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SUPERVALU Inc. (SVU)

F1Q08 Earnings Call

July 24, 2007 10:00 am ET

Executives

Yolanda Scharton - IR

Jeff Noddle - Chairman, CEO

Pam Knous - CFO

Analysts

Perry Caicco - CIBC World Markets

Meredith Adler - Lehman Brothers

Jason Whitmer - FTN Midwest Research

Carla Casella – JP Morgan

Mark Wiltamuth - Morgan Stanley

John Heinbockel - Goldman Sachs

Ed Kelly - Credit Suisse

Eric Larson - Piper Jaffray

Chuck Cerankosky - FTN Midwest Research

Ajay Jain – UBS

Bob Summers - Bear Stearns

Gary Giblen - Brean Murray

Presentation

Operator

Good morning, ladies and gentlemen. Welcome to the SUPERVALU fiscal 2008 first quarter conference call. (Operator Instructions) I would now like to turn the call over to Ms. Yolanda Scharton. Ms. Scharton, you may begin.

Yolanda Scharton

Thank you. Good morning, everyone and welcome to today's call. I remind you that today's call is also webcast and will be archived for a few weeks and be available on our website.

On today's call this morning are Jeff Noddle, SUPERVALU’s Chairman and Chief Executive Officer, who also appeared on Bloomberg this morning in case some of you saw that; as well as Pam Knous, Corporate Executive Vice President and Chief Financial Officer.

As you know today, the information we present and discuss includes forward-looking statements which are, as always, covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act, and the risks and uncertainties related to such statements are detailed in our fiscal 2007 10-K.

After today's call and prepared remarks by Jeff and Pam, we will have a Q&A session. If we could limit the questions to one per person, that would be great because we have many, many people on the call this morning. As always, I will be available after the call for additional questions.

Now I would like to turn the call over to Jeff.

Jeff Noddle

Thank you, Yolanda and welcome, everyone to today's call. Today's call marks the completion of our year 1 as well as the first quarter of fiscal 2008 following our very transformational acquisition last year. As such, I am very pleased to report that our first quarter diluted earnings per share increased 21% and that completes the fourth consecutive quarter of double-digit earnings per share increases following the acquisition of Albertsons premier retail operations late in the first quarter last year.

Year 1 clearly demonstrated the substantial economic benefits of the new SUPERVALU. Year 1 also marked an important beginning phase of our journey where we brought our teams together and developed key programs and initiatives to leverage the full potential of our new business model and delivered the expected synergies.

So as we enter the next two years of our journey, we will execute these programs and initiatives supporting our guidance of another year of double-digit earnings accretion for fiscal 2008 in comparison to fiscal 2007.

In fact, we raised the bottom end of our earnings per share guidance today by $0.05 before one-time costs. Clearly today's revised guidance demonstrates our confidence in our outlook and it includes all the initiatives that we will be discussing today. Our results will reflect not only our new scale but our ability to capture benefits of the transaction which will continue to emerge over the next several years. We are well positioned as we embark on our Year 2.

Before I cover some of our key initiatives in fiscal 2008, I would like to make a few comments regarding the current retail and consumer environment. First, we continue to see big box grocery retailers shifting capital from new square footage growth to remodeling opportunities. For example, Wal-Mart announced its change in strategy in June. We believe this bodes well for our industry's long-term prospects.

Similarly, SUPERVALU is committed to driving improvements in return on invested capital through its Premium, Fresh & Healthy program as well as maximizing any in-market consolidation opportunities as a preference to adding square footage organic growth.

Second, inflation has gradually increased over this timeframe. We are seeing fuel prices rise again and in certain food categories, the impact of corn costs has created short-term volatility, particularly in meat and dairy. On our last call in April we discussed this trend, and at that time we estimated food inflation at approximately 2%. Our current estimate would now have us moderately higher than 2%. These cost increases are impacting consumer spending behaviors as are other macro economic influences, specifically the slowdown in the housing industry. In fact, the consumer confidence index has declined since May after many months of strong performance.

While inflation is somewhat higher than we have seen in recent history, our objective remains to pass on the cost increases, and to date the market has been rational in this regard. As always, we strive to maintain an appropriate balance between managing our costs and maintaining the best value for our customers.

Overall from a margin perspective, our total gross margin rate was consistent between the first quarter when compared to the fourth quarter, being one of the best measures of our ability to manage in this current inflationary environment.

Our identical store sales on a combined basis increased 1.2% in the quarter with the acquired properties at 1.7% and legacy SUPERVALU at negative 0.4. Consistent with my comment on the decline in the consumer confidence index, we saw our identical store sales soften late in the quarter and continue somewhat softer today compared to our previous run rate.

We attribute this to a combination of factors including: competitive activities in certain markets, the pressured consumer, as well as its inflationary impact to our pharmacy sales related to price reductions for several major generics; another industry wide dynamic that will play out over the next several quarters. Nonetheless, we're still projecting our fiscal 2008 ID sales in a range of 1% to 2% for the year based on our current assessment of the economic environment.

