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SUPERVALU, Inc. (SVU)

F2Q11 (Qtr End 09/11/10) Earnings Call

October 19, 2010 pm ET

Executives

Ken Levy - IR

Craig Herkert - President and CEO

Sherry Smith - SVP, Finance.

CFO

Analysts

Deborah Weinswig - Citi

Mark Wiltamuth - Morgan Stanley

Meredith Adler - Barclays Capital

Neill Currie - UBS

Scott Mushkin - Jefferies & Company

John Heinbockel - Goldman Sachs

Ajay Jain - Hapoalim Securities USA Inc

Radina Russell - JPMorgan

Karen Short - BMO Capital Markets

Operator

Good morning. My name is Kenisha, and I will be your conference operator today. At this time, I would like to welcome everyone for the SUPERVALU Second Quarter Fiscal 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question and answer session. (Operator Instructions). Thank you, Mr. Ken Levy, you may begin your conference.

Ken Levy

Thank you, Kenisha. I want to welcome everyone today to SUPERVALU’s Second Quarter 2011 Earnings Conference Call.. Joining me on today's call are Craig Herkert, Chief Executive Officer and President; and Sherry Smith, Senior Vice President of Finance.

Following prepared remarks, we will open up the call for your questions. I would ask that you limit yourself to one question and one follow up, so that we can accommodate as many people as possible.

The information presented and discussed today includes forward-looking statements, which are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our most recent 10-K filing. A replay of today's call will be available on our corporate website at supervalu.com.

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

Craig Herkert

Thanks Ken, and good morning everybody. This morning SUPERVALU reported adjusted net income of $59 million and adjusted diluted earnings per share of $0.28 excluding a non-cash impairment and other charges. We continue to generate strong cash flows and now expect to pay down $650 million of debt by fiscal year-end. Free cash flow for the quarter was a strong $285 million and we have reduced debt by $512 million through Q2. Sales for the quarter were $8.7 billion and ID sales were negative 5.9%, excluding Shaw’s which was impacted by a labor dispute.

These results are disappointing to me and my leadership team and frankly given this forward and anticipated economic recovery, we see a longer time line for our corporate initiatives to gain attraction. Consequently, we are revising downward our full year guidance to a range of $1.40 to $1.60.

The economy continues to provide a headwind to our efforts. In spite of near record low interest rates meant to drive spending, the mindset of our customers remains decisively cautious with an ongoing focus on price. We find a continuing sluggishness of the private sector employment has made any uplift in grocery spending difficult. Remember that the bulk of our retail footprint is in large metropolitan areas where unemployment remains above the national average.

While the results this quarter were below our internal projections, we did make steady progress on some of our key strategic goals, which are geared towards positioning us for improving the long-term performance of this company. So, rather than spend my time on today's call looking backward, I would like to use this time to give you an update on where we are in the transformation that is currently underway. Sherry will provide more insight into our second quarter performance and revised guidance later on the call.

About a year ago, I introduced our vision for SUPERVALU to become America’s neighborhood grocer, and I remain convinced that there is an absolute need for well-run neighborhood grocery stores. We know this from our many longstanding relationships with our great independent retailers across the country. They know their customers intimately, stock products to satisfy local taste and operate with the efficiency of a family owned business.

At the core of this vision is our unwavering focus on operating as one company winning for our costumers. This means our stores will be merchandised locally, carry fresh perishables and relevant regional brands and cater to the fundamental needs of the shoppers who call these neighborhoods home. We will leverage the scale of SUPERVALU’s 4,300 store network to economically buy product, but assort based on customer preferences and execute at a local level, region by region, neighborhood by neighborhood, and importantly store by store.

This focus and discipline around hyper-local retailing will make our stores more compelling for the customers we serve. To this end, SUPERVALU began taking initial steps late last year to realign its business, clarify accountability and refocus priorities on customer-centric measures. Over the past 12 months, this organization has aligned key reporting structures as it added several new senior leaders.

We secured flexible long-term funding, we reviewed our store portfolio and monetized select non-core assets. When completed our culture will have shifted to one that is singularly focused on anticipating and meeting the needs of our customers. Through our traditional retail operations and independent partners we will deliver the freshest meat and produce, unmatched assortment of fairly priced products, great promotions, and a no hassle customer oriented experience. This commitment to our customers who underscore what SUPERVALU stands for and give us a more favorable position in the minds of our customers, something that has waned in the recent quarters.

To guide us, we have developed a detailed action plan that is now being put into motion. The near term impact will be a more robust understanding of our key business metrics, which will enhance our ability to measure real time result and react to ongoing business trends. Over the long-term, this intense focus around doing the right thing for our customers will pay off in terms of increased loyalty, top line growth end profitability.

I also want to be clear that this transformation will require additional price investments. We believe, however, that widespread efficiency improvement will help to offset the margin impact of these moves and result in improved operating results over time.

SUPERVALU remains committed to operating as one company, winning for our customers and focused on growth. In line with this strategic imperative the company will undergo a business transformation that we will expect to take about three years and address both our price position and product offering to ensure that we are dedicated to the hyper-local activities. Our stores are our company’s resources and are focused on growth and innovation.

Let me start with SUPERVALU’s renewed commitment to its customers. Our focus on the customer is the single most important element of our corporate transformation. To that end, we have begun to act as an agent of our customers and are working to offer those products shoppers want at a fair price in a friendly inviting environment. From my standpoint anything less is simply unacceptable. Our ability to deliver on these core expectations will ensure that we are rewarded with loyal customers, positive sales trends, and improved customer satisfaction scores.

