Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Safeway (NYSE:SWY)

Q4 2011 Earnings Call

February 23, 2012 11:00 am ET

Executives

Melissa C. Plaisance - Senior Vice President of Finance & Investor Relations

Steven Burd -

Robert L. Edwards - Chief Financial Officer and Executive Vice President

Analysts

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

John Heinbockel - Guggenheim Securities, LLC, Research Division

Michael Palahicky

Meredith Adler - Barclays Capital, Research Division

Kelly A. Bania - BofA Merrill Lynch, Research Division

Edward J. Kelly - Crédit Suisse AG, Research Division

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

Charles X. Grom - Deutsche Bank AG, Research Division

Charles Edward Cerankosky - Northcoast Research

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Mark Wiltamuth - Morgan Stanley, Research Division

Andrew P. Wolf - BB&T Capital Markets, Research Division

Operator

Welcome to the Safeway Fourth 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 C. Plaisance

Good morning, everyone, and thank you for joining us for our fourth quarter and full year 2011 earnings conference call. With me today this morning is Steve Burd, our Chairman, President and CEO; and Robert Edwards, Executive Vice President and Chief Financial Officer.

I'd like to remind you that management will be making 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, future events or otherwise. For a list and description of these risks and uncertainties, please see our filings with the SEC.

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

Steven Burd

Thank you, Melissa. So let me start with net income. Net income for the quarter was just under $216 million. This compares with a number from last year of just under $230 million. Expressed in earnings per share, we made $0.67 per share in the quarter contrasted with $0.62 from one year ago.

Let's start with a couple of highlights for the quarter. I'll start with the fact that we exceeded the consensus estimates, as estimated by First Call, by at least $0.02. ID sales matched the performance that we had in the third quarter. Our gross margin rate was lower than last year but almost entirely the result of the LIFO charge, which I'll talk more about later. Our O&A expenses, as usual, were very well controlled. And then lastly, we took advantage of a low share price and purchased 43.3 million shares in the quarter.

So let me start with sales. Total sales increased 6.2% versus last year. This strong increase in reported sales is largely the result of 3 factors:

The first is high fuel sales. We had a 19% increase in price per gallon. That wouldn't be unique to us. It was basically unique to the marketplace. Or not unique, but it was a common marketplace price increase. And we, perhaps unique to the marketplace, had a 10% increase in gallons. Overall, in the U.S., gallons are down about 3% or 4%.

Secondly, we had a change in the reporting for gift cards. Again, we started mentioning this a couple of quarters ago, so we haven't quite cycled that.

And then the third explanation is that ID sales increased. Now ID sales, excluding fuel, increased 1.5% on the quarter.

Inflation, as we measure it, and everybody measures it just a little bit differently, was higher than the third quarter. You may recall in the third quarter we said that our inflation was about 4%. Here in the fourth quarter, it was 4.7%.

Volume did decline in the quarter. That's going to be common, I think, to the vast majority of retailers. I know it's common to the CPG world. But the good news is our market share, as we measure it -- again, we do a sector market share measurement because we can get more precise on that. Our market share was exactly flat with last year.

We believe the volume declines are the direct result of both rising fuel prices and rising food inflation. We've talked about this before. I'm sure in the Q&A we'll talk about it again.

Turning to gross margin. Our gross margin rate, adjusting for both fuel sales and the Blackhawk accounting change, was down 41 basis points. Were it not for a $42 million year-over-year change in the LIFO charge, our gross margin decline would have been only 6 basis points. This large swing in our LIFO charge is the direct result of transitioning from a year of unprecedented deflation to a year of above-normal inflation. A change of this magnitude is not likely to be repeated anytime soon since it's kind of -- I might even -- it's the first time in 20 years. It could be the 100-year storm.

Turning to O&A expenses. O&A expenses, expressed as a percentage of sales, declined 98 basis points. Excluding fuel sales and the Blackhawk accounting changes, the O&A expense ratio declined or, if you will, actually improved 7 basis points. The largest positive changes occurred in property gains, the vast majority of which were planned, not only planned for the year but planned to be happening in large part in the fourth quarter; secondly, labor costs; and third, depreciation.

The negative impacts included an increase in Blackhawk's O&A expenses, which is basically about making an investment in building a future income stream. And what we call PL and PD expenses, that stands for property liability and property damage -- translation, slips and falls by customers in our stores -- would be the dominant piece of that. And then we had some additional IT costs to support the just for U rollout.

While the positive property charge was 45 basis points, this was more than offset by a couple of factors. One is the workers' comp expense, which was actually quite good in the quarter. We had a positive variance to last year. But when we calculate our workers' comp expense into present value calculation -- and we key off of the 5-year Treasury bill, which a couple of years ago was about 4.5%. Last year it was 2%. In this last calculation it was 0.75%.

So our experience in terms of reducing accidents and the severity of accidents is phenomenal. But that actually hurt us about 19 basis points in the quarter had that interest rate not declined like that. So a decline in interest rates is not always good.

And the other factor I mentioned earlier was the LIFO charge, which went the other way on us, but that affected gross margin. But together, they affect operating margin.

Turning to interest expense. Interest expense declined $5.9 million in the quarter. This decline reflects both a lower interest rate -- a lower interest rate of about 90, 91 basis points, and, frankly, higher debt outstanding. Our average debt outstanding was $494 million for the quarter. This increase in debt level was used to finance some of the share repurchases in the quarter. Early in the quarter, those share repurchases were financed with commercial paper. Late in the quarter, we elected to refinance $800 million of debt that matures in August of this year. We will retire that debt when it matures and replace it with this new borrowing. It gave us the opportunity to borrow early and then also make share repurchase in the first quarter, which, as you'll recall, is typically a negative cash flow quarter for us. We also raised another $700 million in term debt in the quarter but did not draw it down at all in the fourth quarter.