I would also like to provide a comment on the Southern California contract settlement. As I certainly think have you heard by now, the employees ratified a new four-year labor contract over the weekend. The new contract, which is one year longer than the last contract and is retroactive to March 6, 2007, allows to us maintain a competitive position in Southern California while offering our associates a comprehensive wage and benefit package.

As you know, these negotiations took a considerable amount of time to complete, and I am very appreciative of the patience of our associates. Their commitment to service to our customers during this time of uncertainty has been truly remarkable.

With these considerations as a backdrop, where are our priorities as we look to the second year of our journey? As we have discussed with you extensively over the past year, Year 1 of the acquisition was very much a planning year. We made sure the right team was in place to lead the organization. Road maps were developed to the level of detail necessary to have an executable plan, and we undertook activities to engage our associates across the entire organization to position SUPERVALU to be the best place to work, shop, and invest.

So Year 2 of our three-year journey begins as the year of execution with many plans now in early stages of implementation. We believe our customer initiatives are one of the most important underway. These programs focus on enhancing the customer's in-store experience. Our goal is to delight and excite the customer every time they shop in our stores. We have specific initiatives designed around customer service, new merchandising offerings as well as our capital activities. These programs are key to our ability to retain and attract new customers and thereby build long-term sales momentum. Many of these programs were implemented late last year and are proceeding well.

In addition to the same-store sales growth, we also measure our progress using metrics such as product quality, courtesy and friendliness of associates, variety, and speed at checkout. Across all markets, customer service improvements have been achieved quarter over quarter. We are committed to truly raising the bar on our store standards.

New merchandise offerings are a key component of our ability to compete for today's customer. We need to anticipate what the customer is going to want and need before even they know. Innovation will be a key ingredient in responding to a demanding and quickly changing arena.

Another important initiative in Year 2 is our capital activity that support our Premium, Fresh & Healthy remodel and new store program. As you know, each remodeled store is tailored to the needs of the customer and the banner positioning so no two stores look exactly alike. Over the course of this multi-year program, we will continue to refine our remodels to incorporate the changes that come from our research and changing customer preferences.

Another area of focus for fiscal 2008 will be to jump start our private label program, which we refer to as owned brands. Previously this is an area where neither SUPERVALU nor Albertsons had a program adequate to fully leverage scale. Today we have a team dedicated to achieving this goal. Our strategy will require that we develop a tiering philosophy, SKU rationalization and development of marketing programs to support the owned brands. The benefits of this initiative are a component of the synergies of the transaction and we expect real traction on this initiative this year.

During fiscal 2008 we will be ramping up our national merchandising promotional event capability, benefiting our customers through lower prices. As we work to reinforce our brand position and build customer loyalty, we will also be selectively investing some margin in certain markets. As a reminder, from the very beginning of the acquisition, we said we would invest in certain geographies. So as we enter Year 2, we will begin launching this initiative later in the year.

We will also continue to invest this year in our supply chain infrastructure, specifically our automation technology. With our Minnesota facility almost complete and our Pennsylvania facility underway, we will be optimizing our distribution network for efficiencies for our retail operations as well as our independent retailers.

In summary, with nearly 80% of SUPERVALU's total sales now coming from retail operations and encompassing a store network of approximately 2,450 stores and leading market shares in many of our markets, as well as one of the best supply chain infrastructures serving the grocery channel, we are well positioned to leverage our new scale and achieve the $150 million to $175 million of synergies by the end of the third full year anticipated since the acquisition of the Albertsons premier retail properties. Fiscal 2008 is off to a very good start with strong business plans to build upon this first year of success.

Now I would like to turn the call over to Pam, after which I will make some closing comments.

Pam Knous

Thanks, Jeff and good morning, everyone. As Jeff mentioned, this quarter marks the first full year of the acquisition of the premier Albertsons properties which transformed SUPERVALU into one of the nation's largest retail grocery companies. We are very pleased with our first quarter results, and the economic benefits of our new business model delivered the fourth consecutive quarter of record results and double-digit earnings per share growth.

Today I will focus my discussion on operating results for the first quarter, our financial condition, and an update of our fiscal 2008 outlook. As we have now fully cycled our acquisitions, this will be the last quarter that any detailed results will be given for the acquired operations. Going forward, we will only talk about the combined results.

In retail, first quarter sales increased to $10.4 billion with $7.5 billion coming from the acquired operations. Retail operating earnings in the first quarter increased to $449 million or 4.3% of sales, reflecting the benefit of the acquired operations. This compares to $128 million or 4.4% of sales for the first quarter of last year. As a reminder, last year's first quarter operating earnings included a $10 million benefit or approximately 40 basis points from the sale of a minority partnership interest.

First quarter total retail EBIT of $449 million includes approximately $295 million of depreciation and amortization expense. The acquired properties’ EBIT of approximately $332 million includes depreciation and amortization expense of $237 million. As you recall, in the original pro forma analysis shared with you in March of 2006, the acquired properties’ historical EBITDA margin was 7.2%. During the past four quarters, we have not only sustained that level of performance, but we have improved upon it, reflecting the powerful portfolio of retail assets acquired as well as the benefit of some synergies that have begun to emerge.

