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SUPERVALU (NYSE:SVU)

Q3 2012 Earnings Call

January 11, 2012 10:00 am ET

Executives

Sherry M. Smith - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Craig R. Herkert - Chief Executive Officer, President, Director and Member of Executive Committee

Kenneth B. Levy - Vice President of Investor Relations

Analysts

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

Kelly A. Bania - BofA Merrill Lynch, Research Division

Mark Wiltamuth - Morgan Stanley, Research Division

Shane Higgins - Deutsche Bank AG, Research Division

Karen F. Short - BMO Capital Markets U.S.

Mike Otway - Jefferies & Company, Inc., Research Division

Deborah L. Weinswig - Citigroup Inc, Research Division

Meredith Adler - Barclays Capital, Research Division

Ajay Jain - Cantor Fitzgerald & Co., Research Division

Operator

Good morning. My name is Ashley, and I will be your conference operator today. At this time, I would like to welcome everyone to the SUPERVALU's third quarter earnings call. [Operator Instructions] I would now like to turn the conference over to Ken Levy. Sir, you may begin your conference.

Kenneth B. Levy

Thank you, Ashley. I want to welcome everyone to SUPERVALU's Third Quarter 2012 Earnings Conference Call. Joining me on today's call are Craig Herkert, Chief Executive Officer and President; and Sherry Smith, Executive Vice President and Chief Financial Officer.

We have prepared some supplemental information to accompany our prepared remarks, which is available on SUPERVALU's Investor Relations website under the Presentations and Webcasts section. Following prepared remarks, we will open up the call for your questions. So that we can accommodate as many people as possible, I would ask that you limit yourself to one question with one follow-up.

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 as well as the supplemental information will be available on our corporate website at www.supervalu.com.

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

Craig R. Herkert

Thank you, Ken, and good morning, everyone. As you saw in this morning's press release, SUPERVALU reported earnings per share of $0.24, excluding impairment charges on identical store sales of negative 2.9%. We remain on track with our business transformation plan and with our earnings guidance for fiscal 2012.

It's been 3 quarters since we first introduced our 8 Plays to Win, which defines our organizational priorities and our vision to becoming America's Neighborhood Grocer. To date, we've made good progress on implementing new tools that better utilize data and improve decision making, while generating funding that has been provided for meaningful investment in retail price across our stores. We've lowered costs across the enterprise and continue to see opportunities to do so. We have invested in our asset base, adding 29 Save-A-Lot stores this year, 19 of which are located in food deserts and completing 49 traditional remodels.

Our independent business remains strong with some of the best operators in the industry. We've also stepped up our sustainability efforts, which is both good for the environment and for our bottom line. The transformation work we are doing is fundamentally repositioning SUPERVALU so that this company will better serve its customers while providing solid returns for our shareholders and bond owners.

At the foundation of our strategy is hyperlocal retailing. We've equipped our store directors with new tools and insights about their trade areas to better meet the needs of the communities they serve. And as we have rolled out our hyperlocal strategy across the store network, we've also changed long-held practices at the enterprise level to simplify operations and better support our stores.

We're committed to narrowing the relative price gap that exists in our markets through a focus on fair price plus promotion. By design, we've moved away from short-term promotions that trigger cherry picking, and implemented more pricing and marketing programs designed to build long-term loyalty and offer a fair price to our customers.

We've continued to lower prices in certain categories on known value items and in select markets throughout the year. In the third quarter, we launched Fresh Produce, Fresh Prices. This initiative lowered the everyday price on around 200 key produce items in all but one market, and that one will launch tomorrow.

We remain disciplined in our strategy of pre-funding investments through promotional efficiency and operational improvement. This methodical process matches investments with funding, resulting in an improvement to prices, which is increasingly noticeable to our customers and sustainable for our business. In fact, our internal price surveys, as well as those conducted by many of the analysts that follow us, confirm we are making progress. These efforts continue to bring better value to all our customers with improved pricing, enhanced private brand offerings and more targeted weekly promotions. I'll provide more detail on the progress we're making on our 8 Plays to Win, but first, let me turn the call over to Sherry for some color on our third quarter financial performance and our financial position.

Sherry M. Smith

Thank you, Craig, and good morning. Before I discuss our operating results for the quarter, I want to provide some background on the goodwill and impairment charge we recorded. This non-cash charge was related to our market capitalization, which has remained low with the sustained weakness in our share price. Accounting rules require that we reconcile our book value to our market capitalization in assessing recoverable value of goodwill and other intangible assets.

As a result of our analysis, we recorded a third quarter after-tax charge of $800 million. Let me assure you that this non-cash impairment charge does not impact any of our financial covenants, our ability to access our credit facility or any of our business strategies.