Putting the customer front and center has required a significant cultural adjustment. Our company is shifting from a purchase oriented model to a strategy focused on stocking and selling the products most relevant to our customers.

By streamlining decision making, being more responsive to customer preferences, negotiating better terms with our suppliers and allocating more vendor support into pricing. We are slowly shifting our operating paradigm. Over time, I am confident that our renewed focus on customer expectations will reverse any unfavorable value perceptions.

Let me be clear that SUPERVALU is committed to its traditional retail positioning and as part of that, we must regain our relevance to customer who has multiple outlets to choose from to satisfy her grocery needs, our prices must be fair, the quality of our perishables needs to improve, our assortments have to be more locally relevant and our stores have to be simpler to shop.

In short, we must address the underlying issues impacting our retail sales and promote customer engagement through our knowledgeable and friendly associates. In effect, these changes will help SUPERVALU return to its heritage and the values of Sam Skaggs and Joe Albertson's and which many of our banners were about.

We have well-conceived plans to address each of these items. Some are extension to programs that I had previously discussed and others are new to SUPERVALU and modeled after the practices our most successful independent customers. For example, SKU rationalization is improving our steps by removing redundant sizes, creating better in-stock position, reducing labor cost and in most cases sharpening retail prices.

Through the second quarter, we completed resets on 40 center store categories and expect to optimize all of our non-perishable categories by February. More importantly, we have developed enterprise-wide standards that will allow us to better monitor our assortments so we don't allow excess SKUs to creep back into our stores.

This disciplined approach will ensure that appropriate standards are ingrained into our corporate culture and become part of our everyday decision-making. We are also making headway to better match our assortment to the local preferences of neighborhood in which we operate.

As an example, I am Philadelphia-based Acme vendor, covers a broad range of neighborhoods ranging from the, at north suburbs of Northwest Philly and outside (inaudible) to urban locations in the center of both cities to seasonal beach areas on the South Jersey shore such as Wildwood in Avalon.

All of our stores even across these diverse geographies will carry regional staples like tasty cakes, Herr's chips and Scott Bath Tissue, but the individual store assortments are being further tailored to cater to the local shopper. This effectively means that, where appropriate, stores in more affluent suburbs will feature expanded daily counters and (inaudible).

While stores in close proximity to many colleges in the area will cater to students with a border assortment of energy drinks and ready to eat foods and school supplies. Stores in coastal beach towns will now stock a wider selection of convenient and general merchandise like coolers and beach towels to better accommodate the needs of our seasonal shoppers.

Equally important to our work on optimizing assortment is the effort we have taken to improve price and changed customer perceptions. We fully understand our brand and price position relative to our competition and will implement fair pricing plus promotions to appeal to customers' value needs.

Let me give you a few examples of how we are acting on this today. First, in one of our banners, we introduce value pricing on keys seasonal produce. We reset base retails promoted with length, depth and frequency. The results were greater sales volume and stronger margins throughout the category. Given the success with this program, we have accelerated the roll out of this strategy to other banners.

Second. Through our entire retail network, we reduce the pricing on a prominent juice item to a $1.99 every day. That's about a $1 better than our price a year ago and I can tell you that parent shopping for their families have noticed this change in price, and as a result, we are moving more units than we did last summer. This is a great example of how SUPERVALU can drive traffic and changed prices' perception by offering customers better values on key shopping items.

SUPERVALU is increasingly doing more things like this to enhance the relevance of our offering to our customers. These price changes are departure from past practices and good example of how are companies now acting differently.

We are engaging with our vendor partners to discuss how we can change our pricing architecture with the shared goal of moving more units. As we are able to drive price points that are more competitive, shoppers are reacting with increased purchase that drive value for the manufacture and build loyalty to our banners.

You have heard me talk about the power sale items as a way to drive foot traffic, and this quarter, we had success with ready-to-serve items like canned tuna and canned pasta. Our recent promotion delivered double-digit percent increases to category trends with over 200 truckloads of product sold across our entire 4,300 store network in just two weeks time. As of the second quarter, we have also focused on an innovative customer promotion as a means to drive traffic and build customer loyalty.

In September, we rolled out a continuity program to more than 400 stores offering professional great cookware to our top shoppers as a reward for spending their dollars with us. The cookware program encourages repeat visits and is at the heart of what we do, which is the celebration of food and cooking.

Individual pieces are available for full retail and at discount purchases at participating locations. Having just completed the six-week of this program, it is tracking to expectations. The full impact of this promotion, however, won’t be known until we move closer to the program's conclusion in the fourth quarter.

Loyalty programs like this will help pull customers back into our stores, and in doing so, expose them to the investments we are making in sharp prices. These investments remain an important part of our strategy and will allow us to address consumer perceptions and nullify the price differential that we face in some, though not all of our markets.

To assure that our efforts to drive customer traffic, sales and loyalty do not impact profitability, we have created detailed action plans to offset investments in price. These include operational improvements to enhance product freshness, improve our in-stock position and offer fast returning assortments, more effective promotions, improved cost to goods and aggressive cost cutting and things like overhead, energy and goods not-for-resale.

We will be diligent and act with passion and a sense of urgency as we move forward recognizing that this journey will take time. I understand my obligation to our shareholders and the strategy, which we are executing, is intended to build an improved business model for SUPERVALU that will enhance our market position and performance over time.

Human capital is at the cornerstone of any successful enterprise and for our customer-facing business like food retail, associate engagement can be a true competitive advantage.

As we streamline our operations and improve accountability, we have communicated near-term metrics and long-term goals to SUPERVALU's associates to ensure that we operate as one cohesive entity. We have realigned reporting structures and leveraged shared resources. We have helped to empower individuals and removed bureaucratic layers from our decision-making process.

