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Safeway (NYSE:SWY)

Q2 2011 Earnings Call

July 21, 2011 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

Edward Kelly - Crédit Suisse AG

Joseph Feldman - Telsey Advisory Group

Colin Guheen - Cowen and Company, LLC

Meredith Adler - Barclays Capital

John Heinbockel - Guggenheim Securities, LLC

Neil Currie - Dahlman Rose & Company, LLC

Scott Mushkin - Jefferies & Company, Inc.

Mark Wiltamuth - Morgan Stanley

Karen Short - BMO Capital Markets U.S.

Robert Ohmes - BofA Merrill Lynch

Deborah Weinswig - Citigroup Inc

Stephen Grambling - Goldman Sachs Group Inc.

Unknown Analyst -

Andrew Wolf - BB&T Capital Markets

Operator

Welcome to the Safeway Second Quarter 2011 Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Melissa Plaisance, Safeway's Senior Vice President of Finance and Investor Relations. Please go ahead.

Melissa Plaisance

Good morning, everyone, and thank you for joining us for the second quarter conference call for Safeway. With me today this morning is Steve Burd, Safeway's 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 management will make statements during this call that include forward-looking statements within the meaning of the federal securities laws. Forward-looking statements contain information about future operating or financial performance. Forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. However, we undertake no obligation to update or revise any such statements as a result of new information or future events. For a list and description of those risks and uncertainties, please see our filings with the SEC.

And with that, I'd like to turn the call over to Steve Burd.

Steven Burd

Thank you, Melissa. Let me start with net income. Net income for the quarter was just under $146 million. This compares with $141 million from the same quarter one year ago. When you express those earnings in earnings per share, we earned $0.41 this quarter as compared to $0.37 last year, which is an earnings increase per share of 11%. Now this marks the third consecutive quarter of double-digit earnings improvement.

Making just a few general comments at the outset, our earnings per share results were above first call consensus estimates, and frankly, above our own internal expectations. Sales were softer than we expected, but strong enough to produce our sixth consecutive quarter of improvement.

We had a small improvement in O&A when you adjust for both fuel sales and the Blackhawk accounting change, which we talked about for the first time one quarter ago. Our gross margin rate was lower than last year, largely because cost inflation, while being passed along to consumers, is being passed along with just a bit of a delay.

Our operating margin, excluding fuel on a year-to-date basis, is flat with last year. And you recall in our guidance that operating margin will be flat to up slightly on the year. So we're on track with that guidance.

Turning first to sales, our total sales increased 7.1% over last year. This strong increase in sales was largely the result of higher fuel sales, which are a combination of gallons being up double digits, as well as prices being up over 30%, our price per gallon. Also a change in the Blackhawk accounting, a third item would be an improved Canadian exchange rate. And then lastly, an increase in nonfuel-related ID sales. ID sales, excluding fuel, increased 0.5%, which is just up slightly from the first quarter.

Sales were relatively strong early in the quarter, but then softened -- they always soften the week after Easter, but they were soft for about 3 weeks after Easter. As we've looked at that, we believe the softening was largely the result of Easter occurring late in the calendar month. And it's always true that our sales spike during pay periods, which currently happens twice a month, and it's also true that really want to spend for the holiday. And if you look at the retail sales in general, I think most retailers experienced the same kind of Easter. So I think the calendar had something to do with that.

Sales then strengthened significantly in the last 5 weeks of the quarter. If we combine the last 5 weeks of quarter 2 with the first, really, 4.5 weeks now in quarter 3, we're running just below 1%. And we believe that, that momentum will build as we move through the quarter.

Inflation has been stronger than we expected and was north of 2% in quarter 2. When you couple stronger inflation with the fact that fuel retails are up considerably over the last year in our markets expressed in cents per gallon, retail prices are up $0.94 a gallon, which is about 32%. Those 2 things in combination, food inflation plus a rather large inflation on the fuel side, we believe has a dampening effect on demand, and that's particularly true for that segment of our shoppers that believe we're still in a recession, which is the largest segment, I might add. As a result, we continue to see a modest decline in market share, but virtually at the same rate that we've seen for the last 2 quarters.

Turning to gross margin, our total gross margin rate declined 155 basis points from last year. When you exclude fuel sales and the accounting change, our gross margin declined just 19 basis points from last year. Now this decline in growth is largely the result of the delay in recouping cost inflation that I mentioned earlier, coupled with the fact that we had a higher LIFO charge because of inflation in the quarter. Now these declines in gross margin were largely offset by a dramatic improvement in shrink reduction, which we've been experiencing since the fourth quarter of last year, an improvement in the Blackhawk gross margin dollars, and then a reduction in advertising spend.

Turning to O&A expenses. O&A expenses, expressed as a percentage of sales, declined 127 basis points from last year's second quarter. Now, excluding fuel sales, and again, the accounting change, the O&A expense ratio actually declined or, if you will, improved 4 basis points. The largest positive in the quarter were lower labor expenses and lower depreciation as we backed off on our capital spend from the days when we were remodeling 300 Lifestyle stores per year.

The largest negative variances were a higher bonus accrual and increases in the IT expense. Just a comment on the bonus accrual, that's actually a good thing. That was also true in the first quarter as you can appreciate, when you look at our organization, we have more than 22,000 people, including all the department managers in our stores that are bonus-eligible. So as we hit our planned number, that generates an accrual for those. So while it does affect the O&A expenses, we interpret that as a large dose of good news.

All things combined, O&A expenses were very well managed in the quarter. Looking at interest expense, interest expense declined $7.7 million due to lower interest rates and lower average borrowing. On the interest rate side -- excuse me, on the borrowing rate side, our interest rate was down by 22 basis points, which is about 1/3 of that net interest saving. And then our average level of debt outstanding was also lower by some $394 million. So at the end of the quarter, our debts stood at $4.96 billion as compared to $5.35 billion 1 year ago.