This quarter, SUPERVALU continued to make good progress on its business transformation. We rolled out new tools and executed on our funding initiatives, which allowed us to invest in price. We also realized additional cost savings and stayed focused on hyperlocal retailing.

Sales during the third quarter were $8.3 billion, and adjusted earnings per share were $0.24. Earnings this quarter were consistent with our plan and keep us on track to deliver our full year EPS guidance. Our identical store sales were negative 2.9%, with customer counts of negative 4.6%, partially offset by a 1.7% increase in average transaction size.

This quarter, we cycled some ineffective promotions from last year, which have been addressed through the rollout of our promotional planning tools that evaluate the trade-off between pricing, margin and volume. These tools allow us to more accurately forecast expected outcomes for promotions and better manage our margins.

Price investments also served as a near-term headwind to IDs. Over time, however, these efforts will help to improve customer perceptions of the relative value offered by our traditional stores.

We continued to see a better mix of items sold at regular price as a result of more discipline around our promotional spending through the use of these new tools and sales data. This helped to better mix out our ads and gross margin. We remain committed to price investments and want to ensure that shoppers see these investments as deliberate and sustainable. This steady progress will ultimately shape consumer perceptions, build confidence in our value position and win back shopper loyalty.

I am pleased to say that we continue to manage cost inflation well. Product cost inflation came in at 4.5%, flat to last quarter. We are taking a deliberate approach to passing on price increases as soon as practical, along with careful consideration for competitive market-by-market situations. Exceptions have generally been confined through a limited number of sensitive items, primarily in fresh or retailed within categories where we are purposely repositioning our price offering. For the full year, we continue to expect inflation to be about 4%.

Gross profit rate in the third quarter was 21.7% of sales compared to 21.5% last year. Retail gross margin was 27% compared to 26.8% last year. The improvement to gross margin was largely driven by the benefits from promotional effectiveness, which allowed us to fully fund our price investments, consistent with our strategy. We also had a higher LIFO charge this quarter.

Selling and administrative expenses were 19.3% compared to 19.2% last year prior to store exit, severance and labor buyout costs. We continue to look for more cost-efficient ways to run our business, and ongoing expense initiatives are providing meaningful improvement to our bottom line.

In the third quarter, we removed an additional $40 million of permanent costs, bringing our year-to-date total to $130 million. COGS reductions this quarter came from many of the same areas I've talked about before, namely administrative savings, lower benefit costs, store closures and steps we have taken to simplify our business. As we progress on our business transformation, we expect to continue to achieve meaningful savings from additional cost reduction initiatives.

Interest expense was $119 million this quarter, down $5 million from last year, reflecting lower debt levels. Lastly, our tax rate, excluding impairment charges, came in at 37.4%, consistent with our guidance.

Moving to the balance sheet. We have reduced total outstanding debt by approximately $350 million year-to-date through last week and expect to meet our debt reduction target of $525 million to $550 million for fiscal '12. We continue to apply the excess cash flow from the holiday selling season to retire the term B-1 loan which matures in June 2012. To date, we have already prepaid over half of this nearly $250 million loan, and remaining F ’13 maturities now total roughly $480 million.

Over the next 2 fiscal years, we have approximately $750 million in maturities and plan to retire this debt with internally generated cash flow. We remain in compliance with both credit facility covenants, with trailing 12 months EBIT of $1 billion, excluding impairment and other one-time items. Depreciation and amortization were $0.9 billion, and rent expense was $0.3 billion over this period.

Looking forward to the end of F ’12, we would expect the leverage covenant as defined in our credit facility to be 3.4x, with a covenant maximum of 4.0x and the fixed charge coverage covenant to be approximately 2.6x, with a covenant minimum of 2.25x. The credit facility covenants I just spoke to reflect the tightened levels that were effective at the end of the calendar year.

As I have said before, SUPERVALU's free cash flow continues to be solid. We allocate cash flow among investments in our businesses, reducing leverage, and to our shareholders through quarterly dividends. We will generate more than $1 billion in operating cash flow this year, which provides us ample flexibility to meet our obligations, reduce our leverage and lower interest costs. We have managed our capital resources well, and I feel good with our liquidity and the pace of our debt payment.

In the third quarter, we also extended our securitized AR facility by 3 years to November of 2014 at reduced rates. During the third quarter, we closed on the sale of 56 of the fuel centers we previously announced would be sold. Our sales agreements provide for the continuation of SUPERVALU's Fuel Rewards program and actually expands the number of stations at which customers can redeem their reward certificates. We expect to close on the sale of the remainder of these fuel centers this fiscal year.

Capital spending for fiscal 2012 is still planned for $700 million to $725 million, with about 3/4 of it being invested in the traditional retail business or slightly over 2% of traditional retail sales for the full year.