You may recall that earlier this year, I told you we were redesigning the role of our store directors to give them more opportunity to interact with shoppers, manage their stores and develop their associates.

In redefining this critical retail position, we have assessed the skills and performance of each one of our nearly 1,200 store directors, developed leadership training programs to help each of them improve their skill set. We have modified a number of in-store processes to reduce the administrative element of their job and made regular engagement with customers’ primary to this job function.

At the corporate level, our associates are engaging with peers to find better ways to execute on everyday task. As an example, the production of signs and shelve [space] has historically been managed by individual banner teams.

Earlier this summer, members of our retail operations IT and marketing groups came together to simplify this process and establish a set of best practices. Up until this point, there were more than 130 different types of tag stock and over 700 different types of sign templates used throughout our store network.

Our enterprise marketing group took the lead and engaged with consumers to determine the most appealing way to display price and value. Our IT and operations team addressed the logistical challenges posed by streamlining production, concurrent with the ongoing weekly promotions.

The cross functional team crafted a workable plan that began to rollout within weeks. The result has been a 70% reduction in stock inventory on signs and a dramatic streamlining of tag stock types. We should yield an annual cost savings of approximately a $1 million in terms of banner labor and materials procurement.

This new signage has been rolled out half our corporate stores, making for a much cleaner consisted visual display for our customers and will cascade through the rest of our banners through yearend to help simplify customer communications and brand recognition, but excitedly most and is exemplified by this project is that associates are responding to a call could take control and ownership throughout this organization.

Corporate resources are increasingly being managed with the care and attention that is associated would show as if those resources, where their own. Beyond training and solution based collaboration, we continue to aggressively control expenses and seek out new opportunities for efficiency.

As we noted last quarter, we expect to realize more than $160 million in SG&A savings this year alone. This quarter, we saw an additional $40 million in new savings and I believe we still have a tremendous opportunity here specifically an initiatives around strength, facilities and goods not-for-resale, which will continue to reduce operating cost well in to the next year.

SUPERVALU’s long-term competitiveness will depend heavily upon our ability to be better stores of our corporate resources and execute with the sense of urgency. I can assure you that from our enterprise teams to our in-store associates, this organization is committed to running leanly implementing near-term solutions and leveraging our national distribution to support the efforts of our independent retailers and traditional banners.

When I assumed my role as SUPERVALU CEO over a year ago, I did so with the conviction to enhance operations and drive new growth and innovation. This growth can and will come from all parts of the company. I talked about doubling the size of Save-A-Lot by the end of fiscal 15 and I am pleased with the progress we have made to-date. This quarter, we opened 18 new stores for a total of 38 stores during the first half of the year and we remain on track for more than 100 new locations by year end.

This quarter Save-A-Lot launched its first sustained media campaign since 2004, radio and television ads caring the message of savings made easy are now being broadcast in 42 markets with expand more than 700 stores. The cost of this campaign is being shared by our licensees and is already helping to raise ID sales in most of our established geographies.

Over the long-term, this investment will help to strengthen our brand as a hard-discount leader and improve customer awareness in our expansion markets. As you may have heard, drug store operator Rite Aid is among Save-A-Lot’s new list licensees. We are currently working on a co-branding test in 10 existing South Carolina Rite Aid stores.

The conversion of the first store was completed in late September and another nine stores opened earlier this month. We are excited to test this co-branding strategy with an experienced drug store operator and look forward to reporting on our progress next quarter, but also like to mention that the initial performance of our recently converted South Texas stores is showing great promise with sales up double digits in stores that are still undergoing remodeling in which we have yet to formally host their grand reopening as (inaudible) Save-A-Lot stores.

The clear opportunities for this organization to grow and improve upon our existing business model by innovating. Last month we announced a strategic relationship with Tata Consultancy Services through which SUPERVALU would sell its IT operations in India. This long-term business outsourcing solution will improve efficiency and free up corporate resources.

The retail food industry also has a history of implementing new technologies and business efficiencies to service our customers better and keep our cost low. I am proud to say that SUPERVALU has been an early adapter in integrating these new technologies our newest Albertsons store, which opened last month in San Diego, uses state-of-the-art technology for heating, cooling and lighting. The backbone of this effort is the 400 kilowatt fuel cell, which will generate nearly 90% of the energy need of the store. In addition, to improving our energy efficiency this technology also reduces the company’s carbon footprint.

Along the same thing, SUPERVALU received recognition from the Carbon Disclosure Project in last month become the first food retailer to join Worldwide Life Fund’s Climate Savers Program. In doing so, we have taken the leadership position within the industry and pledge to reduce greenhouse gas emissions by 10% in the five-year period ending in 2012.

Finally, SUPERVALU continues to look for cost effective ways to operator stores and improve our environmental stewardship. Our store design group has been installing skylights, more efficient LED lighting and high efficiency air hand doors within our stores as well the distribution team is working to improve logistics to integrate fleet transportation and reduce fuel consumption.

As we move forward, you can expect to see SUPERVALU continue to take steps to innovate and be good environmental partner.

With that, let me turn the call over to Sherry for more detailed look at our second quarter performance and outlook, I will then wrap up with some closing comments.

Sherry Smith

Today, I will be covering our second quarter operating results and financial condition providing an update on a number of our operating metrics and comment on a fiscal 2011 full your guidance.

Let me first address the non-cash impairment charge that we recorded this quarter. This non-cash charge was related to our market capitalization, which has fallen with the recent sustained weakness in our share price. Accounting rules required that we reconcile our book value to our stock price in assessing the recoverable value of goodwill and other intangible assets. Second quarter charge represents an estimate and is subject to our finalizing fair market values, which will be completed in the third quarter. Let me assure you that this non-cash impairment charge does not impact any of our financial covenants, our ability to assess our credit facility or any of our business strategy.