We continue to access -- we continue to have access to commercial paper and have recently borrowed with maturities ranging from overnight, which is really common, to as much as 180 days out, which is less common. And our rates for those different maturities have run the range from 65 basis points to 100 basis points. At year end, no surprise, we had no commercial paper outstanding due to the new public debt and the seasonal cash flow that comes from our gift card business.

Turning briefly to taxes. Our income tax rate was 30% in the fourth quarter of 2011 compared to 31.5% in the same quarter of 2010.

Lastly, on capital expenditures, we opened 11 new stores and completed 10 Lifestyle remodels in the quarter. For the year, we opened 25 new stores, which is the largest new store program we've had in several years, and completed 29 Lifestyle remodels. We now have 1,459 stores, or 87% of our store fleet, in the Lifestyle format. Capital expenditures for the quarter came in at $412 million and for the year came in at $1.95 billion.

In terms of full year results, our net income was $516.7 million or $1.49 a share. Excluding the $0.29-per-share tax impact of the Canadian dividend, diluted earnings per share were $1.78.

Total sales increased 6.3% over last year largely due to higher fuel sales. On the year, the price inflation per gallon was 24%. And on the year for us, ID gallons were up 15%. We also had the Blackhawk accounting change, and we had an ID sales increase.

Our gross margin rate, excluding fuel and the Blackhawk accounting change, on the year was down 13 basis points. All of this, in fact, more than 13 basis points, is explained by the LIFO charge. The LIFO charge alone on the year was 16 basis points. So were it not for that flip in the LIFO charge, gross margin would have actually been positive on the year.

Our O&A expense, excluding fuel and the Blackhawk accounting change, improved some 5 basis points.

Our cash flow was $751 million -- free cash flow, $751 million on the year. This is at the low end of our projected range. We had projected a range of $750 million to $850 million, and the reason it's on the low end is we spent about $95 million more in capital than we had originally planned. The additional capital was spent on store remodels and additional projects with our shopping center entity, Property Development Centers.

In terms of stock repurchase, in the fourth quarter we purchased 43.3 million shares of stock at an average cost of $19.79 for a total of $859 million. For the year, we purchased 76.1 million shares at an average cost of $20.85 for a total of $1,588,000,000. During the fourth quarter, the board increased the authorization for stock repurchases by $1 billion. At year end, authorization remaining was $1.1 billion.

As you noted from our press release, we've continued to purchase shares in quarter 1. And through yesterday, we have purchased an additional 28.7 million shares at an average cost of $21.83 for a total cost, through yesterday, of $626.2 million.

While we temporarily stepped up our debt levels to acquire more stock, our year-end EBITDA and interest coverage ratio stood at 8.9x, which is the second highest coverage ratio we've had in 20 years. In 1998, we actually had a coverage ratio of 9.1. So dangerously close to the 20-year high.

Other notable events in the quarter. Blackhawk's growth continued to accelerate. You'll recall every quarter this year, it was stronger than the previous year, which is an impressive statement given the fact that the business gets larger and larger each year. The face value of cards sold increased 24% in Q4 compared with a 15% increase in Q4 the previous year. The face value of cards sold on the year increased 25% compared with an 18% increase from last year.

Just a little window into the first quarter. Blackhawk's face value of cards sold has stepped up. In other words, it's exceeding the 25% number that we achieved in the -- in calendar year 2011.

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

Melissa C. Plaisance

Shirley?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Scott Mushkin.

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

Jefferies. This is actually Mike Otway in for Scott. Steve, first on your U.S. business. Our research had indicated that the food business in the U.S. had improved during the fourth quarter from an x fuel sales perspective. Yet it didn't really show up in the comp. Is that -- first, is that a fair statement? And if so, what do you think was going on in the quarter that caused it to not show up?

Steven Burd

Yes, I don't know the source of your information, but -- and I can only speak to our markets. But the IDs, as I indicated, were 1.5% in the quarter. That 1.5% was helped out by the fact that the last day of the quarter was actually New Year's Eve, which is a very, very big day for us. And so while we were helped out in the fourth quarter, we will be hurt by the same amount in first quarter of this year, and that's worth mentioning. But when I look at -- and I said that our sector share was essentially flat. It was actually up just a nudge. And so we believe that when you hear other retailers report, you're going to see a similar story. So we think it's not just in our markets. We think it's across the country. And the explanation that we give you, which we've talked about in previous earnings calls, when you have a 25% increase in fuel and you have something close to a 5% increase in food, and others are experiencing even higher rates of inflation; and then you have nearly a 10% increase in apparel, which is another piece of the consumer's budget, so just take fuel and take food. Fuel is a touch more than 8% of a consumer's budget. Then you have food, which is a little over 13%. One going up 25%, one going up just under 5%, that creates -- that bucket of goods purchased goes up an average of 12.5%. Now it didn't all happen in food, but the effects of fuel affect food. I believe, based on the market share data that we have, that it's happening to virtually all food retailers. The other thing I would tell you is if we look at the first quarter, our market share has actually improved in the first quarter. So it's more than flat. Our market share is positive in the first quarter. And yet we're seeing the same kind of softness in sales. So again, I don't know the source of your numbers. And I can tell you that we've never been able to reconcile our inflation to the kind of food price index inflation that comes out of government statistics.

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

Okay, that's helpful. And I guess in terms of U.S. versus Canada, any thoughts on, did Canada do better or worse relative to the third quarter?

Steven Burd

I don't have that split. Robert?

Robert L. Edwards

It's about the same.

Steven Burd

About the same, about the same.

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

And then I just guess secondarily, in looking at the -- in the first quarter, have you seen any benefit in your pharmacy business or your pharmacy comp from the Walgreens Express situation? Any thoughts around that?

