Safeway Q2 2010 Earnings Call Transcript

Jul.22.10 | About: Safeway Inc. (SWY)

Safeway (NYSE:SWY)

Q2 2010 Earnings Call

July 22, 2010 11:00 am ET

Executives

Melissa Plaisance - Senior Vice President of Finance & Investor Relations

Robert Edwards - Chief Financial Officer and Executive Vice President

Steven Burd - Executive Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Alex Bisson - Northcoast Research

Edward Kelly - Crédit Suisse AG

Meredith Adler - Barclays Capital

Scott Mushkin - Jefferies & Company, Inc.

Mark Wiltamuth - Morgan Stanley

Karen Short - BMO Capital Markets U.S.

Todd Duvick - Bank of America Corporation

Deborah Weinswig - Citigroup Inc

Robert Ohmes - BofA Merrill Lynch

Damian Witkowski - Gabelli & Company, Inc.

Andrew Wolf - BB&T Capital Markets

Neil Currie - UBS Investment Bank

Operator

Welcome to the Safeway Second Quarter 2010 Conference Call. [Operator Instructions] I will now like to turn the call over to Miss Melissa Plaisance, Safeway’s Senior Vice President of Finance. Please go ahead.

Melissa Plaisance

Good morning, everyone, and thank you for joining us for our Second Quarter Earnings Release Call. With me this morning is Steve Burd, our Chairman, President and CEO; and Robert Edwards, Executive Vice President and Chief Financial Officer. Before I turn the call over to Steve, let me remind you that this conference call may contain forward-looking statements. Such statements may relate to topics such as sales, margins, earnings, earnings growth, operating improvements, cost production, capital spending, debt financing, dividends, free cash flow, growth of Blackhawk, depreciation, product development, Lifestyle stores, guidance and other related subjects. These statements are based on Safeway's current plans and expectations and are subject to risks and uncertainties that could cause actual events and results to vary significantly from those implied by such statements. We ask you to refer to Safeway's reports and filings with the SEC for a further discussion of these risks and uncertainties, including those set out under forward-looking statements and risk factors in Safeway's annual report to stockholders included in Safeway's most recent Form 10-K and subsequent quarterly reports on Form 10-Q.

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

Steven Burd

Thank you, Melissa. Let me begin with net income. Net income for the quarter was $141.3 million compared with $238.6 million in the same quarter a year ago. Expressed in terms of earnings per share, we made $0.37 per share this quarter versus $0.57 per share last year. While that represents a large difference, I would like to remind you all that last year, we had an extraordinary tax benefit in the second quarter. That tax benefit resulted in $0.14 a share in earnings. So if you want to get a feel for the operating performance of the company last year versus this year, a more fair comparison would be to look at $0.37 versus the $0.57 minus $0.14, which takes you to $0.43. Now that does cause earnings per share to be down 14%.

You'll recall that in our last quarterly call, we indicated that we were doing what we call an employee buyout in one of our divisions that we expected that, that investment and saving money for the future would cost us about $0.02 a share. That number was actually in excess of $0.02 a share, almost $0.025 per share. It will reduce future employee cost by about $20 million a year, which is going to be worth more than $0.03 a share on an annualized basis.

So again, just try to understand the operating performance of the enterprise. Not asking you to look at the earnings any differently than reported, but try to understand the operating performance. I adjust out at $0.37 and I get to $0.39 today, knocked down the buyout, which is good for the future. And so it’s a $0.39 a share performance compared to a $0.43, which given the magnitude of deflation that we’re experiencing, a 9% reduction in EPS in terms of operating performance, I think, is a very strong performance under that deflationary environment.

So let me shift gears now and just kind of give you some quick highlights for the quarter, and then I'll start going into some of the details.

The reported $0.37 per share was consistent with our internal expectations, which also matches what we did in the first quarter. First quarter results were certainly consistent with internal expectations. This $0.37 also matched the consensus estimate for Safeway, which were all at $0.37.

Our volume is really the story this quarter. Our volume continues to improve in both the U.S. and the Canadian market. And we think that volume improvement is really driven in large part by the price reductions that we made last year in third quarter and beginning in the third quarter in the U.S., and then obviously, we made those same price reductions to get the competitive parity in Canada in the early second quarter of this year.

Unfortunately, the retail deflation was much greater than anticipated. Those of you that attended the investor conference know that we predicted that we would have 1% deflation in the first quarter. That's exactly what we had. We predicted also that we would start seeing some inflation in the second quarter. In fact, we had a prediction out there -- I don’t think you can hold me to quarterly prediction, but it was part of the annual number -- we had quarterly prediction of 0.5% inflation, and we experienced 2.4% deflation.

Now we're measuring that at the retail level. Others that sometimes talk about a deflation talk about that on that cost side of the equation. So our definition of deflation or inflation here is retail price per item, which allows you to translate that into top line sales and do your financial models. If I gave you cost deflation, it wouldn't allow you to do the same thing.

So big surprise in the deflation. However, the earnings decline that would normally accompany a 2.4% decline in price per item was greatly moderated by what I would describe as very strong cost control, which I'll talk to you in a few minutes.

So let's move on to some of the details. Often, I talk about sales. I'm going to talk about both sales and volume because as I've been saying for the last several quarters, in this kind of deflationary environment, volume, we think, is more important to keep an eye on than simply sales, and sales without understanding the deflation-inflation component is not particularly meaningful.

So first on sales. Total sales actually increased modestly in the quarter 0.6%. This was largely the result of the Canadian exchange rate that was much more favorable than last year. We expect that favorable condition to continue as we move through the balance of the year. And secondarily, higher fuel sales, which are driven by higher fuel prices. Obviously, those two positive elements were in large part offset by a decline in ID, which, of course, is driven by deflation.

So let's talk about ID. ID sales excluding fuel, which is the way most retailers describe their ID performance that are also engaged in fuel as a piece of their business, declined 2.5%. So if sales declined 2.5%, that means the decline in ID was essentially driven almost entirely by deflation, since deflation was 2.4%. So technically, there was a slight volume decline, but it was about 0.5%. So from a rounding standpoint, you get a sales decline of 2.5% with deflation of 2.4%.

The volume was essentially flat against last year's second quarter, but it was 170 basis points better than Q4 of last year. And the reason I'm giving you that as a reference point is you recall in our first quarter earnings release, we had this odd thing that we did in 2009 relative to Super Bowl weekend. So we sort of presented the quarter as the bookend. So the first three weeks of the quarter married with the last four weeks of the quarter actually produced positive volumes. But quarter four doesn't have any of that in it. So compared to quarter four, we were up 170 basis points in volume compared to quarter one, which was impacted by the comparison to the extra promotion [ph] in 2009, we were up 230 basis points. So just kind of keep those two numbers in mind.

The U.S. volume clearly benefited from last year's price reduction, and so was actually up in absolute terms 0.5%, which is stronger than the two pieces of the bookend that I described in the first quarter, and that 0.5% contrasts with the Q4 volume number of negative 0.4% . Keep in mind that the pricing action that we began taking aggressively in the third quarter of last year was really focused on everyday prices. And so it really shouldn't surprise anybody that it takes consumers a while to absorb and appreciate, given what we've done there. We chose to do it on everyday price because we wanted to create a better everyday value for consumers. It takes longer for them to catch on to the price changes. And some purchase cycles are as much as four and six months. And so on some items, that discovery is not made for some time, and that's why the volume just continues to get sequentially better.