This quarter sales totaled $8.7 billion compared to $9.5 billion a year earlier. The 8.5% decline was a function of four main items. First, weakness in identical store sales, which declined by 6.4% this quarter. Excluding charge, IDs were negative 5.9%. With the labor dispute settled in early July we will only break this out separately in year-to-date comparisons going forward. Second, the impact of previously announced submarket access and retail store closure including Salt Lake City, Connecticut and Cincinnati. Third, target transition to self-distribution and finally the loss of Ukrop's as a supply chain customers.

Breaking down identical stores sales, we saw a 3.9% decline in customer count and a 2% decrease in transaction side. Customer count is down modestly from the first quarter and really reflects the cycling of any sector pricing and promotional initiatives introduced during the third half of fiscal 2010, which drove traffic in several of our largest markets. The sequential improvement in average transaction size is encouraging. This quarter we also saw an improvement in total unit volume compared to Q1. Similar to that quarter, trade down remained essentially flat. We estimate cost inflation ran about 1% this quarter driven partly by increases in the dairy and meat category.

During Q2, we continued to make targeted price investments across our company. Within private brand we improved our marketing and ad plans to better promote items and shelve placements while continuing to realize procurement cost savings.

In the second quarter, private brand sales penetration set a record 18.5%. We also began implementing everyday fair pricing in convenient category. These product lines were promotional pricing generates little incremental volume but requires at this proportionate amount of labor.

Lastly, we started the broader roll out of our fair price plus promotion strategy meant to remove extreme ends of our high low pricing. We believe this change to our pricing architecture is significant and will help us to address the perceived value gap that had weighed on customer traffic trends in recent quarter.

Our same store sales result through the first five weeks of the third quarter have improved about a 100 basis points from the 5.9% decline in Q2, another encouraging sign.

Moving to operating earning retail food was 2.6% of sales before one-time item compared to 2.5% last year. This modest increase was driven by improved margin primarily attributable to more targeted price investments and promotional spending, which was partially offset by the sales de-leveraging.

Supply chain services delivered a very strong quarter as operating earnings were 3.5% of sales compared to last year's 3.0%. Results this quarter continue to benefit from a strong focus on cost and efficiency. Year-over-year operating metrics and supply chain have improved. Total throughput increase which drove improvement in warehousing costs per case by over 1% and we did a better job of optimizing our fleet to reduce miles and fully utilize the capacity of our trailers. We remained pleased with the contributions of our supply chain business as we aggressively manage expenses while producing stable earnings and cash flow.

Now, let me provide some color on the year-over-year variance in corporate expenses, where the 19 million change was predominantly driven by the surplus property activity. Last year, in the second quarter, we had about 9 million in net gains from a number of properties whereas this quarter we have sourced about $6 million in expense due in part to the continued softening of the commercial real estate market .There was also an addition of $3 million in one time charges primarily related to litigations.

On the broader topic of SG&A expenses we remain on track to remove $160 million from business by year-end having taken out over $80 million in the first half fiscal 2011.The savings we expect to achieve for the balance of the year will come largely from administrative costs as we recognize the benefit of centralization efforts and process efficiencies implemented over the last few months. These efforts are ongoing and will lead to additional saving into F'12.

For the quarter, we reported a GAAP EPS loss of $6.94 per diluted share which includes $7.16 in non-cash impairment charges $0.6 in other costs. The largest portion of the other costs were related to the labor dispute at Shaw's with smaller amounts primarily tied to employees’ severance and litigation charges.

Turning to the a balance sheet, inventory days supplied fell by almost a full day compared to the last year's Q2 due to better inventory management and the benefits of skew rationalization.

We finished the second quarter with total outstanding of $7.1 billion down about $280 million from the first quarter. Year-to-date, we have reduced outstanding debt including capital lease obligations by over $500 million putting us on pace to achieve $650 million of debt repayment this fiscal year, $50 million more than originally expected. This increase is driven largely by our inventory reduction efforts and strong working capital management which is more than offsetting our reduced earnings guidance.

We remain in compliance with our debt covenants with trailing 12-month EBIT of $1.2 billion excluding impairment and other costs. Depreciation and amortization was $0.9 billion and rents expense amounted to $0.4 billion. Remaining current fiscal year debt maturities at $475 million and will be repaid from internally generated funds and availability capacity under our revolving credit facility. SUPERVALU's return to investment grade still remains a corporate priority.

Let me now provide some color on the performance of our store remodel, customer satisfaction surveys and market share. With regard to the performance of recently remodeled stores, our first year remodels showed an average lift of 3.5%when compared to other stores in their respective markets. Stores cycling their one year opening were up 180 basis points in a second year on a comparable basis.

Moving to our customer satisfaction metrics I am pleased to report that we have made progress in the last six months. We now have a customer service manager at each banner responsible for improving the shopping experience in each of our stores. We also introduced a new web based tool that allows our customers to provide immediate feedback to our store directors. Through the second quarter eight of the nine banners we tracked enjoyed improved overall satisfaction scores from a year earlier, while scores for the ninth banner remain unchanged

Turning to the market share, in the latest quarter SUPERVALU either gained or held market share in 55% of our top 86 DMAs losing share in the balance. As a reminder, these designated marketing areas generally have at least 10 stores and do over $1.5 million per week in aggregate retail sales which included our traditional retail stores, all (inaudible) location and independent stores for whom we act as the primary supplier.