Steven Burd

The answer is yes. The -- what -- we didn't see it in the first couple of weeks because of -- what you might expect did in fact happen, which is people got their scripts. Some people went out as much as 90 days. And so we didn't see it in the first couple of weeks, but we've seen it ever since. And it's significant. And it's tough to generate positive IDs in the script business with all the generic and branded drugs going into generic, but we're able to do that. And part of that benefit is what we described. Part of that benefit is the strong vaccination business we have. Part of that is an increased focus on specialty. So we expect pharmacy business for us to be quite good this year.

Operator

Your next question comes from John Heinbockel.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Guggenheim Partners. So, guys, a couple of things. Steve, I take your comment with regard -- if you throw the calendar shift out in the first quarter, it sounds like you're probably running a comp that is similar to where you were in the fourth quarter. Is that not right? Has there been -- it's a little bit lower than that?

Steven Burd

Yes, let me -- the short answer is yes, but let me give you a qualifier there.

John Heinbockel - Guggenheim Securities, LLC, Research Division

You guys mean you're in line, right, with the fourth quarter.

Steven Burd

Well, let me give you a qualifier. The -- if you look at -- we ran 1.5% in the quarter, but we were helped out by the holiday shift. Now we're probably going to be the only retailer in the food business, publicly traded company, that had a holiday shift, because everybody else defines their quarter in such a way that, that holiday shift doesn't occur. So there are 2 things that affect us in the first quarter. One is that holiday shift. And the other one is something you've never heard me speak about, and that's an extraordinary difference in weather patterns. I think most people know that a snowstorm -- a predicted snowstorm with no snow is a perfect situation. But even when you get the snow -- on a snow day, we could be up 120% to 150%, okay? And so snow plus the holiday will cost us in the first quarter about 70 basis points, okay? And so you've got to take 70 basis points off of whatever run rate we were experiencing. And then inflation, which picked up in the fourth quarter, has actually picked up even stronger in the first quarter. Now fuel has continued to rise, not by the same incremental magnitude. But if you go back 3 years, people were experiencing $1.75 a gallon versus $3.50 a gallon today. So there's a big difference there. So fuel is up. Food inflation is up. And so that will impact us in the first quarter. Now offsetting that in part is the fact that we, in the middle of the fourth quarter, put together a stronger fuel loyalty program, have made some further adjustments just recently, which will help us out in the first quarter. But we're going to be positive in the first quarter. But we're going to be impacted by weather, the calendar and this additional inflation. So if we were really running at not a 1.5% but 1.2% rate and you take 7 off of that, that's probably closer to where you'll see us actually report. Despite that, we feel that 2012 -- and we'll detail this at the investor conference. 2012, because of what we've done on the loyalty side, because of the rollout of just for U, which is now the new platform, it's only in Southern California, we continue to believe that 2012 is going to be a much stronger ID sales year for us than 2011. And we'll talk about that in the guidance at the investor conference.

John Heinbockel - Guggenheim Securities, LLC, Research Division

And as -- just as a follow-up to that, how much did the -- I imagine the generic shift didn't hit you much in the fourth quarter but is having a bigger impact in the first. Is that notable to call out?

Steven Burd

I think -- yes. Yes, there was some impact in the fourth quarter. There'll be a bigger impact in the first quarter. I think in the fourth quarter, the generic shift on IDs was about 50 basis points. And it's going to be an impact, but it will be masked by the volume increases that we're getting in the overall script business. So -- but that will be a negative drag on the pharmacy IDs and overall IDs as we move forward throughout the year.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Now it also seems, just looking around at your competitors, most people are behaving rationally still. And obviously, comps are pretty good for most. Would you -- is that a fair characterization, that you've seen very little change in competitive activity? And is there -- what do you think happens if comps slow here because of this inflation or gas or whatever? Do you think that'll persist?

Steven Burd

Well, I think that everybody will experience the effects of fuel and food inflation. And I think in the conventional supermarket business, I don't think it's a general -- I don't think it's generally true that everybody has good comps. They don't. We continue to see the bifurcated recovery. And so if you're on a high end of retail, regardless of what form of retail, you do well. And otherwise, you -- if you're in the conventional space, you do a lot less well.

John Heinbockel - Guggenheim Securities, LLC, Research Division

But if -- would you say it's fair that promotional activity has remained fairly rational to date?

Steven Burd

Absolutely. I would say completely rational. And I would expect it to remain rational. It might be a different story if we were just hit with this. But food retailers battled deflation for 2 years and are now putting up with high energy costs and high food costs. And so it's not like they have a lot of spare change to experiment with. So I think you'll find a very rational world in 2012.

John Heinbockel - Guggenheim Securities, LLC, Research Division

And then just one final thing. You talked about investment in Blackhawk. Is that Cardpool? Or is that something else?

Steven Burd

Well, it's not just Cardpool, because the investment that I was referring to on the O&A side is actually coming through the expense structure. And so in a high-growth business like Blackhawk, you are investing a lot in expenses to develop new products going forward. So we've got -- obviously, there's a lot of effort being put by others into the digital wallet. And we think we have the right to own the gift card component of that. And so that is some of where we are spending our time. So we could have easily made more money with Blackhawk, but we're building a business here, and we chose to spend it on the expense side in contemplation of having another income stream that we don't have today.

Operator

Our next question comes from Deborah Weinswig.

Michael Palahicky

This is actually Shane on the call for Deb. Just wanted to ask you, on Canada, what are your kind of expectations with Wal-Mart adding a number of store? And then, obviously, Target in 2013 is going to have its stores in place. I'm just wanting to kind of see what your thoughts are on that.