The Canadian volume also improved 200 basis points against the Q1 performance. Keep in mind, early in the second quarter, we achieved price parity with our conventional competition in Canada. So really, we've got a very strong response in Canada, and that response continues into the third quarter. And I can compare Canada cleanly to Q1 since we didn't do the same Super Bowl activity in 2009 that we did in the U.S. market.

As I said, we believe these improvements are largely the result of price changes that we initiated in Q3. And something kind of to keep in mind, the price changes started in about the fourth week of the third quarter of last year. And by the time we ended the third quarter, we had touched 50% of the volume of this company. And then, we finished those price reductions essentially in the first part of the fourth quarter. So by the time we finished the fourth quarter, we were at total price parity with the conventional competition in the U.S. market.

Now the volume improvements, as you would expect, are not uniform across all geography in terms of their magnitude, but they are universal. Stated differently, there's not a single division that is left out of this improvement in volume. Every division has improved since Q4 of last year.

To give you a sense of magnitude, six of 10 divisions improved in excess of 200 basis points, and there are divisions that improved in excess of 300 basis points. In addition, our performance has steadily improved against our key competition.

Let me just expand on that little bit. One of the things that we keep a close eye on, we identify, for every store in the company, who is our primary competitor. So I might compete with three or four people in a geography. Our primary competitor is a competitor that we are generally the closest to. And so when I look at our top nine competitors and I look at our volume improvements against that competition over the last three quarters, we have sequentially improved against all nine competitors since the fourth quarter of last year. So first is better than fourth, second is better than first and third is better than second.

That's a pretty remarkable statement because I'm not confining it to format. So that includes stores. I am confining this comment in the U.S. It includes stores that would be supercenters. It includes stores that are conventional. It includes stores that would be club. So we feel very good about our volume. We don't like the deflation component, but we believe still that deflation will come to an end.

The components of the volume improvements are essentially in an improvement in transaction and an improvement in items per transaction. And that was really our objective all along. Get customers to come to our stores more often, which creates more transactions, and while they're there, we want them to put more items in their basket per transaction. That's what's driving the volume increases.

Now while it's early in Q3, our volume momentum continues to build, outpacing our Q2 performance in both the U.S. and in Canada, and I'm going to describe by a wide margin. The quarter is shaping up to be the single best quarter we've had in volume in more than four years. Now it's early. We're 4 ½ weeks into the quarter. It's conceivable that the first 4 ½ weeks won't look like the next 7 ½ weeks, but we are quite confident that the third quarter will be stronger than the second quarter, and the fourth quarter will be even stronger from a volume standpoint than the third quarter. So we could get a little slippage right there. But if we had normal inflation instead of deflation right now, the performance that we’re generating in the third quarter, that reported ID would start with the fourth if you put 3% inflation on top of today's volume. So we are absolutely confident that 3% inflation will return. It's difficult to predict exactly when it will return, but I'll give you a sense for how we think deflation for us will play out for the balance of the year.

So let's talk about deflation and inflation. Again, our definition is price per item. Deflation slowed in the U.S. from Q4. Q4, again, for those of you that attended the investor conference or listened to our Q4 earnings release, we had deflation in the U.S. of 3% decline in price per item. In quarter two in the U.S., it had slowed, but it was still negative 2.6%.

So it improved a little bit, but the economy in Canada is stronger than in the U.S. That's been true throughout the entire recession. And Canada is running a bit behind the U.S. in terms of inflation and deflation. So in Canada, we actually went from very high inflation early part of last year to essentially a low level of inflation magnitude of 1.5% in the fourth quarter of last year. And now, they have modest deflation in price per item in the second quarter. And that's why the 2.6%, while we're dominated by U.S. operations, the negative 2.6% actually played out to a deflation of 2.4% when we have the numbers together.

Now we believe that Safeway’s deflation is going to play out a bit differently than our peer group, in large part because of the price actions that we took in quarter three of last year, and we are now cycling some of that. And so in order to really kind of appreciate how deflation or inflation will play out for Safeway for the balance of the year, I need to kind of give you some additional information.

The strongest element of our price per item decline is really driven by the price reductions that we initiated last year. In the dairy category, those are actually initiated across the company in the second quarter. So we've now cycled those. In 50% of the U.S. business that was -- we started that in the third quarter and then finished it off in the fourth quarter. So when you look at kind of a bit of a mirror image of price per item, let’s call it gross margin decline, keep in mind that the gross margin decline in this quarter is not the result of taking additional price action this quarter. It's simply the result of not yet having cycled the price reductions that we made in the third and the fourth quarter, and on the dairy side, in the second quarter of last year. So biggest piece of the deflation would give you some comfort that, that big piece that is going to drift away before the end of this year is the price reduction.

The second piece, which is going to be common, I think, to virtually our entire peer group is that we have a significant growth in generic drugs and a significant growth in private label. And so from a pure price-per-item standpoint, those prices naturally are lower, but generally, that's not a hit to gross margin. So doesn't really affect your gross margin in a negative way. In fact, it affects the gross margin a positive way.

But on price-per-item basis, it does explain a piece of that deflation. And I don't really see that really changing between now and the end of the year. And then there is a third component, and I'm trying to give you these in order of magnitude, that would be deflation in categories like produce and dairy.

But in the case of dairy, as I said, made the moves early, made it across the geography. So when I look at the third quarter today, and I know this is a concern to a lot of people, we are now experiencing cost increases for the dairy category here in the third quarter, and those cost increases are being matched with retail price increases.

So we no longer have a situation where prices are going down from a retail standpoint and costs are going down. We're now kind of on the flip side of that dairy in the second quarter and a bit of the third quarter. Given that there has begun to be some significant cost inflation in the meat category, people are spending more time promoting some of the produce, particularly in the summer season, which makes produce a bit more deflationary and meat actually inflationary.

So those are the big three components. So some real deflation that continues across categories. And then the last thing I want to tell you is that the price per item doesn't always play out once or what [ph] in terms of gross margin decline because if you go back again to our investor conference where we laid out a substantial cost reduction effort for 2010, we had more than 50% of that pie chart that was represented by cost-reduction activity that would actually improve gross margins.

So the gross margin impact is actually softened by some of that activity. A couple of examples of that is with a long-term effort underway to take costs out of the supply chain, which gets booked in gross margin. I've already spoken to the higher margin that results in today's private label.

We have a very strong effort underway, which we're accelerating on shrink reduction. And then we got the Blackhawk component, whose income gets booked on the gross margin line. All of those things add back and soften the effects on gross margin that would've resulted naturally from pure price-per-item decline.

Now as we lap our heavy 2009 price reduction, we should see a significant improvement in price per item. So while the third quarter right now is about where we were in second quarter, we expect as the quarter plays out, in large part because it is cycling, we'll see price-per-item improvement there.

So we’ll still have deflation at the end of the third quarter, but the back half of the third quarter should be considerably better than it is quarter-to-date. And then in the fourth quarter, we should be dramatically better as we lap the remaining price changes.

