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Safeway Stores Inc. (NYSE:SWY)

Q1 2008 Earnings Call

April 24, 2008; 11:00 am ET

Executives

Steve Burd - Chairman, President and CEO

Robert Edwards - Chief Financial Officer

Melissa Plaisance - Safeway’s Senior Vice President of Finance

Analysts

Bob Summers - Bear Stearns

Ed Kelly - Credit Suisse

Steve Chick – JP Morgan

Patricia Baker - Merrill Lynch

Mark Hodes - Copper River Management

Jason Wilmer - Cleveland Research

Meredith Adler - Lehman Brothers

Karen Short - Freidman Billings Ramsey

Chuck Cerankosky - F T N Midwest

Mark Wiltamuth - Morgan Stanley

Scott Mushkin – Bank of America

Operator

Welcome to the Safeway first quarter earnings conference call. Your lines will be placed on a listen-only mode until the question-and-answer portion of today’s conference. I will now turn the call over to Ms. Melissa Plaisance, Safeway’s Senior Vice President of Finance. Please go ahead.

Melissa Plaisance

Good morning everyone and thank you for joining us for the Safeway’s first quarter 2008 conference call. With me this morning is Steve Burd, our Chairman, President and CEO and Robert Edwards, our Chief Financial Officer.

Before we begin, let me remind you that this conference call may contain forward-looking statements. Such statements may relate to topics such as sales, gross margins, earnings growth, operating improvements, cost reduction, capital spending, acquisitions and dispositions, debt reduction, labor relations and other subjects.

These statements are based on Safeway’s current plans and expectations and are subject to risks and uncertainties that could cause actual events and results to vary significantly from those implied by such statements. We ask you to refer to Safeway’s reports and filings with the SEC for further discussion of these risks and uncertainties including those set out under forward-looking statements in Safeway’s annual report to stockholders included in the most recent Form 10-K and subsequent quarterly reports on the Form 10-Q.

And with that, let me turn the call over to Steve.

Steven Burd

Thank you Melissa.

Let me begin with net income. Net income for the quarter was $193.4 million as compared to $174.4 million one year ago. When you express this is earnings per share, we made $0.44 in 2008 versus $0.39 in 2007, roughly a 13% increase in earnings per share.

By way of a I guess quick description, I would say that we are very pleased with our earnings performance on the quarter. Looking back over the last 11 quarters and making the same kinds of adjustments over those quarters that we did when we reported them for things like stock-based compensation expensing, normalizing the tax rate, and some unusual events, EPS has grown at a double-digit rate for us now for 11 consecutive quarters.

While the $0.44 per share benefited by roughly $0.02 per share as a result of the shift in Easter from the second quarter of last year to first quarter this year. This quarter also reflected several negative earnings effects totaling some $0.05 a share which of course we were able to overcome.

To just describe some of those for your benefit, we had a settlement in our labor contract in Alberta which as you know is subject to retroactive wage increases. So we had to put in the first quarter the expense 11 months of the retroactive wage increases and that was a cost slightly in excess of $10 million.

You have probably also noticed that our tax rate was up this quarter. We have been running in the 37% range and it was 39% this quarter. We don’t think that’s going to become a normal quarter, we expect this rate to return to lower levels. That cost almost $10 million if you look at it as a pretax number which was my description of the Alberta buy out.

And then Casa Ley which is an operation in Mexico of which we own a 49% interest had a income difference between last year and this year of about $7 million. And then we had a severance payment reflecting the staff reductions that we made late in the first quarter. That number was around $5 million and then finally we had a weather related property loss that was -- fell below our level of deductibility but was also a significant number. So, all of those events what if had an impact -- a negative impact for us with $0.05 per share but we were able to produce strong results despite that. We also for those of you keeping track beat the first call from census estimate by some $0.02 per share and of course we had signaled all along that Easter would be in the first quarter.

Turning first to sales, total sales increased 7.3% for the quarter, comparable store sales which is what a lot of non-proved retailers report increased 4.7% in the fair field and 3.1% when they export fuel. ID sales increased 4.5% with fuels included and 2.9% when fuel is excluded. Our ID sales benefit from the Easter shopping shifts and so we thought that it’s appropriate to point out how much that benefit was. The benefit was 0.9% so when you take out the Easter holiday, which of course when we report the second quarter we will put it back in so you can do the profit comparison, but take Easter out of it and think about our ID run rate, the run rate for the quarter was 2% which of course is softer than what we were in the fourth quarter and we telegraphed that when we reported our fourth quarter earnings with instincts of softness.

This 2% is on top of last years holiday adjusted 4% number giving us a two year ID number of 6%. The ID sales continued as we expected to be effected negatively by two mix changes. The first is a shift from branded drugs to generic and that shift will continue for sometime yet to come as more branded drugs come into generic forms and then also we have a shift -- a very significant from national brands to what we call corporate brands others might refer to as private brands. Those two things in combination actually lower our ID sales by if you round it’s basically 70 basis points, it’s actually 66 basis points. In fact the corporate brand growth outpaced national brand growth by a fact with quarter one. So when you look at the ID sales for national brands as compared to corporate brands, corporate brands had a four to one edge over national brands.