Steven Burd

I mean, I think that we've seen a lot of competition come into various markets over the course of time. We've heard about their plans. We've heard about others. We have a differentiated business. We have very strong market shares. We think that our reputation in Canada is second to none. That creates a lot of loyalty among shoppers. And it's been my long-held view that price guys compete against price guys. And so we wish they weren't building stores in Canada, but they have a prerogative to do that. But we think we'll do fine.

Michael Palahicky

And would you say -- and remember on your Analyst -- at your Analyst Day last year, you kind of had an index for the various different formats. Do you think that would hold true in Canada? Or do you think it would be a bit different?

Steven Burd

We did the analysis in the U.S. I don't think it would be materially different in Canada. As I think about the supercenters, I can't tell you -- I don't think the supercenter effect in Canada has been any greater than the supercenter effect in the U.S., maybe even less, in part because there was a mini supercenter that we've competed with in that marketplace for years. And so other supercenters just begin to look like the other player that has been there for a long time. And so that's who they have to differentiate with.

Michael Palahicky

Okay, makes sense. And then just a quick housekeeping. Did you mean -- did you -- the distribution center that you mentioned, was that -- did you say it was a $0.14 benefit to earnings? Or was that...

Steven Burd

No, I didn't. But let me just comment on that. I think some people might be surprised by the level of property gains that we had in the fourth quarter, which came in at $68 million. $42 million of that gain was Burnaby. It was a very smart thing for us to do. It allowed us to free up an asset and lower our operating expenses simultaneously. We didn't immediately sell the distribution center because we wanted to get good value for it. In the guidance that we provided at the beginning of the year, we contemplated a very large gain on this center. If you look at the $68 million in gain that we had in the quarter, or let's take the $65 million across the entire year, that was $12 million higher than what we anticipated, okay? So on the year, we don't see a big surprise here. Now I know some people like to look at property gains, and wipe those away from our earnings. We think that's a mistake. We think that if you're in the food retail business, you are virtually in the real estate business. So we have commented repeatedly that we think we have a core competency in real estate. And that's why in 2008, we created an entity to not only develop our stores but develop centers. We have over 32 shopping centers under development right now. And so I would say that investors should get used to these property gains because they're going to be routine and they're going to be substantial. And so on a go-forward basis, keep looking for them. They're in our plans.

Operator

Our next question comes from Meredith Adler.

Meredith Adler - Barclays Capital, Research Division

Meredith Adler from Barclays Capital. This was a year where you put a fair amount of cash into your pension plan. I was wondering if you could talk a little bit about whether that was the corporate pension plan or multiemployer, what the status of the multiemployer is. And I think FASB is talking about having more disclosure in the footnotes about multiemployer plans, and I was wondering whether you're aware whether that's going to happen this year or at some later date.

Robert L. Edwards

Meredith, in answer to -- you had a number of questions, but the contribution was to the corporate plan that's identified, and it was up substantially from the prior year. But I think we had called that out, that we expected the contribution to be up. And we'll be filing our 10-K here in the next few days, and there is increased disclosure consistent with what we're required to do. So you'll see that there are 3 or 4 additional pages with detail on all the multiemployer plans. So it is and we've complied.

Steven Burd

Yes. The other thing I would add to that is that, and we've talked about this in the past, there are regulations about how those shortfalls get remedied. And they are the subject of virtually every labor negotiation that we have engaged in. And across the board, we've put in place essentially a plan that brings those things back to an appropriate level of funding. And it usually happens over an extended period of time. And it's the reason that our wage increases have actually been on the light side, because we have to address the pension shortfall when we do and then we have to address health benefits and wages. And over the last several years, including 2011, our compound annual growth in that combination of those 3 has been quite modest, and we expect that to continue.

Meredith Adler - Barclays Capital, Research Division

Okay. And then I have a question, probably another question for Robert or for Melissa. I think Steve mentioned that you guys are still borrowing in the commercial paper market. I probably had made a bad assumption, because you got downgraded by 2 rating agencies, that you might have less access to the commercial paper market. In terms of availability, and I think Steve actually mentioned the cost, has there been any change since the downgrades, any of the availability of commercial paper or the cost?

Melissa C. Plaisance

I've been pleasantly surprised, Meredith, about the availability in commercial paper. As Steve indicated, we are paying up from where we were prior to the downgrade. And he mentioned that from overnight to 180 days, we're paying between 65 and 100 basis points, and we had been in about 35 to 40 basis points before the downgrade. But there has been plenty of availability not only just for working capital, but we've developed a number of investor relationships over time in that market and that's paid off for us.

Steven Burd

I think if you also go back historically, even before we added the debt, the rate that we pay for commercial paper has always been lower than what our credit rating would actually suggest. And I think that people look at -- I mean, if you look at an 8.9 EBITDA coverage ratio, the government should be so lucky. I mean, we're in -- we're a very good credit, and so we have great access to commercial paper. And maybe more than we thought we would have, but that's terrific for us.

Operator

Your next question comes from Kelly Bania.

Kelly A. Bania - BofA Merrill Lynch, Research Division

This is Kelly from BofA Merrill Lynch. Just wondering if you could go back to your comments on market share. I think you mentioned they were flat in Q4 and maybe positive in Q1. I think you're referring to market share versus last year, but if you could clarify that. And then talk about how you're defining that market share. Is that just traditional retailers? And what maybe drove the improvement into Q1? Is that just the fuel rewards programs that you started to add?