So hopefully that gives you a good sense for what's happening on the deflation [ph] front and how we think that changes.

So moving on to gross margin. Our total gross margin rate decreased 32 basis points. Oftentimes, we sort of give you with or without fuel, but basically, fuel sales have virtually no impact on gross margin in this particular quarter.

The declining gross margin rate is largely the result of: Number one, last year's price investments, coupled with an increase in advertising as we explain our price position and changes in offering to our customers. And then all of that gets partially offset by these gross margin-enhancing activities that I just referred to.

Now turning to O&A expenses. O&A expenses increased 46 basis points from last year's second quarter. Now that number is as reported. When exclude fuel sales, you can get a real handle for the lion's share of the business. The O&A expense ratio actually increased 77 basis points.

Now because of the buyout expense that we had in the quarter, which was $14.5 million, an unusual event, but it's going to provide a great return and it provides $20 million worth of annual savings going forward. That by itself quantifies out the 16 basis points. So what I think you should really look at, the de-leveraging effects of deflation, is that we had essentially a 61-basis point increase in O&A expenses.

Now while you have expenses that go up -- for us, we've signed contracts and there're obligations on wage increases and maybe some benefit increases -- I'm often asked, "Hey, at what level of sales could you actually leverage your O&A?" In other words, what kind of sales increase would you have to have in order for O&A to be improving? And the answer is, if sales were absolutely flat, we would've leveraged O&A 3 basis points.

Now volume wasn’t flat. Volume was up. So if deflation didn’t exist and a big piece of this goes away as we cycle the price reductions, we would have actually leveraged O&A. Kind of just a fun a number, and it’ll give you a sense of the leverage here, 1% inflation, pure price-per-item inflation, would've given us a 29-basis point improvement, 2% would've given us 55 basis points and it basically moves up in the increments of almost 25 basis p1oints.

So let's turn to interest expense. That's why I said -- and maybe finish it off on O&A – that’s why I believe we had a very strong O&A quarter. I mean, if you get to the point where you could have leveraged it at sales increases is a testament to the kind of cost control that's happening inside the company.

Interest expense declined $8 million due to lower average borrowings and lower average interest rates. Our average debt outstanding declined $259 million versus last year, while the average borrowing rate declined from 5.96% last year to 5.60% this year.

Talking about capital expenditures, not a big year for us in terms of new stores or even remodels because we're winding down the remodel effort. Although our new store program has a back-half component to it. So I think, Robert, our new stores this year are actually larger in expectation than last year. But we opened five new stores and completed 17 Lifestyle remodels during the quarter. So a lot of our capital this year is devoted to infrastructure investment. But year-to-date, we've invested $385 million and we’re still expecting to spend, in terms of total capital, somewhere between $900 million and $1 billion. So functionally, not that different from where we were last year.

In terms of income taxes, our tax rate for the quarter, substantially higher than last year obviously because of the large tax benefit. For the quarter, it was 35.3%, and that's really our expectation as well for the balance of the year. So 35.3% this quarter, that's about where we expect it to be as we move through the second half. In terms of cash flow, free cash flow for the quarter was $330 million compared with $596 million for the same quarter last year.

The two biggest components of that is we have a higher tax cash payment this year than last year, and we had a smaller improvement in inventory relative to last year. Free cash flow for the first half is $272 million and compared with $409 million from last year

Two other notable events for the quarter just to kind of keep you somewhat updated on Blackhawk. We've always given a metric on Blackhawk card sale because the face value of the card would give you a sense for the momentum of the business -- increased 21% in the second quarter. So not behaving as if they’re in a recession. But again, I would tell you if we didn't have the recessionary environment, the results would be even higher. And then, on the first-half basis, and keep in mind, this is really a second-half-type business, they're up 24% on the first half. Other notable event, we purchased 7.1 million shares of stock at a total cost of $169 million.

So now, let me shift over to guidance. While we still believe that we could achieve the low end of our original EPS guidance, and for a refresher, that was a range of $1.65 to $1.85. So we still think we could achieve the low end of that range. We believe, given what we announced vis-à-vis deflation, we believe it's more prudent to adjust the EPS guidance to a range that includes the low end of our earlier guidance.

So our guidance going forward is, we think we are going to end the year with earnings per share in the range of $1.50 to $1.70. Price-per-item declines are much greater than originally anticipated. Just to sort of further quantify that, 2009, as you recall, was really an unprecedented year, not just for us, but for the industry, when instead of normal inflation on price per item at 3%, which have been our eight-year average, it was replaced with deflation of 0.3%.

Now we expect expected 2010 to be another unusual year. We didn't expect it to be normal, but we did contemplate that we would have inflation of about 0.4%. And I think the general reaction when we laid that at the investor conference, I think there was a general sense of some people that we were probably low and that we might have more inflation than that.

So now we have two quarters under our belt. As I indicated earlier, we were right in the first quarter. We were very wrong in the second quarter. Instead of a 0.5%, missed it by a wide margin, negative 2.4%. As a result, as we now try to, and this is dangerous stuff, but you can't really get to an earnings number without thinking about a volume number and then without thinking about your inflation-deflation number. So everybody has to do this whether they tell you they do it or not.

We believe that 2010 price per item, instead of being a positive 0.4%, we believe that deflation will be a negative 1.2%. Now we also believe that as we end the fourth quarter, we could be dangerously close to flat. Okay, so it's important so to keep that in mind.

But we think on the year, given the 1% in the first quarter, the 2.4 in the second quarter, despite the fact that deflation is going to improve, we think that for the year, deflation of 1.2% is what you should be thinking about for Safeway.

Now as I indicated earlier, our deflation in all likelihood is greater than our peer group because of pricing actions taken a year ago, which we will cycle completely about mid-fourth quarter. So this change in deflation from 0.4% positive inflation to deflation of 120 basis points is a change of 160 basis points, which is a pretty big number.

Now with all other things being equal, if you and do the math, that would actually drive the EPS decline of $0.30 per share. So we're not changing our guidance $0.30. We're changing the range of $0.15. So we feel very comfortable at $0.15 and I'll try to get you to be comfortable with it.

One of the things that you should know besides that effect of a 160-basis point decline, we have seized on yet another opportunity to engage in employee buyout, which will actually cost us between now and the end of the year approximately $0.04 a share. And that will deliver on an ongoing basis an improvement per share of at least $0.04. So again, it's on an annual basis, and so that's a good thing to do. That will also be affecting our second half, so weighs in the decision calculate of how to adjust our guidance.

Much like last year, we've stepped up our cost reduction efforts, affecting both O&A and gross margin, to achieve the revised guidance. But just to kind of recap that guidance, we’ve gone from an EPS range of $1.65 to $1.85 to a new range which overlaps the first of $1.50 to $1.70.

On the ID sales, which is really driven by our assumptions about inflation and deflation, we had original guidance that thought we could be somewhere between 0% and maybe 1%. We're now revising that so that on the low side, it could be from a reported standpoint as low as negative 1.5%, and probably isn't going to get any better than negative 1%. Now from a free-cash-flow standpoint, our original range was $0.9 billion to $1.1 billion. We don't have any change there.