Today, with the retail-driven business model where approximately 80% of our revenues and approximately 90% of our earnings are coming from retail, we are beginning to see operating leverage from our new scale as well as the benefits from our focus on execution standards, customer service initiatives, and locally-driven merchandising programs.

As we continue to leverage our retail operations, the important strategy is to invest capital in store remodels to improve the condition of our fleet. In the first quarter, 15 remodels were completed. Remodeling activity will accelerate through the rest of the year, and we expect to complete 100 to 110 major remodels for the full year. As we gain momentum on this initiative over the next few years, we will be poised to deliver improved return on investments and sales growth.

Complementing the investment in our fleet is the appropriate recycling of assets. As with any large retail operation, we regularly cull locations, and in conjunction with the completion of our purchase accounting analysis during the quarter, we identified approximately 15 additional stores for closure this year. In total in fiscal 2008, we expect to close or sell approximately 50 stores, including the previously announced Scott's and Jewel Milwaukee stores. By redeploying capital generated from these disposals to SUPERVALU's best growth opportunities, we can build upon our successes while improving our return on invested capital. This effort is part of our ongoing commitment to improve return to our shareholders.

Turning to the supply chain services segment, sales in the first quarter were $2.9 billion, approximately flat with the prior year, as strong new business was offset by attrition and reduced temporary business in comparison to the prior year. Supply chain operating earnings in the first quarter were $67 million or 2.3% of sales. This compares to $76 million or 2.6% of sales for the first quarter of last year. The decrease in operating earnings as a percent of sales in the first quarter primarily reflects shifts in customer and product mix combined with softer perishable margin performance in the current year.

Now I will cover some other income statement items. During the first quarter we incurred approximately $28 million of pre-tax one-time acquisition related costs, including Eastern region supply chain consolidation, employee benefit related costs, and consultant fees, compared to $13 million in the prior year.

SUPERVALU's total operating margin at the end of the first quarter, even with $28 million of one-time acquisition related costs, was 3.5%, an increase of 60 basis points over last year, again reflecting the increased scale and profitability of our new retail operations.

Reported net earnings were $148 million compared to $87 million last year. Then when factoring in the higher share count to effect this transformational acquisition, reported diluted earnings per share in the first quarter increased 21% to $0.69 compared to $0.57 last year.

From a balance sheet perspective, we are on track. Debt to total capital at the end of the quarter was approximately 62%, improving from 64% at fiscal year end, beating our original estimate of Year 1 given in May of last year. As we have stated, our goal is to reduce debt by at least $400 million annually starting in the first full year after the acquisition, which is from June 2007 to June 2008, Year 2. We are very pleased we have all been able to reduce debt by $140 million in Year 1. As we move to our results this year, you will see improvement in our debt related ratios, as we are poised to make meaningful debt reductions.

As an aside, in May the remaining HITS purchase contracts were settled, with approximately 1.1 million shares of stock issued and $52 million of net cash received. At this point we can put the HITS behind us. We also remain in full compliance with our debt covenants, with first quarter reported EBIT of $466 million, depreciation and amortization expense of approximately $324 million, net rent expense of approximately $113 million, and total debt of $9.3 billion. These financial results put us well within our required covenant levels.

Turning to our outlook, as Jeff said, we are raising the bottom end of our earnings per share guidance by $0.05, to $2.93 to $3.03 before one-time acquisition-related costs. I would like to quickly cover some of the more significant factors that led to our ability to narrow the earnings range.

First, as you saw in our release, we are revising upward our estimate for diluted weighted average shares outstanding from the original estimate of $214 million to $217 million to $216 million to $218 million, reflecting the impact of our stock performance in both higher stock option exercises and dilutions.

As I just mentioned, we expect to close approximately 15 more stores this year than we had planned for in our previous guidance. As a result, additional store closing costs for items such as inventory liquidation and employee severance costs will be incurred over the course of the year as the stores are closed.

As you heard from Jeff, we expect to make selective investments later this year in certain markets to solidify our banner positions and drive customer loyalty, consistent with our Year 2 business execution plans.

As you know, we finalized our purchase accounting review in the quarter, including receipt evaluations from outside experts. The balance sheet at the end of the first quarter reflects the results of the final valuations, increasing goodwill by approximately $900 million with offsetting adjustments to property, plant and equipment, intangibles and deferred taxes. In contrast to the balance sheet treatment, please note the valuation adjustment impact to depreciation and amortization expense will be reflected on a prospective basis, resulting in lower overall depreciation and amortization expense on a go-forward basis.

The combination of these items and other business trends collectively allowed us to narrow the earnings range for fiscal 2008. We are also moving our guidance on one-time acquisition-related costs to $0.20 per diluted share, reflecting better visibility on these costs.