Steven Burd

Okay. If I miss any of your questions, come back at me. Let me start with how we measure it. What we do is we are measuring -- there are lots of ways to measure market share, and some are better than others. We measure channel share because we can get the best possible information, and we can get it by market, and we can get it by business unit. We can get just great detail. So when you're looking at channel market share, you have 2 pieces of data that you can rely on. You can rely on what we call census data. And that's the retailers that basically provide to Nielsen virtually all of their scan data. So you're not picking up random weighed stuff. You're not picking up pharmacy. And so you're missing probably easily 25% of all sales when you do that. But you are picking up real sales data. And so for most of your larger players, virtually all in the conventional space, are providing all of that scan data to companies like Nielsen. Now -- so we rely on census data in our markets to draw those conclusions. We then make an adjustment based on other sources of data to try to get at the random weighed stuff, okay? But let me just leave that aside for a second. So what is not in here -- Nielsen and IRI, I guess, would do the same thing. We happen to use Nielsen. They can get sample data for people that do not provide scan data. But we've looked at the sample data, and we don't feel it's universally accurate. And therefore, we went to census players only. And so when I say that we were flat in the fourth quarter, that's basically looking at the census data. And when I say that we've actually improved in the first quarter, that's looking at that same information. Now have I answered all of your questions?

Kelly A. Bania - BofA Merrill Lynch, Research Division

Yes. I was just also wondering if you attribute that -- what you attribute that to.

Steven Burd

Oh, yes. I think that we attribute the improvement to a couple of things. First of all, we do have version 1 of just for U in 2 markets. And that's helping us. Secondly, we improved our fuel loyalty program mid-fourth quarter. And only recently, I mean, it's less than a week, but we've seen it respond, that we've enhanced that yet again. And then a little early, but we did roll San Diego before we rolled all of Vons. So we're getting some benefit for just for U in the Southern California market. So my feeling would be that as we report our first quarter, we'll have the benefits of really having some run time with our fuel program, plus we should have some real run time in Southern California. But we will roll out just for U. It should be completely rolled out by the end of the second quarter. So that gives us the confidence that sales and market share will continue to build.

Kelly A. Bania - BofA Merrill Lynch, Research Division

And so just to kind of tie that in with your comments that sales may be a little bit lighter in the first quarter, is that just due to the inflation that you're seeing into the first quarter?

Steven Burd

Yes, in the first quarter, it's 3 things. It's the fact that -- let's see if I can get this thing right. We've had something like 92 inches of snowfall quarter-to-date last year. We've had 44 this year. We've had 25 snow events last year. We had 12 this year. So that's a piece of it. And the other piece of it is the flip in the holiday. And then the third piece is the demand depressing effects of this simultaneous inflation occurring in both fuel and in food. Now that's where the fuel loyalty program becomes helpful, because one indicator that we're winning in this equation is that unlike the branded gasoline stations, whose volume is down 3%, our volume, I indicated, was up 15% on the year. And that's really, I think now, Robert, the second year in a row that we've been running volume increases of that magnitude. So people are responding to our fuel loyalty program, and we've -- we dramatically improved that program in probably the last 8 weeks.

Operator

Your next question comes from Ed Kelly.

Edward J. Kelly - Crédit Suisse AG, Research Division

Crédit Suisse. Steve, could you maybe give us your thought process behind the huge ramp in the share repo? And I ask this question because the cynic is going to say that basically, you guys want to make numbers next year. And I'll tell you that's obviously the growing consensus view. The optimists would say that you think the business is going to turn at some point and there's value here. But I think it'd be worth it to at least get your take on this.

Steven Burd

Sure. Well, I fit into the category of the optimist. We believe several things. The core business is a relatively slow growing business, particularly in this economic environment. And so going back a few years, we created Blackhawk, which has extraordinary growth compared to most companies. And so we also then created in 2008 Property Development Centers, which also is going to have extraordinary growth. And then we're contemplating a significant -- I'm just going to call it a wellness play, which we think will also be additive to operating income. So part of what was driving our decision is we feel very optimistic about our ability to grow the operating income of this company over the next 3 years. Second factor was that we're confronted with near 0 interest rates. And then you'll recall our share price dropped to as low as $16 in the fourth quarter. I mean, we have a remarkable situation where we could borrow some money to move forward some share repurchases, and the interest expense, after tax, on that money is actually financed entirely by the dividends that we no longer have to pay. In other words, our debt-financed share repurchase program is actually cash flow positive. And so the stars have lined up. Future operating income, we feel very good about our ability to do that. We feel good about being able to grow as well as anybody in the core, and we feel like we're uniquely positioned to grow what I might call noncore. So low interest rates, low share price. It makes sense to buy the stock.

Edward J. Kelly - Crédit Suisse AG, Research Division

Steve, you, I mean, mentioned Blackhawk. And over the years, you've been asked to provide more financial detail on this business. Is this something that you think we'll get anytime soon? Or are we looking at sort of status on this [ph]...

Steven Burd

You'll get it on March 6. We're committed to sharing more details with the financial community on Blackhawk. We've deferred that for a long time as we build that business. We think the business has been helped out a lot by not having to share a lot of information. But we'll share -- I haven't decided yet, but it will be either operating income or EBITDA. We'll share something of that order of magnitude so you can see how Blackhawk fits in, and I think you'll get a real strong sense for the business.

Edward J. Kelly - Crédit Suisse AG, Research Division

Then related to divestitures, you did, it looks like, exit Philly. Could you maybe talk about the rationale behind that? And then are there additional opportunities out there for you?

Steven Burd

The -- with respect to the Genuardi's stores, we've probably been approached every year, if not several times a year, from the time we first bought that asset. And for most of those years, we said no. This year, we said yes. And that transaction, obviously, has been announced. It goes through a traditional Federal Trade Commission approval process, and we're in that process right now. But I think for us, we think that we're in the business of making money for our shareholders and providing good share price appreciation. That's our job. And so, I think, we're in the supermarket business, but we're building other businesses. So we always want to make a good return on the asset. So if somebody's going to pay us more for an asset than we think that asset is worth to ourselves, then we'll look at that. Sitting here today, I can't forecast if there's anything else in the future. But I think that's what a good steward of the asset should do. If you can get more for an asset than you can provide in terms of cash flow and return out of that asset, then you should sell it.