Let me next update you with the quarterly scorecard on our business transformation and cost savings initiatives. We have removed approximately $130 million in permanent costs from our business on a year-to-date basis and now expect to realize approximately $160 million in savings for the fiscal year. Our in-stock tools continued to roll out across our traditional store network, with perishable and nonperishable tools in essentially all stores at quarter end. As we use and learn from these tools, we expect to have improved utilization and will make future enhancements to add to their effectiveness.

Year-to-date through the third quarter, retail shrink has improved approximately 15 basis points. Private brands' dollar penetration increased by about 15 basis points year-over-year to 19%. Our store directors are continuing to embrace hyperlocal to address unique needs of their communities.

Lastly, our total market share in our top 20 DMAs, accounting for about 2/3 of our sales volume, fell 40 basis points compared to a year ago, the same year-over-year share change as in Q1 and Q2. Remember that these figures include market exits, strategic store closures and normal attrition within our Independent Business, which we have cited previously.

Finally, let me update you on our guidance expectations for the full year. We are now forecasting total sales to be approximately $36.1 billion and ID sales in a range of approximately negative 2.5% to negative 3% to reflect Q3 and our current outlook for Q4. Sales in our Independent Business are expected to decline about 4.5%. Our earnings per share guidance, adjusted for goodwill and impairment charges, remains intact at $1.20 to $1.30, and operating cash flows are anticipated to fund our capital spending of $700 million to $725 million, in addition to the debt paydown of $525 million to $550 million that I discussed earlier.

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

Craig R. Herkert

Thank you, Sherry. Our price investments have accelerated throughout the fiscal year, with more invested into retail price each subsequent quarter. We've invested in categories across all stores, maintained competitive pricing on key sensitive items during this inflationary time and have put meaningful investment in certain large markets. This is the result of funding that we've generated by effectively managing our promotions, reducing our shrink, improving our in-store availability and most recently, improving our cost of goods through structural changes to existing vendor contracts and business plans. We're making steady progress and continue to execute on all aspects of the plan.

Another great example of our work is in our produce department. As I mentioned earlier, we are broadly promoting everyday fair pricing and great quality after having lowered prices on around 200 key items. This investment touches a large department, which is visible to customers when they enter our stores. We believe our strategy of moving to fair price plus promotion will result in more units and ultimately increased share of wallet from our customers over time.

We're supporting our produce initiative through high-profile marketing and advertising efforts. Within our stores, we've installed new signage with language that directly communicates improved pricing across the produce department. In addition to new signage, a number of our traditional retail banners are running an advertising campaign called TALK ABOUT FRESH. The ads are high energy, fun and quite distinctive. With the tagline Fresh Produce, Fresh Prices, we're aggressively promoting everyday fair pricing and great quality.

We're also leveraging high engagement, traffic-driving consumer promotions, like our most recent Collect & Win game, Wish Big Win Big, which brings shoppers into our stores and exposes them to the price investments we've been making. While these programs are more impactful on center store merchandise, we do believe that they're also effective in exposing shoppers to the changes we're making in our fresh departments. Sales activity confirms that shoppers respond to this type of program, and our research in customer comments indicate that shoppers enjoyed the added thrill of the hunt while doing their everyday shopping.

Another way in which we're delivering value to our customers is through our private brand program. Across our entire portfolio, sales are up from last year, led by demand for our entry level Shopper's Value label, which was up over 5%, and Shopper's Value will have more than 300 SKUs by end of fiscal year. We continue to add items to the Essential Everyday label, which is replacing our banner brands in areas such as frozen food, condiments and canned vegetables. Consumer acceptance of this brand has been in line with our expectations as it becomes the mainstay of our private brand portfolio.

We're also responding to customer's value orientation by expanding our premium offering with private brand products under our Wild Harvest and Culinary Circle labels.

Moving to our hard discount format, Save-A-Lot, we continue to focus on connecting with our core customer. ID sales were up nearly 4%, benefiting from inflation and the innovative merchandising and marketing programs we've implemented. The Save-A-Lot Today brand continues to add new opening price points and our customers have reacted favorably to the continuation of our Mix & Match and 10-for-$10 promotions, along with our midmonth mailers. While Save-A-Lot is a market leader in hard discount retailing, hurdles for small business financing and general uncertainty about the economic climate have factored into new store growth in the near term, and we now expect to open approximately 50 to 60 locations this fiscal year.

Save-A-Lot remains an ideal format for addressing the problem of food deserts across the country, and we expect about half of fiscal '12's openings to be located in these areas. As part of our partnership for a healthier America, we're proud of our pledge to open stores in both rural and urban food deserts, an undertaking that can revitalize communities by giving neighborhoods access to healthy, inexpensive food while also providing new job opportunities. It's a meaningful social benefit in addition to creating value for SUPERVALU shareholders.