All in, our new reported diluted earnings per share guidance range is $2.73 to $2.83, compared to $2.68 to $2.87. The top end of our GAAP guidance has come down by $0.04, solely due to the tightening of our one-time acquisition related costs to $0.20 per diluted share.

I would like to briefly mention that we have agreed to extend our transition services agreement with Albertsons LLC for one additional year to June of 2009, whereby we will continue to provide overhead support services. As you recall, the fees generated from the transition services agreement are reflected in SG&A and represent fees for the overhead expense we incur to support the requirement of the service agreement.

In closing, the new SUPERVALU business model is now a strong retail powerhouse. We are excited about the opportunities and potential of our company and believe we are in excellent financial position to support future growth and financial deleveraging.

Thank you. Now I will turn it back to Jeff.

Jeff Noddle

Thanks, Pam. The foundation we set in Year 1 will benefit us over the next two years. Now our plans are truly in place. We have the right team, and we will execute against that plan and expect to deliver our second year of double-digit increases in earnings. Once again, as evidenced by the tightening of our earnings guidance this year, we're on schedule with our three-year plan to leverage our transformed business model into improved operating metrics and improved return on invested capital delivering value to our shareholders.

Thank you, and now we'll be open to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Perry Caicco – CIBC World Markets.

Perry Caicco - CIBC World Markets

I want to focus a bit on some of the comments you made around same-store sales, perhaps focusing a bit more on the acquired assets. How much was the drop off in same-store sales as you progressed through the quarter? How much inflation is in the number? Was there any sort of range between various geographies or store types and a little bit of the balance between traffic and basket?

Jeff Noddle

Good morning, Perry. That was a basket full of questions there. What I said -- and again we're not going to go into it certainly by market, but I will give you a little bit of color. What we said is toward the end of the first quarter we did see some softening in sales, and it continues into this second quarter in the weeks we've had so far. Again, going forward, we are not delineating between acquired properties. We are now one entity beginning in this second quarter, and that's how in the future, while we'll certainly talk about our like stores, but as a combined entity. We did see a strong performance by the acquired properties of 1.7 which was all pretty close I think with 1.8 in the quarter before that.

I forgot the rest of your question.

Perry Caicco - CIBC World Markets

How much inflation would be in that number?

Jeff Noddle

As I made the comment on the inflation, we said that entering the year we were running about 2%. We're running moderately higher than that now. A lot of that is coming certainly from dairy and meat, and to some degree from produce. My feeling about inflation is obviously we're at a higher level than 2% now, so it is somewhere in the 2% to 3% range, but because a lot of it is in the perishables of meet and produce, some of those can change rather quickly and are more volatile.

We're hopeful that later in the year as new crops come on, that we'll see some lessening, at least of the inflation rate later in the year, and always we're always faced with mix changes as consumers change their buying habits, it changes the mix of the basket. Obviously dairy right now has probably been under the most pressure in terms of inflation. I think raw dairy prices are up 60%, 70% over last year.

I do think there is some hope the rate can come down later in the year, but at this point we seem to be in the teeth of the wind of inflation at the moment.

Perry Caicco - CIBC World Markets

Was there any impact on earnings in the quarter from inflation, Jeff?

Jeff Noddle

Very little and very hard to determine, but I would say practically none.

Operator

Our next question comes from Meredith Adler – Lehman Brothers.

Meredith Adler - Lehman Brothers

I would like to talk a little bit about the wholesale business. We saw changes in mix. I think that was both customers and the kind of products they were buying. Can you talk a little bit about what you see the outlook for that business? Are you going to be able to bring on customers who will be more profitable customers or is this sort of where we think the business will go for the next couple of years?

Jeff Noddle

Meredith, in any given quarter we're going to have some changes of product mix and some changes in customer mix that do show up in our distribution. Distribution was off a little bit in earnings to last year. Of course to the whole company, it is a rather minor difference.

Nonetheless, though, I expect a very solid year in distribution this year. We think that we will end the year with very solid results in that business. We continue as we did in the first quarter, you saw that the attrition was fully replaced with new business and no reason to believe at this point we can't continue that the rest of the year.

Meredith Adler - Lehman Brothers

The focus for the market on inflation has been all of the volatile, highly visible items and where there may be difficulty passing it along. What is your view about inflation on the packaged goods side? Do you think you will be able to pass that along and is that good for your business or not?

Jeff Noddle

I actually think that the passing on of inflation in the packaged goods is frankly a little bit easier than it is in the perishables because the perishables move so quickly, and oftentimes you've got promotional opportunities and you can't adjust quick enough to the changes as they move up or down, as they occur. I do think in packaged goods historically we've seen about a 1% to 2% annual increase in packaged goods as I would describe them, and that's kind of a healthy run rate in our view. Right now it has run a little bit above that.

Normally they all happen kind of together at one time. For example, you're seeing cereal this summer being increased either by package size changes or by price increases, depending on the vendor, so they tend to all hit at the same time. They tend to get passed through in an orderly manner. Again, I expect later in the year to actually hope – I would expect and hope -- that there would be some deceleration of that in the packaged goods.

