've also given you the impact on the change and the borrowing cost for the new revolver. So I think from those components that you could – you could drive an annual interest expense number?

Karen Short – BMO Capital

Yes. I mean, I can calculate it, but if you knew it off the top of your head that'll be helpful. Then I guess the other question I had is you gave a 1.5% of sales list at remodels. First, just to clarify is that at major remodels or all are remodels?

Pamela Knous

That was for major remodels.

Karen Short – BMO Capital

Okay. So I guess following on that question, can you help me understand why it makes sense to be doing major remodels if that's only – if that's the return that you're getting? Because that doesn't seem that a major remodel with a 1.5% sales list that your one – I realize that this is a tough year, so it's not a great example. But does it really make sense to do that? Or would it be better just to preserve the capital?

Craig Herkert

First of all, you have to continue to update your physical asset base. I guess it's the price of entry if you want to be in the retail business. I think the landscape is littered with companies who did not invest in their physical assets. And so, we will continue, as we've said in the past, to invest appropriately in our physical assets to ensure that – quite frankly, it seems like refrigeration breaks over time. They need to be replaced.

These stores get a lot of customer traffic, and particularly, if you look in places like Chicago where we have very high volume stores, you need to make sure you continue to maintain those assets, and so almost regardless of what the lift is. What I like is the fact that we are being thoughtful and deliberative, as I said, I think in the Q3 call. Instead of doing what we did in the past, which was a one size-fits-all major remodel. I think we called the premium fresh and healthy. What we're now doing is being very thoughtful. In some neighborhood and some demographics, maybe that is in fact the appropriate store, but we now have several versions of a remodel that we can go. And therefore, we don't necessarily have to have this huge lift to go in and spend that money.

So long story, but we will continue to remodel stores. I think it's part of what we must do. And then what we'll do, which is very exciting to me, is in those stores where we really don't have the need to replace the physical assets and spend all that money, but we do want to make the store feel fresher and more relevant, this is where project C comes in really handy because you can go with a fairly modest expense and make that store much more relevant to the consumer without having that big capital outlay.

But again, to make sure our store base is fresh, we will continue to make sure all of our stores or 70% of our stores are remodeled between seven and eight years. So we need to make sure that we keep spending that money.

Karen Short – BMO Capital

Okay. And then, I guess just lastly, maybe – do you have any comments on what you're seeing in the competitive environment? There's been a lot of noise on whether – and the Wal-Mart rollbacks are happening of their – more smoking mirrors, but just comments in general on what you're seeing?

Craig Herkert

All I can say is competitively we see this to be a very competitive time across all forms of retail. Just about everybody out there sells food and consumables. Consumers in America today have almost a limitless amount of choice. And I think with the economy the way it is, and with consumers being stressed the way they are, and with unemployment, we will continue to see a lot of challenges out there from a competitive standpoint. It is what it is. Our job is to make sure we're paying attention market-by-market, and to do those things that cause us to be more relevant for consumer so she can choose to shop at our stores.

Karen Short – BMO Capital

Those studies say competitive, but not worse.

Craig Herkert

I think that's probably a fair statement. And I would say our outlook would be that we'll continue to be very competitive in America in this coming year.

Karen Short – BMO Capital

Okay. Great. Thanks very much.

Ken Levy

Well, thank you for joining us in today's call. If you have any follow-up questions, I am available, as well replay of this call will be available for the next two weeks. Thank you for your time.

Operator

This concluded today's conference call. You may now disconnect.

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Source: SuperValu Inc. F4Q10 (Qtr End 2/27/10) Earnings Call Transcript
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