Perhaps more interesting for some of view if you look at the center of the store brands which excludes the perishable brands, our growth outpaced national brands six to one and then the other thing I would tell you is that our corporate brand growth also outpaced the market, so everybody is looking is there any evidence for trading down; this is about the strongest evidence I could possible give you. The consumers are looking are value and as you might expect we are going to reinforce with consumers in our marketing plans and already had done so.

Normally if 66 basis points decline and ID would lower earnings per share about $0.02, but the profit enhancing characteristics of generic growth and private brands really have the opposite effect for us that was true in the fourth quarter and is clearly true here in the first quarter and so it had the effect not of reducing earnings a few cents but it had the effect of increasing earnings per share actually $0.01, representing a $0.03 swing maybe just a little bit differently and we experienced no mix change which of course is not totally under control, but had we experienced no mix change at all, the Easter adjusted IDs would not have been 2%, they would have been 2.7% and since the mix change itself is profit enhancing, we actually experienced a profit effect of a 3% ID. Don’t misunderstand; I'm not suggesting our ID wasn’t really two, it was three. I'm merely trying to point out that the profit implications of the mix change which require in these economic times for you to look sort of beneath ID and look at the profit characteristics of those mix changes.

We also increased market share in the supermarket channel for the 13th consecutive quarter.

Turning to gross margins, our total gross margin declined by 50 basis points but when you exclude the effects of fuel sales, gross margin declined by only 12 basis points. This decline was largely the result of making some significant price investments which is part of our strategy and those price investments were supported by strong improvements in both shrink and lower advertising expense.

Turning to O&A expenses; O&A expenses declined 65 basis points from last year’s first quarter. Now when you exclude the fuel effects on the O&A expense margin, that margin improved a very healthy 36 basis points despite some of those negative events I referred to in the first part of this call. In addition to the Alberta labor contract settlement, we experienced higher utility costs which would be true of I'm sure of everybody in the retail business and for us also higher occupancy costs driven in part by our capital program which is adding to depreciation.

Looking at interest expense; Interest expense declined just over $5 million due to both to lower debt outstanding as well as a reduction in our average borrowing rate. The average debt outstanding was actually lowered by just under $129 million while the average borrowing rate declined 23 basis points from last year’s 6.43% to 6.2%.

We were also recently upgraded by Standard & Poor’s that occurred on April 8 moving our rating to BBB with a stable outlook and then also moving our short-term rating from A3 to A2 which gave us an advantage in being able to access twice as much commercial paper as well as a reduction in our borrowing rate of about 25 basis points. So we consider that to be a quite positive event on the quarter.

Turning to capital expenses, we completed one new store and 22 Lifestyle remodels in the quarter and spent a total of $373 million.

Now, if you have been following the company for some time, you know that our first quarter is always soft on the remodel and new store completions and then really get stronger as we move through the year. And so this compares very closely with the same capital we spent in the first quarter last year which was $386 million. We believe we are on track to spend somewhere between $1.7 billion and a $1.75 on the year.

In terms of cash flow net cash flow used by operations was $41.2 million in the quarter and this compares with net cash flow generated from operations and about $19 million in the first quarter of last year. A lot of that differences explained by the timing in cash flow to the result from having a highly seasonal business in Blackhawk and then it’s very consistent with our pattern quarter-to-quarter and so we are confident that we are on track to produce that $500 to $700 million with that free cash flow by the end of 2008.

Just a brief update on Blackhawk, there could be some questions on it. I thought in essence the Blackhawk business is going very well just as planned I got the most interesting number for using here from us given that we carry gift cards most all other retailers is how is that business being affected because you see how is their ID sales are being effected by the current economic circumstance and the short answer is it’s not being effected negatively at all. If you look at our gift card partners which would be that retail component, so I am excluding that we have referred with open loop and I am excluding the Telecom business; that business is up 90% and so what we really saying is that our distribution channel that is created here is becoming a distribution channel of choice and that also is becoming a very popular gift for people’s gift.

Other notable events in the quarter, we purchased 2.5 million shares across that $74 million. We also settled two major labor contracts one being in Alberta, that we already touched on, the other being in our Eastern divisions and we are currently in process supporting an offer in our Denver areas and that particular offer if ratified would be one or two years ahead of the original contracts extension. So, it not only plays out that original contract, but adds another 36 months to that.

In terms of guidance we remain quiet comfortable with the EPS guidance range that we provided in December. Which was 225 to 235 per share, we are however lowering our ID sales guidance, ex- fuel from an original range of three to 3 to 32 to a range of two to 23 and I think that’s just basically a reality of their current economic environments and that reduction in range really shouldn’t surprise anyone. Our confident on our ability to achieve the December guidance rest largely with two items; the first is our process improvement and cost reduction efforts. That effort was begun in October and November of 2007 and when we put together our annual plans we always have cost reduction as a major component of that, but the efforts that I am referring to that begin in October and November of 2007 is completely additive to plan that we build for the Company and the guidance that we provided in December to the investment community. In other words it was not contemplated as part of that EPS guidance.