The perishables are harder to predict. They're more volatile, but as I said earlier, I am hopeful as we bring new crops on and things that we'll see a better situation there.

Operator

Our next question comes from Jason Whitmer – FTN Midwest Research.

Jason Whitmer - FTN Midwest Research

Jeff, I wanted to follow up on some of the portfolio rationalization or optimization that you're still working on. How much longer do you think you will work through that process? Referring back to the question at the start of this, what are some of your longer term thoughts on the wholesale enterprise and the core part of the distribution of supply chain services?

Jeff Noddle

I am not going to comment much on portfolio rationalization. We have always said that we're going to improve and continue the journey back toward improvement in our return on invested capital. You certainly see the evidence of that in this quarter.

I think the stores that Pam discussed, the 15 or so further identified to close this year, as we took a look at purchase accounting and finished and wrapped that up, we took a final look at the stores and from what we see today those are the closures going forward this year.

But we continually look at our portfolio and evaluate that and Jason, as you know over the years, if we don't think that we have a good long-term outlook in a situation, we'll make a different decision. But what we know today is certainly what we've announced today.

In terms of distribution, as I said many times, distribution and supply chain is a very integral part of our strategy as we brought the two companies together, and competency in supply chain brought together with the great retail properties we were able to hand select out of Albertson’s really has made what we think is the right formula for the long term.

Again, our board and we look strategically long term at all of our businesses and discuss those, but certainly today we think supply chain's a very important part of our prospective outlook.

Jason Whitmer - FTN Midwest Research

Any details you can provide us on some of these headwinds that have been invested in T Squared over the last couple years maybe turning into a tailwind over the next couple?

Jeff Noddle

We're just about complete with our Minnesota facility, it is working but we had to finish the migration of another separate distribution center. That is practically complete, so we certainly expect a benefit in contribution out of T Squared going forward for this point forward, but now again we have another operation now that we're beginning to install it in.

That is actually a little more complex one because it involves multiple distribution centers, and in the multiple distribution centers they tend to go down in phases. One is closed now, another one later this year, and the major one is actually two years from now as we complete the installation in the Lancaster, Pennsylvania facility.

Obviously the tailwinds we get from one will have some headwinds from another, and that's another reason why our synergies are pushed out a little more on supply chain, and I think we discussed that on the last call. I would also just comment that any benefits that begin to show you will see primarily on the retail side where we serve our own corporate retail.

Operator

Our next question comes from Carla Casella – JP Morgan.

Carla Casella - JP Morgan

Your interest expense line is a lot higher than we would have expected. Is there some one-time expense in that line?

Pam Knous

Are you recognizing the fact that this is a 16-week quarter?

Carla Casella - JP Morgan

That could be. Yes. Let me recalculate that. Great. You're expecting inflation to remain elevated. Do you expect your comps then will stay below inflation, and is that purely traffic or would you say that's a mix shift?

Jeff Noddle

The consumer is constantly adjusting their purchasing and responding to the inflation that they encounter and we have always said for a long time, it is very hard to take inflation and translate that into what is expected for like store sales. You will see that all over the lot. People adjust their purchases, they trade down at times, depends what else is going on. With the high gas prices it is very hard to predict.

We are generally seeing, and this has been going on for more than a year now, that traffic is lower but average purchases are generally higher, and that's true of us and true about the industry because if you note the comments are made by others. It is pretty common sense that people are making less trips to the store and trying to consolidate their purchases when they do. We definitely do see that.

We've given guidance for the year on our like-store sales. I remind people that we just finished the first year of a long-term journey for us, and I know we're compared to others in the industry who have put up some very good results but have been working plans for five years or more to achieve those kind of results. Frankly, our first year was a little better than we even thought in terms of like-store sales. But our long-term outlook, and I said many times, that as we bring all of our strategies and get our remodeling program well underway later this year, we didn't expect any benefit of that until later in the year and as we really convert more stores and as we incorporate all the things we've been working on, I certainly expect our numbers to look the same as others somewhere down the road.

Carla Casella - JP Morgan

For the legacy SUPERVALU stores, would you say they just had more competitive threats, or why was the performance there worse than the Albertson’s stores?

Jeff Noddle

The biggest factor there is the end market cannibalization that we have had by opening stores in our own markets. If you factor in that basis, they actually were up about 70 basis points. They were impacted a little bit more on cannibalization than the others, and that's the primary reason you see the difference in those like stores numbers.

Operator

Our next question comes from Mark Wiltamuth – Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

I wonder if you can give us a few milestones on how you're doing on synergy progress? Maybe if you could talk about some of the major functions that have been integrated and how are you doing on merchandising and sourcing and et cetera and if you have any quantification of the dollar synergies you think you have realized to date?

Jeff Noddle

Mark, in terms of synergies we have made comments that obviously within our guidance in a range this year are some synergies. We haven't quantified those by dollar amount, but clearly they have begun to emerge in our guidance.

