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SUPERVALU INC. (NYSE:SVU)

F2Q08 Earnings Call

October 16, 200710:00 am ET

Executives

Yolanda Scharton - VicePresident, Investor Relations and Corporate Communications

Jeff Noddle - Chairman, Chief ExecutiveOfficer

Duncan MacNaughton - Executive Vice President, Merchandisingand Marketing

Pam Knous - Corporate ExecutiveVice President and Chief Financial Officer

Analysts

Charmaine Tang - Citigroup

John Heinbockel - Goldman Sachs

Edward Kelly - Credit Suisse

Steve Chick - J.P. Morgan

Meredith Adler - Lehman Brothers

Perry Ciacco - CIBC World Markets

Robert Summers - Bear Stearns

Mark Husson - HSBC

Operator

Good morning, ladies and gentlemen, and welcome to the Q2fiscal 2008 earnings conference call. (Operator Instructions) I would now liketo turn the call to Ms. Yolanda Scharton. Ms. Scharton,you may begin.

YolandaScharton

Thank you. Good morning, everyone. As you know, today’s callis webcast and will be archived for a few weeks and be available on our websitefor future listening. On today’s call today are: Jeff Noddle,SUPERVALU's Chairman and Chief Executive Officer;

Pam Knous, Corporate Executive Vice President andChief Financial Officer; as well as Duncan MacNaughton, Corporate ExecutiveVice President of Merchandising and Marketing.

Today’s information presented anddiscussed includes forward-looking statements which are made under the SafeHarbor provision of the Private Securities Litigation Reform Act. The risks anduncertainties related to such statements are detailed in our fiscal 2007 10-K.

After today’s call, we will have aQ&A session and if you can, I ask you to limit it to one question so we canaccommodate everyone, as we have a very large group on the phone this morning.As always, I will be available after the call for additional questions.

Thank you and now I would like toturn the call to Jeff.

Jeff Noddle

Thanks, Yolanda and welcome to today’s call. As you know, weare on a three-year journey to deliver the full economic benefits as mapped outin 2006 following the acquisition of Albertson’s premier retail property. Wehave now fully cycled the first full year of the acquisition and we remain ontrack with virtually every key metric, including the delivery of the fifthstraight quarter of double-digit earnings per share improvement.

In the second quarter, we reported diluted earnings pershare of $0.69 compared to last year’s reported diluted earnings per share of$0.61, an increase of 13%. When adjusted for last year’s extra week in theacquired property, earnings per share increased by 18% in the first truequarter-over-quarter comparison.

Also in the second quarter, we delivered operating earningsmargin improvement on a year-over-year basis. This improvement reflects ourability to generate sales leverage, manage our costs, and deliver the synergybenefits.

One area in the quarter that did not fully meet ourexpectations was identical store sales. When we provided fiscal 2008 guidance,we estimated ID sales growth of 1% to 2%. As such, our earnings growth plan forfiscal 2008 was not dependent on significant ID sales improvement. That has notchanged.

Despite this expectation, we are not pleased with our IDsales performance this quarter. Second quarter ID sales, excluding fuel, forthe entire network increased year over year by approximately 50 basis points.

As we commented, sales softened as we finished our firstquarter. Deflationary pressures in our pharmacy business from increased salesof generics continued in the second quarter, causing a 30 basis point decreasein ID year over year. In addition to competitive challenges in several markets,we did not adequately plan for and cycle prior year promotional activities.

However, our current run-rate is slightly improved. As such,our ID sales range for the year remains at 1% to 2%, with the expectation thatwe will be at the low end of the range.

However, I assure you; ID sales improvement is one of ourtop priorities and I am confident that as we continue to invest in remodels, inimplementing our merchandising and marketing program, and execute at the storelevel, our banners will be well-positioned for success.

It is this confidence that allows us to introduce anidentical store sales goal today of 3% or more during fiscal 2010. Our fiscal2010 year begins in March of calendar 2009, or in about 16 months.

This goal is based on several things. First, where westarted from; as you’ll recall, the ID sales of the acquired operations wereslightly negative at the time of the acquisition; the success and pace of ourremodels over the next few years; and the building of the momentum of ournumerous merchandising and marketing activity.

So now let’s turn to the initiative we have underway todeliver the full potential of SUPERVALU. As you’ll recall, in most cases theproperties we acquired had excellent market share position, superb real estatelocations, and top notch local management. We also knew we needed time toimprove several key operations -- several key aspects of our operations toignite sales.

I would like to quickly cover the key activities we areimplementing to build momentum over the next few years and contribute to ourlong-term sales success.

Achieving the right pace of combination for an acquisitionof this magnitude is a very important component to ensuring SUPERVALU'slong-term success. Some may say we are moving to slow on certain aspects; somesay too fast. From day one, we have said this was a three-year effort and weare holding to this timeline. And remember, we are almost halfway through thattimeframe.

What we took on first was in-store customer service, orraising the standards across our store base. It was an area we could quickly implementand have impact. Customer service programs are currently deployed across all ofour banners and showing steady progress. These programs also engage all of ourassociates, building a common culture across the company.

Next, we began to implement a sizable retail capital programof approximately $1 billion. Most of this capital is directed to the biggestarea of sales opportunity, our remodel program. It will take a sizable amountof capital and a number of years to achieve a store network that is 80% new ornewly remodeled in the past seven years.

Starting with the second quarter of fiscal 2007 through endof the second quarter of fiscal 2008, we have completed 100 major remodels and35 minor remodels. Each major remodel represents a spend of between $1 millionand $4 million.

Our remodel activities are ramping up in the back half ofthis year and we now expect the completed total of 110 to 120 major remodels,which is up from 100 to 110 given previously. In addition, we expect tocomplete 25 to 35 minor remodels for the full fiscal year. The increase in ourremodel activity is all within our $1.2 billion capital plan.