Turning to capital expenditures, we spent $209 million on capital projects in the second quarter. This included 6 new stores and 7 Lifestyle remodels. This compares with the capital expenditures of $192 million from the same quarter a year ago. Commenting a bit on income taxes, our income tax rate for the quarter was 33.3%. This tax rate is slightly above the 33% we suggested on our last earnings call and 200 basis points lower than what it was last year. The rate is lower than last year due to a higher portion of income coming from Canada, where tax rates are simply lower. It also reflects an election we made, provide for withholding tax on Canadian income, allowing us to bring more cash back from Canada, later this year at a very inexpensive rate.

Turning to free cash flow. Free cash flow for the quarter was unusually low. It was just under $5 million. Now this compares with $330 million from the prior year, but this difference is largely explained by 2 facts. The first is that we made a $154 million contribution to a nonunion pension plan. That is the first cash contribution we've made to that plan since 1982. And we elected to actually make that contribution in a single quarter, and we chose this quarter. Secondly, the taxes on the Canadian dividends came to $97 million, and those were all paid in this quarter. So without those 2 events, it's a pretty common cash flow generation quarter.

Year-to-date, free cash flow is $116 million versus $272 million in the prior year, and we remain confident that free cash flow is on target to achieve the range that we set out at the March investor conference where we initially provided guidance, which will put us in that range of $750 million to $850 million on the year.

In the last earnings release, as a result of some conversation we had at the investor conference, I committed to making some comments about some of the more volatile items that might be embedded in our earnings for the quarter, and those tend to be items like property gains and losses, maybe workers' comp, a number of things. In essence, there's not much to say this quarter because, first of all, there was little volatility in those standard categories. Secondly, the positives exactly matched up against the negatives. So anybody wanting to make some adjustments would be hard-pressed to do that. And then finally, I would tell you that the LIFO charge was up, considerably over last year, at $9 million, but we don't really think we should adjust either positively or negatively for LIFO, because LIFO is up because inflation is up. Inflation is up, so our gross margin dollars are higher. So we don't feel compelled to say, "But for LIFO, earnings would've been higher." So bottom line is nothing to report this quarter, but if there is next quarter I'll continue to make some comments along those lines.

Other notable events in the quarter. We repurchased 14.9 million shares at an average price of $24.13 per share, spending a total of just under $361 million. And as it has been my practice to just comment on Blackhawk, a very strong quarter for Blackhawk, face value of cards sold increased 29%. And just to compare that to the second quarter a year ago, face value of card sales increased 21%. So what's remarkable about that, that as the business gets increasingly larger, we're still putting up some very strong increases. And so if you looked over the last couple of years, those increases, while always double-digit, have actually been coming down. This is a reversal of trend, and we expect that reversal of trend to occur in the third quarter as well. And I have no reason to believe it won't occur in the fourth quarter. So the Blackhawk business is going very well.

And then lastly, just to comment a little bit on guidance, our earnings per share and free cash flow guidance remain unchanged from the guidance that we provided in early March. In early March, we provided guidance of $1.60 to $1.80, and that was without acknowledging the fact that we were going to do a Canadian dividend. When you look at the cost of doing that dividend, which we experienced in the first quarter, which is $0.22, and then you consider the benefit as we play out the balance of the year, the net cost of that Canadian dividend we expect to be $0.15 on the year. As a result, we provided a Canadian dividend adjusted number with our initial guidance in March, and that number was $1.45 to $1.65. And the only reason I'm reminding everybody of that, there seems to be a little confusion.

There was an article early this morning that recounted our guidance at $1.45 to $1.65 and then compared that to the first call consensus estimates of $1.74, and said, "Well, looks like the company is not going to hit the guidance -- or excuse me, the consensus estimates of $1.74." When in fact, I would just remind everybody, if you look at the first call estimate, we reported $0.07 in the first quarter. The first call consensus treated that as if it was $0.29, ignoring the $0.22. Now we actually think that's a good way of looking at things because you're trying to look at the ongoing earnings power in the enterprise. But we had no change in guidance and we think that a few people got confused, and that was reflected in some early-morning write-ups.

Turning to free cash flow, I commented on that, it's exactly what we said in March. Operating margin flagged up slightly, exactly what we said in March. Then on the ID sales range, we had a range of 1% to 1.5%. We're still in that range. We believe that our ID sales will approach 1%, not the1.5%, but still in that range. I mean, everybody has to appreciate that these are pretty unusual times. We're benefiting from some additional inflation, which we said could happen but we'd not embedded in our basic plan. At the same time, I don't think anybody expected fuel costs to be up 32% on the year, unemployment to be at 9.2% and consumer confidence to be hovering around 60%. So all of those things add up to having a respectable range in terms of guidance. And if you look at the first call earnings estimate, absent the cost of the Canadian dividend, essentially, it's practically in the middle of the range that we presented in March.

So with that, Melissa, I'm prepared to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Edward Kelly.

Edward Kelly - Crédit Suisse AG

Crédit Suisse. So my question for you is around the gross margin. You mentioned delays in passing through cost increases and also your stocks, Steve, I mean, I think the market looks at that and they just hear, "Can't pass through inflation." So can you maybe help us understand why that conclusion is wrong? And then why are you having difficulty just in terms of the delay?

Steven Burd

Okay. I'll give you several reasons why that conclusion is wrong. At the investor conference, and I don't know how many people on the call were at the investor conference, we presented a series of slides, and essentially, we tracked our sales in every market, we tracked our conventional competition in every market and we tracked several of the key price operators. And what we demonstrated, market by market, competitor by competitor, was that between the fourth quarter and the first quarter, the price increases on regular retail exceeded the price declines on regular retail across every market, across every competitor, including price leaders. All right. We did the same analysis in the second quarter. Numbers move around a little bit, but the same statement is true. All competitors, pricing conventional have higher numbers of increases than they have declines. And so everybody is passing this along. Secondly, if you sit in on other retailers' earnings call, you will hear them say that they're passing it along. Now let me comment on the delay aspect of this thing, and I would also take it back to my first quarter call when I talked about how one reflects price increases and how it actually happens kind of department by department. And so let's start with one of the all-time favorite categories, dairy. Dairy has been a category that for almost 20 years, if the cost of milk goes up $0.20, the retail goes up $0.20. You're not protecting your gross margin rate, but you're protecting your penny's profit. That 20-year relationship was broken for a period of about 14 months. For the last 2 if not 3 quarters, that relationship is back. And so on dairy products, which are a little bit unique, when we get a cost increase, there's an immediate recoupment of the cost increase, but you could have a gross margin decline there because you're back to historical relationships where you're protecting penny's profit. Now let's go to other elements of the store. In the meat department where there is a fair amount of inflation. What typically happens is when you get a cost increase, you immediately reflect that in your regular retail, but you don't always immediately reflect it in your promotional retail. As you got a standard price point out there that you've been using to drive customers into your store and until you see that inflation exist for a while, no one wants to be the first one to break that magic price point. And ultimately, you break that price point, so you'll get a little bit of a delay there. So no one should -- delay is not a substitute for it's not happening. It's delay. So you might be delayed by anywhere from 4 to 6 weeks, and you would generally not be delayed on your regular, only on your promotional. So for highly promotional operators, it probably has a little bit more of an effect. But I would invite you to talk to other retailers. You'll hear the same story.

Edward Kelly - Crédit Suisse AG

And is the delay that we're seeing, is it broad-based or is it isolated to certain regions?

Steven Burd

No, it's broad-based. Because when we do our analysis that we thought was a definitive work to display to the investors, we look at it across every single market, and we look at 5 different competitors. And I don't see -- you might from one quarter to another, you might see a little more in one market than the other, but I would say, it's across the board. There's no one market that's isolated, and it's not happened.

Edward Kelly - Crédit Suisse AG

And second question for you is on Durban. That's obviously been resolved at this point. Can you just help us understand what this means for you? And if you think about this right on the signature side, you're obviously, going to get lower fees. But on the pin side, it's a little less clear because you were already paying a lower fee than what's been enacted. Is this a net positive for you from a cost perspective?

Robert Edwards

Well, Ed, it's -- clearly, we're disappointed by the ruling. But the rates that were set are the maximum rate sets and our fees were generally below that. So it hasn't actually been determined what the impact will be on the company. And so I guess it's going to be a bit before we got clarity on that. But we're clearly disappointed in the outcome of that decision.

Operator

Our next question comes from Karen Short.

Karen Short - BMO Capital Markets U.S.

Karen Short, BMO capital. Just looking at your comps a little bit, in a little more detail, I guess, the first question is if you said and I missed it, what is your inflation this quarter? And I guess, if you could maybe breakdown Canada versus the U.S. inflation.

Steven Burd

My comment -- inflation, first of all is not -- it's got as much art and it reminds of medicine. There's a little art and a little science. So we would say that inflation in the quarter was north of 2%. I think it's tough to get a precise measure on that because you've got mix exchanges and everything else going on. But just a bit north of 2% is a fair number. You might hear a slightly different number from other retailers, and frankly, we've never been able to reconcile what we see on our books with the Consumer Price Index, Food Retail Index. We've never -- we can never get the 2 to reconcile. And that might be something that everybody has readily available, but that's what we see. And then in Canada, Canada tends to -- it's been running behind U.S. in almost every respect. It entered the recession later, although it actually went through a recovery much quicker. And I'm sure you know that the Canadian economy is in much better shape than the U.S. economy, unemployment in Canada is much lower than in the U.S. And in fact, there's a great article in The Wall Street Journal today about how they have solved their debt problem. But so, inflation in Canada is running a bit lower than that in the U.S., as you might expect.

Karen Short - BMO Capital Markets U.S.

Sorry, the 2% was the U.S. and Canada is lower than that and that's retail inflation?

Steven Burd

Correct. And that might also be why our inflation number, as you hear from other retailers, might be a little bit on the low side because we've got the Canadian influence.

Karen Short - BMO Capital Markets U.S.

Okay. And then I guess, you did give us revised ID guidance for the year that was revised down. Can you give some color on what that implies in terms of the full year inflation?

Steven Burd

Well, I don't want to get into the semantics. You call it a revision. The range was 1% to 1.5% and we said that you can expect it to be in the range, but a number approaching 1%, as opposed to a number approaching 1.5%. We provided a range for reason and that is that we're not clairvoyant. And that as we move through the year, we're in a better position to tell you where we think that sorts out.

Karen Short - BMO Capital Markets U.S.

Okay. And what does that imply in terms of inflation for the full year?

Steven Burd

That number would imply that it kind of stays about where it is. And I don't think any of us really know.

Karen Short - BMO Capital Markets U.S.

Okay. And then I don't know if you're -- if this maybe can help clarify what's going on in the U.S. Obviously, people would've thought your comp would've been a little stronger this quarter, and it sounds like you hope sales would be a little stronger too. Was there a big difference between what you're seeing in the U.S. versus Canada? Is one recovering faster than the other? Or does that maybe make the U.S. look a little stronger if you break out Canada separately?

Steven Burd

Well, the bottom line is, the economy is doing better in Canada. And I don't know what people were expecting in terms of ID sales. But I would tell you that we're comforted by the fact when we look at our market share position, it's essentially been stable for the last 3 quarters. And let me see if I can -- I don't know if I did on the last quarter, forgive me if I did, but the average household has 2.3 members. The average spend per member in a retail food store is about $40 a week. Just to facilitate the math here, let me use 2.5 instead of 2.3 because that works out to roughly $100 spent. If they were spending $100 last year, and then you get some inflation there, say that goes up to $102, let's just use that number. Now let's go over the fuel side. On the fuel side, you probably have, in this day and age, you have 2 income earners and 2 automobiles in that family, and they're probably buying about 30 gallons a week. And they're spending now almost $4. So that's $120. When that goes up 30%, it goes up $36. When you consider the market basket for food and the market basket for fuel, that's an extraordinary increase. There isn't anybody on this phone call that, that if we add a 32% increase in food prices in the quarter would be surprised of the demand's dampening effect. So when you consider food and fuel together, you're going to have that dampening effect. And again, I've heard other retailers speak to exactly the same point. Because people have to use fuel to get to work, and they have to get to work to buy food, and so they're connected. And so we're not that surprised. We are disappointed in our sales numbers. But we're not surprised because we can do the math.

Karen Short - BMO Capital Markets U.S.

So I guess, taking that analogy and thanks for that, it obviously makes sense. But when you talk about the sales kind of being weaker for 3 weeks including the week after Easter and then 2 more weeks, but then improving in the next 5 and then into the next 3 weeks of the third quarter. Can you overlay that with the gas prices? I mean, what, did it kind of stay soft as gas prices peaked and then recovered as they declined a bit or?

Steven Burd

No. That phenomenon that I described is independent of what's going on with gas, and essentially inflation in food. Here's what we experienced in our business. Holidays are important to consumers and they save for those holidays. And they spend just as well as they did last year for that holiday. The other thing that happens in the retail food business, and it's hard for people in this call maybe to relate to this, but the vast majority of all consumers live paycheck to paycheck. So in a soft economy like we're experiencing, the difference in sales, between the beginning of the pay period and the end of the pay period is approaching double digits, that delta. I've never seen that in 20 years. And so when you have a holiday that occurs near the end of the month, people want that to be as good as the last holiday. And so they pinch and save for that, and they have a good holiday. But it occurred at the end of the month, and now their financial resources are drained, and so we had a more pronounced sort of sales experience that's just one week after Easter. The Easter last year occurred at the first of the month. And so we were soft for not one week, we were soft for basically 3 weeks. And then, they got another pay period and things kind of returned to normal. So that's the retail food business, and frankly, that's the retail business in the midst of a business downturn or a soft economy.

Operator

Our next question comes from Scott Mushkin.

Scott Mushkin - Jefferies & Company, Inc.

Yes, it's Jefferies. So, Steve, I know in answering Karen's question you've said that your expectations for inflation are kind of where they are now, around about 2%. Kind of play a little bit devil's advocate there. I mean, our data suggest that prices are continuing to march up pretty steadily here. We could be facing much higher inflation in the back half of the year. And I was wondering if you guys are thinking about contingency plans, if that indeed is the case and given the weakness of the consumer, how you think that affects your business in the back half? And then just secondly, if you could give me an update on the Just for U program, I'd love that too.

Steven Burd

Sure. I've seen some other people's estimates for inflation. So I'm aware that other people have higher estimates. When we look at our inflation there is a huge difference between perishable and nonperishable. And the perishable side is essentially 3x to 4x that of the nonperishable side, which might be new news to a lot of people on this call. The perishable side is much more of a commodity business. And so I can't really tell whether what we experienced in the second quarter was largely in balances in supply and demand. It could be short-lived, i.e. produce. And therefore, I'm not confident, as confident as you might be that, that will necessarily continue. And so I'm safe to say that it's going to be north of 2%. I can't tell you exactly what it's going to be, but we're watching that. But there's a huge difference between the nonperishable and the perishable side. And then Scott, if you could repeat, there was another aspect to your question.

Scott Mushkin - Jefferies & Company, Inc.

Just for U.

Steven Burd

Oh, Just for U. I think we talked about this on the last earnings call. We're in 2 markets at this point. We delayed our rollout from our earlier expectation as we make changes to Just for U and as we get ready to scale that into a much larger operation. We're on track with our internal targets for getting that done. And so there is nothing new on there except that you would see us launch -- you'll see us refresh the 2 markets we're in, probably either in late third or early fourth quarter. And then you could see us add a division or 2 by the end of the year. And then you could see us complete the rollout in the first quarter. I mean, if I were to try to give you a guesstimate of that, that would be my schedule.

Scott Mushkin - Jefferies & Company, Inc.

That's good. And can I follow up on the inflation, and just, it's good to hear you kind of distinguish about the perishable and nonperishables. It seems like on the packaged food side, we're hearing, continuing to hear about price, them wanting to push price through and pretty aggressively and maybe mid- to high-single digits. How are those discussions going? Are you trying to resist that type of thing, given the volumes that may come off? Or if you can give us a little flavor on how the channel is behaving given what may be coming out of the center of the grocery store on the back half of the year.

Steven Burd

Sure. I think that what you read about in the press are -- you never really read that a CPG company has done across the board 8% increase, all sides. What you read about is a category, or you read about a brand and -- so you read about bits and pieces. And if you just read the newspaper, I know you go way beyond that. But just the casual person reading a newspaper is going to think there's greater inflation than there really is. Because what hits the news is the inflation, not what's going on with other prices. I do believe that the CPG world is sensitive to reaching coupon. And we always push back on them about price increases, and they're sensitive to it. And so I think it's reflected in the numbers. It's reflected in the fact that on the nonperishable, largely consumer packaged goods' side, we're seeing much lower inflation. A sensitivity on their part and a pushback on our part, and I suspect others'.

Operator

Our next question comes from John Heinbockel.

John Heinbockel - Guggenheim Securities, LLC

Sure, Guggenheim. So Steve, a couple of things. With regard to competitor price pass-through, when you look at the price leaders in the market, someone like a Wal-Mart, for example, it looks like there is an incredible amount of rationality of putting that pricing through pretty consistently and pretty quickly, at least among the price leaders. Do you see that -- do you also see that or -- and are they behaving a little bit differently than the non-price leaders?

Steven Burd

No. I think the market is totally rational. While we would prefer not to see this level of inflation in the midst of a soft economy, even if it's demand dampening, it's in your economic best interest to pass it along. And so we've seen -- no, we haven't seen any hesitation and we see all retailers doing it so I -- your observation matches mine.

John Heinbockel - Guggenheim Securities, LLC

The second thing, you mentioned the health of the consumer a little bit. Can you talk about that in a little more detail? Particularly segments. So if you look at your higher-end customer, you have more of those than some other folks, to what degree do you think their spending is holding up versus the lower income group? And have you seen any changes in that more recently?

Steven Burd

I would say, really no changes. We continue to characterize the economy as a bifurcated recovery. I can't give you a quantitative percentage, but my guess basically splits our customers as about 25% recession's over with, times are good, spending as they always did. And then the other 75%, really very cautious and very concerned. It doesn't help when people predict years of relatively high unemployment. That creates uncertainty. And I've always said that I think the most important indicator to watch is the Consumer Confidence Index. We've always seen a very high correlation. Our sales correlate more with consumer confidence than any other index you can access publicly.