In terms of other components of guidance, I think if you have an EPS and the sales and the cash flow, you kind of have what you need.

So let me try to summarize because I’ve been talking longer than normal here. We'll give the Q&A ample time. By way of summary, we've achieved price parity against our conventional competition in all markets including Canada. That's new news.

Deflation is now expected to be negative 1.2% instead of inflation of 0.4%. Price-per-item deflation dissipates considerably as we cycled last year's adjustment to price, which happened second half of third quarter, finished off in the fourth quarter. Trading down to generics and private label still impacting price per item. I don't see that abating.

Competitive circumstances, which has impacted both dairy and produce, appear to have moderated. In other words, we are recouping cost increases at the retail level. We've now cycled our Milk investment from last year and retail changes are matching cost inflation. Our U.S. volume has improved dramatically since the fourth quarter of 2009.

Third quarter improvement in the U.S. is currently well north of 200 basis points. It's at a level where we're not only building share in our channel, we actually believe we’re building share across all channels from a volume standpoint.

So when you look at the U.S., which is the bulk of our business, we believe that we'll have positive volume on the year. And some day, that’ll get married with normal inflation and it should get married with a substantial reduction in deflation in the fourth quarter.

We think the fourth quarter volume will be even better than the third quarter. Given Canada's response to our second quarter price changes, volume should continue to improve in Canada. And finally, with our cost-reduction efforts in high gear, volume steadily improving, we think we're going to be well positioned for 2011 and beyond.

So realizing it was a longer dissertation than normal, but I wanted to make it crystal clear how deflation plays into this and to give you as much, sort of insight, as I could.

Melissa Plaisance

Okay. We're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Neil Currie. [UBS]

Neil Currie - UBS Investment Bank

The first on is just about the deflationary and inflationary environment. We did see through recent months, we actually saw producer-price inflation coming through, but it wasn't necessarily matched by what we saw in retail. Do you think a part of, I don't want to call it a miscalculation, but the part of your perhaps over-optimism about inflation to start the year, was not so much due to inflation not coming through, because it clearly has come through on the producer side, but more of the ability of the industry to pass it through to the consumer. If it is difficult to pass through to the consumer, what prospects are there next year to pass on what could be more inflation coming through?

Steven Burd

I think that there was a time there, Neil, where there was a bit of difficulty in passing things across. And I might even describe that as first quarter, kind of early second quarter. With what you have going on in the retail arena is, you have a very significant financial effect of going from a world of normal inflation of 3% to basically deflation. And as we look at the competitive landscape, people that don't have our cost-reduction capability are really suffering. And so I think there is a pent-up demand both on the CPG side of the ledger as well as there is on the retail side of the ledger to stop taking all these body blows and pass some of them along. And that's what we're seeing in the back half of the second quarter. That's what we're seeing here in the third quarter. So I think you can only sit on that for so long.

Neil Currie - UBS Investment Bank

So are you seeing the more rational approach to it than you have seen...

Steven Burd

I am. Yes, absolutely. I think retail, because it is such a cash flow business, I think it doesn't have large periods of irrationality. I would never describe any part of the last few years as irrational. Oh, you get a little behavior here and there, but I think there's a real pent-up demand here for things to return to normal.

Neil Currie - UBS Investment Bank

Now that may be true for the retailers, but what about the consumer? The consumers still seems to be in pretty bad shape and how easy is it convincing the shopper that we can raise prices and hope to hold on to volume?

Steven Burd

Well, keep in mind that we're not going to do anything to harm our competitive price position. And I think that what we're seeing with us an extra price reduction that took place because of parity in the third and fourth quarter. So I think that these things just happened, they happened kind of naturally. I mean when beef costs went up, people didn't hesitate to reflect those at retail. Now that does create a little bit of a shift with consumers and what they choose to buy, and that's how consumers typically adapt to this. But the consumers have had a very good two years in the retail food world, and this is a thin-margin business. So I think, frankly, one of the first sectors to reflect the kind of cost inflation that's been occurring but not reflected at retail will in fact be this sector, and it's a sector that people have to buy in every week. And it may create in the near-term an acceleration in private label, but I think you will see a return to normal. You may not see full normalcy until late in 2011. I'm not going to try to predict that now. But I think you can only go so long and you're going to see a lot of retail -- you can see it in stores when you go out, but you will see, I think, liquidations and bankruptcies, and deteriorating store conditions in some of the smaller regional players. Think about our volume as building against all competitors in a down economy, so we're taking that from people that don't have our cost-reduction capability. So we're starting to build market share.

Neil Currie - UBS Investment Bank

In terms of that volume increase that you're seeing, are you seeing it build on a two-year basis? Is this just a reflection of negative volumes you're seeing or are you generally saying two-year basis?

Steven Burd

No. If you did two-year stack, the two-year numbers are getting better.

Neil Currie - UBS Investment Bank

I didn't quite catch fully what you said about, you could've cut guidance by $0.30 but you cut by $0.15".

Steven Burd

I'm glad you asked that. I said that it's not that we could've cut, it's basically the mathematical effect of 160-basis point change in price per item would yield a $0.30 reduction in EPS, much like last year. Recall, we stepped up our cost reduction effort last year. It was a record year. And we stepped it up in excess of 40% in response to last year's deflation. So we're stepping it up again. One of the opportunities for us that exists for a lot of retailers, you hate to confess to this, we've trimmed our shrink by almost $600 million over the last eight years. We still have almost $1 billion worth of shrink. And so what we're doing is we're reinventing our approach to shrink as a major opportunity, being careful not to impair volume growth, and so that becomes a real source of opportunity here. So since we have those opportunities, we should exploit those. And it moderates what would otherwise be a bigger earnings effect.

Operator

Our next question comes from Karen Short.

Karen Short - BMO Capital Markets U.S.

So we could dig in to volume improvements little bit, can you give some color around what you're seeing in perishables and non-perishable volumes? And I think if I look at 2Q last year, non-perishable volume was down quite a bit, but maybe a little color on that. And maybe if you can break that down into the U.S. and Canada.

Steven Burd

Well, I can't break it down between U.S. and Canada, but consistent with what we've really said now for several quarters, the volume improvements are being led by perishable category. But the volume improvements have not left out the non-perishable category. So both categories are improving. The non-perishable category, elements of it are quite positive. Other elements are still negative. In the perishable category, universally improving, universally positive volume.

Karen Short - BMO Capital Markets U.S.

And I guess what is your outlook going forward, I mean, to the extent that you might get more support from vendors going forward? A, do you think that's happening? And B, do you think that could help drive non-perishable volumes, at least into positive territory?

Steven Burd

Well, I think that we always welcome increased vendor support. I mean if you just think about it logically, and vendors are pretty logical, if you can drive the business, you get more support. So they're not just saying, "Hey, here's some money. Please have a good time." Basically, so we don't sit here and try to figure out necessarily how we get more vendor support. We try to cooperate with vendors, and as we build our business and their business, they are more supportive. But we don't have anything planned here in the back half for some big money flying our way from the vendor community. We think that everybody sees what we're doing, I think, generally pleased that momentum has really picked up and that generally yields better vendor support.