For the top 20 DMAs which account for approximately two-thirds of our sales volume, the cumulative total share loss was approximately 40 basis points relative to a year ago and is consistent with the trend we reported on April. I should also note that this figure captures plans for closures which amount to over 2 million square feet in addition to our negative id sales performance for the quarter.

Let me next provide some comments on our fiscal 2011 guidance. Our second quarter sales we softer than planned and as a result our correct expectation is for full year ID to be around negative 5.5%.

We also reduced full year EPS guidance based on first half results. Our initial guidance calls for the first half of fiscal ‘11 to be considerably more challenging than the second half and this will continue to be the case through the third quarter. Traction has clearly been slower than expected. As Craig noted, we now expect full year adjusted earning to be within a range of $1.40 to $1.60 this fiscal year. Our capital plan of $700 million remains unchanged and, as noted, we have increased our debt reduction goal to $650 million this fiscal year.

Let me conclude by saying that we have firm plans in place around sales margin and expenses to deliver our revised guidance of a $1.40 to $1.60 per share. This reduced estimate reflects the still competitive landscape, a stretched consumer and some changes in the pace of our execution as we carry out the business transformation Craig outlined. We still expect gain traction on many of our initiatives in the back half of this fiscal year. By and large, Q3 will remain a transition quarter and we will begin to realize the true impact of our marketing, merchandising, and operational initiatives in Q4. Our leadership team is committed to taking both actions to execute on this timeline and ensure a long-term success.

With that, I will turn the call back to Craig.

Craig Herkert

Thank you, Sherry. Before I close, I wanted to provide an update on our CFO search. We are currently in our final stages and plan to announce this key team member by the end of the month. Since my arrival at SUPERVALU, the company has made significant strides to realign operations, streamline decision-making, and shine a light on those areas on which we must improve. Today, our company is modifying its operating norms and redefining its business culture and financial expectations.

While we remain in the early stages of this process, these efforts will address our competitive position within food retail and instill culture that promotes action and continues improvement. We have a strong leadership team and together with SUPERVALU’s 150,000 associates we share a sense of urgency to improve enterprise-wide execution, reintegrate sales, address the perceived value gap that exists for some of our banners.

The business transformation currently underway will be end-to-end and allow us to better serve the local needs of the neighborhoods we serve and in doing so, the value we create will accrue to our shareholders.

I would now like to open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will pause for just few moments to compel the Q&A roster. The first question comes from Deborah Weinswig.

Deborah Weinswig - Citi

In terms of opportunities going forward, can you dive into more of the details with regards to ongoing cost reduction initiatives, how much room is left and where are the greatest opportunities?

Craig Herkert

Yes, sure. Without getting too specific, there are lots of opportunities. Yet, some of those will simply be in how we operate as we deliver some more system solutions to our merchandising teams. They could be more efficient, and some of it is because of how we run our stores, I mentioned about SKU rationalization actually really has a nice impact on how we run a store. I think you are still some real left outside potential as we continue to elaborate buying as one company and goods not for resale, we’re seeing some very nice wins there already Deborah, but we think there is more. So, along with an answer we have a lot of runway in front of us yet in a broad range of areas to reduce our cost.

Deborah Weinswig - Citi

Okay, in terms of my follow up question, you talk about this idea of being hyper locally assorted. What percentage of your store would you say is locally assorted right now just in general and what would you say the opportunity is?

Craig Herkert

It’s a great question. It’s interesting as we really gotten to understand this. It’s really a very small percentage of the store, Deborah, but they can be very important items. So the vast majority of what we sell are national brands. In most of the stores, our merchandising team here and Helden clearly is responsible for all of the procurement and assortment in pricing for the vast majority of what we sell, I do not want to give you the particular number. What we are trying to do though is empower our store directors to be able to make those decisions on the key items that are local. It might be simple things like a local barbecue sauce or a local salsa. It is not a large majority of what we call but often times it's an important part of what we sell that we have so stinged that the consumer wants in her neighborhood.

Operator

Your next question comes from Mark Wiltamuth.

Mark Wiltamuth - Morgan Stanley

I wanted to ask what really changed between last quarter's guidance and this quarter because it sounds like the price reduction you are going to purse are going to be funded by cost cutting? So, I am kind of unclear on why there is this big if in the cut.

Craig Herkert

I think primarily driven by the fact that sales had been forward than we anticipated. Part of it is because of the macroeconomic environment clearly. I don't have to tell you guys certainly read all the things that I am reading about the macroeconomic environment. As I mentioned, we are heavily invested our real estate into the major metropolitan markets. So, we are impacted heavily by what's going on macroeconomically. Frankly, some of our initiatives, they take a long time, and longer than perhaps I would have liked. So, I feel good about where we are going. I think it's just the fact that our sales have come in below our expectations that caused some de-leveraging.

Mark Wiltamuth - Morgan Stanley

Just to focus a little on the sales, it seems like you still need a 200 to 250 basis points sales improvement to get to the comp guidance for the year. Is that fair? What do you think will drive that?

Craig Herkert

Let me say that, as Sherry indicated in her comments, in the weeks since the quarter closed we continue to see continuing improvement in our sales trends across the vast majority of our business, which I think is really good news. Quite frankly, as I think we both mentioned, the merchandising and marketing programs that this leadership team put in place really only just started to take effect in Q3.

If you think about the fact that our Head Merchant only joined the company and our Head Marketer, Julie only joined the company six, seven months ago. Even in a normal environment it takes a number of months before programs that they have put in place where to actually hit our customer. So, frankly, Mark, we are just now seeing the impact of this leadership team and the good news is the impact we are seeing has been positive.