I would just make a few comments about our milestones. In supply chain we actually have got quite a bit done already. We did some consolidation in the Midwest on pharmaceutical distribution, and that actually was completed I think in January of this year. We're well underway with some work in Southern California that will go on through this year, and eventually consolidate. We actually are dependent on an outside distribution center that is now owned by CVS drugstores, and that will be migrating over a year or so into Southern California. That work is going on.

As I mentioned, we've begun the work in the Northeast which is a major supply chain project. The biggest functional area, as you mentioned, this year that we have is in merchandising and marketing. That's well underway. We have quite a number of people who are moving this summer to Minnesota, as we said, that we were going to consolidate those activities; actually about 400 jobs, not 400 people, but 400 jobs are migrating to Minnesota. That is on time. The synergies that we began to see early on in cost of goods, we actually got a little bit of that last year, and it accelerated this year. I think we made very good progress in that regard.

I also commented earlier in the call on our owned brands. And that's an area where we think we can accelerate our synergies even quicker than even some of the other areas. So I think generally we don't see anything that we don't see as on track and on time, and as you've seen, our numbers have been very predictable over this last year and I think the synergies and the benefits we've gotten reflect that.

Mark Wiltamuth - Morgan Stanley

Thank you.

Operator

Our next question comes from John Heinbockel – Goldman Sachs.

John Heinbockel - Goldman Sachs

My questions have been asked. Thanks.

Jeff Noddle

John has no questions? I can't believe that.

Operator

Our next question comes from Ed Kelly – Credit Suisse.

Ed Kelly - Credit Suisse

Jeff, could you give us some color on how the quarter should unfold the next few quarters given that you have a few unusual events in here with Albertson’s losing a week of sales as well as I think there is a Labor Day shift from Q3 into Q2? If you could just give us some color on how we should be thinking about it, it would be helpful. Thank you.

Pam Knous

Well, I think that, Ed, you seem to understand it quite well. I mean, the key factor shifting are the fact that the acquired properties as all of you know, Albertson’s has been on a 13-week quarter. SUPERVALU is on 16-12-12-12. So as we cycle the second and third quarters of this year, our results will include 12 weeks of the acquired properties whereas last year would include 13.

As you know from a more of a margin perspective, the Labor Day holiday will shift into the second quarter consistent with how the holidays have flowed through the SUPERVALU calendar. I really think that those are the major items, Ed.

Ed Kelly - Credit Suisse

And just in terms of the Albertson’s stores on the weeks, is it just as simple as taking a week of sales at whatever margin we're using and removing that?

Pam Knous

Well, I think that you just need to remember that to the extent that you're shifting a major holiday, it is probably not as simple as a week, but you can certainly follow up with Yolanda to have further discussion around that.

Operator

Our next question comes from Eric Larson – Piper Jaffray.

Eric Larson - Piper Jaffray

Good morning. The last question was the same one that I was sort of going to drill down on. Given that you were in a transition year last year in your second and third quarters, obviously you have another year under your belt and you should have some operational benefits, I would think, year-over-year that could compensate for maybe some of that shortfall in weeks. Or are we really a first quarter/fourth quarter in terms of the size of the increase in quarterly gains in fiscal '08?

Pam Knous

I would say that a week of sales of the acquired properties is a fairly significant number, and so I think that you really need to really look at your model to make sure that you're adjusting for that week.

Yolanda Scharton

Keep in mind we're not opening that many new stores, so that wouldn't be flowing into the sales line, and we have reinforced IDs of 1 to 2, so it is really those factors you need to think about.

Pam Knous

I would say something to remember which somewhat confirms what you're saying is our guidance does equate to double-digit accretion year over year, so there is benefit coming in on a year-over-year basis. The key thing to remember is when you align those quarters, that's going to be a challenge point just because of the difference of a week. A week of the acquired properties is almost $500 million. That's a pretty significant shift.

Eric Larson - Piper Jaffray

I would definitely agree, and of course that's why I think we're drilling down a little bit on it here as well.

Just one quick follow-up question. I know it's a really specific question, and maybe Jeff can comment on it. How is your experience with the Sunflower stores? I think you have opened three or four now in Indiana, first one Indianapolis. How are those working out?

Jeff Noddle

Well, we said at the beginning on Sunflower that we were going to get about five or six stores open and take a look at how they're doing. The fifth store just opened several weeks ago in Columbus, Ohio. We now have one in Chicago, one in Indianapolis, actually three in Columbus. I think it is very early to assess it. We actually opened in a center that's just under construction and it is not done, so I think we're going to have to wait a few months before we see a little bit more of the results.

We're going to evaluate it this year, and we'll have more to say about Sunflower later in the year, but we certainly like the concept of it, and we think we're delivering great value to people who are primarily organic and natural shoppers. But at the same time in our stores and in all stores you're seeing a lot more organic and natural sections in traditional stores.