Karen Short - BMO Capital Markets U.S.

And I guess in the past, you've talked a little bit about the customer perception on price. I guess you refer to it as “winning the survey versus actually getting the traffic”. Can you talk a little bit about where you stand?

Steven Burd

I don't have an update for you on winning the survey, although I think the volume numbers kind of speak for themselves. I do think that it depends on what you do in a specific market. In some markets, I think where we might've made larger price changes and if those markets tended to be more price-sensitive, and I could think of a couple that are, we’re much closer to winning the survey in those markets that we're already winning our highest volume changes. And so if you really think about -- it's always been true that the foot traffic and the volume comes first, the survey comes second. And it could take you in some markets as much as four or five years to win the survey. The survey is nice. I'll take the volume any day. If I had to choose one to win and one to lose, I would choose to win on volume every day and not necessarily be perceived as the best-price guy. But we’re improving both price perception, which takes a while to get that message across, you pound on it. But consumers are smart. When you lower prices, they detect it. And when lower prices on items that have high purchase frequency, they detect those sooner and they reward you accordingly.

Karen Short - BMO Capital Markets U.S.

.

I think when you reported your first quarter, you'd indicated that all your divisions were positive for the four weeks of the second quarter. Did that remain the case throughout the second quarter? And is that the case in the third quarter in the U.S.?

Steven Burd

Yes, I don't recall saying all divisions were positive in the third quarter. I could tell you that from a U.S.-volume standpoint today, 4 ½ weeks into the third quarter, all divisions are positive.

Operator

Your next question comes from Andrew Wolf.

Andrew Wolf - BB&T Capital Markets

Just wanted to ask you on total volume going from roughly flat in the quarter you reported to, sounds like it’s around 1% or a little better. Could you give us a little flavor on how that's trended in the quarter and how the improvement is trending in the current period on customer traffic versus items per basket?

Steven Burd

I'm not going to split those out for you, but it's a nice blend of traffic and items per basket. And if you just think about it as a retailer, one of your single best opportunities, since they're in your store, they chose to come to your location, is to get more items in the basket. The pricing helps that. I would say that our volume improvement is probably 75% pricing, 25% merchandising and communication. So once they're in our store, let's make sure that we can draw their attention that puts increased items in the basket. And so it's really a nice blend of the two of those. And then with respect to how the quarter shapes up -- particularly in quarters with holidays, there's a lot of jumping around of the numbers. But if you were to look at a four-week rolling kind of number, what you see is momentum build as you move through the quarter. And in the third quarter, we just don't want people to think that as strong as we are right now that, that will necessarily build. Because between now and the end of the quarter, we come out the heavy soft fruit season, and a lot of our volume is basically driven by produce. I would love for the momentum to build exactly from where we are. But I'd be pretty content if it hovers around that number by the end of the third quarter and then we'll build on it in Q4.

Andrew Wolf - BB&T Capital Markets

Okay. When you described the item price deflation getting worse, you didn't mention competition, which is interesting. But could you give Safeway's view, particularly on Wal-Mart and their accelerated rollback activity, and what effect that might be having on Safeway? Doesn't look like it's on volumes, but is some of your increased advertising a response to that?

Steven Burd

Yes. I think their increased advertising is basically driven by a message to convey that we've got great everyday value. And so that's the dominant message there. So we had to step that up just because we're not striped exactly the same way we were a year ago. So you absolutely have to spend more. So it was not a response to what any competitor might be spending. Now I don't want to sort of necessarily isolate particularly competitors. It's a little bit like NFL players talking about the opposition, and we don't want a poster quote for the locker room here. But basically, what I would tell you is that today, you probably don't have a pure, everyday value, everyday price player in the entire market. I wouldn't have said that two years ago. I wouldn't have said that a year ago. There are a couple of players out there that are all about price. And so what's happened is people have maybe gotten increasingly into the Food Retail business. They should have morphed into behaving more like conventional retailers. Promotional prices, lower these prices, talk about them; raise other prices, don't talk about them. We have probably 7,000 promotional price tags in our store per week. And we're changing out 3,000 to 4,000 of those every week. That's the way we've gone to market, as have other supermarkets for decades. And so you basically see the vast majority of people that we compete with doing the same thing. So what I would say to you is that while there have been commodities that people will grab a hold of for a certain period of time and do some unusual things with, I cannot tell you that the world is any more competitive in quarter two or quarter three than it was in quarter four. I would say that it's about the same. But I would emphasize to you there's not a single everyday low price, pure-price non-promotional player that we compete with it. So they've all morphed into semi-supermarkets. And so you have to take all of that into account. And then I would go back to the comments that I made about our progress against our top nine competitors, which are basically comprising stores that represent 90% of the U.S. volume and regardless of format we've gained. So I think the volume improvements, my comments and others before me about the general competitive landscape, together with our progress, I think says it all.

Andrew Wolf - BB&T Capital Markets

And just wanted to ask two housekeeping items. On the buyout, the upcoming buyout, do you know which quarter that might fall in?

Steven Burd

Don't know yet but clearly, second half.

Andrew Wolf - BB&T Capital Markets

And just I think you said you're going to cycle the price investment mid-Q4. Should we be thinking of that U.S. only? Or is that for the entire entity?

Steven Burd

No, think of that as U.S. only. And it didn't happen at a uniform rate. The last bit of price investments, but it was one of our smaller divisions, was essentially made in week 43. So that's less than halfway into the quarter. So the back half of the quarter is a complete cycling. We cycled some of those things. Obviously, we cycled some in three. We cycled 50% of our business in three, some time in quarter three. And then we cycled most of the balance halfway through quarter four.

Operator

Our next question comes from Scott Mushkin. [Jefferies]

Scott Mushkin - Jefferies & Company, Inc.

So I just wanted to make sure that I understand when we're talking about price per item, Steve, are we adjusting for mix in that? I mean it's a silly question, but I don't know, so I figured I'd ask it.

Steven Burd

The price per item, I'm not adjusting for mix, and that's why I gave a second component. You can call it a mix, you could call it elements of trading down generic and private labels, although I'm sure you know on the generic side, that's not consumers going to generics necessarily because they're cheaper. It's a lot of drugs coming off patent and so there are more generic drugs out there. And so it's not necessarily recessionary shift; it's kind of a natural shift. And so no, I'm not adjusting for mix and that's why I tried to put that item in there as one that will sustain itself. It sustains itself on a price-per-item basis, which affect sales, but it's generally enhancing the gross margin rate.

Scott Mushkin - Jefferies & Company, Inc.

So one of the things -- that's interesting, and I'm glad I clarified. So there is, obviously, the potential that the price-per-item decline that you saw, what we're calling deflation, may be consumer behavior still being very challenged. In other words...