Mark Wiltamuth - Morgan Stanley

I know you previously were not chasing the discounting of others. Are you going to be reactive to others now or just put in more of your own strategic price cuts?

Craig Herkert

We watch what everybody is doing. We are unbelievably diligent on tracking the pricing across all of our competitors. So, let me say that we are aware of what everybody is doing, but we are trying to create our own destiny. So, there is a little bit of a mix answer there. We are being very targeted and we thought going strategic in what we are doing. So the couple of areas I mentioned in my comments were driven not because a response to what a competitor did but because our team decided to go after those items. I think that’s the right approach and we will continued to head that way. That said, we will watch what our competitors are doing and be response where we need to be.

Operator

Your next question comes from Meredith Adler.

Meredith Adler - Barclays Capital

I actually like to go back to the question you just had about understanding the reduction in guidance, but I am going to focus on cuts in laborers at store level. You have been very successful at bringing down labor at the stores but I'm wondering whether you are reaching a point where you can't cut any further, skew rationalization will help efficiency because just a cut of your guidance spread same-store sales by 50 basis points shouldn’t lead to this kind of a reduction in earnings? So, there's need to be something else.

Craig Herkert

Yeah, in addition to that we'd like to see obviously more margin increase. We want to give ourselves the opportunity to continue to invest where appropriate for our customers. Let me touch on, Meredith, the challenge on in-store. What Pete Van Helden has done with his team, I think is really, really good in that he continues to work towards eliminating bureaucratic processes that caused not only our store directors but our department managers and our associates to be focused non-customer facing things.

So what he and his team are doing is really trying to re-engineer. He has to take some labor out but I think more importantly to put the labor back and to taking care of our customers. In some parts of our country where we got an earlier start than in other parts we've seen some very positive responses not only in customer indices but quite frankly in sales trends because it is a core part of who you want to be which is a friendly easy place to shop.

Meredith Adler - Barclays Capital

I just have another question about vendors and maybe having watched SUPERVALU for many, many years and the predecessor companies actually. I’m surprised that you talked about local merchandizing because it was at one-time a strength of your individual banners of knowing your local customers were and meeting their needs. So, we just returning to or strength of the company used to have and how do the vendors feel about some of the changes that have been going on.

Craig Herkert

To answer your first question first, yes in fact it was a purposeful reason that I brought up to Albertsons. The idea is, we do want to behave like our great independent retailers and all of our banners owned or not at one point we are independent grocers. We do think there is great value in behaving like in US you owned your business, when you take care your local customer.

Yes, we do in many ways want to return to that incredible heritage that we have, whether that be at Albertsons, Jewel, Shaw's, Acme, Farm Fresh. Yes to that, but be it actually a little bit of difference not going back to what was happening in the 1970s or 80s, what I’m to articulate this is really about the store, Meredith. It’s less about the banner

It’s about the store and that’s why I want to bring up the story about Acme because if that there was only about the banner then the assumption might be that every Acme store will be a sort of the same, but frankly we know that the store in [Avalon] needs to be assorted differently than the store in Ridley and really what we are trying to build is the process whereby the vast majority of what we sell isn’t back supported here and I think the vendors love what they are taking from support of this company and feed the young men in the team, but they are those things on the edges, which are going to be local. My sense is the vendors are comfortable with it because if our sales improve so to theirs and the only thing our vendors are looking for from us is increased moving the product.

Operator

Your next question comes from Neill Currie.

Neill Currie - UBS

If I look back at your two year all the trends they have been declining well for quite some time therefore a large number of quarters and that continue in the most recent quarter, but if I look at your guidance the second half of the year even though you say if you see an improvement in the first five weeks of the quarter its probably not going to be enough to get your negative 5.5% ID for the year although it’s a decent start and seeing the comparison may ease.

The question I want to ask is, basically the guidance called for the second quarter to be the low point in the two year trends until things have improved from here. What gives you the confidence that you can show an improvements in the two year ID numbers in the second half of the years, it’s only that you are seeing or is it just hope that the economy doesn’t get any worse.

Craig Herkert

Well, first of all speaking in the macroeconomic I can’t predict the macroeconomic. We are certainly not anticipating it getting better Neill. We are operating our stores with great understanding and insight in to where our customer is today. I think we really look at the second half of the year particularly the earlier part of the second half of the year is the continuation of the same and as I have said in the comment section, we think that the initiatives and the programs that we are put together by this team really do begin to payoff as we ended the latter part of the year, whether that be the impact some of the price changes that I have spoke of are the continuity program that I spoke are frankly the fact that we have a much more coherent and thoughtful marketing program that really just begins to kick in.

I mentioned briefly in my call that we have gone on the air for Save-A-Lot for the first time since 2004 and if you have the desire to do so if you go on savealot.com, on our home page you can click on the TV ad, which I think is fantastic. So, you are starting to see the impact of Julie Dexter Berg and her team as we get in to the latter part of this year.

Neill Currie - UBS

Tom mentioned earlier I may have understand and correct me for the first half of the year so far it has been already $140 million of cost savings. Is that right Craig?

Craig Herkert

Yes.

Sherry Smith

80 million.

Neill Currie - UBS

Thank you. I was wondering how much about is due to store closures and on the ongoing reduction in cost from having fewer number of stores and how much is on the same store basis?

Sherry Smith

None of that is related to store closure so that is all on a same-store basis, when we have focused around all of our class C whether its admin, process improvement than various initiatives.

Operator

Your next question comes from Scott Mushkin.