I think the playing field has changed a little bit in that regard, and we predicted at the beginning these products would go more mainstream, and we're seeing that across the industry. So we have to evaluate whether a separate distinct format is the right way to address it or incorporating more into traditional stores is a better path, and we'll be looking at that throughout the year.

Operator

Our next question comes from Chuck Cerankosky – FTN Midwest Research.

Chuck Cerankosky - FTN Midwest Research

Good morning, everyone. Jeff, I would like to ask, what are you looking at in terms of the drivers for investing margin in certain markets? What's driving the timing? What aspects of the competitive environment and geography are involved where you do this?

Jeff Noddle

Well, Chuck, there is really no new news here. We said from day one because one of the first questions I ever got asked when we announced this thing was in certain of the acquired properties people felt that Albertson’s over time had not put themselves in the price position people think they should have been. We said in some markets we agree and in some markets not, and it is not like we haven't concentrated or focused on this over the first year. We have; but we're just making comment that this year that as the year unfolds we'll be making some investments in certain markets. We're certainly not going to identify those. It's not all, but it's some. Where we think our overall mix of pricing, which is not just shelf pricing, it's promotion, it is online activity, it is price reflection from manufacturers, where we want to make adjustment in how that whole basket comes together.

So it is very specific by very specific markets and even different activities within those markets. Due to that complexity I am not going to identify those, but it really is not any new news here. We said we would migrate, we said we're in a better position this year to do it and we'll probably accelerate it in a couple of locations.

Chuck Cerankosky - FTN Midwest Research

Distribution consolidation or work in Southern Cal, you mentioned CVS. Is that just shifting the HDC-type merchandise into your own warehouses?

Jeff Noddle

Yes, it is. Part of the agreement, the La Habra distribution center in Southern California was acquired by CVS as part of the transaction. It actually supported both standalone drug stores and Albertson’s combination stores, primarily health and beauty care items and some general merchandise items come out of that facility. So we're in essence buying from CVS as they acquired it and we had an agreement that ends sometime this year. I am sorry, I don't remember the exact date.

So we're redoing the Southern California facility to handle it. We actually have moved some of the distribution currently to Boise, Idaho, but when we get our reconstruction done in Southern California, we'll move it all back in.

Operator

Our next question comes from Ajay Jain – UBS.

Ajay Jain – UBS

I just had a question on the labor contract in Southern California. My understanding was that the agreement is retroactive to March 5th, so for the retroactive period specifically, when do you expect those additional costs to be accrued or recognized?

Jeff Noddle

Well, the additional costs are accrued beginning on March 5th. The anticipation of a settlement we would always accrue when we have an open contract, we would always accrue to what at least we expect the results to be.

Pam Knous

And clearly we have the results to include in this quarter.

Jeff Noddle

All of this is taken into account with the guidance that you have for this year, and I would just make the comment that the outcome in southern California I think was very good, it was very good for our associates. They do get some improvement in wages and benefits. We felt that from day one that that was important that this occurred at this time in this contract and that's been achieved. Yet it was a good balance for us and came in fairly close to what we anticipated, and that's all included in our guidance for this year. The recognition is already there, Ajay.

Ajay Jain – UBS

If I could just ask one follow-up question on the synergy ramp up. I know it has been pointed out it is very early in that process and you talked already about the consolidation in Boise and the workforce reduction, but can you talk in terms of any net benefit you're getting based purely on lower corporate overhead or would you still say there is negative synergies, some residual costs in the transaction that are offsetting?

Jeff Noddle

We said in Year 1 there were some negative synergies, but I believe we also said at the end of the year we still had synergies that accrued right at the beginning of the transaction. For example, the two public company costs were eliminated early. Obviously we didn't need two CEO, CFOs, et cetera, and those costs were eliminated early. What that did was offset some of our negative synergies in the first year. Now this year we are realizing those benefits without question, but we also have some one-time costs being affected by relocation and some of those kinds of things.

We still do have some consultant costs ongoing as we made comment, Pam did, for the first quarter. Those will begin to tail off as the year unfolds as well, so there really is really again no new news in that regard. We're very much on track with what we said at the beginning.

Operator

Our next question is from Gary Giblen – Brean Murray.

Gary Giblen - Brean Murray

Hate to belabor the inflation topic, but I would like to understand, is there a consumer behavioral element to having more resistance to inflation or was it just the amount of inflation, especially in perishables, that created a swing in the quarter or a challenge?

Jeff Noddle

Gary, it is really a tough call in a short period of time. You can do it more looking retrospectively than you can at current data. I think there is some resistance that we saw. I can't quantify it. We saw some short-term climatic effects that affected produce, and of course the whole meat and dairy complex being affected by a tremendous rise in corn prices. I think consumers on the one hand will respond rather immediately to fresh meat and fresh produce, but I think overall the inflation rate, there is a delay factor I think as people adjust themselves. They have to get used to it for a little while.

But we continue to see, as I mentioned, earlier higher average ring and consolidated trips, and I think that's more driven by the gas situation than anything else, but it is really a tough call in a very short window that we're talking about.