Steven Burd

Yes, I mean if you think about it -- I kind of think that what the market is sort of breaking into -- there are some people that still feel challenged and there are others that don't. So how do you explain the fact that we take a category like wine or frankly, floral, which are very strong categories for us, pick up in wine, pick up in the premium wines, pick up on floral, pick up in Starbucks. You probably saw Starbucks' earnings release yesterday. Relative to coffee beans you could buy in the store, and of course, you can buy Starbucks in the stores as well, those are indications that there's an element of the economy, they haven't been laid off, it's been two plus years, they're comfortable, it's not going to happen, some recovery in their investment portfolio. They feel safe; they're starting to spend. And then you got another chunk of the economy that isn't quite in the same position. So I think really consumer behavior is a bit bifurcated here. So you see some trading up while you still see some elements of trading down. At the same time, on the private label, I think that when you get into a long recession like this, you're able to introduce people into private label that haven't been using it. They see the quality of the product. I don't think that the share that we pick up necessarily goes away.

Scott Mushkin - Jefferies & Company, Inc.

So for your basic customer, and I guess I'm going to beat on this a little bit, I mean because there are those trends in floral, and like you said about Starbucks, but to get a 2.4% price-per-item decline, it seems to me that you're not seeing a lot of people, at least the broad swath of your customers go from ground beef to sirloin for their barbecues on July 4 because it seems to be almost -- in fact, if that was taking hold, it'd almost be impossible to get a 2.4% decline in your selling price per item or your price per item. Or is that in correct?

Steven Burd

Well, keep in mind that the largest piece of this is the pricing action we took ourselves. And then I would tell you that generally on the holidays, and this has been true all throughout this business downturn, I think your comment about ground beef and sirloin during non-holidays is probably a fair comment. But during holidays, people are going to have a good holiday. And so they go ahead and they actually do trade up to those middle meats and those premium meats just for July 4, just for Labor Day, just for Memorial Day and that kind of thing. But you are seeing as beef increased in cost of goods, basically due to the general conditions of supply and demand, you do see a little bit of shift away from beef. And since you can't really put a hot beef price on the front page like you could when costs were declining, you see ads with a little more produce content.

Scott Mushkin - Jefferies & Company, Inc.

But sequentially first quarter to second quarter, your contribution to that item-price decline, was it similar, the same, more in the second quarter?

Steven Burd

Well, I think that the difference -- the reason it appears to be more in the second quarter than the first quarter because of that Super Bowl thing that we did last year. I think we once quantified that as about, I'm going a little bit from memory here, but it was in excess of 30 basis points, maybe as much as 38 basis points of four-week price investments that we made in Q1. So the gross margin effects in Q1 of this year were much more moderate than here. But essentially, the price reductions that took place in the third and fourth quarter last year, we haven't added to those price investments. They're simply cycling. So from a comparative basis, the investments that you made in quarter three is essentially the same investment in quarter one, same investment in quarter two and then when you lap it in quarter three, it goes away.

Operator

Our next question comes from Robbie Ohmes. [Bank of America Merrill Lynch]

Robert Ohmes - BofA Merrill Lynch

I just had a sort of broader question and I think people are asking it in different ways. I'm just trying to -- maybe you could help me understand the mechanism here for how the price increases in inflation comes back. And what I mean by that is should we, the analysts, be looking at regional players to see if they get so pressured that they have to raise prices to survive? I think you said you wouldn't be leaving it in the price investments you haven't added to. But as you look to seeing more inflation in what you guys are doing, are you maybe not going to repeat as you move through the back half of this year some programs you might have done, maybe some club pricing programs you did, et cetera? Anything you can do to help us understand what the mechanism will be for sort of that 3% inflation rate to come back.

Steven Burd

Two parts to your question. What I want you to envision is two water glasses sitting side-by-side, and somehow, these things have been separated into four sections. And so the water glass on my left was essentially at a constant level but for dairy in the first and the second quarter, so it stepped down a little bit for diary. Then in the third quarter, when I finished 50% of the company in the U.S., the water level dropped. Then in the fourth quarter, as I finished off the balance of the year, the water level dropped again. Now I'm looking at the glass on the right, which you can think of as 2010. The water level that I achieved in the fourth quarter, and these were everyday prices, actually, it's not promotional. So the water level in the first quarter is the same as it was in the fourth quarter. And the water level in the second quarter is the same. And the water level in the third quarter is at the same level as where I finished the third quarter. And so when I get around to the fourth quarter -- so the water level is no longer dropping. And so that expresses itself. Remember price per item is the comparison of the previous year. And so when you express this as price per item, price per item doesn't keep dropping. It finished dropping in the fourth quarter. Yes, and things kind of move around quarter-to-quarter and you promote and you do this and that, but this is not a bunch of promotions done in the third and fourth quarter, which we are now failing to repeat. This was a water level lowering. Now in terms of a number of sort of off the radar screen, private companies, regional people and frankly, it would include some public companies, they not only didn't react to these price changes because we were going after the market leaders and we were just trying to get to their level. What happened is because they can't really manage cost and they're suffering with a recession, some of them have actually increased prices as their volumes have deteriorated. Now our volumes are moving in the opposite direction. Their volumes have deteriorated. And so we find ourselves, and I covered this in the investor conference, our price position relative to our secondary competitor is really light and sometimes you're tempted to try to narrow that, but given the fact that we compete with all these other people, we can't do that. And so if there's one thing I want people to understand in this call is the gross margin declines that you see here in the second quarter are not the result of things that we did here in the second quarter. They're the result of things that we did in the third and fourth quarter of last year. Consumers are responding. Volumes improving, best volume numbers right now in four years. And I think the industry got a little bit comfortable with abnormal inflation and was fooled by some respectable ID sales numbers without looking at the underlying volume. And we've been looking at the underlying volume now for almost two years.

Robert Ohmes - BofA Merrill Lynch

So just really quickly on the water-glass analogy, which was great, so just in terms of the surprise to you for your items because it seems like you would know what the water glasses are as you're going through the quarter. So in aggregate, it would seem like your own deflation shouldn't be the surprise. Is it the volume, then, that's been the surprise, particularly the downside to your comps? And...

Steven Burd

No, I think that we've been sort of looking at volume longer than most people and we looked at it at a very disaggregate level. And so we might not have calculated everything perfectly when we forecasted inflation. Obviously, there are a few surprises in there along the way. So it's kind of combination of that thing. I think we know more about volume and deflation than almost anybody we compete with, and yet we still learn a little bit about this every day.

Operator

Our next question comes from Meredith Adler. [Barclays]

Meredith Adler - Barclays Capital

I was wondering if you could -- I actually was glad to hear Robbie ask that question because I kind of had the same question. So you obviously knew what the impact of your own investments and everyday prices would be. The two other things that could've happened is that the cost of products could have been different then you had originally anticipated and the environment could've been more competitive. Or the mix I guess the other piece of it could have been the mix. If you look at those three things, which of those would be the most important in terms of the differential versus what you originally expected?

Steven Burd

I think the biggest differential is that we expected a stronger return of inflation than we've actually experienced, and so that has kind of kept deflation at a higher level.

Meredith Adler - Barclays Capital

Okay. I understand that you feel that you have gotten where you want to get on those everyday prices but you also have done a fair amount of advertising and it sounds like that continued in Canada in the most recent quarter. What is your plans for advertising going forward? Do you feel that you need to keep repeating the message to people that you've made these changes? Or do you think that you'll be able to cut back on it?