Edward J. Kelly - Crédit Suisse AG, Research Division

Last question for you. There is one other guy out there that actually has the same calendar as you. They have suggested that the holiday shift could be 30, 40 basis points. Is that kind of the neighborhood that we're talking about, you think?

Steven Burd

I'd say those guys are very good with their numbers. I gave a 0.7 shift, and I would say it's equally split between the weather effects -- and, I think, if you're talking about somebody who might be in more winter climates than we are -- it was 78 degrees yesterday in Northern California. So although -- I mean, no material snow events really in California, even though we have the Sierras to contend with. But you could have other retailers in the eastern half of the United States that might have a bigger snow effect than we would have. But I would say 30 to 40 basis points is right there.

Operator

Our next question comes from Karen Short.

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

BMO Capital. Just following on that comment on the impact of the calendar on your -- actually on your fourth quarter. I guess I'm wondering if you can talk a little bit more about the cadence of the business throughout the quarter. I mean, I think I remember you started the comp -- or you started the quarter at about 2%. You came in at 1.5% for the quarter, but that was with the benefit of the calendar shift. So it would seem that the comps deteriorated throughout the quarter. Can you maybe just elaborate on that?

Steven Burd

I think what I said maybe in the last quarter release was that if you look -- I probably gave you a 2% number that was a combination of the end of the previous quarter and the early start of this quarter, okay? But I would tell you that the business became affected by the fuel cost rise, as well as the inflation rise, pretty early on in that fourth quarter. And so I would say that it wasn't some deterioration. We had a strong finish in the third quarter. We had a very strong early start in the fourth quarter. But otherwise, I would say that inflation in fuel had its effects pretty much throughout the quarter. And now just keep in mind that we've layered -- not we, but energy costs have gone up again so far this quarter. So we're putting increases on top of the 25% increase from last year. And right now, inflation on food is running higher than it did in the fourth quarter. Now I actually think that's going to moderate. I think it's going to moderate late in the first quarter. I think it will be lower in the second quarter just because the comparisons that you're going against -- let me give you one example. We had some extraordinary inflation in produce in the back half of the first quarter of last year. The weather patterns that I referred to earlier actually are going to create a greater abundance of produce, we think, as we move through late second quarter -- or late first quarter and early into the second quarter, probably even all summer. That will, in all likelihood, produce a deflation in produce. And produce, which we love to sell, is going to experience some actual deflation. But the energy costs are really the unknown factor here because they wind their way into distribution costs, and they also wind their way into packaging costs. And so there will be a desire on the part of manufacturers to reflect some of that, although as a group, they're suffering volume declines in the U.S., so they might hold back on that. I think that I'm seeing a renewed interest on the part of consumer packaged goods companies to attack their cost structure. And I think that's in response to not wanting to necessarily layer more cost of goods inflation on the marketplace.

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

Okay, that was helpful. And then I'm just curious. Looking at your EBITDA, and I'm kind of doing this, making an adjustment for LIFO, like the year-over-year change, and then also backing out your property gains, your EBITDA was down quite a bit more in the fourth quarter than it was in the third. And I know you've commented on the fact that some of the property gain was offset by an investment in Blackhawk, but I have to believe it wasn't a $65-million investment in Blackhawk, so that just seems high. So could you maybe just talk a little bit about why you think your -- if maybe [ph] the fundamentals are actually deteriorating?

Steven Burd

Yes, I can tell you that if you look at -- I'm staring at a number that just looks at operating profit, okay? Operating profit in 2010 was $1,159,000,000. And in 2011, it was $1,135,000,000, okay? And so that's a $25-million reduction in operating profit, which would correlate with some EBITDA number that you're using. $43 million was the swing -- or yes, $43 million was the swing in LIFO alone. And another $23 million was the oddity of the decline in the 5-year T-bill rate. So were it not for those 2 factors, we actually would have had an improvement in operating profit and, frankly, EBITDA.

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

Okay, that's helpful. And then I guess the last question. I know you're going to give more detailed guidance at your Analyst Day, but can you just give the rank order of your priorities for free cash flow in 2012 given the higher debt levels?

Robert L. Edwards

Karen, they remain the dividend, stock buyback and paying off debt. They haven't changed.

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

And the same kind of percent allocation?

Robert L. Edwards

Well, clearly, with accelerated program that we've been in, the relative allocation has changed. But the priorities remain the same, and those will be consistent on a long-term basis.

Operator

Our next question comes from Charles Grom.

Charles X. Grom - Deutsche Bank AG, Research Division

It's Deutsche Bank. I'm just wondering if you guys could just address a little bit for us the decline in tonnage here so far in the fourth quarter, and if you could speak to the tonnage so far here in the first quarter.

Steven Burd

Well, I think there's not much to say about the fourth quarter. I mean, you had a sales increase. You had inflation. So you had a tonnage decline. My prediction is that if you could add up the tonnage decline across the food retail channel, it would be down. It would be down from the fourth quarter. And the only way you can get close to that is to ask CPG companies how their volume behaves in the fourth quarter. And I think they'll tell you in the U.S. it was down, and in international markets, particularly emerging markets, it was up. And some of those companies don't have enough emerging market business to offset the decline in the U.S. So I go back to the little analysis I did on fuel and food, just as a market basket, going up 12.5%. And I would just ask if anybody on this call thinks that if people who make an average of $50,000 a year had a 12.5% increase in that market basket of those 2 items, do they think they would make an attempt to buy less fuel and less food? And the answer is absolutely. And fuel, one, they have -- unless they live next to a good friend and they happen to work in the same building, there's not a lot they can do about it. Their response has been a 3% decline in volume. But they've paid whatever those gasoline prices are. And so they've softened up on their food spend as well.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. And just my second question is if I look at the fourth quarter print, your total sales were up 6.2%, and your IDs were up -- with fuel, up about 4%. And just with not a lot of new store growth and with foreign exchange moderating, can you just explain to me the gap between the ID as well as the total sales number? I'm just trying -- I'm having difficulty reconciling it.