In our Independent Business, we continue to pursue affiliations with a broad number of retail partners. In December, we finalized negotiations with Western Bee and will expand our supply relationships with the New York-based retailer to include an additional 21 conventional stores and 5 limited-assortment stores, which will be served from our Lancaster facility. Our independent retailers are agile and innovative with their fingers on the pulse of their communities. In the third quarter, our like store shipments to these retailers increased by 2.2%.

One other area I'd like to speak to is our commitment to environmental sustainability. In December, SUPERVALU joined the U.S. Department of Energy's Better Buildings challenge, a program whose objective is to challenge building operators to improve energy efficiency nationwide by 20% between now and 2020. This program is a natural addition to our environmental efforts, of which energy reduction is a key component.

It also complements our goal of producing 40 zero-waste stores by the end of this fiscal year and underscores our commitment to reducing our impact on the environment. Last month, our Santa Barbara ALBERTSONS stores were recognized by the governor of California as the first supermarkets in the U.S. to have achieved a zero-waste classification. These efforts are not only good for the environment but are also driving cost reductions throughout our enterprise. I'm both proud and excited about the work our team is doing and look forward to keeping you updated on our efforts.

By and large, the fiscal year has tracked to our plan, even with the many uncertainties around inflation, the economy and consumer behavior. I remain confident in our people and our transformation plan and believe we have provided a realistic time line, a clear roadmap and are executing in a deliberate way to make lasting price investments across our retail network. My goal is to create a sustainable platform that is streamlined, efficient and responsive to customers in every neighborhood where we operate.

I will now open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Charles Grom with Deutsche Bank.

Shane Higgins - Deutsche Bank AG, Research Division

This is Shane for Chuck, actually. Hey Craig, how has your shift towards everyday fair pricing plus promotions positioned you guys versus competitors? And how close do you think you are to pricing parity today?

Craig R. Herkert

It's a great question, Shane. Well, as I've mentioned in the call, we've begun to do it most importantly in the produce area where we've been fairly vocal about it and really like what we've done there. What we see is that we’ve brought us much closer. We track it weekly. We are now, on a base price level, we are very, very competitive and we still promote. What we see is, and this is the really good news, is we see a continued change in the mix from what we sell on promotion and what we sell every day. Recall that our goal here is to improve the everyday mix that our customers feel comfortable about shopping at our stores for products when they're not on sale, as well as when they are on sale. So we do track it. We're very, very happy with the movements that we've made, and we have a ways to go.

Shane Higgins - Deutsche Bank AG, Research Division

Great. And just one last question. Can you provide any color around sales trends at the stores that have had the in-stock tools now for a few months versus the stores that just recently got them?

Craig R. Herkert

No. It's really -- sort of recent. It is within the quarter that we got this fully rolled out. We track it store by store, it's a key initiative for us but we're not reporting on that.

Operator

Our next question comes from the line of Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital, Research Division

I guess I have 2 questions, the first just related to sales. I'm still struggling a little bit. You clearly have a lot of initiatives, I think they're good initiatives but the sales trend weakened again. Inflation was very high. Do you think that's a function of how the customer is behaving or is there something that tells you you're not doing enough to win customers back?

Craig R. Herkert

Boy, it's -- it continues to be a challenging environment for the consumer out there, that's not new news for any of us. We are cycling though, Meredith, some pretty irrational behavior on our side a year ago. And so as we get more areas, more departments, particularly produce, into this fair pricing and we believe much more rational behavior on our part, there is a near-term impact on some of that traffic driving, but we feel very good about what the long-term plan is for that. So I'd say it's a combination of the external environment and what we're cycling. But I will tell you that I feel good about what this team has done and the direction we're going and the pace with which we're moving it.

Meredith Adler - Barclays Capital, Research Division

And so would that imply that once you cycle this profitable promotion, that you would start to get back to some of the trends we were seeing, and I'm assuming that's in the fourth quarter?

Craig R. Herkert

Yes, that would imply that.

Meredith Adler - Barclays Capital, Research Division

Okay. And then I'm sorry, my second question was about forward buy, and you did a lot of forward buy it looks like in the quarter, which just seems like a smart thing to do in this inflationary environment. And I'm just wondering whether there's any concern you have because -- whether sales were actually on track with what you were expecting, and so do you have any concerns about the inventory you've bought? Obviously, it doesn't need to be marked down, but do you feel your inventories are heavy at this point?