Steven Burd

No, we look at that on a consistent basis. And I don't want anybody to think that the only thing we've done in the last eight months is to lower prices. So there's a lot going on under the hood of this car. There's a lot of targeted marketing efforts and some other things. And so as we make subtle changes to our offering, we feel a compulsion to communicate those things. And so I don't look at advertising -- if we see an opportunity to purchase more efficiently, we will. We experiment all the time with different ways to communicate with customers. And as we increasingly crack that code, that could create a reduction in advertising spend. But if you are a retailer, who, until recently, was the most promotional supermarket in the marketplace and you've now changed your mode of operation to create better everyday value, you absolutely have to be communicating that on a regular basis. Now in order for you to really see that in our stores, you actually have to kind of shop our stores because there are a lot of tags there. Some of those tags are conveying a new everyday value. Some of those tags are conveying a promotional price. So when we have a new everyday value on an item, it doesn't mean we'll never promote it. We absolutely will promote it. But we may promote it with either less steps or less frequency because we have a better everyday value. And so I'm not expecting that the advertising spend will materially change. But we're extremely pleased about the volume improvement. And every time we do our surveys, we're seeing an improvement in customer perception about our price position. And that's, again, not uniform but it's true across every division of the company, including Canada.

Operator

Our next question comes from Deborah Weinswig. [Citigroup]

Deborah Weinswig - Citigroup Inc

So Steve, at the 2009 Analyst Meeting, you went through some great detail with regards to the planned cost reduction, and it sounds like it will help maybe even better than expected your earnings for this year in response to Neil Currie's question at the beginning. You went through some details on shrink, and I think you had originally stated that there would be, for 2010, $390 million with regards to planned cost reductions. Can we expect those now to be greater than $390 million? Or how should we think about that number at this point in the game?

Steven Burd

You should think about them being greater. And the other thing that I would just sort of refresh you on is that as soon as we put our plan to bed, so to speak, we immediately began efforts, internally, in the company to beat that $390 million. So this isn't something we decided to do earlier in the week. So we're running at a pace greater than $390 million. So we have stepped that up and it is going to affect virtually both the gross margin elements of the pie as well as the O&A elements of the pie. So you're correct to think -- in fact, I believe that this will probably be our second-best year with last year being an extraordinary year in terms of cost reduction.

Deborah Weinswig - Citigroup Inc

.

Okay. And then with regards to your most loyal households -- I know you do an incredible amount of data mining with regards to your loyalty card. Should we think that you're getting greater trips from your most loyal households and/or are you gaining more loyal households? How should we think about that?

Steven Burd

I think that for us, one of our biggest opportunities is to take somebody that shops our stores but not very often and get them to come more often and then get them to buy more. So obviously, there's great value in retaining the most loyal customers that we have, and we make a great effort to do that. But when I look at the volume gain, they're driven by people who used to shop us more occasionally and at a spend level that might be half or less than our most loyal shopper, which is kind of what you would expect. If you have a very loyal shopper and now you have had a serious reduction in price, the people that were shopping you with less loyalty but are in there with enough frequency, some as much as once a week instead of three or 4x a week, they're getting it, and so now they're coming in more often. So the biggest volume changes are coming from not the most loyal, but the rung below that, all the way down to what I would call an occasional shopper.

Deborah Weinswig - Citigroup Inc

Okay. One of your competitors recently talked about on their earnings call that the continued high use of food stamps and other government programs is causing volatility in their weekly sales trends. And also we've heard from other retailers that there's been significant volatility in discretionary purchases. You spoke earlier in response to a question that, obviously, the environment has been difficult with regards to the health of the consumer. But can you talk about what kind of volatility you've seen in your business and how you've been responding to that?

Steven Burd

Yes, with regard to food stamp buyers, if you were to go back to the beginning of the business downturn, there's been a substantial step up in that [ph]. If you were to look over the last couple of quarters, it's continued to grow but not at the same rate. And so that has really kind of flattened out, if you will. In terms of the volatility, I do think one of the consequences of a recession is that you do get more spikes in your business. And the spikes are driven by what are traditional pay periods versus end of pay periods. So those things are more exaggerated. Any kind of transfer payments including things like food stamps, Social Security checks, those create more daily volatility, but I don't think they result in monthly volatility. So we don't see monthly volatility, but they do result in daily volatility, which, from an earnings standpoint, it does require that you have a good labor-scheduling model so that you're in tune with those volatile movements so you don't have more labor content than you need. So a retailer who really has great scheduling, has the right people there at the right times for those spikes. But some of my 30-year veterans, I turn to periodically when I'm looking at a day's performance, and I say, "Hey," and I call them students of the calendar. So we've got people around here that are sort of like the old stage, although some of them aren't necessarily that old because they started when they were 16. But they really are students of the calendar, and our retailers, in particular, are students of the calendar because they know in this thin margin business if they don't plan the labor content correctly, it's going to hurt them one way or the other. And so when I'm trying to understand a calendar, I turn to one my retailers often.

Operator

Our next question comes from Mike Wiltamuth. [Morgan Stanley]

Mark Wiltamuth - Morgan Stanley

Steve, wanted to ask a little bit about gasoline. If you look at how you did versus a year ago, were you up or down on profits per gallon and overall profitability?

Steven Burd

We were up.

Mark Wiltamuth - Morgan Stanley

And can you quantify the profit per gallon up or down percentage?

Robert Edwards

Mark, this is Robert. In the past, we haven't quantified it specifically, but fuel was a contributor to profitability in the quarter and it was up substantially from last year. It was a good quarter for fuel.

Steven Burd

Right. As you know, from stuff that we've revealed in the past, that's another one of those things that are volatile. Margins expand when pricing is coming down and they shrink when prices are going up, and that can happen inside of a two-week period. So even though we had a good quarter in fuel, our annual performance over the last seven or eight years has been remarkably consistent.

Mark Wiltamuth - Morgan Stanley

If it was a substantial performer this quarter, that means that the rest of the core business was a little softer than it appeared.

Steven Burd

I think that's a fair statement, but again, fuel is not the biggest driver in the garage here.

Mark Wiltamuth - Morgan Stanley

And just to focus a little on free cash flow. The free cash flow year-to-date is actually looking a little negative here. How are you going to get to the big free cash flow guidance you gave? And with your earnings estimates down, how do you end up maintaining your cash flow guidance?

Robert Edwards

Mark, we're on track with our plans for free cash flow. The comparison you're probably making is to last year. If you recall, last year was the highest free cash flow in the history of the company. And the guidance that we initially were maintaining -- and it's a reasonably broad range, and there's a number of variables, as you might suspect, that can be adjusted even in the face of a change in EPS to make our cash flow guidelines. So we've had a good cash flow year-to-date, and we expect we'll have a good year. It will not be extraordinary like last year was. CapEx, as you know from the guidance, is up a bit from what we spent last year. And then also, we're going to have higher cash tax payments this year than we had in 2009, but we expect a good year on free cash flow.

Mark Wiltamuth - Morgan Stanley

Okay. But I mean the cash flow from operating activities the first 24 weeks, you're at $309 million versus $684 million a year ago. Is there going to be a swing in the gift cards that dramatic swings that?