Scott Mushkin - Jefferies & Company

I just wanted to circle back to the guidance and try to get some clarification for myself here. It seems to me that the SG&A reduction goals are right on track and so if I look at the guidance reduction that would lead me with gross margin, so if I go out to the third and fourth quarter and looking what was expecting it seems like you guys are expecting SG&A dollar growth to be coming in lines that only leads me with gross margin and that’s going to be significantly different and that would suggest price investments. So what I’m missing in that?

Craig Herkert

I think mostly it just the continued weak economic environment in the fact that we don’t see our sales turning as quickly as we would have hoped earlier in the year, we put our first guidance out Scott.

Scott Mushkin - Jefferies & Company

I’m assuming a 33% tax rate, those seem like the tax is going to be a little light in the back half of the year, but that suggest over 38 or almost 45 basis point pullback in the operating margins, which is fairly significant, it can’t get there with only a 50 basis point adjustment in sales.

Sherry Smith

We’ve guidance on the tax rates and that’s the 37% yes, and certainly what I mentioned though we really see that taking longer for the traction. So, as Craig mentioned around some of the challenges on the sales and the de-leveraging there that will certainly more impactful in our third quarter as then we move into the fourth quarter.

Scott Mushkin - Jefferies & Company

To the 37 was for the year, so 37.5 for the year, but I’d suggest 33% for the rest of the year that was went off.

Sherry Smith

I think it’s still higher than the 33% because yes, but the rate on our call the $0.28 for the adjusted earning is than running at the 37.5%.

Scott Mushkin - Jefferies & Company

This is for Craig, the strategy of the idea paying back an extra $50 million in debt, when no one is expecting that I’m just trying to understanding why that money wouldn’t be better used to, for example I was in southern California, some of your stores there were pretty tired at the stage especially in LA county, so why not used that $50 million of that money to remodel the stores.

Craig Herkert

Well, the good news is, as you heard Sherry say, and as we talked in the past our newer remodel program were much happier with. You might recall that in the past, we were not getting the uplift that we expected and we’re spending too much money on our remodels. So, we’re aware, where each of our stores are at, we want to be thoughtful stewards of the capital and mixture we spent it appropriately.

I’m happy with where we’re going with our remodel because we’re increasing the learning to be efficient and effective with those moneys. So, fair challenge, but I think you will be happy with where we’re going, going forward to make sure that we’re spending that money appropriately and in the near-term, there is real benefit to our shareholders and continue to pay down our debt.

Scott Mushkin - Jefferies & Company

Sorry to do this, but I guess some (inaudible) to little debt, SG&A dollar growth back half of the year higher than expected, is that an issue or is it really the gross margins are the issue as we look at the back half sorry to ask you again, but I just?

Sherry Smith

Let’s take either the margins or the SG&A, but I think you could look at a factor of both components.

Scott Mushkin - Jefferies & Company

Both components, okay, thanks.

Operator

Your next question comes from John Heinbockel.

John Heinbockel - Goldman Sachs

Craig, so couple of things, I know you can’t be specific, but in your mind how wide is the value gap and how long does that take to close to your satisfaction and then secondly, if inflation is reaccelerating, which does the combination of the two mean that we see some margin pressure, rest of this year and then on into 2011?

Craig Herkert

Yes, let me take first to the inflation that we’ve all been reading of late about commodity cost. We did have the price increases communicated to us from a major supplier just yesterday, significant cost increases across the board for this particular supplier, so that’s relatively new news to us.

Here the value, yes john it’s a great question, but what we really look at is if you look at our total basket versus the total basket of our traditional retail competitors, what actually fairly in line, which is what we’ve articulated in the past, where we’re going, however, is we want to make sure that the reduced the extremes of the high low.

In too many cases, particularly on some key items that our customers want, we've allowed over the years, our regular prices to get too high. So a great example is that juice item I mentioned where we were at 2.99 in many of our banners. We were promoted down to a great price in which case we sell a bunch on promotion and we could argue that the average of those prices was fair. The problem for us is the regular price clearly was not fair, was not in line with what our customers were looking for.

So the basket actually is pretty good today, John. So, I think that gives us the room we need to go and surgically address items, literally items, not even categories and say, "How do we redirect our vendor negotiations and our internal funding to make sure that rather than the extreme high-low, where we've been for a numbers of years, we get to what Steve has called fair pricing plus promotion."

Where we've done this in particularly? In some fresh food areas, we've seen customers respond very, very positively. We think it will take us time, which is why I said that we think this is a multi-year journey, we are not going to take any broad-based price cuts. We are going to be very surgical and very thoughtful and work with our vendor partners as we go down this journey.

John Heinbockel - Goldman Sachs

As a follow-up, it sounds like, because you are relatively happy with the pricing position in the aggregate, you do think that you can achieve pass-through on whatever cost increases we get over the next six to nine months. Then secondly, the supplier that communicate the price increases, that's center store or perishable?

Craig Herkert

A big supplier center store, and it's a great question, how consumers are going to react to price increases. Frankly, Steve and the team are going to have to balance those price increases with our ongoing desire to get their fair pricing plus. So again, my expectation will be that will be a vendor-by-vendor. In some cases, item-by-item discussion on what does or does not get passed through and how we manage those things, but I don't think this particular vendor is the last one.

Based on everything that we read about commodity cost across the world right now, I think we are going to see price increases being pushed through to retailers and we'll have to see how we manage that with our customers.

Operator

Your next question comes from Ajay Jain.

Ajay Jain - Hapoalim Securities USA Inc

Craig, on last quarter's conference call, I asked you what was implicit in your earnings guidance from a gross margin perspective and I understand that maybe you don't want to be granular in talking about gross margin specifically, but it seems like this widest cut in guidance, it's disproportionate to the change in your sales forecast and I'm just wondering now that you are prepared to take much more aggressive steps and be certainly more price competitive than you have been recently, how long did you take for those price investments to show up in customer traffic? Is this new pricing strategy a multi-year process or are they're really just hard to get price investments that are intended to be short-term in nature?