Craig R. Herkert

No, we're actually very comfortable. We've got a great team of people who look at the forward buy opportunities. And as you said, we did take advantage of it. We monitor it and we feel very good. In fact, we feel really good about how our stores handled sell-through for both of the holiday periods. So no, we're generally comfortable with where our inventory levels are at.

Sherry M. Smith

And Meredith, as I updated as well, certainly, we've been seeing the cash come in as we’ve cycled out of the holiday levels there and have paid down over $350 million as of last Friday on debt.

Meredith Adler - Barclays Capital, Research Division

Okay. I'm rarely worried about liquidity, just wondering about inventory.

Operator

Our next question comes from the line of Ajay Jain with Cantor Fitzgerald.

Ajay Jain - Cantor Fitzgerald & Co., Research Division

I wanted to ask about your outlook for inflation in the current quarter and any implications for LIFO. So either in terms of the actual dollar impact or even just directionally, can you give any specifics on what you expect for the LIFO charge in the fourth quarter? And as a related question, I think your full year EPS guidance, it still implies a pretty wide range for Q4, like $0.33 to $0.43, so can you give any better frame of reference on the earnings outlook in Q4?

Sherry M. Smith

Ajay, in regards to the LIFO, we see that trending similar to what you've seen the first part to this year continuing there as inflation has been slightly higher in that calculation. And in regards to the guidance, we have remained unchanged with the EPS guidance and believe that we are on track to deliver our overall plan there.

Ajay Jain - Cantor Fitzgerald & Co., Research Division

Okay. And as a follow-up question, I seem to recall last year around the holiday period, you hired some consultants to help you introduce some of those inventory management and customer analytic tools. And I think that there were obviously some costs associated with that in the fourth quarter of last year, so there's clearly some awareness now that gross margin comparisons are getting better with the improvement in promotional effectiveness. But in terms of the SG&A comparisons, do you see any opportunity in that area as you cycle some of that spending from the fourth quarter of last year?

Craig R. Herkert

Well, I don't know that I would say we see opportunities as we cycle that. I would say, as both Sherry and I said in our call, we see opportunities on SG&A broadly across this enterprise. This is in line with what we articulated 3 quarters ago. As we introduce new processes, new disciplines, we clearly believe there's opportunities on SG&A across the enterprise moving forward. I'm pleased with the cost takeout that we've been able to achieve this quarter, and again, these are permanent cost takeouts, and clearly believe that we have more opportunities as we go forward.

Ajay Jain - Cantor Fitzgerald & Co., Research Division

So with $130 million in cost savings year-to-date, clearly, I think your previous target level was something like $115 million. So is there any incremental cost savings that you're expecting in Q4?

Sherry M. Smith

So what I had commented is that we would see the full year being at $160 million.

Ajay Jain - Cantor Fitzgerald & Co., Research Division

Okay. And one final question, Sherry. I wanted to just confirm your prepared comment on average transaction size. Did you say that average transaction size was up sequentially 1.7%? Is that correct?

Sherry M. Smith

That's year-over-year.

Ajay Jain - Cantor Fitzgerald & Co., Research Division

That's year-over-year? And what about customer count?

Sherry M. Smith

So customer count is at negative 4.6% this quarter compared to a year ago.

Operator

And our next question comes from the line of Scott Mushkin with Jefferies & Company.

Mike Otway - Jefferies & Company, Inc., Research Division

This is actually Mike Otway in for Scott. Sherry, I guess the first one for you. Could you give us an update on how IDs and maybe volumes have progressed 4Q to date?

Sherry M. Smith

Well, I think we've embedded that in our guidance update so you can look at that. For IDs for the full year we would expect to be at the negative 2.5% to negative 3%.

Mike Otway - Jefferies & Company, Inc., Research Division

Okay, great. And then I guess as a follow-up, Craig, it's clear that you and the team are making a lot of progress with the hyperlocal efforts and your work under the 8 Plays to Win strategy. At the same time, there are still parts of the business that are seeing some more pressure. Any updated thoughts surrounding on the current asset platform and which assets you believe will be most integral as you move through the business transformation?

Craig R. Herkert

Yes. We feel very good about the platform that we have today. As we articulated last quarter, we divested of our fuel centers because we felt that we had a better plan to do something with local partners, and I like what we're doing now with some of our local partners who have already begun in a couple of markets to initiate our fuel rewards program more broadly. I think that was the right move. And other than that, I feel comfortable with the platform that we have today.

Operator

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

Mark Wiltamuth - Morgan Stanley, Research Division

Wanted to get a little more breakout on the ticket that's up 1.7%. Can you tell us what the items per basket change was?

Sherry M. Smith

I think what we said is certainly you can see that customer count was at negative 4.6%, and some of that is timing of cycling from last year where we had driven a lot of traffic into our stores, and then the sales per customer was positive 1.7%. So that's the 2 pieces for the negative 2.9%.

Mark Wiltamuth - Morgan Stanley, Research Division

Right, but there's got to be some inflation in the 1.7%, so what do you think the items per basket number is?

Sherry M. Smith

Yes, so the inflation is running about the same as Q2 at 4.5%.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. And that's price per item or that's a cost inflation number?

Sherry M. Smith

That's the cost inflation number.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. And just to dig in a little more on the fair price issue, Craig, in the areas where you have put it in, have you seen any change in volume trends from the customer? And maybe you could just give a little color on that? And if you have any numbers you can share with us on the changing mix of promo purchases versus everyday purchases, that would be great.

Craig R. Herkert

Well, let me take the first part and I'll have Sherry take the second part on the promo mix which we do see differences. Yes. We have to, as I've said at every call, as we move to fair pricing plus promotion, we've got to go through it for a period of time, and as in those areas where we've done it for a period of time, we have seen very positive consumer behavior change on both volume and profitability mix. Remember, our goal here is to move that mix so that consumers feel comfortable spending their hard-earned grocery dollars on products on the shelf that are not on sale in addition to those that are on sale. So to answer your question, yes, we measure it. We see very good results everywhere we've done it, so I feel encouraged with the plan that we articulated 3 quarters ago. And we are moving aggressively down that path, and we believe it's the right journey for this company. And Sherry, I think you want to talk about the change in promo mix, which again, I think, confirms relatively that we're headed in the right direction.

Sherry M. Smith

Right. So certainly, as we implemented the tools that we talked about in the fourth quarter of last year has given us better visibility and mixing out our ads and what's that right amount on promotions. So from Q3 of last year to this quarter, we see a significant shift in the mix-out of what's promoted and non-promoted items, and it's moving towards the direction of what we see as the right balance for both margin and as well as the mix-out of the overall as a whole across the categories.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. And I guess, Sherry, at one point you said there that the change here leads to some pressure on volumes because you're not promoting as much, is that right? So there's a near-term negative volume story until the customer gets used to the new pricing?

Sherry M. Smith

Part of it, remember, is this quarter specifically, we are cycling a fair amount of ineffective promotions from a year ago so it's more pronounced. But our overall plan, as we're shifting, as Craig talked about a little earlier, to the fair price plus promotion, we would expect to see some of that as we go through that process.

Mark Wiltamuth - Morgan Stanley, Research Division

And just lastly, in total, was volume better or worse than the second quarter?

Sherry M. Smith

So slightly worse but again, somewhat anticipated given that last year, we were driving a lot of ineffective unit movement almost and some things selling at no profit.

Operator

Our next question comes from the line of Deborah Weinswig with Citigroup.

Deborah L. Weinswig - Citigroup Inc, Research Division

Craig, in terms of Save-A-Lot...

[Technical Difficulty]

Craig R. Herkert

We lost Deborah.

Operator

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

Karen F. Short - BMO Capital Markets U.S.

Looking at your traffic trends, well I guess taking a step back, we've done some store tours back in the fourth quarter, and it definitely seemed like some of the tools that you're rolling out are helping your store directors and helping to improve EBITDA at the store level. But looking at your traffic trends, especially on a 2-year basis, there was pretty meaningful deterioration. So I guess I'm wondering, first question is do you have any comments or color on what really is going on with the traffic? And then the second question is are these tools that you're rolling out, are they really just kind of leveling the playing field or do you think they're giving your store directors an advantage?

Craig R. Herkert

So I'll take both these. The first one, I think, is really what we talked about. It is part of what we're cycling and part of a purposeful self-imposed change to eliminate ineffective traffic-driving programs. This is part of our strategy, Karen, is to get to a fair pricing plus promotions and get away from this idea that we would have deep, deep, deep discount promotions where we made no money and drove a lot of traffic only to have consumers buy those products that were deep, deep discounts but then went elsewhere to continue their shopping because our regular base prices were out of line with consumer expectations. So it is our long-term plan to change the mix and change the behavior. On the tools front, I was in stores yesterday, and I will tell you I think these are competitive advantages, many of them. Some of them clearly would be level setting with some of the better retailers in the country. Many of these tools, I believe, along with the processes and the governance rules we've put in place actually give our stores a competitive advantage, and I continue to hear that from our better store directors.

Karen F. Short - BMO Capital Markets U.S.

That's helpful. But then I guess just back to the traffic, I understand the year-over-year comparison, but the sequential is what seems strange given that you had kind of been making progress on the traffic, gradual progress, and then this quarter took a fairly big stepdown. And I guess into the next quarter, if you're at the low end of your guidance on your comp, it would indicate another stepdown so...