Since we are at the one year point, I will quickly commenton a couple of the specific remodels we previewed with you as representativelast year at this time. As you know, our remodel program is called premium,fresh and healthy, which consists of tailored modules for each demographic andbanner proposition. We chose not to take a broad-brush cookie cutter approachto our remodel program, but instead utilize a disciplined, localized approachwith built-in flexibility so we can be locally responsive to our customers intheir respective community.

For example, in Cambridge, Massachusetts, we remodeled a 56,000 square foot Shaw’sstore that was last remodeled in 1991. The $4 million capital project includedan enhanced produce, meat, deli and bakery department. In addition, wesignificantly enhanced and repositioned the entrance in this densely populatedneighborhood located only minutes from downtown Boston and very close toHarvard College.

Since the remodel was completed in late August, averageweekly sales exceed the prior year by approximately 9%.

Another successful early remodel that we discussed last yearis the one in Fullerton, California. This Albertson’s store was opened in 1998and never remodeled. This store serves a large college population, asignificant Hispanic population, and has a considerable high income customerbase as well.

With tailored modules, such as wild harvest and shop theworld, this remodeled store has seen average weekly sales up nearly 8% comparedto the prior year. These remodeled stores are clearly delivering internal rateof returns well in excess of 15%.

Even though it is not our practice to comment on anindividual banner, I would like to make a few comments on Shaw’s, as therecertainly has been much written of late.

As you may recall, Shaw’s was acquired by Albertson’s, notuntil 2004 and was never integrated into Albertson’s programs or systems.Therefore, our migration of plans and activities at Shaw’s are different thanall other banners. Clearly Shaw’s stores have premium real estate and awell-developed loyalty program, making them prime candidates for a strongremodel program, as well as enhanced merchandising.

In fiscal 2008, we will complete 20 major remodels,representing almost 10% of the chain. To date, half of these remodels have beencompleted and we are very pleased with the performance we are seeing.

In addition to remodels, we are also building new stores inthis market. One new store that we are seeing fantastic results it the EastHampton Connecticut store. The store opened in September of last year and theyear-on-year cycle starts this week. The store is averaging in excess of $0.5million in sales per week and well ahead of expectation.

We also recently made a management change at Shaw’s. When CarlJablonski announced his retirement as banner president, Larry Wahlstrom, formerlypresident of our Jewel Osco stores, took the top job at Shaw’s. Larry actuallyspent 16 years in this market so he understands the competitive New Englandmarket very well.

As I have said many times, we see tremendous opportunity atShaw’s to enhance our brand loyalty through a variety of initiatives that willgenerate long-term sustainable growth.

Coming behind our important remodel and customer serviceprogram is our center led merchandising and marketing organization that willcollaborate with our banners and leverage the scale and potential of ourcoast-to-coast store network, while maintaining local relevance.

This competency will have tremendous potential to drivelong-term success across the organization. To date, we are making good progresson this initiative. As you know, moving from a decentralized model to a morecentralized one will cause some natural friction with associates, vendors, andservice providers. Naturally, our changes impact all of them as well but wefirmly believe it is the right decision and we are moving forward at the pacewe consider appropriate.

Now I am going to take a moment to make a general commentabout pricing surveys. They have been very popular recently and written aboutas well. As you are well aware, a pricing sample may or may not be a good indicatorof the actual price paid by the customer.

For grocery retail, a comprehensive survey would need totake in all pricing variation, including special buys, advertised specials,temporary price reduction, coupon, and loyalty card benefits both at the storeand at home, to list a few. These variables make it very difficult for many toget a reliable sample.

We monitor all of our markets across the countryconsistently and we are well aware of what the actual spreads to ourcompetitors are. It would be great to be in a market that we hold a leadingmarket share position with a large, unfavorable price spread to our primarycompetitors in the mid-teens, as some have written about in certain markets.

The truth is that would never happen and it doesn’t today.As I have said many times, we’ll be making pricing investments when needed asany retailer would to be competitive. We need to be competitive not only inprice but in service, selection and quality to deliver overall value to theconsumer.

I hope this gives you an idea where at least I stand onpricing surveys. Now let’s move on.

The foundation is now laid for our national merchandisingprograms, including acceleration of our owned brands private label, new productintroduction, high impact seasonal promotions, and center store initiative.

To hear more about this, I will turn the call over to Duncan MacNaughton, our Executive Vice President of Merchandisingand Marketing, who will share with you some of the very exciting merchandisingactivities underway. Duncan.

Duncan MacNaughton

Thank you, Jeff. I’m thrilled todiscuss the progress that we are making on our merchandising and marketingefforts. In the interest of time today, I am going to focus on three keyactivities that are underway to deliver the tremendous potential of SUPERVALU.

First, leveraging our scale; ourmigration to a more centralized model that leverages our scale and buying poweris essential to our future success. In addition to the cost of good savings,this model also leverages our ability to deliver stronger merchandisingprograms, category planning, assortment enhancements, advertising andpromotional initiatives, and new product introduction, which in turn driveretail sales.

Yet we don’t underestimate the needto be locally relevant. When our SKU commonality across the country exceeds acritical mass threshold, a central procurement model is vital. When SKUs aretruly local, the banners manage the deal. We call this go-to-market modelcorporate led collaboration.

As we finalize SUPERVALU'smerchandising and marketing center of excellence, it must be based on acustomer-centric, locally relevant philosophy. Without this underpinning, ourprograms will not resonate with the consumer. We are taking this to the nextlevel by enhancing our already strong research and analytical capabilities tofurther harness loyalty card data, including using real-time information,target our distinct customer segments by banner and by market, and create newways to engage, educate and motivate our shoppers.

The next key activity underway is theacceleration of our owned brands program. Clearly this offers a substantialopportunity for SUPERVALU. With SUPERVALU's owned brands, or as some of youmight call, private label, at only 15% of total sales today and manycompetitors well above 25%, we have lots of upside in sales and gross marginopportunity.

Let me give you a quick update onthis exciting initiative. We have already begun to reduce our label count from100 to approximately 20. The rationalization of our label count will result insome savings or synergies.

Our owned brand product strategy isfocused on a powerful, three-tier philosophy offering premium private label, anational brand equivalence, and a value label. With a targeted spectrum ofquality and value, our products will be attractive options to all of ourcustomers.

Product rollout will be in phases andby category over the next year and beyond. One large launch will occur shortlyafter the end of the calendar year. Many of our product labels and packagingare currently being updated, or in some cases completely relaunched.

And lastly, strong in-storemerchandising programs will support our owned brand efforts.

As you know, private label productsdeliver higher margins than their national brand counterparts, but equallyimportant is they offer a powerful pricing proposition to our customers lookingfor value.

As we increased our penetration ofowned brand products across the banners, it provides another strong buildingblock for our many other initiatives that are taking root, like customerservice and our premium, fresh and healthy remodel program.

The last key activity underway isleveraging our center store. As you heard today, our remodeled stores areshowing some very nice results and we will certainly continue to refine andtweak this program with learnings from our banners. But we are alreadydeveloping the next in-store initiative -- the center store. As you know, ourremodel program primarily focuses on theperimeter departments. We need to also drive center store sales and profits.

We have a world class team of centerstore merchants with deep category knowledge, merchandising expertise, andmarket experience. This team has been identifying new ways to leverage thescale of our new enterprise to benefit our center store and absolute focus onincreasing both sales and margin across all departments, while creating ashopping destination that is customer-centric and easy to shop.

We are still relatively early in ourcenter store process but we’ve had some early wins that show us we are on theright track. Several of these have come through our revamped first to marketprogram. Being first to market has many advantages for center store. It allowsus to drive new incremental sales and profits and generates excitement in ourstores, helping us to grow market share and win core consumer loyalty.

In recent months, [we have relied on]some important product launches in soda, cereal and soup. Recent examples ofthis are the launches of Diet Pepsi Max, Kellogg’s Cereal Straws, andCampbell’s Chunky Fully Loaded Soups. Through collaborative efforts across thecompany and with our vendors, we had 100% of all commodity volume, or ACV, forthe first two weeks of each product’s market introduction. The products werevery well-received by our customers as well.

These are definitely early wins thatsupport our first-to-market vision in center store.

Additionally, we are working with ourvendors on exclusive seasonal merchandising and product introduction. I can’tsay too much about these today but they are another indicator that we areleveraging our relationships with our suppliers as we build our center ofexcellence.

I look forward to sharing our ongoingprocess in creating a merchandising and marketing competency that is abest-in-class organization that fully supports long-term retail success anddelights our customers. I am confident we are on the right path to drive topline sales with compelling, timely and localized offers to our shoppers.

Now I would like to turn the callback to Jeff.

Jeff Noddle

Thanks, Duncan. Now let me turn to our outlook for fiscal2008. For the full year, we remain on track. We have our fiscal 2008 earningsper share guidance of $2.93 to $3.03 a share, which is before one-timeacquisition related costs of approximately $0.20 a share. This range representsan 11% to 15% increase over last year. On a GAAP basis, our range is $2.73 to$2.83, representing an increase of 18% to 22%.

The source of the earnings growth this year will include acombination of the following: a full-year’s impact of the acquisition, as weare comparing to 37 weeks of acquired operations in last year’s results;continued improvements in our operations, ranging from improved store standardto ongoing expense management; the benefit of approximately $40 million to $50million in pretax net synergy as we overcome the negative synergies from lossof scale, primarily from the sale of the standalone drug business. Netsynergies this year will come primarily from cost of goods savings and lowercorporate overhead costs; and lastly, earnings will be aided by deleveragingthe balance sheet as we march toward the $400 million goal of annual debtreduction.

With that, I would now like to turn the call over to Pam Knous. Pam.

Pam Knous

Thanks, Jeff and good morning,everyone. We are very pleased with our financial performance in the secondquarter. With the exception of identical store sales, we delivered on virtuallyevery key metric. Through strong expense management, the elimination of 79under-performing stores, primarily the acquired properties, benefits ofmerchandising programs, the emergence of synergies, and interest expensesavings coupled with the expected reduction in depreciation expense as a resultof the final purchase accounting valuation, we improved margins across theboard. This improvement more than offset the previously announced store closurecosts in the second quarter.

Our performance this quarterdemonstrates SUPERVALU's ability to deliver continued earnings improvement aswe have cycled the acquisition and now have meaningful year-over-yearcomparisons.

My comments this morning will coverthree areas; operating results for the quarter, a synergy update, and review ofour financial condition.

Total sales for the second quarterwere $10.2 billion compared to $10.7 billion last year. The sales decrease isprimarily attributable to one less week of acquired operations compared to lastyear, which approximates $450 million. As a reminder, our third quarter willalso have one less week of acquired operations than last year.

For the quarter, increased sales fromnew stores and positive ID sales were more than offset by the closure ofunder-performing stores.

Total gross profit as a percent ofnet sales was 23% for the second quarter of fiscal 2008 compared with 23.1%last year. This change primarily reflects the decrease in net sales for retailfood resulting from one less week of acquired operations in the quartercompared to last year.

When adjusted for one less week ofacquired operations in the quarter, our gross margin was up approximately 20basis points, primarily reflecting the benefits of merchandising programs,including certain cost of goods synergies.

SG&A was another area where wesaw good progress in the quarter. In the second quarter, SG&A as a percentof sales was 19% compared to 19.4% in last year’s second quarter, or 19.2% whenadjusted for the extra week. The reduction in our SG&A rate reflects loweremployee related costs, including health and welfare, workers’ comp, andpension, as well as lower depreciation expense, which more than offset storeclosure costs.

We expect to see favorablecomparisons in SG&A as a percent of sales for the remainder of the year,despite the impact of anticipated additional store closure costs for previouslyannounced closures.

Looking at our retail segment, whenadjusting last year for the extra week, retail EBIT was up 13% over the prior year,a double-digit increase in our first year-over-year comparison. Retailoperating earnings in the second quarter were $385 million, or 4.8% of sales.This compares to $361 million, or 4.2% of sales for the second quarter of lastyear. This improvement reflects leveraging the scale of our retail operations.

As we have said, our ability to driveresults in fiscal ’08 is not dependent on significant ID improvement.

Turning to the supply chain servicessegment, sales in the quarter were $2.2 billion, up 1.8% over the prior year asstrong, new business was more than offset -- I’m sorry, as strong new businessmore than offset attrition, which included the loss of Clemen in the thirdquarter last year.

Supply chain operating earnings inthe second quarter increased by 12% to $63 million, or 2.9% of sales. Thiscompares to $56 million, or 2.6% of sales for the second quarter of last year.

In regards to other items in thequarter, we incurred approximately $19 million of pretax, one-time acquisitionrelated costs, which included eastern region supply chain consolidation costs,retention expenses, and consultant fees.

I would like to provide a quick recapon our one-time costs since the acquisition. Last year in fiscal 2007, weincurred $65 million. This year, we expect to incur approximately $70 millionand in fiscal 2009, we expect to incur the remaining $10 million for a total of$145 million pretax, matching our original estimates from 2006.

In total, the majority of ourone-time costs had been necessary to plan and implement key acquisition-relatedactivities, as well as retain necessary resources as we combine our twocompanies.

Wrapping up the earnings discussion,reported diluted earnings per share in the second quarter increased 13% to$0.69 per share, compared to $0.61 per share last year, and as Jeff said, whenadjusted for the extra week, earnings per share increased by 19% in the firsttrue quarter-over-quarter comparison.

Outstanding shares at the end of thequarter were 211 million. Year-to-date, we have repurchased approximately 5million shares under our stock repurchase program, including 3 million in thesecond quarter.

I would also like to spend a fewminutes updating you on our synergies. Today, we have provided a range of $40million to $50 million of expected synergies by the end of fiscal 2008.Positive synergies now exceed negative synergies; therefore, synergies areoverall benefiting our results in year two.

Our synergies will come from thefollowing three large categories.

Retail leverage and efficiencies,primarily resulting from a reduction in cost of goods sold. We started to seesome of these benefits in the first quarter and expect to see them for theremainder of the year.

Corporate synergies come from theelimination of duplicative corporate overhead, as well as systemsrationalization. The elimination of corporate overhead for the most partoccurred during year one. Until we migrate to common platforms and processes,the majority of the additional corporate synergies will not occur until late inour three-year plans. Supply chain optimization will come primarily fromnetwork rationalization, as well as utilization of common warehouse andtransportation management systems. At the end of the second quarter, we standardizedthe Lancaster facility, an important milestone of the East Coastrationalization initiative. This is the first of 10 facilities to bestandardized. This important effort will also take three years to complete, sowe do not disrupt service to our customers, thus minimizing overall risk.

To wrap up the synergy discussion,our estimate of $150 million to $175 million of synergies is a net figure,which is after absorbing our negative synergies. Going forward, the best way totrack our synergy progress is to monitor our EBITDA margins against ouroriginal pro forma assumptions, or approximately 30 to 40 basis points on $44billion of sales. As synergies are realized, you will see EBITDA marginimprovement.

As a reminder, pricing investmentshave never been a component of our synergy expectations. As Jeff has oftensaid, we may choose to invest in some of our markets to enhance our overallbrand proposition, not different than what any other retailer would do, and webelieve we have the flexibility to do so when necessary and deliver on ourearnings guidance.

Turning now to our financialcondition, net cash provided year to date by operating activities isapproximately $1 billion for fiscal 2008, representing 28 weeks of the combinedoperations. I know there has been a lot of confusion about cash flow generationand as we have discussed previously, the prior year cash flows weresignificantly impacted for the three quarters post-acquisition close frompayables related to standalone drug, non-core, and acquisition-related payouts.

Therefore, not until these mostrecent 28 weeks have you been able to simply take the totals and not add backfor these non-recurring items.

From a balance sheet perspective, weare on track. Debt to total capital at the end of the quarter was approximately61% compared to 62% at the end of the first quarter, and 64% at the end offiscal 2007.

As you are aware, our goal is toreduce debt by at least $400 million annually, starting in the first full yearafter the acquisition, which is from June 2007 to June 2008. When you look atthe balance sheet as of this quarter, you will see debt reduction ofapproximately $540 million. This is purely a function of timing, other than the$140 million mentioned in quarter one that we are ahead of schedule in thefirst year.

As we enter our peak borrowing seasonin the third quarter and accelerate our remodel program in the last twoquarters, we are on track with our goal to deliver an additional $400 millionof debt reduction by Q1 FY09.

In addition, we expect workingcapital to favorably impact cash flow at year-end, reflecting continued focuson inventory and other balance sheet metrics after the seasonal peak.

We are in full compliance with ourdebt covenants. The second quarter reported EBIT of $406 million, depreciationand amortization expense of approximately $228 million, net rent expense ofapproximately $87 million, and total debt of $8.9 billion. These financialresults put us well within our required covenant levels.

Capital spending through the firstsix months was $511 million. We still expect to be at $1.2 billion for theyear. The majority of the remodels in the pipeline were slated to be completedin the third and fourth quarter, and we remain on plan with this importantinitiative.

For the full year, retail capitalspending is estimated at 2.9% of total retail sales, representing a strongcommitment to our retail operations.

In summary, we are pleased with theseresults and remain on track with our three-year plan. We measure our success bysales performance, improvement in operating margins, debt to capital ratio,delivering on our annual EPS guidance, as well as return on invested capital.

In addition, we are generating strongcash flows which will fund our capital plan, allow us to reduce debt, paydividends and drive returns to our shareholders. We are making progress towardreturning to investment grade and we remain focused and committed to ourlong-term goals of 15% return on invested capital.

Thank you, and now I will turn thecall back to Jeff.

Jeff Noddle

Thank you, Pam. In closing, simply stated, our three-yearplans are being executed and we are committed to delivering our goal. As Pamindicated and she detailed, we will achieve full delivery of our $150 millionto $170 million in net synergies and continue to generate substantial cash flowto reduce debt, putting us in the position to regain investment grade.

We are well on our way and I am confident that we arebuilding a strong enterprise for the long haul that will translate into returnsfor our shareholders.

Now we’ll be happy to take your questions. Operator.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question comes fromDeborah Weinswig from Citigroup. Please go ahead.

Charmaine Tang -Citigroup

Good morning. It’s Charmaine Tang for Deb Weinswig. Can youtalk a bit about the impact of food inflation, what you saw in the quarter?

Jeff Noddle

As we commented in the first quarter, we said that food inflationwas running higher as we enter this new year, between 2% and 3%. I think wesaid in the first quarter that we were trending toward the high side of thatnumber. That is pretty consistent with what we saw in the second quarter, so Ithink the trends really are no different than they were in the first quarter.We are still hopeful that we’ll see some abatement but we’ve seen oil pricesspike here recently and although some commodity prices have improved somewhat,it is still not enough to say that we see a lower run-rate during the thirdquarter but we are still hopeful as we move through the year that we’ll seesome abatement, particularly in the meat and dairy complex.

Charmaine Tang -Citigroup

And then just one other question; can you share some of yourrecent observations on your core customer? Specifically, did you see anytrading down behavior during the quarter?

Jeff Noddle

Well, we also made the comment in the first quarter -- andlet me prepare that comment by saying remember, we look across probably abroader spectrum than most food retailers when we comment on how the consumeris reacting because we are looking through a window that includes theSave-A-Lot customer, which is a lower income demographic, all the way throughmore traditional to even the high end as well. And we did make a comment thatwe did see some trading down, particularly looking at our Save-A-Lot, throughour Save-A-Lot window.

Those trends were fairly consistent in the second quarter aswell, so the trend we saw in that regard I think continues. I think it is notof any great surprise with the pressure from fuel prices, the resets of homemortgages. I think those issues clearly are making people more prudent in theirgrocery shopping and we think because of our wide spectrum, we have a greatwindow and a good opportunity in that regard.

Charmaine Tang -Citigroup

Great. Thank you.

Operator

Thank you. Our next question comes from John Heinbockel fromGoldman Sachs. Please go ahead.

John Heinbockel -Goldman Sachs

If I wanted to drill down on the 2010 comp target, whatrough number of remodels do you think you will do in calendar ’09? Slightly upfrom this year or the same or what?

Jeff Noddle

You know, we haven’t given any numbers yet, John, for thatbut as you notice, we ramped up another 10 to 20 or so, depending on the range,for this year. I would certainly hope that we could do that or even hopefullymore next year. Later in the year we’ll have a more definitive outlook on thatbut that’s certainly our plan at this point.

John Heinbockel -Goldman Sachs

And you would be disappointed, I guess, if on balance, ifthe remodels first year didn’t give you a double-digit comp increase? Wouldthat be disappointing or is that too optimistic?

Jeff Noddle

It is very dependent on the exact project. We cited twotoday that are in very mature markets with not a lot of competitive change andI think we cited one was 9% and one was 8%, and those are certainly adequate tomake the returns that we need from remodels.

We will have some that will go significantly above that andthere will be some that will have a competitive situation that will producelower than that. It really is project dependent. And on some cases, we areactually relocating stores, John. We are relocating a store and actuallysometimes the rules say you can’t includes those in like stores, which is avast mystery to me, by the way, but those are accounting procedures.

So those kind of projects, again we would expect even agreater increase.

John Heinbockel -Goldman Sachs

Finally, what that then looks like is to get to three, it isnot totally remodel driven. It looks like it’s about half remodel driven andmaybe half improvement in non-remodeled stores. Is that pretty fair?

Jeff Noddle

That’s your calculation. My comment would be yes, it is notjust remodel dependent. There are a number of initiatives. I think the onecomment I would make, we highlighted that early on, the thing that we could dofirst was improve the service standards in our stores. And if you think aboutthat, we could do that but it’s really out of significance without much of acapital and something we could do early on in the transaction. We highlightedthat from day one and I think some of the early progress we have on like storesales that first year were actually from that initiative.

Now, we are investing hard dollars against the consumer inpremium, fresh and healthy, in the remodels of the store, and investingsignificantly in building a marketing competency at the same time.

So I think all those things are essential elements to usproducing that kind of number in fiscal 2010 or better.

John Heinbockel -Goldman Sachs

Okay, thanks.

Operator

Thank you. Our next question comes from Edward Kelly fromCredit Suisse. Please go ahead.

Edward Kelly - CreditSuisse

Good morning. Nice quarter. Jeff, could you talkspecifically about what you think led to an improvement in the sales toward theend of the quarter?

Jeff Noddle

Ed, I would like to have that complete vision but it’s alittle hard to do. As we commented when we reported our first quarter, we saw asoftening at the end of the quarter and it continued into the beginning. Therejust seemed to be that period of time had a softening of sales. It’s reallyhard to arrive at a specific cause or specific metric and, as we commented onthe call, we have seen slight improvements in spend.

I noticed some other retailers also reported during thattimeframe that -- Costco happens to be one that sticks in my mind that reporteda real softening during that same period of time.

I would remind you also, we were beginning at that time tocycle positive year-over-year comps, which we still continue to compare againsttoday. As I mentioned a year ago, I think we got some early wins, particularlyout of the service initiative.

I don’t have anything more specific for that short period oftime.

Edward Kelly - CreditSuisse

If I read your comments correctly, it kind of sounds likeyou are confident that you can maintain the profitability of the acquiredstores, achieve your $150 million to $175 million synergy estimate, and yetstill selectively invest in price. Does that mean that the price investmentultimately comes from other areas, such as potential synergy upside? Is thathow we should interpret that?