Steven Burd

Yes. Robert, if you've got that page...

Robert L. Edwards

Well, the -- if you look at the growth in sales year-over-year, the #1 factor were higher fuel sales in terms of total dollars. The second, if you recall from prior quarters, based on some of this guidance that we had received, we re-classed how we were accounting for the revenue with Blackhawk. That added a significant increase in the second quarter. So that may be the piece that you're missing, and we've done that now for a number of quarters.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay, great. And then can you just kind of shed a little bit more light on the competitive environment? I know you alluded to it earlier but as -- Wal-Mart is talking a lot about price investment, but it doesn't seem like you're seeing it. Do you expect the environment to remain rational here over the next several quarters?

Steven Burd

Absolutely. I think the -- I've been doing these earnings calls for 19 years, and I think only twice have I spoke to an environment that's a little irrational. And so I would say the environment is very rational. And I gave some reasons earlier in the call as to why it will remain rational. And so I don't think that volume declines are going to cause anybody to do anything irrational. I think everybody understands why sales are a little bit tough to come by. Our strategy is to build share. We have now stabilized share over the last 2 quarters. Early indicators are in this quarter that we're starting to gain share. Our points of difference created by our Private Label program; our points of difference created by our in-store environment and service that goes with it; and the digital platform complete with mobile application, which you all will see at the investor conference, give us cause for real optimism. Marry that with our unique ability to create noncore income streams, and we feel very good about how the business is going to perform over the next 3 years.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. And Steve, if I could, just one more. And I apologize if you answered this. I was on the Target call. But it -- there's been a lot of talk amongst some sell siders and on the buy side just about improvements in California. And I'm just wondering if you could -- and if you addressed this already, I apologize. But could you just kind of flesh out how the state is trending for you guys?

Steven Burd

No, not in any detail. I will tell you that the economy has gotten slightly better in California. But I wouldn't say the business climate has gotten any better. But I think the advantage that we have in California, particularly Northern California, is that we are the strongest player by far. And therefore, the challenges that we and other food retailers face from 2 years of deflation and now above-normal inflation, those challenges are much greater for the people that we compete with who don't have a near-9x coverage ratio. And so that puts us in a position to gain share that we wouldn't be. And if you look -- if you think about our operations all up and down the West Coast, we are a very big player. Southern California is a market where it seems to be shared almost equally among 3 large players and then you've got some smaller players. But I think California -- we'll be fine in California, particularly with our ability to take share.

Operator

Our next question comes from Chuck Cerankosky.

Charles Edward Cerankosky - Northcoast Research

Northcoast Research. Steve, I wanted to ask a little bit about Private Label. How did that perform in the quarter? How did consumers react to it, especially given the food inflation and the gasoline inflation out there?

Steven Burd

Yes, on Private Label, Chuck, we're running about 400 basis points higher in Private Label sales than we are in national brand sales. At last year's investor conference, we launched a new brand, Open Nature. I think at the time, we told investors that we thought we could do maybe $85 million in the first year. We ended up doing $104 million.

Charles Edward Cerankosky - Northcoast Research

1 0 4?

Steven Burd

1 0 4. And so consumers reacted very well to that brand. So if you couple Open Nature at $104 million with O Organics, which is around $426 million; Eating Right, which is around $340 million, these are all brands playing kind of in that health and wellness arena that we didn't have 6 years ago. And the beauty about those brands is you can -- with few exceptions, you can buy them only at Safeway. And so we're now using our Private Label to build loyalty among our customers.

Charles Edward Cerankosky - Northcoast Research

How -- what are the -- when you're talking about that 400-basis-points advantage your private brands have, are you saying more of it take place in the higher price points like Safeway SELECT or Open Nature? Or is it disproportionate towards the -- I forget what your value price point is called in corporate brands.

Steven Burd

Yes, I think it's predominantly coming from what I would call the upper end and the middle tier as opposed to the low end. But we've added SKUs on the low end. But most of that growth is coming from the middle and upper tier.

Charles Edward Cerankosky - Northcoast Research

How did traffic and ticket break out in the quarter?

Steven Burd

Traffic was actually up. Ticket was up. Transactions were down.

Charles Edward Cerankosky - Northcoast Research

So transactions up...

Steven Burd

So [indiscernible] with that increase.

Charles Edward Cerankosky - Northcoast Research

Okay. And for the current fiscal year, what are you looking at for capital spending? And how might that be spread around between stores, new fuel centers and other projects?

Robert L. Edwards

Chuck, we're going to hold off on any guidance for 2012 until the investor conference on the 6th. And so we'll have a full discussion about that on the 6th.

Operator

Your next question comes from Stephen Grambling.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

It's Steven from Goldman Sachs. Just had a quick follow-up on some of the inflation commentary. You referenced that it continued to accelerate into the first quarter, which seems to conflict with some of the other food retailers have reported as well as government data. I'm just trying to figure out kind of, where is that coming from? And then a quick follow-up would just be, with the CPG companies seeing significant volume declines, do you anticipate incremental promotional support from them?