Craig R. Herkert

Moving to fair pricing plus promotion across almost all the enterprise in the third quarter in produce is a big deal. Produce is a significant department for us. It is a major emotional department for our customers. So this is not a minor move for us. And I just want to highlight, as we said, it's broadly across produce and it was significant price declines. This was not a marginal around-the-edges price reduction on these 200 or so items. This was significant, so it has an impact.

Karen F. Short - BMO Capital Markets U.S.

Okay. And then just on your range of earnings guidance as it relates to the obviously the $0.10 range in the fourth quarter, is that basically sales? That high or low end of sales gets you the high or low end of earnings or is there anything else in there?

Craig R. Herkert

I think that's a fair challenge or a fair statement.

Operator

And our next question comes from the line of Kelly Bania with Bank of America.

Kelly A. Bania - BofA Merrill Lynch, Research Division

I was wondering if we could dig in on gross margin a little bit. There's been a lot of discussion on cycling ineffective promotions from last year. But I'm wondering how you're thinking about gross margin as we start to cycle some of those tools that were implemented to support an improved promotional effectiveness?

Sherry M. Smith

Yes. So as we've talked about, a lot of these funding initiatives that are margin-related such as promotional effectiveness, such as shrink, they do benefit margin, and then we're funding in advance of price investment. So our guidance for the full year has been that our gross margin rate would essentially be about flat, and so that's the components that go into it, albeit that we are experiencing a slightly higher LIFO rate this year, that also does put some pressure on the overall margin.

Kelly A. Bania - BofA Merrill Lynch, Research Division

Got it, that's helpful. And then another follow-up on just the hyperlocal efforts. I'm curious if there's any qualitative data points that you can share with us on how this program is being embraced by your customers and your store directors, and how are you measuring your progress there with respect to hyperlocal merchandising and sales response?

Craig R. Herkert

Yes, we do measure it. Let me think about how we can address that with you in future calls. We do measure it. I am really, really encouraged, and I mean really encouraged with how our customers are embracing this and how our store directors are embracing this. So I don't know that I have a specific measure that I can give to you that is quantifiable, qualified. We like what we see, we're encouraged by it and we think it's a strong play for us.

Operator

Our next question comes from the line of Jonathan Feeney with Janney Capital Markets.

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

I wanted to follow up on the comments about promotional performance. I think it's interesting because you see across the whole value chain a pretty wide variance in promotional effectiveness, it seems, by categories where some categories seem real elastic and you see a lot of pantry drawdown when you try to raise prices, even though everybody is doing it at the same time, and then some categories prices just pass right through. I think confectionery has been like one of the very limited examples of that. So I guess, when you look at your categories, are you seeing that kind of experience where some of your categories are vastly outperforming others as far as promotional effectiveness?

Craig R. Herkert

Well, I think you have 2 things there. I think you're asking 2 things on inflation and cost pass-through versus promotional effectiveness. And yes, clearly we see different behaviors across different categories. The good news is we have people today, particularly in our merchandising areas, who have both the processes and the capabilities to manage their way through that so that we can be very thoughtful about where we choose to invest and where we choose to pass through. The other thing that I think is important as, I believe, Sherry highlighted is we see our teams reacting to where customers need value, and a lot of that is through our private label program. We're very happy with the growth we see in private brands, particularly Shopper's Value and Essential Everyday, the rollout of that is going according to plan, and I'm thrilled that we'll have several hundred more new Essential Everyday items coming out this quarter. So I think broadly speaking, we're trying to look at where customers are and react accordingly. In some areas, Jonathan, like in bakery department, we've seen a growth of consumers looking for smaller indulgences, so our teams have made it easier for customers to buy smaller packages of cake or maybe cupcakes and cookies. So smaller indulgences even in this economic time, and those efforts have been very successful.

Jonathan P. Feeney - Janney Montgomery Scott LLC, Research Division

But it's the -- so you would say it's been -- sorry to conflate 2 concepts, Craig, but I'm thinking that promotional effectiveness, to me, in an environment where we know the consumer wants value and we know upstream costs are affecting you guys, is largely about deciding which items to charge full price for and therefore raising prices, and which items actually drive volume when you discount. That's why I sort of conflated those 2 things, just assume. I know that's not always the case, but it does seem to be the case in this economy. So you would say generally across-the-board, it's about the same? There's not been any really huge outside surprises as far as your promotional performance by category?

Craig R. Herkert

No, I agree with what you just said. Absolutely.

Operator

Our next question comes from the line of Deborah Weinswig with Citigroup.

Deborah L. Weinswig - Citigroup Inc, Research Division

All right, so I just wanted to focus on Save-A-Lot, which does seem to be sort of the bright news in our report today. So with the sequential improvement in IDs, can you maybe provide a bit more color in terms of the trends there?