Robert Edwards

I mean, Mark, if you look at the detail on the cash flow statement, a big reason for that year-to-date is what's happened at Blackhawk. We break out on that cash flow statement payables net of receivables at Blackhawk. And so the growth that you'll see on the cash flow statement from last year to this year is actually a good thing, because, as you recall, we collected a lot of cash right at the end of the year, and then, for the most part, we have not paid that cash to what we call the content providers until say sometime in January, and so it's a typical pattern. And as Blackhawk grows, that line on the cash from operations statement will actually get more negative as Blackhawk becomes a bigger piece of the business. So we feel good about cash flow for the year. And also, Mark, from our free cash flow guidance we actually exclude that. So it takes out the temporary change in cash position from Blackhawk. So we'll be okay.

Operator

Our next question comes from Ed Kelly. [Crédit Suisse]

Edward Kelly - Crédit Suisse AG

Steve, I'd like to just circle back quickly on the competitive landscape. I heard you say on this call about having the ability to pass through higher dairy prices, which I don't think you said last quarter. I've kind of been hearing in the marketplace just about some of your traditional competitors, even regionals and independents just getting tired after chasing volume last year with low returns. Are you seeing competitives generally easing off the price and margin pressure out there today?

Steven Burd

I think the answer would be yes. But the longer answer would be we're seeing a quicker recovery on cost of goods increases, particularly in things like the dairy category. I think part of that stems from the fact that not everybody two years ago split this discussion into inflation, deflation and volume. And when they started to see sales declines, they might not have interpreted them as no change in volume but a change in deflation. And I think as everybody gets smarter about volume, they get smarter about cost of goods increases and how to reflect them. But we've seen it now in two broad categories: meat and dairy, where as costs change, the retails change.

Edward Kelly - Crédit Suisse AG

And then just as it relates to your guidance, thinking about your EPS and your comp and guidance, I mean I think it certainly has to imply that the rate of growth in your SG&A in the back half is not as high as it was in the first half. And I think what you've said on the cost-cutting front would support that. I don't know if you agree. And then secondly, I think it also kind of implies that the gross margin has to probably be flattish to up as you start the cycle some of these price investments that you made last year. I mean is that an accurate way to think of that?

Steven Burd

You're correct on both counts.

Edward Kelly - Crédit Suisse AG

Okay. Share repurchase, you didn't buy back as much stock as I would've thought this quarter. You ended with a fair amount of cash on the balance sheet. Now some of that may be because you reduced guidance and there's clearly opportunity in terms of how you think about it. But the second part of that is does the lower guidance have any impact on that because it changes the way that the rating agencies think about you and, therefore, changes your attitude towards share repurchase?

Steven Burd

I don't think it has an impact on our priority. It's just the way the chips fell in the second quarter. The priorities are the same.

Operator

Our next question comes from Alex Bisson. [Northcoast Research]

Alex Bisson - Northcoast Research

Steve, I guess first off on market share, you said you thought Safeway was taking market share across channels. And I was just curious given the strong comps, especially on the food side, coming out of supercenters, dollar stores, cost stores, what gives you confidence that you are taking share?

Steven Burd

What I said was that the current performance through quarter three was clearly taking share into those channels and those are good indication that we're taking share across channels. And here's how I get there. If you have population growth, which could've slowed but it's been running kind of in the 1.1% range, and if you have volume increases that are equal or north of that, then if you're north of that, then you're probably taking share. That's how I get there. I don't get there by going to Nielsen and asking them to do some elaborate study. I get there by just looking at my current volume versus what I know about general population trends.

Alex Bisson - Northcoast Research

Got you. You suggested that a lot of your volume growth is coming from the occasional shopper. And I'm just curious if you could talk a little bit about that shopper's basket relative to the average. I guess, specifically, is that a cherry picker shopper who's only coming in for the deals? Or are you seeing that shopper expand kind of their breadth of shopping across your store?

Steven Burd

Let me just sort of repeat what I said. I said that we've got our very loyal shopper, who is less affected by the price reductions that we made in everyday because they really love the experience. And they appreciate the new lower prices, but there's not that much behavior change they can engage in. And so if you look at everybody below that, which could be somebody that's visiting you twice a week but is not totally loyal, all the way down to the occasional. So I did not mean to suggest that the occasional is the lion's share of our sales growth because it's not. But basically, as you tier away from the most loyal, basically it's the other categories that are generating most of the volume increases, other categories of shoppers.

Alex Bisson - Northcoast Research

Got you. So I shouldn't take that to mean you're just getting more cherry pickers. You're getting more shopping across the store.

Steven Burd

Yes, we kind of look at our shoppers in about five different levels. And so if the most loyal is level one, then the gains are coming from the other four levels.

Operator

The next question comes from Todd Duvick. [Bank of America Merrill Lynch]

Todd Duvick - Bank of America Corporation

And I guess it's really kind of a follow up to Ed Kelly's question in terms of financial policy. According to my calculations, anyway, your EBITDA is down like 15% or so over the past year on an LTM basis and your financial leverage is going a little higher. And according to my compilations, anyway, it's getting close to the range where the rating agencies say that's about the upper range for your current rating. And I know you've been very committed to your credit rating, so the question I have is does this increase in leverage at all temper your appetite for share buybacks or near-term debt refinancing?

Steven Burd

Well I'm not sure what calculations you're making, but we look at our coverage ratios as, frankly, very strong and generally getting better. And we don't think that any of the rating agencies are worried at all.

Robert Edwards

And then, Todd, you're aware that we have some debt coming due in mid-August. We expect to refinance some or all of that prior of that coming due.

Todd Duvick - Bank of America Corporation

Okay. So your plans for that have not changed at all?

Robert Edwards

Correct.

Operator

Our final question comes from Damian Witkowski. [Gabelli and Company]

Damian Witkowski - Gabelli & Company, Inc.

Steve, are you seeing private label accelerating its gains? And if so, which categories?

Steven Burd

Private label for us has been quite strong and I'm not sure it's accelerated in the last couple quarters, but it's been strong and we're now seeing some acceleration here in the third quarter. But we are making -- it's always been a good business for us. And we have some particularly strong brands, and so we think that we should see some acceleration in private brands as we move through the balance of the year.

Damian Witkowski - Gabelli & Company, Inc.

But in aggregate, is private label growing faster than national brands?

Steven Burd

[indiscernible] margins, by country model would be too small, call it a continent-wide.

Damian Witkowski - Gabelli & Company, Inc.

Okay. And then you mentioned that the change in the competitive environment in terms of everyday low pricing versus everyone now being just more promotional. Is that an environment you think will continue? And are you more comfortable operating within that kind of environment versus competing against everyday low pricing?

Steven Burd

So it's interesting the way you put that. I mean we've sort of migrated in the direction of more everyday values. And then people who used to be everyday price have migrated a bit in our direction. Yes, I'm actually probably more comfortable with that.

Damian Witkowski - Gabelli & Company, Inc.

And do you give guidance on what do you think your total square footage is going to end up at the end of the year?

Melissa Plaisance

Not specifically. Okay, thank you, everyone. If there are any follow-up questions, Christiane Pelz and I will be available through the balance of the day, and thank you for your the long conference call. It took a lot of your time but we appreciate your support.

Operator

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

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

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

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