Gary Giblen - Brean Murray

I can understand why at retail you would experience some degree of consumer resistance to a spiked inflation on produce or something from your wholesale standpoint where apparently you were not able to pass on that to your retail customers. Why is that? Just because the retailer thought the consumer wouldn't accept it, so pushes back to the wholesale level?

Pam Knous

Gary, I think maybe there is some confusion around that comment. As you know, our wholesale business is a question of supply and demand, and clearly with the very cold spring and some of the issues that we had as well as product inflation, there has been somewhat less demand for that type of product. So I think you have to look at that as Jeff said as a very situational moment in time, and it is not indicative of any long-term trend. It was a very slow crop season early in the spring due to the cold weather.

Gary Giblen - Brean Murray

So that was more slightly below plan on units whereas the other aspect is maybe consumer behavior? I am just trying to understand the comment in your press release because it talks about the inflation topic within the supply services segment. So you're saying that's units and not really retailer resistance?

Yolanda Scharton

This is Yolanda, and I can take this offline with you, but we really didn't say it was inflation-related in supply chain in the quarter. It was more a product mix and perishable margin performance, so I can discuss that with you offline if you would like.

Operator

Our final question comes from Bob Summers – Bear Stearns.

Bob Summers - Bear Stearns

Can we dig a little bit deeper into how you're thinking about the relationship between margin in the acquired business and comp growth? The comments were that you continue to hold the EBITDA margin in, but at the same time it doesn't seem like you're participating in the sales acceleration that the broader industry is seeing. Within that, could you give us what the EBITDA margin in the acquired business was in the quarter?

As we go ahead, at what point do you have to maybe start thinking about investing gross margin a little more aggressively if some of the initiatives you're pursuing right now from an overall consumer experience point of view don't gain traction?

Jeff Noddle

Bob, I want to come back and try to explain how we see this again because I think it is important to your question. There is no question that we have said we think it is a very good thing to see some of our traditional competitors put up some very good like-store sales numbers over these last several years because it is very good news for the industry.

As we talked before, there were some years ago that we said that would never occur again and it did. However, we are comparing ourselves against several companies who have had some very well thought out programs and have been working it for a long period of time. In both cases they've been at it for five years or more, and we don't need to take time on the call to go into differences between the two, but there are differences, but the fact is they've been at it for five years or more.

We said that particularly in bringing all the things together in the two companies that we thought we needed to bring together, that's a three-year journey; some of that relates to synergies and one-times and supply chain and those kinds of things. But also it is a general comment about bringing these stores up to the standards that we believe they should be, investing more against the consumer, making changes in merchandising and marketing.

Our bar wasn't very high in terms of our expectation on like-store sales from the beginning. We said over time we should migrate and certainly should look like the rest of the industry. Frankly, in the first year we had higher like-store sales, and we even anticipated it, which was very good news. We now of course, are turning the corner on some of those, and some of the further improvements are somewhat dependent on our remodeling program which is accelerating, which we said early in the year it will be back of half of the year before we begin to see the benefit, and are coordinated also with a lot of the merchandising and marketing things we're doing.

We made comments this quarter that we can see our way clearer now to make some investments in certain markets where we think we need to and we will do that. We are doing that because we're comfortable now. We know more. We know what our competition is. We know where we stand and we know what our outlook is in each market and the remodeling activity and the other things we're doing.

We just have a clearer view now, and those investments are not just made because of whatever our last quarter like-store sales performance was. We're trying to build loyal customers for the long term. We're just not going to do things just to make one quarter different than the next. What we're going to do is invest against a long-term attachment to customers, and that's really what we're making comment on today.

Bob Summers - Bear Stearns

Have you seen any initial traction in that? If we work from the argument that under the prior owners the businesses were shared donors, have you improved upon that rate?

Jeff Noddle

Well, you saw that in the first year, I will comment on the numbers we just had 1.7 in the acquired properties, the 1.8 in like store was the quarter before that. You can go back and look at the previous filings and see that they were pretty flat coming into the closing of the transaction.

Another factor, you're talking about those properties within Albertson’s which really were frozen for almost a year-and-a-quarter as the company was up for sale. By frozen I mean they just didn't take a lot of new initiatives on and they certainly weren't going to invest a lot against the future in that regard. But we had an accelerated performance in the acquired properties; they were actually negative in the first quarter we reported and we accelerated upward from there. I am not going to comment prospectively. It is within our 1% to 2% guidance that we have, but we watch it very closely.

Bob Summers - Bear Stearns

I might have missed it, but what was the EBITDA margin in the acquired businesses in the quarter?

Pam Knous

Actually, Bob, what I did is I gave out the pieces, so you can assume that sales are around $7.5 billion. EBIT is approximately $332 million, and depreciation and amortization expense is $237 million.

Yolanda Scharton

That wraps up today's call. Thanks again for joining us today and we look forward to seeing you in the near future.

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Source: SUPERVALU F1Q08 (Qtr End 6/16/07) Earnings Call Transcript
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