John Heinbockel - Guggenheim Securities, LLC

Is there a way to tell how much the payroll tax holiday has helped bolster spending here this year? And what would happen if that went away next year, or do you just know that it's helpful?

Steven Burd

Yes, I think we just know that it's helpful because it was predictable, and I think it's been embedded when people look at their take-home pay, and it's been the same week after week. Now if suddenly that gets a lot of attention and people think it's going to go away, then it could have a negative effect. But I don't think -- I think it's just kind of embedded in there, it's just like going to work every morning, it's there, the people come to rely on it.

John Heinbockel - Guggenheim Securities, LLC

All right. And then finally, if you look at -- so vendor trade spend, there has been a lot of talk. They haven't -- I guess, many haven't been happy with the effectiveness of trade spend. You want to move more toward direct-to-consumer, add spend, yet obviously, their volumes are soft, Private Label is still as a threat. What do you see happening with trade spend and is it -- to listen to them, the vendors, you would think it would pull back a fair bit, do you think that'll happen or no?

Steven Burd

I think, generally, what I would say is that we think that all in trade spend is about where it's always been. If you look at reports that we put out on vendor allowances could be misleading. You know that. I do think that they would like to spend it more efficiently. I think everybody wants to spend money more efficiently. And I frankly think the marketing platform that we're building, actually allows them to do that. And actually allows them to measure the return very directly. So I think that -- I think that what we're doing actually plays to that desire of theirs. And I think that speaks well to what we should be able to do once we're fully rolled out.

Operator

Your next question comes from Meredith Adler.

Meredith Adler - Barclays Capital

I'm Meredith Adler from Barclays Capital. I just have a real quick question first. When you think about the inflation, that's just above 2%, you are including a perishable even though your LIFO calculation doesn't include perishables?

Steven Burd

Correct.

Meredith Adler - Barclays Capital

Okay. Great. And then I just want to follow on the last question we got about the payroll tax holiday. What about unemployment benefits? Do you have concerns that as that rolls off, then that's going to have a big impact? You have a lot of customers who are still hurting.

Steven Burd

Yes. That's a tough one. I don't know what's going to happen on unemployment benefits. There are those that would argue that unemployment benefits, the longer they are, the longer people stay unemployed. And so you've got some economists who would advocate that you shorten that. And then wages would drop, and I don't need to tell you the rest of the story, and costs would decline and price would decline and the economy would recover. There are others that obviously argue the other side. So I don't really know what's going to happen on unemployment benefits. I think that there are a lot of other things that would have improve consumer confidence. And unemployment benefits, in my view, is not on the top of the list.

Meredith Adler - Barclays Capital

And then I'd just like to switch gears and talk a little bit about real estate. I know when you had your Analyst Meeting, you did fascinating presentation on the new stores you're building. And I'm wondering whether the fact that there's not a lot of new development matters in terms of how you building new stores, what you do with relocating stores. And then also, it seems like the pace has picked up. Is there any particular reason, competition or whatever that you would be interested in building more stores?

Steven Burd

Yes. Go ahead, Robert.

Robert Edwards

Meredith, at the investor conference our -- the leaders in the Property Development Center group made a presentation there, if you recall. We've made very good progress since then. We have a lot of work under way. We're very pleased with the developments. We've got 15 projects currently under way and 5 of those just started in the second quarter. So we're quite pleased with what we're seeing. And in terms of the leasing activity we're seeing related to the shops that we're building, we're having excellent receptivity. So we've got great assets there, we've got a good management team, and we expect to create value there. So there's really been no change in our expectations for that business since we reviewed it at the investor conference. Things are going actually quite well there.

Steven Burd

The other comment I would add, Meredith, is that compared to September 2008, it's a very different world out there. And so development is occurring, not just us, but assets that we may want to sell. I'm not thinking to sell you store assets in our operating stores, but obviously, we've got a surplus distribution center and a lot of interest. And so I think that we're doing well in our development side. It's the strongest store program we've had in over 4 years. Considerably a larger number of new stores this year than last year, and I sense a real change in the competitive landscape among developers. And so as we try to acquire property, we're not the only guy there with cash. We're competing with people. And so -- and often, developers. And so it's-- that is changing. So that's probably a good thing overall for the economy.

Meredith Adler - Barclays Capital

And then I have my follow-up. My question had also been -- was there something that particularly made you decide to open more stores now? Was that competition or just opportunity?

Robert Edwards

Well, a significant percentage of the new stores we're doing are replacement stores. And they are primarily in urban areas and related to your previous question, in years past, when housing starts were strong, employment was strong, we were building more stores on the periphery of the Metropolitan areas. Whereas now, it's concentrated in urban areas for the most part. But it's driven, to some extent, by replacement stores.

Operator

Your next question comes from Deborah Weinswig.

Deborah Weinswig - Citigroup Inc

Citigroup. So, Steve, you've stated in your prepared remarks that you believe that the momentum would build as you move throughout the quarter. Can you just talk about what you're obviously currently seeing and what you think is driving that?

Steven Burd

Well, I think a couple of things. We lowered our prices really at the beginning of 2009. So we were relying on more consumers appreciating our price position. We continue to find ways to differentiate our offering from those of our competitors. We've developed a whole new marketing platform that is more targeted than anything else in the marketplace. We see the results of that plus some other pilots that we're running throughout the company. And our expectation is we get more of those things in place between now and the end of the year and that builds our business. So we're not sitting here thinking the economy is going to get better. We don't believe that we can allow ourselves to be held hostage to an improving economy, but we instead have to find ways to take share. And so that's what our marketing strategy is all about.

Deborah Weinswig - Citigroup Inc

And if we go back to the investor conference, I think I'd actually asked you the question there, but I had thought that at the time the 1% to 1.5% ID guidance was conservative based on some of the initiatives you just mentioned. So can you walk us from the investor conference to today where we're now at a guidance of 1%? What's different than your expectations? And is it mainly the macro environment or is it more the competitive landscape?

Steven Burd

I think that -- I'll put them in order. I think the dominant sort of change from the investor conference in my mind is fuel cost. We had probably the longest uninterrupted rise in fuel costs, and therefore retail, that we've seen since we've been in this business for 8 years. And so I want you to think back about what I said about thinking about fuel and food as a bucket. So that's the number one thing. Number two, since the investor conference, if I recall correctly at the investor conference, we were actually looking at unemployment that had actually fallen. I think we're in the 8.6% range, now we're at 9.2%. And we looked at consumer confidence, that it was actually improving. I think it was in the 70s, then we thought it was on its way to 75%, and now it's at 60%. And so those are the things that I would say plus, I guess, the third factor would be that we are delayed in our implementation of our Just for U platform. And so if those are the top 3 reasons, the competitive landscape -- I don't know what I would put between there and the competitive landscape, but I'd put competitive landscape fixed without pushing me on what is fourth and fifth right now. So it's really those 3 elements.

Operator

Your next question comes from Andrew Wolf.

Andrew Wolf - BB&T Capital Markets

BB&T. Just wanted to see if my takeaway of what you're trying to talk about in terms of sales is accurate with how you're thinking. So as you look at the last period, 2 periods where sales have sort of gone back up post-Easter, would you say that's more traffic? Folks who are returning after paycheck cycles have emptied them of their money? Or is it more that basket size went up because you're starting -- the markets are starting to pass through more of the inflation?

Steven Burd

Well, what we see in our numbers is the -- it's a change in the basket and in our company, additional households shopping with it.

Andrew Wolf - BB&T Capital Markets

And that's post-Easter?

Steven Burd

Correct.

Andrew Wolf - BB&T Capital Markets

So it's a little of both?

Steven Burd

Yes.

Andrew Wolf - BB&T Capital Markets

And so in reference to the stickiness in pricing, are you still seeing the incremental -- are the markets still starting to incrementally test price and having it pass through or are you seeing in certain categories whether it's maybe a large, perishable category or something, the market is kind of stuck on pricing and there's some uncertainty?

Steven Burd

It varies by category. So if you're seeing -- if you're looking at a category which is on a somewhat predictable uptrend, there's virtually no delay, because you got serious inflation, people are expecting it, costs go up, they immediately get deflected. In other categories, where there hasn't been much inflation and then suddenly there is some, then that's where you get a little bit of a delay. In a market where you are a large market share player, you're often the first to go. In a market where you're a much smaller player, you may not be the first to go. But I think that deflation has been sufficiently hard on retailers over the last couple of years. That no one is really going to sit back and not increase prices when cost of goods goes up. And they wouldn't normally do it and on the heels of deflation, they can't afford to do it. And so again, I think it's -- what we're experiencing is rational and we continue to watch to see whether everybody's passing it along and they certainly are. It's helpful, I think, to think about dairy. And I always thought that the reason dairy took such a hit when deflation and when we started getting inflation again, it wasn't necessarily recouped, is people were looking at variety of sales and they hadn't really parsed out volume versus price. Now I think everybody understands that. And so dairy is back to normal, and I don't see any backsliding on that. So I think to some folks it's a learning experience and we're going through in time, the likes of which I've never seen in my career. And so I think some of the old rules get sort of put on the side, because they don't work the same.

Andrew Wolf - BB&T Capital Markets

My other question is if you look at the gross margin differential sequentially and try to explain that, that contraction. Could you help us and do you think about it in terms of sticky pricing or delays? Was it more on getting gross margins, maintaining gross margins in those categories where that's how the categories traditionally run? Or was it more just sort of the mix going to categories where you're just trying to maintain penny profit per unit anyways or per pound and that's going to mathematically occur in any case?

Steven Burd

Yes, I think that there really is just a handful of categories where it's a pay per pound gain. In the vast majority, it's a gross margin gain. So I said this earlier on the call, but just to keep everybody sort of on track, the delay we're talking about is 4 to 6 weeks before it gets into the promotional prices and gets into regular retail's virtually immediately. And so I wish they weren't any delay. And maybe the delay will go away. But also, I think, if inflation continues to accelerate, that would probably cause that delay to shrink or disappear.

Operator

The next question comes from Stephen Grambling.

Stephen Grambling - Goldman Sachs Group Inc.

This is Stephen Grambling from Goldman Sachs. Just a follow up on Andrew's question, at the Analyst Day, you provided data that suggests inflation drive stronger operating marginal leverage and earlier you said that it's in retailer's best interest to pass it along. But is there an absolute level where this relationship breaks down or retailers are less willing to pass along?

Steven Burd

Well, I said at the investor conference that I'm very comfortable that 3% inflation is readily passed along. Because that's been the average rate of inflation in this business for a decade. So it's when you start getting above 3% that we really don't know. Now maybe in this kind of economy, when you get above 4% on the heels of 2 years of deflation, maybe 4% isn't a problem. Maybe 5% isn't a problem. I think, we just don't know. And so my preference is that inflation remain in that 2% to 3% or not much above 3%, that would be my preference. Because that's within the range of the experience that we've had. And so what would happen if food inflation goes to 5% and the price of fuel drops and instead of 32% up, it's only 15% up. Well, I don't think you can look at these independently, you have to look at them in combination.

Stephen Grambling - Goldman Sachs Group Inc.

Okay. That's helpful. And one quick follow-up, if I may, I think Karen tried to address this a bit, but have you seen a change in spending behavior within the stores as gas came down? Any commentary by category particularly on the discretionary side?

Steven Burd

I think the spending patterns are not materially different with the events in the last couple of quarters. Those that feel they've recovered, are spending as normal and the others are spending carefully. And I don't see a change in that.

Operator

The next question comes from Robby Ohmes.

Robert Ohmes - BofA Merrill Lynch

Robby Ohmes, BofA Merrill. Hey, Steve, a couple of quick ones for you. The first one may be a follow-up on some other questions. I like how you broke up about 25% of your customers are doing about the same, 75% under a lot of pressure. Where do you think you're seeing more market share pressure is? Is it in the upper end people or is it in the lower end? The second question is, if you could help us understand how fuel played out for you this quarter. Was it in EPS benefit, that year-over-year? And also for the stores where you have gas stations, was it a significant traffic driver so that it was helping comps in those, I think it's 20% or 25% of your stores have fuel stations. And then the last question was just I don't think you updated us on Private Label trends. I apologize if you did, but I would love to sort of hear any color on that.

Steven Burd

Okay. Last question is -- hopefully Robert will help me out. On the fuel side, we do find that our stores at fuel stations have significantly higher ID. On the fuel profitability, when you weigh in all the costs including the credit and debit card fees, relatively flat with one year ago. On the Private Label side, Private Label is running higher growth than national brand by a couple of hundred basis points. And one of the things that I think is helping us there is that we introduced a new brand. I think it was actually at the early part of the year, maybe even last September, Open Nature. And we're still filling up that SKU pallet, but it's a very unique brand, all-natural ingredients. And it's beating our expectations by some distance. On the issue of the 25%, 75%, I think that when we look at our most loyal customers, we're experiencing very large increases with that most loyal crowd. And we tend to skew higher income than a lot of our competition. And so I think where you see the greatest challenge is on the other 75%, who are doing more shopping around and are less loyal. Again, some of the marketing strategies that we're putting in place addresses that very directly by making it much easier for people to shop at our stores and get, on a targeted basis, the best prices in the market. And so you'll hear us talk more about that as that platform gets more fully rolled out. But that's the way I would describe that bifurcated set right now.

Operator

Your next question comes from Neil Currie.

Neil Currie - Dahlman Rose & Company, LLC

Dahlman Rose. I wanted to really ask about volume growth. Because with 2% inflation with your 0.5% ID sales, it's implying another quarter of negative volumes, which has been the case for some time now. So I'm wondering with inflation being in the sweet spot of what you've always said is very manageable inflation, flat EBITDA. How are you going to improve volume growth going forward without having to address perhaps your pricing position, or are indeed you comfortable with your pricing position relative to other competitors?

Steven Burd

Yes. I would tell you, on our pricing position, we're totally comfortable. We lowered our prices, we've kept them there, we're watching them every week. The price position is fine. It takes a while for that perception to play out. On the volume notion, we think it's actually more relevant to kind of look at share than it is actual volume. When I say that we see a dampening effect on volume, I don't think if fuel prices hadn't gone up 32%, we would see a dampening effect, right? But fuel prices -- again go back to my little market basket in a world where your just looking at fuel and food, it dominates the equation. And so it's a much more complicated equation than simply looking in an isolated way at food. I don't think 3% inflation, 2% inflation would be any problem at all, would have a dampening effect on demand. And I think, but for fuel, we would have had positive volume. I'm encouraged by the fact that our share position is basically holding. And so we want to take share, and we think we have designed the tools that will allow us to take share. We just have to get them in the market. And I think we'll be fine.

Neil Currie - Dahlman Rose & Company, LLC

And secondly, on price inflation on the sense of store, as you went through the second quarter, did you also hold back some price increases in sense of store or perhaps pass through price increases using profit dollars spend rather than rates and, how do you expect that to pan out in the third quarter and going forward?

Steven Burd

Yes, I mean, as I indicated, cost inflation was dominated on the perishable side. You would see a similar delay on the nonperishable side, but its effect would be pretty de minimis relative to the perishable side.

Operator

Your next question comes from Marc Wiltamuth.

Mark Wiltamuth - Morgan Stanley

On the share issue, didn't you say at the top of the call that you lost some market share and you were just saying a minute ago, you thought you were holding share. Maybe you could square that up for us.

Steven Burd

Sure. I can clear that up. What I did say, and I can understand confusion, I said if you look over the last 3 quarters, we've lost just a small amount of share, recognizing this as we can get good share information on the nonperishable side. Our information on the perishable side is -- it's as good as we can get, but it's nowhere near completed, the nonperishable side. So there's a lot of filling in the blanks that we do there. So over the last 3 quarters, we have actually said it better on the front part of the call, we've had a very modest, as we measure it, share loss. And that has been essentially the same for the last 3 quarters. So that's a better way to say it. Very modest share loss. But I can't actually be certain that it's share loss, given that how you measure perishable. But we've been measuring the same for the last 3 quarters, and it's virtually identical. So it's an overstatement. We're not holding share. We've got a very modest share loss, and that hasn't changed for 3 quarters.

Mark Wiltamuth - Morgan Stanley

So do you think the rest of the industry is doing negative volume growth right now?

Steven Burd

Yes.

Mark Wiltamuth - Morgan Stanley

And on fuel, maybe you could talk about how the quarter progressed. It seems like we had some ups and downs in fuel during the quarter. And did you end up having an EPS gain versus year ago on fuel? Obviously, the volumes were up strongly, pricing was up, but margins probably moved around quite a bit. So if you could help us quite of bit on how that played out.

Steven Burd

Margins in the second quarter were better than what they've been on average over the course of the year. But they were essentially identical to what they were in the second quarter a year ago. So when you're looking at the earnings increase.

Robert Edwards

Mark, the fuel profitability last year, second quarter was the highest profitability of the year last year so as we had, on a relative basis, a more difficult comparison.

Steven Burd

And so against that good number last year, we had a good number this year. So there is no additional income as compared to last year in this quarter.

Robert Edwards

But we saw significant gallon growth as we've commented on the last couple of calls, over, say, the last 1.5 years, we've had very strong volume growth. And so that clearly helped improve profitability. And we estimate that at about $0.01 a share.

Mark Wiltamuth - Morgan Stanley

$0.01 a share help from volume growth?

Robert Edwards

In total. If you look at total profitability of fuel, it's roughly $0.01 a share to this quarter compared to the quarter last year.

Mark Wiltamuth - Morgan Stanley

Okay. So you're saying a year ago, margin percentage was much higher, but now you have...

Robert Edwards

No, it's just -- Roughly, I think what Steve said it's about the same, but based primarily on volume growth, earnings were up about $0.01 a share this quarter relative to the quarter last year.

Mark Wiltamuth - Morgan Stanley

Okay, that helps. And then going back to the volume, this theme of price up, volume down due to the dampening effects, Steve, if you continue to do negative volume growth, doesn't that kind of speak to a need to get a little sharper on price?

Steven Burd

Well, you want us to be below all of our competition?

Mark Wiltamuth - Morgan Stanley

Well, if you're losing share, that tends to imply something is going on there.

Steven Burd

No. I think our price position is fine. I mean, oftentimes, we get asked, "But why don't we just lower prices and life would be good." It's not really about price. We are considerably lower, although we are lower than everyone but our primary conventional competitor, and we are debt-equal to our primary conventional competitor. And so there should be plenty of share that we can capture from others. And we think that we've got a marketing plan that when we get it rolled out, we'll do exactly that.

Operator

Our next question comes from Colin Guheen.

Colin Guheen - Cowen and Company, LLC

Cowen and Company. Not to over emphasize this, but where is nonperishable inflation today? Where was it entering the second quarter and where do you expect it to be in the third quarter?

Steven Burd

I'm not going to split that out except to say that perishable inflation was 3x to 4x higher than that of nonperishable. And I don't think there is any way to predict that or I would be in the commodity trading business.

Colin Guheen - Cowen and Company, LLC

But you are seeing nonperishable inflation accelerate sequentially month-to-month?

Steven Burd

Nonperishable inflation, there was some acceleration in the nonperishable, but it's really dominated on the perishable side.

Operator

Our final question comes from Charles Gram [ph].

Unknown Analyst -

Just on your expectations for the back half of the year, I'm just wondered if you could outline what you think you're LIFO accrual will be?

Robert Edwards

Well, it's difficult to predict. We don't give specific guidance on that metric. So I think we won't give guidance on that.

Unknown Analyst -

Okay. Fair enough. And then it looks like G&A helped out by about 24 basis points. Would you expect that benefit to continue assuming you continue to get the volume lift on the fuel side?

Robert Edwards

I missed -- you're talking about -- you said O&A or...

Unknown Analyst -

Depreciation, sorry.

Robert Edwards

Yes, clearly because of the reduced capital spend, depreciation is helping, it helped in the quarter. So, we think it will be favorable for the year.

Unknown Analyst -

Okay. And then, Steve, one for you. Just again on this cost issue, as you pass on cost increases from retail, I was wondering if you could give a little bit of light on the unit elasticity across different categories, both perishable and nonperishable.

Steven Burd

I mean, I think that if you have a volume decline and I answered the question, do I think the sector has a volume declined, my answer is yes. That suggests that there's some positive elasticity with price. And I can't actually tell you what it is commodity by commodity, but it's a basket elasticity because I have to buy the fuel to get to work. I wish you had you had to buy the food to get to the fuel station, but it works in reverse order.

Melissa Plaisance

Okay. We have time for one last question.

Operator

And that comes from Joe Feldman.

Joseph Feldman - Telsey Advisory Group

Telsey Advisory Group. Just 1 or 2 other quick points. On shrink, I know that was one of the better categories within the gross margin. Anything that's driving some of the success there that you can speak to? I know there's been some work on some of the just leveraging systems a little better, but anything you could talk about?

Steven Burd

Well, I think that -- I probably can't expand on it a lot. I think we may have said at the investor conference that after being, I think, more successful at this than any of our competitors over the course of the last 8 to 10 years, we took a fresh look at shrink, which was still pretty substantial in the company last August, and we elected to sort of reinvent how we did this. And I think we may have given a target at that time that we intended over about an 18-month period. And so in month 18th we would expect our shrink to be about $300 million lower at an annual run rate. And that's after having taking out over $600 million in shrink. So that's a pretty good result. And for competitive reasons, I don't really want to expand on that because I think we're way ahead of our competition. And I don't want to give them ideas on how they could reduce their shrink.

Joseph Feldman - Telsey Advisory Group

Understood. And then one other thing I wanted to ask about is on the Blackhawk business, could you discuss a little about the trends of your expansion efforts? And if I recall correctly, weren't you going a little more focused in Europe and trying to do a little more internationally with Blackhawk?

Steven Burd

Yes. Blackhawk has been in several other countries. I'll try to rattle them off from memory here. We're in Australia, obviously, we're in Canada, we're in the U.K., we're in France, we're in the Netherlands, we're in Mexico. Those are the ones that would dominate that picture.

Joseph Feldman - Telsey Advisory Group

And your business has been better there?

Steven Burd

Well, obviously, those are relatively young markets where you have high growth. But in terms of -- if you look at the absolute dollars of growth, it's actually coming from North America that we found a way to essentially drive best practices across the distribution network, and that's driving -- the big driver in the equation is what we call closed loop gift cards.

Joseph Feldman - Telsey Advisory Group

Got it. And the gross profit dollar's up there, I assume, speaks to more of the volume as opposed to -- or is it the margin spreads are a little better as well?

Steven Burd

It's partially volume. Let me just -- I want to make just kind of a summary comment here at the end. I feel compelled to make a couple of comments. One is that the guidance that we gave on March 8 remains unchanged across the board. It hasn't changed on earnings, it hasn't changed on free cash flow, it hasn't changed on operating profit margin and where we expect to be on sales is consistent with the range that we gave on that same day. Okay?

Point #2, I would encourage all of you to think about the fact that when fuel costs are up 32% and food prices are up 2-plus percent, and you add those baskets together, it's a pretty impactful event for consumers. And then reflect on other earnings calls you may have listened to, you should not have heard anything different on this call than you've heard on any of those.

Last comment I would make, if you should take some comfort in the fact that a company that has built a marketing platform, has demonstrated it works in a couple of markets, is prepared to put in all of the markets in relatively short order and produced double-digit earnings growth for the third consecutive quarter because of its prowess in managing cost at a 0.5% ID. So we put more to the bottom line than anybody we compete with, and we're confident we can get our sales level to the level of the best in the sector. And when we do, that should be a very good results for shareholders.

Melissa Plaisance

Thank you very much. Christiane Pelz and I will be available through the balance of the day if there are any follow-up questions.

Operator

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

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