Craig Herkert

I think these are long-term commitments to changing the way we do business, Ajay. If I talk about the fresh areas, these are not short-term promotional programs. Getting to fair pricing everyday is a new paradigm for us. It is a new way of living, so we are not going backwards off that.

The good news is, we are doing it today. Quite frankly, across our network, you would if you went into any of our stores today, I think it's fair to say in every single department now, you would see us culling out items where we have made these changes in our regular pricing. These are not programs that are going to come off at some point. These are our new programs. We talked about it in bakery, I mentioned in other parts of fresh, I think across our store today.

What you're going to see is, we'll continue to learn and roll out more. They are very targeted to your point, so these are not broad-based. Let me take an entire category or entire department or certainly not the entire store like we've done in the past. They are very targeted, very specific researched and then worked on with our vendor partners.

We'll do it as we can take the cost out, or just we are trying desperately not to destroy the bottom line as we go through this process. As we said, both last quarter and this quarter, we intend to pay for these price investments, which is why we think this is a multi-year journey. Did I hit most of your questions, there?

Ajay Jain - Hapoalim Securities USA Inc

If I could just ask a quick follow-up, I wanted to ask about maybe I'll address it to Sherry. The debt issue that you have coming up in February I think it’s around $650 million in senior notes that are coming due. So, can you comment on your plans for that debt issue? It looks like you are obviously on track to deliver on your debt reduction target of $650 million for this year? Just wondering what your plans are to roll over any or part of that debt issue that’s coming due in February?

Sherry Smith

Sure. There's about $175 million remaining on that maturity. We had some opportunity to take some of that debt out early, and we totally intend that through our operating cash flow and revolver. We will manage that very efficiently in February.

Ajay Jain - Hapoalim Securities USA Inc

So you will roll some of that towards your revolver?

Sherry Smith

Yes.

Operator

Your next question comes from Charles Grom.

Radina Russell - JPMorgan

This is Radina Russell on for Chuck today. I wanted to first touch on the skew reduction program. In light of the fact that Wal-Mart has obviously reversed much of the skew reduction made over the past year, I was wondering if you could provide some color on your progress to-date, and whether or not some of the skew reduction could be affecting your sales trends?

Craig Herkert

First, I'd just say ours is a very specific program for our company. It is not tied to any of our competitors. It is primarily, Radina, focused on redundant sizes more than taking brands out. There have been some cases where we have taken brands out that weren't effective. For the most part, what this has been focused on is taking out redundant sizes. I have to spoken to that in the past. We also have taken out some entire categories that ended up being fairly skew intensive but were not selling at all. So, we just removed some categories.

So that’s really where we are and we've had some items we've put back in. we're listening to our customers but it's been at the edges as opposed to wholesale having to put things back in. we do have a program in place where we make sure we are listening, we're taking care of our customers.

Radina Russell - JPMorgan

When is the skew reduction program expected to be completed?

Craig Herkert

I think the best part of the center store we hope to have done by next year. I think, quite frankly, the way Steve and I talk about this, this has got to be a way of life for us. The nature of the beast in food retail is that new items come out, and thank goodness, it is the life blood of this business that new items come out. I think we've done so, we need to develop a process that makes sure that we continue to bring to our customers innovative new products, new flavors, new designs. We got to get a discipline in our business that says when we do that we got to take other things out. So, its just a natural course of affairs I believe that you have to be doing skew reduction all the time and that’s sort of becoming part of our DNA today.

Radina Russell - JPMorgan

One more question on your quarter-to-date sales trend. Is that being driven primarily by inflation or are you seeing some sequential pick up in traffic right now?

Craig Herkert

It's really not inflation. It's really in traffic and item count for our customers. It's really in the core business of getting some traction.

Ken Levy

Operator, we will take one more call.

Operator

Your next question comes from Karen Short.

Karen Short - BMO Capital Markets

Just wanted to find out a little bit of your commentary given in your press release. You said ids were negatively impacted by heightened competitive activity, but I guess your competitors really don’t seem to be seeing this and especially with Wal-Mart on rollbacks, just kind of wondering why is the environment a bit different with you, a little color?

Craig Herkert

We compete with everybody in America who sells groceries, so not just the one you mentioned but including the other major discounter in this country who has aggressively rolled out food. I think there are many, just about everybody is selling food and consumables. So, I think in this heightened economic environment a lot of people are looking for value. So, we see an incredibly competitive landscape. It's not just the traditional grocers, Karen that we are talking about here, it's everybody who is trying to sell consumables and food products.

Karen Short - BMO Capital Markets

Just to clarify, is your actual run rate this quarter on corporate excluding kind of one time more like the $16 million range and is that what we should use going forward?

Sherry Smith

Karen, really as I said, yes, the variance in the run rate was more due to some of the timing of surplus properties and the timing in this quarter, so there's plus minuses on that?

Karen Short - BMO Capital Markets

Then on the distributions commentary for guidance, the target loss is obviously nothing new. I guess, you did reduced your top line on that, or is there something else going on just environmental? Maybe a little color on that?

Sherry Smith

More just environmental. Very strong earnings as we have some supply chain driven by a lot of productivity enhancements in the business.

Ken Levy

Thank you, all, for joining us today. A reply of this call will be available through November 2nd, and your IR team will be available for questions thereafter.

Operator

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

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Source: SUPERVALU, Inc. F2Q11 (Qtr End 09/11/10) Earnings Call Transcript
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