Steven Burd

Well, I think Pepsi for one has articulated that they intend to give a lot more support for their brands this year. I think there are others that are -- have clearly struggled, that indicate that they're going to spend more in supporting their brands this year as well. So I think you will see -- I will -- I think you will see more of that. On the inflation front, I can't really reconcile for you our inflation to any national statistic. Historically, the inflation that we reported is actually less than the inflation that other retailers that I have observed, conventional grocers, have articulated on their own earnings calls. So whether or not we're going to see a flip in that, I don't really know. I will tell you that inflation by geography is quite different. And so it's not inconceivable that some retailers would experience more inflation than others. So we are a bit higher so far in the first quarter. As I indicated, I'm predicting that, that softens up as we move through the balance of the quarter, and I'm predicting it softens up in the second quarter. In terms of the government statistics, our numbers have never ever come close to matching theirs.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

And then just a quick follow-up. I know last year you had provided kind of helpful matrix referencing the leverage that you see from volume- and price-driven comps. I mean, does that still hold? Or will that ultimately depend on gas as well and fuel prices?

Steven Burd

Well, I think that the kind of leverage that I talked about, I think the economics of that still hold. The thing that's different, and I think if you attended the investor conferences over time, I have routinely said that as long as inflation is 3% or lower, it's not demand depressing. Now it's conceivable that when you marry that with 25% fuel inflation, you could get a demand-depressing food inflation at a lower level than 3%. But once you get over 3%, you are clearly in that territory of having an effect on demand. And I think that when you throw in energy prices and the struggles that people are having, it makes a difference. At the high end of the income level, if food is 13% for the average American family, it's not 13% for somebody with an income over $200,000. And if fuel is 8% for the average American family, it's not 8% for somebody in the high end. And therefore, these things are not as troubling to the high income earner who believes they have a stable job. And so the bifurcated economy, as witnessed by Saks and Neiman Marcus and others, continues. The bifurcated recovery is still in full swing.

Operator

Our next question comes from Mark Wiltamuth.

Mark Wiltamuth - Morgan Stanley, Research Division

Steve, it's Mark Wiltamuth from Morgan Stanley. I wanted to ask a little more about the volume decline since it got worse sequentially here. Do you think you can turn this on your own? Or do you need the gas and the inflation and maybe some consumer confidence or a recovery to kind of get the volumes turned?

Steven Burd

I think that in order for volume to really turn, I think you need some abatement in fuel inflation. I mean, if you think about the company leading the conventional supermarket on ID sales, they've reported flat volume with an ID number approaching 5%. And so I think that a rising consumer confidence -- I think that last number I saw was 64. When the number was in the 40, I said a number that begins with a 7 would be good. Given the fact that it's been so low for so long, I think that, that number needs to begin with an 8 at this point. And you have to get some reduction in energy costs. Otherwise it takes probably an ID sales number, with normal inflation, of something north of 4 in order to get positive volume.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay. And, Robert, since we had a property gain here this quarter and it looks like Philadelphia is probably going to come in the next quarter, can you just give us a general idea of how big that is, so we know what to expect when the quarter is reported on the first quarter?

Robert L. Edwards

Mark, because of the potential review by the -- the review by the FTC on Genuardi's, difficult to say with certainty which quarter that's going to close. I think on the 6th, at the investor conference, we'll have a couple of slides on this topic, specifically on Genuardi's.

Operator

Our final question comes from Andrew Wolf.

Andrew P. Wolf - BB&T Capital Markets, Research Division

BB&T Capital Markets. A couple of follow-ups on just for U. Steve, can you comment how much better market share is for the 2 Safeway divisions where just for U has rolled out?

Steven Burd

I -- let me just go a little bit from memory here. I didn't bring the market share data with me. But I believe in the fourth quarter, the 2 divisions with just for U both had positive share gains.

Andrew P. Wolf - BB&T Capital Markets, Research Division

And that's -- could you be any more specific? Order of magnitude? Is that something that's still growing because you're basically still tweaking how you're doing? And you also mentioned there's sort of a 2.0 that's, I guess, down in Vons. Is that a complete -- a major overhaul?

Steven Burd

Well, Vons wasn't live in the fourth quarter. I would tell you that in the fourth quarter, the market share gains in one market were substantial, okay? And I would regard "substantial" as anything over 50 basis points. That's a pretty big movement in market share. And then in the second market, a little bit less than substantial, but meaningful, okay?

Andrew P. Wolf - BB&T Capital Markets, Research Division

Okay, I appreciate that. And the last question here is, as we look to the Investor Day -- and I'm sure you're going to talk more about this, but what's the governor to the pace of rolling this out throughout Safeway? Is it -- I think you had mentioned IT systems previously. Is it more on the vendor relations side? Is it more funding it? And how do we think about how fast you can roll it out and what can get in the way of that?

Steven Burd

Okay, let me answer that. Before I do, I did scramble and find my market share data. We did roll, I think, a piece of Vons in the fourth quarter, okay? So I can tell you that all 3 markets that had just for U had positive share gains, okay? And then the rollout, our expectation is that we should complete the rollout by the end of the second quarter. And keep in mind that one of the things that we did after really piloting this in 2 markets, we elected to build our own platform, which is what exists in Southern California. And so the rollout also contemplates putting that platform in the 2 existing markets as well. And so that slows us down a little bit, but the new platform is so much more robust than what we had put together in the pilot and just performs so much better that we expect a much greater consumer response. And then we'll put full marketing dollars behind it. So the market share gains that we've had -- the Southern California rollout was what we would call a soft launch. This was not real hard marketing. And even the marketing on just for U in Southern California, we've got some marketing going on now, but that thing goes on steroids here shortly. And so that will increase our registrations, and that will increase our use of that vehicle. Again, we'll talk more about this at the investor conference.

Melissa C. Plaisance

Okay, thank you, everyone. I appreciate you participating in the call. Christiane Pelz and I will be available through the balance of the day for any follow-up questions. Thank you.

Operator

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

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

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

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

Source: Safeway Management Discusses Q4 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts