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Delhaize Group SA (DEG)

Q3 2007 Earnings Call

November 8, 2007, 9:00 AM ET

Executives

Guy Elewaut - VP, IR and Corporate Communications

Pierre-Olivier Beckers - President and CEO

Craig Owens - EVP and CFO

Rick Anicetti - CEO, Food Lion

Ron Hodge - CEO, Hannaford

Michel Eckhout - CEO, Delhaize Belgium

Analysts

Fernand de Boer - Petercam

Alistair Johnston - JP Morgan

Fabienne Caron - Morgan Stanley

Dan McFetrich - Dresdner Kleinwort Wasserstein

Todd Duvick - Banc of America

Xavier Le Mene - Credit Suisse

Presentation

Operator

Welcome to Delhaize Group's Third Quarter 2007 Earnings Conference Call. I would like to notify that the call today is being recorded. If you do have any objections you may disconnect at this time. Your lines are on a listen-only mode until the question and answer of the call today. I would now like to hand the call over to Guy Elewaut, Vice President, Investor Relations and Corporate Communications of Delhaize Group. Thank you, sir, you may begin.

Guy Elewaut - Vice President, Investor Relations and Corporate Communications

Thank you operator. Good afternoon everyone in Europe, good morning in the U.S. Welcome to the conference call concerning Delhaize Group's results in the third quarter of 2007. This presentation contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statements. Factors that could cause results to differ materially from those in the forward-looking statements are detailed from time to time in reports filed by the company with the SEC. These forward-looking statements are made as of the date of this presentation. Delhaize Group assumes no obligation to update the information contained in this presentation.

An audio webcast of this conference call will be available on the company's website. Delhaize Group reserves all rights to the content of this webcast and this webcast cannot be recorded or otherwise reproduced without the prior express written consent of Delhaize Group.

Today we have the following people with us. Pierre-Olivier Beckers, CEO of Delhaize Group, Craig Owens, CFO of Delhaize Group, Rick Anicetti, CEO of Food Lion; Ron Hodge, CEO, Hannaford; and Michel Eeckhout, CEO, Delhaize Belgium.

During this call, we will first look back on our performance in the third quarter of 2007 followed by comments on operations and strategy. Afterwards, we will take questions. For those unable to stay on the call or who wish to listen to it again, a replay will be available on the company's website. I will now turn it to Pierre Beckers for introduction of our third quarter results.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you Guy. Hello everyone and thank you for joining our conference call. Delhaize Group's third quarter results contributed to the strong year we are having in 2007. We are very happy with the sales and profit performance of our operations in the US. We realized 4.6% comparable store sales growth, the highest since 2000, driven by volume growth at all of our US companies. Food Lion and Hannaford continued their strong sales momentum while Sweetbay realized its strongest comparable store sales growth since the launch of the conversion project, showing encouraging signs in the rebranding of our Florida business.

Also our Greek, Romanian, and Indonesian businesses performed very well realizing now for more than a year quarter after quarter double-digit revenue growth. Only the performance of Delhaize Belgium, which cycled its strongest quarter of 2006, was below our expectations due to the intense competitive... competition and bad weather during the summer months and significant price investments to gain sales and support our price strategy.

During the third quarter, we succeeded in keeping our margins at their industry-leading levels, offsetting the price investments by Delhaize Belgium, Sweetbay and Hannaford, with the positive impact on gross margins of our sales mix initiatives, better shrink management at Hannaford and Sweetbay, and good cost control overall.

The strong sales performance during the third quarter allows us to increase our US comparable store sales guidance for the full year and to confirm our Group sales and profit guidance communicated in August at the time of the announcement of our second quarter results.

I will now turn to Craig... Craig Owens for an introduction of our second quarter results. Craig?

Craig Owens - Executive Vice President and Chief Financial Officer

Thank you Pierre-Olivier. Welcome everyone. In the third quarter of the year, Delhaize Group revenues decreased by 1.3%, a decrease due entirely to the weakening of the US dollar by 7.2% against the euro. Our organic sales growth amounted to 4.6% on top of a very good third quarter in 2006 when we posted 6% organic sales growth. All of our US operations and Alfa-Beta in Greece showed strong revenue growth during the most recent quarter.

Our US revenues increased by 5.4% and comparable store sales grew by 4.6% based on a continued positive sales performance at Food Lion and Hannaford, and better sales at Sweetbay. More customer traffic at Food Lion and Hannaford was the chief driver of the volume growth in the US operations. And at Sweetbay, the finalization of the store conversions and the increased price investments have resulted in stronger sales in Florida in spite of some underperforming stores.

In Belgium, total revenues decreased by 2.4%, largely due to the fact that prior year revenues included those of Di, health and body care stores that were sold in the second quarter of this year. Additionally, this quarter's revenues were impacted by a less favorable calendar. Adjusted for both of those elements, Delhaize Belgium revenues increased by 1.2%.

Comparable store sales growth in Belgium amounted to 0.4% compared with 4.3% last year, the strongest quarter of 2006 in Belgium. Sales were hampered by increased aggressiveness by the discount chain competition, bad summer weather, and the planned temporary closings of Cash Fresh stores during the conversion to Delhaize banners.

Our Greek company, Alfa-Beta, again realized outstanding revenue growth of 11.6% due to good sales momentum in existing stores and an aggressive store opening program. This marks the sixth quarter in a row that our Greek operations posted double-digit organic revenue growth.

Good sales dynamics in Indonesia and Romania resulted in an increase of 28.9% revenues in our emerging markets segment. This marks more than two years of consistent quarterly double-digit revenue growth.

Gross margin for the Group remained stable at 25% of revenues. In several of our companies we realized sales mix and shrink improvements, while we also invested significantly in price, particularly in Florida, at Hannaford and in Belgium where internal inflation was 150 basis points less than the national food inflation. Inventory results in Belgium have improved due to ACIS and other initiatives, but inventory shrinkage continues to have a negative impact on margins and we expect to see further improvement.

Cost inflation in the US was approximately 3%, which was passed through at Food Lion, resulting in a comparable level of retail inflation. Hannaford and Sweetbay recorded retail inflation below cost inflation, particularly Sweetbay due to significant price investments throughout the quarter which boosted sales growth. We expect inflation to continue to be a factor in the coming months. Generally we intend to continue to pass through cost increases while maintaining our commitment to our targeted price positions, which vary by operating company and geographical location.

Other operating income was higher than in prior year, primarily because of sale of several Cash Fresh stores to independent owners who will operate those stores as Delhaize affiliates. Selling, general, and administrative expenses increased by 31 basis points to 21%. However, last year the positive impact of $13.8 million forfeiture related to benefit plans was included in SG&A. Without that positive impact in the prior year, selling, general and administrative expenses would have remained almost stable as a percent of revenues due to the strong sales dynamics and ongoing cost discipline, offsetting increased advertisement and other expenses supporting our sales initiatives.

Correcting for the positive effect related to the forfeitures in prior year, the operating margin remained stable at 4.5% and operating profit increased by 6.1% adjusted for the forfeitures and at identical exchange rates.

Our net financial expenses decreased to Ä51.7 million compared to Ä66.6 million last year. This decrease is primarily due to lower interest rates as a result of the refinancing operation in the second quarter of this year and a weaker US dollar.

The effective tax rate was 35%, an increase versus an usually low quarter in the prior year. Our prior year loss from discontinued operations amounted to Ä61.4 million because of the impairment loss recorded on our former Czech business, which was reclassified into discontinued operations at that time. Lower financial expenses and last year's losses from discontinued operations resulted in an increase of net profit of 128.2% to Ä103.2 million.

In the third quarter we generated operating cash flow of Ä214.1 million. Our capital expenditures amounted to Ä218.3 million compared to Ä179.1 million in prior year. At the end September, our net debt-to-equity ratio was 62% compared to 74% at the end of 2006 as a result of the generation of free cash flow, the partial conversion of convertible bonds, and a weaker US dollar.

Based on our strong sale performance in the first nine months of 2007 and our expectations for the fourth quarter, we feel comfortable increasing the guidance for US comparable store sales growth to 3.5% to 4% as opposed to the previous range of 2.5% to 3.5%. Additionally, we confirm the remainder of our revenue and profit guidance that was communicated along with our second quarter results in August. We expect to end 2007 with a store network of 2555 stores, 18 less than previously communicated, due to slower openings of small-sized stores in Belgium. We expect to have approximately Ä780 million of capital expenditures instead of the Ä825 million that we previously communicated. These expenditures include US$750 million for our US operations, down from $755 million communicated earlier.

I will now turn the conversation back over to the Pierre-Olivier.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you Craig Our performance in this third quarter reflecting the excellent revenue growth in the US and Greece and in the emerging markets is the result of increasingly strong local market positions, as well as of distinctive and well-defined brands.

In the US, we continue to reinforce our differentiation through convenience of location and store size, combined with our constant focus on freshness, health and wellness, private label, and great prices. And soon we will add a unique chilled prepared meal program in the US. Food Lion is confident in strengthening its lead in the Southeast and Mid-Atlantic by locating the right brands, products and services in the right place based on its analysis of segmentation and store clustering information. It has modified the assortment and offering in 164 Food Lion stores year-to-date based on its segmentation and clustering data. We have there instituted a separate weekly promotional planner and cluster-specific assortments for produce and meat.

Food Lion's market renewal program has maintained its momentum. In August, the Norfolk, Virginia market marked its first phase of completion with the opening of 10 Bottom Dollar stores. A few days ago we reopened 66 renewed Food Lions and the conversion of eight Bloom stores will be finished before year-end.

The Myrtle Beach, South Carolina market renewal that was launched in late spring has resulted in outstanding results with double-digit sales growth in key categories such as produce, meat, and deli-bakery. And customer count growth has been particularly impressive in this market.

By the end of the year, Bloom will have opened 60 stores within just three years. The Bloom brand has performed strongly, exceeding most competitors in convenience, quality, variety, and service including checkout efficiency. The earliest Bloom stores are already profitable.

Meanwhile Hannaford is building on its solid and long-term relationship with its customers. One year ago, as you remember, Hannaford launched Guiding Stars, its nutritional guidance program. This system helps customers shop for healthy products and is enjoying a very high awareness rate of 81% after only one year. Guiding Stars has also brought major shifts in customer behavior towards healthier food decisions. Indeed, already more than 40% of customers indicate they are using it often to make shopping decisions. This past year packaged foods with Stars... with Guiding Stars grew 2.5 times the rate of those without Stars and yogurts, cereals and soups grew more than three times faster.

The expertise that Hannaford has developed in its nutritional value initiative is really an example of the leverage our operating companies are continuing to build as customer-oriented brands. Sweetbay has now also adopted the Guiding Stars program and there it is similarly appreciated by its customer base.

Another opportunity for differentiation and growth lies in private label products. By offering low-price alternatives, ease of shopping, and an expanded choice, private label products are a great quality and value proposition, and they contribute to our brand distinctiveness in our local markets. In the US, the rollout of our new US private brands has indeed continued. Our brands include, as you remember, Healthy Accents, Taste of Inspirations, Home 360, Nature's Place, and Smart Option. The Home 360 brand will be now expanded to new categories adding 260 SKUs and reducing banner-specific SKUs, which will result obviously in logistics savings.

In reaction to changing consumer lifestyles in the US and thanks to our success in fresh meals in Europe, we believe that a significant engine of growth in the US exists in home meal solutions. The US consumers' tastes are getting more and more sophisticated, yet consumers lack the time to cook at home. Therefore, in order to address this demand, from early 2008, Delhaize Group plans to introduce in all of its US companies a brand which we will call On The Go Bistro, a new private label brand, which will be for chilled prepared meals focusing on great taste and quality. We will work on an exclusive basis with one of our long-standing Belgian partners building on the experience and cooperation that made the Belgian home meal replacement program such a success. Quality, taste, and flexibility in serving size and recipes will distinguish this private label from our competitors. Our Belgian partner is currently setting up production facility outside Philadelphia.

At the end of August, Sweetbay converted the last Kash n' Karry store finishing as planned the very demanding three-year remodeling and rebranding program. Sweetbay's management can now focus entirely on reinforcing the brand position of high quality products for competitive prices, but I have to admit it, we still have much work to build a profitable business.

During the early summer, Sweetbay launched a major sales building program using significant price investments as the lever to stimulate customer traffic in key fresh departments and to show customers our competitive center store prices. This program cut prices on hundreds of items to market-leading position and was communicated through an aggressive marketing campaign using Hot Spot features in fresh departments and what we call locked-in-low-prices on center store items.

Combined with a stronger commitment to executional excellence, these initiatives resulted in strong sales growth in the third quarter in most Sweetbay stores showing that the potential customer base is responding to the new initiatives here at Sweetbay. Currently the percentage of customers shopping exclusively at Sweetbay is more than double the number at the old Kash n' Karry stores.

In Belgium, the fight among the discounters resulted in aggressive price and marketing actions by competition and in the addition of significant additional store capacity. In that context, Delhaize Belgium remained very aggressive in pricing resulting in an internal price inflation that was 1.5% below the national food inflation. We also continue the dynamic rollout of the value line, 365, and will have 500 365 products in place by year-end. The 365 product has the same price as similar Aldi product and offer at least the same quality, while we also carry identical prices on approximately the 80 national brand products that Lidl introduced since the beginning of the year.

Delhaize Belgium also continued the rollout of other private label products now comprising over 6000 items at prices 10% to 15% below comparable national brand products.

We also deliver on our targeted price positions in national brand and fresh products versus the other supermarket chains like Super GB, Carrefour, and Colruyt, and we continue to communicate aggressively our pricing position recently adding a weekly advertisement focused on prices in the Belgian newspapers and launching radio spots on 365.

Continued focus on systems, processes, and cost management is a great way to support and fund our many sales initiatives, including our price investments. In order to support the management of its multiple brands in a cost-efficient way, Food Lion is rolling out new systems and processes in IT and supply chain. Two such applications are a new retail pricing and promotion system, and an application that automates the creation of store-specific product assortments and planograms. As of today, the new pricing system has been rolled out in about 20% of the major product categories for the Food Lion and Bloom banners, and early results for the categories where it's being used are very positive for sales and margin.

At the end of October, a number of categories were reset in the stores according to this other system, this new planogram software. By the end of next year, the new system will be rolled out to all categories. Delhaize Belgium and Hannaford are also beginning the process of implementing the same planogram software across their store base.

Building on the ACIS platform, Hannaford has been rolling out during this past year Computer Assisted Ordering or CAO to 134 stores. CAO makes forecasts based on actual inventory data, significantly helps building sales through reduced out of stocks and has a positive effect on working capital through reduced store inventories.

Another example of cost reduction is the energy initiative within our corporate responsibilities strategy. In 2008, Hannaford plans to open the first worldwide Platinum certified LEED supermarkets, and LEED stands for Leadership in Energy and Environmental Design. This store will be a research laboratory for the whole Group to test innovations supporting lower energy usage, waste, and water consumption.

To-date more than half of Food Lion stores have been granted Energy Star award issued by the US Energy Protection Agency, recognizing top performing buildings that have a proven energy management strategy. Despite its fast growth since 2000, Food Lion has reduced its total energy use by more than 25%.

At Delhaize Belgium, our energy efforts resulted in lower energy use this year compared with the previous years in spite of the larger store network. Another sign of our energy commitment is a decision by Delhaize Belgium to use 100% renewable energy sources making us the largest user of green energy in Belgium and allowing us to avoid the emission of some 60,000 tons of CO2 per year.

At Delhaize Group, we continue our strategy of reinforcing the differentiation of our store concepts and focusing on executional excellence. This resulted in solid quarterly results, increase of our US comparable store sales guidance, and the confirmation of our other revenues and profit guidance for the Group.

This concludes our prepared remarks. We are now available to take questions. At this time, I will turn the program over to our conference call operator who will give you the instructions for asking questions. Thank you.

Question And Answer

Operator

Thank you. [Operator Instructions] Fernand de Boer, you may ask your question and please state your company name.

Fernand de Boer - Petercam

Yes, good afternoon. It's Fernand de Boer calling from Petercam. I have a couple of questions. First, on US, could you break down, let's say, the same store sale growth in terms of volume growth and in terms with food inflation? And then on Belgium, you saw underlying, I think, a strong drop in EBIT margin, going down from 4.1% underlying from 2.3%. Could you also give some more highlights on that apart from gross margin pressure, what can you tell us about cost structure and also what can you tell us about this kind of margin going forward?

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you Fernand. I am looking at Craig for the first question on the US, which was... I don't know that we want to break down.

Craig Owens - Executive Vice President and Chief Financial Officer

Yeah, I don't think we will break it down specifically. I mean, the inflation number that we had in the US for the quarter is around 3%. The cost inflation was more or less faster directly at Food Lion and we did not pass all of that through at either Hannaford or Sweetbay because we had question there where were investing in Hannaford's case, a continuing investment in price competitiveness that's started a year ago, and in Sweetbay, the continuation of a program that's started in the last quarter to be more price-competitive in a very pointed way in a very competitive market in Florida.

On Belgium, I think the primary element that caused our EBIT margin to be around 2.3%, clearly price pressure and investment in continued price positioning there for ourselves, a competitive marketplace, the loss of some operating leverage because of relatively weak sales due to the pretty bad weather quarter for us, as well as the competitive pressures in that market. And higher shrink... now, it was lower shrink than same quarter prior year, but it was higher shrink than we would normally expect and higher shrink than we would have targeted.

I think as we look forward, we would expect that structurally our margin position in Belgium would be more like our year-to-date number, the 4 plus percent certainly than it would be like the number that we turned in this quarter. And the areas that we would work on to move ourselves back in that direction would include the cost and expense structure, and improvement in our shrink. And I think that we would also look forward to a price environment that would not be at the same kind of level that we have seen in the just trailing quarter. And lots of sales initiatives that are going to give you better sales and better operating leverage as we move forward.

Pierre-Olivier Beckers - President and Chief Executive Officer

We clearly have a number of strong levers supporting our stronger margin structurally around sales building initiatives, our firm commitment to keep lowering the cost of sales and the cost of our expenses, our SG&A overall. And obviously, with the ACIS system now in place and the training taking place throughout the stores to allow our associates to understand what happens and take action, we are very confident to be able to move structurally our margin towards, as Craig mentioned, the year-to-date number as we look into the future.

Fernand de Boer - Petercam

Right. Then with regard to your guidance for, let's say, the EBIT underlying of same currencies, 6% to 8% up and then at the higher end. This still stands at the higher end because I think if you look at the US results last year were on IFRS quite strong and weaker on US GAAP, while you also had quite good numbers in Belgium in the last quarter. So I personally believe that at the higher end of 6% to 8% is going to be quite tough, can you say something about that?

Craig Owens - Executive Vice President and Chief Financial Officer

We've got no change to our guidance. For the full year we would... we have said that the range of 6 to 8, and we've said in August that we thought we would be at the higher end of that and we've got no change to that guidance.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you Fernand. As we move to the next question, if I may ask you to limit to two questions so that we have as many participants as possible able to ask questions. Operator?

Operator

Okay. Alistair Johnston, you may ask your question and please state your company name.

Alistair Johnston - JP Morgan

Hi, it's Alistair Johnston from J.P. Morgan here. Just coming back to Belgium really, you are saying obviously that you hope the pricing environment will improve going forward. What evidence is there... what reason is there to believe it will improve? Because whenever I look at the price surveys across Europe, Belgium tends to be a high price country. Do you think... do you see the discounts is becoming less aggressive or do you see the effect of them introducing branded products kind of lessening now? That's my first question.

Pierre-Olivier Beckers - President and Chief Executive Officer

Well, clearly there was a cyclical element in the third quarter, which hopefully we will not see repeating before long time, and that was an exceptional whether last year and a terrible weather this year. And for retailer like Delhaize De Leeuw in Belgium, obviously that created a lot of tension in... because of not selling the typical summer products and then of course a lot of them are fresh products based. So that is an element. For the rest, we are certainly focusing more on what we can control than guessing much about what the market will do. And what we can control is the number of initiatives we're putting in place to keep building sales and keep building more differentiated concept, and we are pretty confident that our concept is getting stronger and that includes of course our price... our stronger price position, and we believe that our total equation is getting stronger on the Belgium market. This being said, we believe that with now a pretty good part of the market being in the hands of discounters like Cora/Louis [ph], Aldi and Lidl, the price environment in Belgium is contrary to what some perception thinks, the price environment is quite aggressive.

Alistair Johnston - JP Morgan

Okay, thanks for that. Just turning to your... I mean, I suppose you find it very hard to quantify the effect of the whether on the EBITDA. But in terms of the shrink, you say that it was less than last year. Can you guys give us a number on indication of how much, would it be Ä5 million or something like that?

Craig Owens - Executive Vice President and Chief Financial Officer

Well, we don't break that number out separately. Last year, we did in fact have some one-offs or some outer period catch up as we in the third quarter introduced a number of new systems. But on an ongoing basis, we don't break out all of those effect. The shrink impact this quarter was less than it was a year ago same quarter because we didn't have the one off impact, but we are absolutely convinced that we've still got a lot of opportunity in shrink. ACIS has been in now for several quarters, training against ACIS and the reporting work that goes around that system has been in. So our radar screen in terms of shrink is much better than it has been in the past. We've got some very specific indicators of where we have got room for improvement. And I feel confident and I think Michel feels confident in Belgium that as we move forward now shrink can be a source of margin improvement for us as opposed to a source of margin pressure.

Alistair Johnston - JP Morgan

Thank you.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you.

Operator

Fabienne Caron, you may ask your question and state your company name.

Fabienne Caron - Morgan Stanley

Hi, Fabienne Caron, Morgan Stanley. Sorry to come back on Belgium, but I am still struggling to understand why your margin is so low because if you do quickly the math, you are missing Ä51 million year-on-year on an underlying basis. Last I remember this shrink you quantified it to Ä30 million, it's... this year let it be Ä10 million. I am still missing Ä40 million of 3.8% of sales. And I am still struggling with your explanation with your lack of operating leverage because minus 2% like for like is not really dramatic store. Can you tell us roughly out of this 3.8% in percentage of sales we are missing, are we talking here 3.8% price investment or did you have strong inflation in SG&A?

Pierre-Olivier Beckers - President and Chief Executive Officer

We have obviously some automatic inflation in the SG&A, especially in the labor area, as you know, where we have no... not much flexibility there around the indexation of salaries. So that was an element and indeed it creates a real operational pressure when you have a few percentage points of less sales by the pressure on the SG&A. So that was an element. Shrink was an improvement over the last... over the same quarter last year. There was nothing particular in the other areas of the SG&A that impacted. So we really see the margin as we you saw for the third quarter being the result of the sales and of the sales pressure and the shrink, and of course our price investments in the quarter.

Fabienne Caron - Morgan Stanley

Okay. So following on that because your price investments seems to have been massive in Q3, how can you be sure that you want to have to do the same in Q4?

Pierre-Olivier Beckers - President and Chief Executive Officer

Well, again, some of the price investments were related to getting attracting customers in a quarter where we had lost those customers last year and where those customers were not coming in this year, and some of the shrink we had in this quarter was clearly related to the lack of sales. We built in inventories around... especially on fresh products and seasonal products, and of course, the sales didn't materialize the way we wanted. So, that we are sure of, and that represents... and it represents a material part of the numbers.

Craig Owens - Executive Vice President and Chief Financial Officer

But to be clear, we will continue to invest in price in Belgium. I mea, it continues to be a competitive environment and we are going to continue to be on strategy in terms of our price positon.

Fabienne Caron - Morgan Stanley

No, I agree with you. But I mean, if we look at the [indiscernible] it was mainly price investment and shrink. So, that's why I was asking the question. But thanks of your help.

Pierre-Olivier Beckers - President and Chief Executive Officer

Okay, thank you Fabienne. The next question.

Operator

Dan McFetrich, you may ask your question and state your company name.

Dan McFetrich - Dresdner Kleinwort Wasserstein

Yes, good afternoon everyone. Dan McFetrich from Dresdner. Back to Belgium, I am afraid, I was just trying to understand the comment on the SG&A in Belgium. I understood that you guys had obviously spent quite a lot more on advertising and promotion in Q3. Could you give me a feel for how that... how much that was in Q3 if [indiscernible] year ago and also what your outlook is for Q4? And my second question is really on the US competitive outlook, clearly you have done very well in Q3, it looks from your statement that competitively things haven't got much worse. Can you just talk about your outlook competitively in Food Lion and in Hannaford in Q4? Thank you.

Pierre-Olivier Beckers - President and Chief Executive Officer

Okay. I am looking at Craig for the first question. And we will be very happy to talk about 80% of our business, which has done terrifically well in the quarter.

Craig Owens - Executive Vice President and Chief Financial Officer

We don't break out separate lines of the expenses. The pressure in expense in Belgium, you are right, was advertising. We would expect to see I think probably higher than normal advertising expenses into the fourth quarter also. We also had some higher depreciation expense running through the P&L and hitting EBIT due to a little bit higher than prior year remodeling activity in Belgium. And so, those were probably the negative pressure, but Belgium is working very hard to help offset some of those things. The supplies expense was lower than it was in previous quarter. And as I said in my opening comments, Belgium clearly recognizes that part of their margin recovery as we go forward, particularly as we look into 2008 is going to be a lot of work around operating expense.

Pierre-Olivier Beckers - President and Chief Executive Officer

I will ask... I think it's better to address the US question by region and since Rick and Ron are with us, we will turn to both of them to make some comments on their... on our views on the environment.

Rick Anicetti - Chief Executive Officer, Food Lion

Hi, Rick Anicetti from Food Lion. As I look at the competitive landscape, I guess I would characterize it as essentially unchanged in an environment that remains very competitive. But with really no one more regressive than what has been the norm, leading up until... up to this quarter, obviously we are going to have a better indication of what the tone of the holiday season that we are heading into is going to be like very quickly. Most of our competitors as well as ourselves will be breaking holiday promotions next week for Thanksgiving and I think that's going to give us a real sense of what the challenge is going to be.

Having said that, I think we continue to focus on initiatives that would position Food Lion well in... above a competitive environment as well as an environment where consumers are feeling under pressures as a result of a lot of external factors. And just a couple of examples of that, I think we continue to lead the market in strong promotional events. I think we have strong seasonal merchandising plans in all of our regions as a result of the upcoming holiday season. I think we continue to strengthen our price optimization through the delivery of new programs that we Pierre-Olivier highlighted such as DemandTec, the introduction of the three tier private brand program which is going to pay us some significant dividends, I think our overall market basket position. And finally anecdotal information we have which suggests that in primetimes in terms of what customers may be feeling in terms of pressures, we continue to really appear as a more convenient low-priced alternatives for customers. Ron?

Ron Hodge - Chief Executive Officer, Hannaford

Sure. If you look at the northeast and particularly with some of our competitors, starting with Stop & Shop, we've talked about their gradual price reduction category by category, moving into a more of an ETLP pricing strategy that has continued in the third quarter and we expect it to continue in the same manner in the fourth quarter. In Q3, there were rumors about Shaw's taking some price reductions and in fact that has occurred at the beginning of Q4. During Q3 and looking forward, our sales remain very-very strong at Hannaford, and we continue to grow our market share. And I think some of the reasoning behind that is our initiatives in non-price areas such as, as Pierre mentioned earlier, the strong impact that we are getting and the strong results from Guiding Stars that is building loyalty in our customer base. We've also had an increase in the amount of organics and our selection. I think we're getting pretty strong response to that. Computer assisted ordering has improved our sales. Our out-of-stocks are down by 50%. We have the right products more available for our customers and I think that's helping our sales going forward. So, it's a pretty strong story for us in the northeast.

And just a second, I will switch to Sweetbay. We've talked about sales improvement down there and we have had a fairly significant price investment as we concluded the conversion from Kash n' Karry to Sweetbay. And the response has been quite strong. We are happy with that sales gain. Our competitors are not standing by, but at this point in time we see our competitors reacting to our activities rather than the other way around. And I think that's the place we want to be.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you.

Dan McFetrich - Dresdner Kleinwort Wasserstein

Thank you.

Pierre-Olivier Beckers - President and Chief Executive Officer

Next question?

Operator

Todd Duvick, you may ask your question and please state your company name.

Todd Duvick - Banc of America

Yes, Banc of America, good morning.

Pierre-Olivier Beckers - President and Chief Executive Officer

Good morning.

Todd Duvick - Banc of America

Or I should take it afternoon.

Pierre-Olivier Beckers - President and Chief Executive Officer

Yes, both.

Todd Duvick - Banc of America

A couple of questions for you on capital spending and as it pertains to free cash flow generation, your are spending a lot on renovating some of those stores, looks like Sweetbay is done now and you are continuing the conversion within the Food Lion banners. Going forward, do you expect the capital spending to remain about the level it is today or do you expect that to come down?

Craig Owens - Executive Vice President and Chief Financial Officer

Well, I think we would expect it actually to be around the same of level although we would expect to see a little less of it allocated to remodel and more of it allocated to the new space. So I don't think whatever rule of thumb you want to use, you look at it as a percentage of revenue, or percentage of depreciation, we don't see it going up much higher than we currently are, but we think we've got into a level that's pretty comfortable for us and look forward to swing some of that from renovation projects in to new space generation.

Todd Duvick - Banc of America

Okay, that's helpful. And then I guess just the other question I have is your leverage on the balance sheet, it seems like it's at a very comfortable level and I am wondering if you could speak to your free cash flow priorities and at what point you might consider moving back to share repurchases?

Craig Owens - Executive Vice President and Chief Financial Officer

Well, we've had conversation about that. We do feel like we're in a pretty conservative place in terms of our leverage balance sheet and our cash flow. The refinancing operation gave us not only some relief on our fixed charges, lowering interest expense, but also reduced the big 2011 maturity hurdle that we had and spread that out a little bit. So we were happy to get that off before the... all of the credit volatility in the markets out there and we feel pretty good about where we are. I think that if we think about our priorities, it... they are first and foremost to continue to fund our expansion program and the work against initiatives that are going to help us drive sales inside the four walls. Secondly, to look for fill-in and adjacent acquisition opportunities, which we continue to analyze. We are very conservative in the way that we look at that, but if we find good ones, we want to be ready to act. And then while we don't have any program that we're about to launch or any plan for share repurchase, that would clearly be on the list of things that we would look at. As we move down the road, we'd sort of like to get out of this split rating position that we're in and get fully into an investment grade position. But as far as all of our internal metrics and where we are with respect to leverage, we're in a place where we feel pretty comfortable.

Todd Duvick - Banc of America

Okay. Thank you very much, that's helpful.

Pierre-Olivier Beckers - President and Chief Executive Officer

Yes, next question.

Operator

Christine Howie [ph] you may ask your question and state your company name.

Unidentified Analyst

Hi, this is Christine Howie [ph] from J.P. Morgan. Just following up on the rating split, have you been able to talk to the rating agencies?

Craig Owens - Executive Vice President and Chief Financial Officer

We routinely talk to the rating agencies. We have had recently a change, as you know, I am sure we went from having our rating on our US businesses to now being rated at the Group level, which means that with respect to the rating agencies, we have moved the site of our relationship from New York to Europe. So we are getting into a new relationship phase there, but we continue to have a regular program of contact with them, yes.

Unidentified Analyst

Okay, great. And just wondering if there is any more specifics on what they are looking for to get to the upgrade?

Craig Owens - Executive Vice President and Chief Financial Officer

Well, they have got... I can't speak for them. I think we feel very comfortable that we are moving all of our metrics in the right direction to be where they are expecting us to be, or where they would like for us to be to... for S&P to look at the potential for an upgrade. They've got a positive outlook on us now. I don't have any news about what the timing of that might be or what a specific trigger to that might be, but directionally we continue to lower our fixed charge cover ratio and we continue to improve our balance sheet ratios. I guess one thing just many of you would be aware of this, but if you look at our balance sheet numbers, I mean, we actually look much better than most of our peers because we have a fairly low percentage property ownership and consequently a high percentage of lease debt. And also because while we've regressed it some with the recent refinancing, we still have some fairly high coupon bonds out there. The pinch point for us tends to be more around fixed charge cover ratio than it does around the balance sheet measure.

Unidentified Analyst

Okay, great. Thank you.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you. Is there another question operator?

Operator

We do have one more question. Xavier Le Mene, you may ask your question and please state your company name.

Xavier Le Mene - Credit Suisse

Yes, good afternoon. Xevier Le from Credit Suisse. Three questions if may. The first one is regarding Belgium and the ACIS system. You implemented it in the US and we saw strong improvement in the margin while in Belgium the margin seems to be a bit more volatile. So I would like to know what is working, what is not working with ACIS system in Belgium, and how long should it take maybe to fix everything, and what could be the impact on the operating margin in future? The other one is regarding Sweetbay, can we get any indication on the comp sales? So you used to say last year that you had 14%, 15% positive comp sales, now you reached you said a peak. So can we get an indication on how many stores are now in the comparable sales index also? And lastly can you just justify the calendar impact in Belgium or can you at least mention whether the plus 0.4% in Belgium is restated or not from the calander impact?

Pierre-Olivier Beckers - President and Chief Executive Officer

Okay. Well, perhaps you can address that last question, which is checking [ph] on the same-store sales in Belgium, Craig?

Craig Owens - Executive Vice President and Chief Financial Officer

Right. The negative calendar impact was 190 basis points in Belgium.

Pierre-Olivier Beckers - President and Chief Executive Officer

The plus 0.... the 0.4% is adjusted for the calendar impact. Maybe I could turn to Michel in Brussels. Michel Eckhout, the CEO of Delhaize Le Lion to give a few examples of what ACIS can do for us in... as we work forward with this tool, which indeed has really been helpful in the management of shrink and the identification of shrink in the US. So Michel, maybe you might want to give a few examples.

Michel Eckhout - Chief Executive Officer, Delhaize Belgium

Yes, thank you Pierre-Olivier. As you have stated, Pierre-Olivier, the system is in use. The personnel have been trained and specific action plan procedures have been installed in all the stores in case the level of shrink doesn't meet the requirement. And this has been proven to already deliver first tangible results. For example, in the departments where we have in-store preparations like meet, fresh, in deli, we noticed really tangible reduction in shrink. So of course it's a learning process with gradual and steady improvement, and really we expect to see further improvement in the forthcoming weeks and months.

Pierre-Olivier Beckers - President and Chief Executive Officer

Okay, thank you Michel. The Sweetbay question, Rom, may be you.

Ron Hodge - Chief Executive Officer, Hannaford

Sure, I will address that. You referenced the 14% to 15 % sales improvement that we talked about in previous years and that was directly related to the first 12 months' improvement for stores after conversation. What we are talking about now is total company sales growth at its highest level that we are seeing down here. So there are two different types of numbers.

Craig Owens - Executive Vice President and Chief Financial Officer

Nevertheless, the dynamic of getting really excellent response in the first year post-conversion continues to be the case.

Ron Hodge - Chief Executive Officer, Hannaford

Right. Absolutely.

Xavier Le Mene - Credit Suisse

Okay, thank you

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you very much. Operator I understand this was the last question. Of course, if there is one more question, we will take one more question at this time.

Okay well, operator, operator?

Operator

I am not showing any further questions, sir.

Pierre-Olivier Beckers - President and Chief Executive Officer

Thank you very much. I will turn now to Guy for closing remarks.

Guy Elewaut - Vice President, Investor Relations and Corporate Communications

Thank you for participating in today's conference call. The replay is available on the company's website. You can also find on the website a text with our prepared remarks. If you have additional questions, do not hesitate to contact our Investor Relations department. Delhaize Group will be announcing its full year sales figures on Thursday, January the 17th and its full results for fiscal year 2007 on March, the 6th of 2008. Have a nice day and thank you.

Pierre-Olivier Beckers - President and Chief Executive Officer

Bye-bye everyone.

Operator

Thank you. This concludes today's conference.

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Source: Delhaize Group SA Q3 2007 Earnings Call Transcript
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