Craig R. Herkert

The trends are in line with where we've been going. We love the business. Our consumers are responding well to it. Santiago Roces and the team have, I think, a fantastic business plan to, in fact, continue to improve the value proposition of Save-A-Lot. And as I said in the call, I like the fact that we've been able to open new stores and new stores in food deserts. I think this is more on track with our plan. So I'd say broadly speaking, I'm happy with the performance of the business and continue to be optimistic about it.

Deborah L. Weinswig - Citigroup Inc, Research Division

And should we expect, going forward, to see more new stores in the food deserts?

Craig R. Herkert

Yes, we've been very public with our commitment with the partnership for a Healthier America to open a number of stores in food deserts over the coming 5 years and it will continue to be a focus of ours. It won't be the only focus, but it will continue to be a focus of ours.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And as we think about IDs going forward, would you expect transaction size to come back first with the initiatives that you have in place?

Craig R. Herkert

Yes. I think broadly speaking, that's exactly what we're looking for. Although I want to be clear, I don't know that our experience would tell us that it is an immediate return. That is when we get to fair pricing, there is a lag between fixing something that's been sort of aggressively high priced for a number of years that the consumer responds immediately. The consumer responds differently to fair pricing plus promotions than they do when you just put in a hot ad. A hot ad, call it a BOGO or some significant hot promotion, can drive instant consumer behavior. It may not drive long-term behavior that is beneficial to us. So as we get to fair pricing, Deborah, it's really about the long-term change we're looking for here. But yes, what we're looking for is increased basket as we move to this.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And then lastly talking about long-term change, can you just talk about the opportunities to do more with your loyalty card?

Craig R. Herkert

Yes. I think we'll talk more about that in the future. We've had a couple of interesting tests going on, but let me defer that conversation for a future call.

Operator

Our final question comes from the line of John Heinbockel with Guggenheim.

John Heinbockel - Guggenheim Securities, LLC, Research Division

A couple of things. The produce program is impacting both traffic and ticket, is that fair?

Craig R. Herkert

Yes.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Okay. The impact is, I guess, you think it's material, correct? It's a noticeable impact on the...

Craig R. Herkert

It's noticeable. The produce department in our store generates a significant amount of volume. It's a large department in our store so it's a noticeable impact in how we manage and run our promotional program and run our business.

John Heinbockel - Guggenheim Securities, LLC, Research Division

So when you think about, and I know you're planning your budgeting process for next year, do you think -- is this inflation a top line headwind for next year or do you think that gets made up for in unit demand? If we see 2% inflation next year instead of 4% or 4-plus, we'll see a better unit demand number?

Craig R. Herkert

I guess kind of like I said in the previous calls, John, I cannot predict where inflation will be next year. I don't know that I would look at it as a headwind if it goes to 2%. I think, in fact, anything that helps consumers in America be able to afford more food easier is probably good. So I think broadly speaking, we can manage through whatever inflation throws at us today for the country. I think leveling off of inflation is a good thing. And if it's a good thing for the country, it's good for SUPERVALU.

John Heinbockel - Guggenheim Securities, LLC, Research Division

And just related to that, as you've looked at it, how much correlation has there been with your comps --and I'm thinking more a local basis as opposed to the reported number -- that your comps and the level of gas prices? Because we're at the highest level we've seen in January in a while. I'm just curious if we end up $3.50, $3.70 for the year, is that a big headwind or is food inflation a bigger driver of consumer behavior?

Craig R. Herkert

I would say it's probably more about food inflation, John. We don't see a wildly fast correlate with gas pricing and consumer behavior. Now over time, huge swings in gas pricing obviously has an impact, but not in the localized level with a $0.20 to $0.50 move. Broadly speaking, if it gets crazy, it certainly has an impact on consumers. But our business is more affected by inflationary pressures.

John Heinbockel - Guggenheim Securities, LLC, Research Division

All right. Then one final thing. When you think about taking more cost out of the business, I assume most of that is going to be along the lines of 20 or 30 individual items that add up to maybe a couple of million each. I assume it's more that. Is there any thought of what you may want to do with organizational structure? And is that an opportunity, particularly as you've continued to upgrade the quality of your store managers, is there an opportunity to do something with the organizational structure generally?

Craig R. Herkert

Yes, I don't want to forecast where we'll go on future costs. I would just say we continue to have opportunities as we simplify our business. It is one of our 8 Plays is to simplify our business. And as we have capabilities, we will continue to take cost out.

Kenneth B. Levy

Great. Well, thank you for your time today. And with that, we will be available after the call for any follow-up questions.

Operator

Thanks, ladies and gentlemen, and this does conclude today's conference call. You may now disconnect.

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