Jeff Noddle

I think that’s certainly a potential source but you know,there are a lot of good -- we announced this thing a year ago January, so a lot-- the world doesn’t stay static and there are a lot of opportunities for usthat are clearer now than they were then, whether they be cost opportunities,whether they be cost of goods magnitude, and certainly some of those, you know,if we exceed our synergy target, we have the option available to us and what dowe do with that? Do we invest that against price?

You know, we make those decisions really frankly everysingle day, even if we weren’t in the midst of a major acquisition. So I thinkit’s a combination of a lot of factors and I guess at the end of the day, adollar is a dollar and we try to make a measured decision on how to invest it.

Edward Kelly - CreditSuisse

Okay. And it seems like your free cash flow this quartermust have been very strong. I mean, you had significant debt reduction, youbought back 3 million shares -- how should we think about going forward? Youknow, anything in excess of that $400 million that you would either spend onshare repurchase or debt reduction or remodels?

Pam Knous

Well, as the guidance that we’ve given at this point is forthe $400 million for this timeframe, and that is our guidance so we are notchanging that guidance.

Edward Kelly - CreditSuisse

Okay.

Jeff Noddle

I have said several times before that if our cash flows arestronger, our first priority is primarily on the $400 million to pay down debt,which we’ve committed to. If the cash flows are stronger, we will consideraccelerating remodels. As you’ve seen, we’ve ramped those up a little bit, eventhough still staying within our capital plan for this year. But that’s alsogoverned by how many you can do at any single time. We certainly, if we thinkthere is available, we can still hit our financial metrics on debt, then wewould consider ramping those up faster if we think that’s feasible.

Edward Kelly - CreditSuisse

Last question, I guess a question for Pam, your LIFO chargeincreased sequentially. It actually looks like it penalized you by about $0.01.How should we look at that in the second half of the year?

Pam Knous

Well, what we see, you know, as Jeff commented on, we areseeing inflation running at the 2% to 3% level and as a result of that, we haveincurred a higher LIFO charge in the second quarter and absent some significantchange in that trend, you should assume that this higher rate of charge willoccur in the third and the fourth quarter.

Jeff Noddle

I would just add that remember that not all those categoriesthat have high inflation at the moment are LIFO categories, such as fresh meat,for example, so just keep in mind. I think what Pam is saying is that isindicative of what the impact might be, but if you get a spike or fall in thenon-LIFO category, that still might not change the outcome.

Edward Kelly - CreditSuisse

Okay. Thank you.

Operator

Thank you. Our next question comes from Steve Chick fromJ.P. Morgan. Please go ahead.

Steve Chick - J.P.Morgan

Thanks. I was wondering I guess first, with the $40 millionto $50 million of net synergies that you are targeting for this year, FY08, I’mnot sure if for the first half if you’ve told us what the run-rate has been andif that’s a net number that you would expect to garner in the second half here?

Pam Knous

No, what we have said, Steve, is in the first quarter, thesynergies had just started to emerge, so really just to make sure this isabsolutely clear, that means we really just overcame the negative synergiesjust slightly in Q1. So at this point, when we talk about synergies, it’sbecause they are actually having a favorable impact on the bottom line.

And we were actually slightly above that rate in the secondquarter. We didn’t give a specific number and we’ll -- we will move to thatlevel kind of pro rata over the remainder of the year. We have given you arange of 40 to 50 because a lot of it is dependent on timing and other thingsthat could possibly shift, but this is where we are at right now.

Steve Chick - J.P.Morgan

Okay. I guess I could understand maybe you don’t want to gettoo granular with it, but is it -- I mean, is it safe to assume that say $10million has been achieved in the first half and the remainder is second halfrelated, or we can --

Pam Knous

We’re not going to give the specifics by quarter.

Steve Chick - J.P.Morgan

Okay, but I guess it is safe to assume that the bulk or thechunk of it is second-half related? I guess we’re not going to go there.

Pam Knous

We’re not going to give guidance by quarter.

Jeff Noddle

Well, do remember also, Pam commented on the first quarter,that’s a four period quarter for us also, so you have to kind of do your ownanalysis and weight those across, but that’s the number we think we willachieve for the year. Clearly -- well, I’ll leave it at that.

Steve Chick - J.P.Morgan

Okay, second question, if I could; the depreciation andamortization expense was a little tough to model I think for the quarter. Whatis your expectation where depreciation and amortization will be for the year?And of the year-over-year decline this quarter, which I think was about $36million or so, how much of that decline might have been related to the lack ofthat extra week from Albertson’s?

Pam Knous

I think that, you know, we haven’t given specific guidanceon depreciation expense but you are exactly right, Steve, that clearly a weekof depreciation from the acquired properties is a sizable number and actuallytoo if you would look at a new Albertson’s 10-Q, which was filed for thisquarter off a couple of weeks but still a quarter of results, you’ll be able toget pretty close to what that incremental week of depreciation was. But that isa sizable number.

And then as I commented in my remarks, we have closed inthis timeframe 79 underperforming stores, and so to the extent that those wereall under, we had equipment in them. There clearly were fairly significantdepreciation charges related to that, as well as then we’ve been on our highercapital spending program, really launching it last year. Our capital spend lastyear was $1 billion and we are on pace for $1.2 billion this year.

So to -- I would say that this probably is the best youcould use as kind of a proxy for the run-rate, but I think that the impact ofthe store closures and some -- and the ramp up of the capital in the back halfof the year will result in there not necessarily being a consistent patternacross the four quarters.

Jeff Noddle

And remember the third quarter still has an extra week inlast year and then in the fourth quarter, we are comparable.

Steve Chick - J.P.Morgan

Right, but I guess if I take this quarter’s run-rate andkind of think about it on a per week basis, that’s a good starting point interms of getting to the rest of the year?

Pam Knous

Definitely.

Steve Chick - J.P.Morgan

Okay, and then sorry, to clarify, the 79 closures, Pam, isthat for the -- is that over the last year plus of the deal or is that the lasttwo quarters? How many stores did you close in the quarter?

Pam Knous

Actually, that’s the count from second quarter of last yearthrough second quarter of this year. I don’t have the count for the quarter.Yolanda can get that for you later.

Steve Chick - J.P.Morgan

Okay, great. Thank you.

Operator

Thank you.

Jeff Noddle

By the way, that includes Scott’s, the sale of Scott’s aswell. Sorry. Go ahead, Operator.

Operator

Our next question comes from Meredith Adler from LehmanBrothers. Please go ahead.

Meredith Adler -Lehman Brothers

I would really like to talk about a topic that I don’t thinkhas been discussed very much, which is the frequent shopper program. I guess tosome extent this question is aimed at Duncan but it is not something thatSUPERVALU had before and I don’t actually remember how sophisticatedAlbertson’s was in using the data they got. Do you see that as an importanttool in terms of what you are going to be able to do to drive sales goingforward?

Duncan MacNaughton

Meredith, great question. Thanks. The loyalty programsacross the Albertson’s legacy markets are a very important and critical part ofour growth in the coming years and I would say that a lot of the work that weare doing in the marketing center of excellence is to really hone our skills onhow to drive top line sales and grow market basket size to our loyal customersby targeting meaningful and relevant offers to that customer.

As we look across the entire enterprise and look at what thebrand means to our customers by market, there could be some naturalopportunities. At the same time, the cards to different things for differentcustomers, so we’ve not made a decision whether to roll out that program acrossthe enterprise at this time. We look market by market.

Jeff Noddle

We will, however, Meredith, gatherthe data we need from other methods and other sources so that we still havegood quality marketing information to use in the non-loyalty card markets. Butit’s another tool we have available to us in the previously SUPERVALUproperties should we choose to do so. We think we have some that are very priceoriented and we would make that decision very carefully.

Meredith Adler -Lehman Brothers

Okay, and then just one more question about real estate. Iknow your focus is on remodels. I’m just wondering, when you look around themarkets where you operate, do you also feel that there are competitivepressures on the real estate side to be opening new stores? Is there any riskof losing ground if you are not actively in the real estate market?

Jeff Noddle

I suppose there is always a risk of that but we are going toget 20 plus new stores open this year. What I think is important, Meredith, isthat there are certain markets in certain locations that we must build newstores in. By that I mean -- I use Las Vegas as a fast-growing market. Youwould have to stake your claim as the city pushes out and new areas aredeveloped. You’ve got to get into that prime retail property. And in fact, wejust opened a new store in Las Vegas several weeks ago and we will do others.

In the far suburbs of Chicago for Jewel, for example, as themigration of population reaches further out into the further suburbs, againyou’ve got to get that primary location. And we’ll continue to do that.

Oftentimes, some of these new stores frankly are open from aland banking program, where we’ll buy land or Albertson’s owned land and we saton it until such time as we thought the timing was right.

So we are just going to be a little more cautious andcareful in doing the new stores. We are going to really hold those to thosekinds of situations that I described while we get caught up on the remodels.But if we think the right thing to do -- you know, we are going to look at thatevery year and we’ll dial that dial back and forth a little bit.

But right now, the best return for our shareholders is toget these stores brought up to date so that we not only have a more modern facilitybut we also can deliver all the merchandising programs that we think areessential to the future.

Meredith Adler -Lehman Brothers

Okay, great. Thank you very much.

Operator

Thank you. Our next question comes from Perry Ciacco fromCIBC World Markets. Please go ahead.

Perry Ciacco - CIBCWorld Markets

Thanks. Good morning. Jeff, just a little bit more on thesynergies, if I could; when I think of the two big chunks, which is negotiatinglower cost from vendors and eliminating the duplicated sort of admininfrastructure, I just wonder where you are on those two big chunks. Maybe as apercentage you could express that.

Jeff Noddle

Perry, I appreciate the question. Those are the right issuesbut again, we’re not going to get that granular in where we stand on any givenquarter or any given point in time on all the various metrics.

I will tell you that generally speaking, the overhead issueis a good portion that we were able to get very early on, although now itcontinues on, dependent on systems and technology as we make those changesacross the enterprise. And we have those very definitive and very delineated bydepartment, by area and by when.

The cost of goods is something that continues to getmomentum and continues to grow. We started even before the transaction closedby comparing all of the contracts, agreements in pricing and costing betweenthe two organizations. In the first several quarters, we spent time reallysitting down with our vendors and saying well, we got this from one and thisfrom another -- how do we make this better off?

Now we are just starting to really, in my mind, leveragereally the scale. We are just starting to leverage common promotions across theenterprise. We are using more marketing information, which makes us moreintelligent in delivering very specific things into each market.

And though cost of goods savings, you know I -- in my mind,there’s more ahead of us than certainly behind us and that’s the bestdescription I can give you for it.

Perry Ciacco - CIBCWorld Markets

All right, that’s quite helpful. Just on the premium, freshand healthy remodels, you’ve given us a little bit on some of the results thatyou are getting in terms of sales. I’m just wondering what results you areseeing in terms of gross margins. Is there a difference in those stores onmargins?

I think you’ve also done those remodels in some differentstore types, including I think some modules into your price impact. So I aminterested in if there are any different results across store types and as Isaid, the impact on the margins.

Jeff Noddle

There is no question, Perry, we expect and do achieve onbalance an improvement in gross margin simply because we are affecting the mixin higher margin departments. As we push harder into fresh, obviously we areexpanding in meal solutions in deli, in bakery, in prepared foods. And eventhough those have higher margins but they also have higher costs also. Theyhave higher labor costs.

So there is no question I think for any retailer moving morefresh, they are going to have to have higher margins, not driven necessarily byhigher pricing but a change in mix, and that’s where our investments are going.And then the key is to balance those costs versus those margins to make it a higherreturn.

Of course, at the same time, until we give them identicalstore increases, that’s really the fuel that makes the whole thing go.

Perry Ciacco - CIBCWorld Markets

Right, and then on the different store types, Jeff?Specifically, price impact and some different --

Jeff Noddle

We are taking many of the components and learnings acrossthe enterprise. As we do, for example, cub stores here in the Twin Cities, or shoppers food and drugin the Washington, D.C./Baltimoremarket, and we’re incorporating certain components. We’d like to call it kindof a plug and play.

Every new store we build or every remodel we do are going tohave a significant components that are out of -- but they will vary by marketand we think that’s the right way to approach it.

Perry Ciacco - CIBCWorld Markets

One last question, if I could; we haven’t heard too muchabout Save-A-Lot over the past year, other than the trading down that you’veseen, and I guess theoretically, that division should be well-positioned for aweakening economy. Can you tell us what condition Save-A-Lot is in? I know youwere working on produce, for instance, and some of the challenges that you’vebeen having and how you see that asset going forward?

Jeff Noddle

I think I said in the first quarter and I’ll repeat again;we feel very bullish on Save-A-Lot. We’ve opened some very important marketsthis year, the Northwest and far south Texas along the U.S./Mexico border,which we think are very important.

We think we should get more Save-A-Lot stores open thisyear, new stores than we have in the last couple of years. I just think thatSave-A-Lot is so well-positioned against the economy and the outlook that wehave, we think it’s a very, very important thing for us to enhance.

They have also, if you get into a Save-A-Lot store recently,you’ll see some merchandising changes. They may be subtle to someone whodoesn’t shop there. They are more important to those who do. They actually havesubtle limited national brand items that are being featured in the stores. Theyhave Pepsi and Coca-Cola type products, Frito Lay, just to mention a few.

So we’ve tested a lot of new merchandising concepts veryquietly and we think we are going to have a very good year.

Perry Ciacco - CIBCWorld Markets

Okay, thanks.

Operator

Thank you. Our next question comes from Robert Summers fromBear Stearns. Please go ahead.

Robert Summers - BearStearns

Good morning. Actually, I would like to build on that lastquestion. Your comment on the consumer suggests that the Save-A-Lot business isprobably choppy at best. Can you just give us a feel for what the sales trendsare like and maybe contrast that performance versus what you are seeing in theacquired stores?

Jeff Noddle

Bob, we really don’t again comment specifically on oneformat or another, or one area or another. I would just repeat that Save-A-Lotis positioned well against this very difficult -- you know, that Save-A-Lotconsumer is a stressed consumer no matter what. Obviously these kinds of thingsthat we’ve seen recently stress them even more.

On the one hand, it makes it more difficult because a lot ofthese shoppers have only so much money they can spend and they have to spreadthat as far as they can when they go into the store. But on the other hand,that attracts more of that kind of shopper to the stores.

So I’ll just repeat again; we think Save-A-Lot is a veryimportant part of our portfolio and we think it really gives us a broad, broadspectrum and a very clear window into the entire consumer, at least retail,food and pharmacy kind of look.

Robert Summers - BearStearns

Okay. Same question, different approach, without gettingspecific on the number, was Save-A-Lot additive or dilutive to the reportedcomp number?

Jeff Noddle

I’m sorry, Bob, we’re just not going to comment byparticular unit on what their effect on the --

Robert Summers - BearStearns

Okay, thanks.

YolandaScharton

We’ll take one more question, please.

Operator

Thank you. Our final question comes from Mark Husson fromHSBC. Please go ahead.

Mark Husson - HSBC

Yes, good morning and thanks for what amounts to a giantprozac pill I think for the market. Just looking at the gross margin numbersagain, sorry, and the synergy numbers one more time, are we to therefore inferthat a year-and-a-half out, that the business will be somewhere between $110million, $135 million as an annual run-rate, more profitable than we would berunning by the end of this year, which is effective for the end of your synergyguidance period?

[Multiple Speakers]

Pam Knous

-- extrapolation of --

Jeff Noddle

Yeah, I guess you extrapolate the number, I hope the rest ofthe world stays exactly static on us and nothing else changes, but in a perfectworld, that would be true, yes.

Mark Husson - HSBC

Okay, well, let’s just have a think about what would gowrong and when you think about gross synergies and net synergies, you clearlygave a number that you thought you would be able to show us at some stage,making some assumptions about the world and the way it looked.

In the event that you talked in the quarter, a couple ofyour markets have become more competitive than you thought they would havebeen. Do you still have the flexibility with what you can see out there with thesynergy picture to continue to show us somewhere with that range and stillinvest in those two big markets?

Jeff Noddle

Well, I would comment first, Mark, that I don’t think thatmarkets are more competitive than we would have thought. I would describe itdifferently. I would describe it -- we always had markets that are becomingmore competitive from time to time, so the fact that we have several is not asurprise. You just never know which one, particularly. So I think again, wehave that flexibility to respond because we have very much tailored localmarketing that allows us to respond.

As I look out, I mentioned earlier on our cost of goodssynergies and our marketing synergies that we are going to realize, as I lookout, I know we are going to have some flexibility, I hope, beyond those kind ofnumbers. I know that as we reach out there will be markets we need to respondto as we have to do each and every day and I think we’ve got some financialflexibility to respond. I think if anything today we’re trying to make thatpoint.

It’s not always about price. If in a market, for example, ifwe’re delivering a significant number of remodels, and we have several marketsthat are more heavily weighted to remodel than others, at least in the nextcouple of years, we think that’s an important component and that doesn’t meanwe don’t do other things but that might be core to what our expectation ofresults are.

So that would be my answer, and as far as the prozaccomment, probably that stuff will go generic one of these days and we’ll evenhave a better value for you on that, if that’s what you’re using, Mark.

Mark Husson - HSBC

Yeah, that seems fine to me. Thank you very much. Goodquarter.

YolandaScharton

Thank you, everyone, and thanks for joining us on today’scall.

Operator

Thank you, ladies and gentlemen. This concludes today’sconference. Thank you for participating. You may all disconnect.

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Source: SUPERVALU F2Q08 (Qtr End 9/8/07) Earnings Call Transcript

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