Most of the actions to produce those savings have in fact already been executed on the most visible one being the staff reduction, but the staff reduction while it is a large number it is less than a third of the total savings that we expect to generate in 2008 from this effort and of course we will continue to add things as we move through the year.

The majority of the second component -- the majority of the ID sales change is really explained by profit enhancing mix shift from branded drugs to generic and national brands to corporate brands and so the residual is really the economic effect which for us is more than compensated by this progressive begun in the fourth quarter of ’07.

Our cash flow guidance remains unchanged at $500 million to $700 million and our operating margin guidance which is the guidance that we gave in December ex-fuel remains today at the same level, we think 15 to 35 basis points but it would be fair to think that we would gravitate toward the upper end of that range.

So by way of a quick summary, we believe we had a strong earnings quarter despite several earnings negative events. Sales were on the soft side but we think consistent with the results of other food retailers and significantly better than retailers in general. We have largely explained -- the earnings enhancing shift again that we talked about in detail here I think will continue to occur and it will be reinforced by our own marketing plans. So you should continue to see that reflected in our IDs as we move through the year.

And then finally the cost reduction effort produced very strong results for the first quarter and those numbers will only build as we move through the year and so first quarter while impressive in cost reduction, we should do better than that particularly as we get into the third and the fourth quarter.

So with that Melissa, why don’t we turn it over to questions?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question today is from Bob Summers.

Bob Summers

Hey, good morning. Seems like the reports at your desks were greatly exaggerated. Can we just dig a little into the ID, tell us how to think about the inflation component, maybe give us an update on how remodels are running. You told us about private label and trading down but if you could maybe give us some geographic feel to what’s going on the sales line and then also traffic versus ticket.

Steven Burd

Let me answer the last part first. Traffic is roughly flat and then ticket is up. In terms of – lets see you have so many questions here; in terms of inflation, it’s become my personal belief, if you consider what’s going on in the economy, the credit squeeze, it’s impact on housing, the loss of people’s equity and their homes, I think that’s clearly affecting consumer behavior along with rising fuel prices and I think rising fuel prices are just as impactful as anything else is going on in the economy and it may turn out that those become driving forces and I think the strongest evidence we have for that is what we are seeing and how consumers are making different choices. If you -- their corporate brand numbers kind of speak for themselves but we continue to see other times that you would consider to be discretionary; people are making difference cheaper choices, so that when you look at something -- we sell a lot of coffee and regular coffee costs less than some other premium coffees and so that’s reflecting their purchasing behavior and so regular coffee sales are up significantly and so I think consumers are really looking for value that’s why we made the price investments that we did that’s why we are emphasizing corporate brands for which we have a good stable appropriate brands and I think they are being squeezed on the fuel side, so we as a retailer are doing all that we can to accommodate those interests.

Bob Summers

And then I guess secondly this the cost saving bucket that completely added even not contemplated in their earnings guidance, what’s the right way to think about the magnitude of the bucket.

Steven Burd

I think that one reason not for a kind of detailing this for everybody is that some of that money will be used to the make a price investment and the other thing that’s worth saying is when we think about cost reductions, we don’t just think about O&A. So strength and sourcing become major components to that, advertising expense leverage becomes a component of that. We put out for the third year in the third year in a row, a pretty aggressive target on shrink reduction and we beat that -- at least our target in the first quarter by some distance and so I don’t want to give a number that people might just try to add to income because some of that money will be spent for a desperate price because we repeatedly said that we would like to provide a little better price on everyday value so don’t think of it as going into promotion expense, most of that goes into everyday value pricing.

Bob Summers

Okay thank you.

Operator

Thank you. Your next question is from John Heinbockel and please say your company name.

John Heinbockel – Goldman Sachs

Golman Sachs. Couple of things I want to drill down on; the first do you have any sense that sales trends in general -- I know there’s a lot of noise with all the things in packing sales and calendar, but any sense at trends have stabilized or we have hit bottom or if its not clear if we have seen the worst yet from your stand point.

Steven Burd

I think there is a growing evidence that we might be leveling. I mean it’s the little hard to say because our quarter end at a rather unusual time and so you get very soft sales that we got through Easter which happened to be he first week in the quarter and then week 14 which was Easter shopping last year and we go up against that and so but I think that we are doing a lot of thinks John to not simply stabilize but to grow that ID numbers despite the mix shift that are taking place. And so we think that as we move through the year, we will stabilize and strengthen those top line sales numbers. Despite the fact that most people are suggesting that the economy will not improve in ’08 and so we are not contemplating if economy will improve. We are contemplating that we will gradually get better as we move through the year.

John Heinbockel – Goldman Sachs

Is California particular drag? I know you don’t like to talk about geography but that’s such a big part of the mix. So that particular drag or that’s not any different than the average comp you are saying?

Steven Burd

If you look around our operation, there are pockets that are more affected by the economy than others. You have seen the same article as we have seen. You have seen the US map of foreclosures and stuff and so. You would look -- you can look at pockets of sale in California that are more impacted than let's say the general economy. You could look at pieces of the Arizona market. We are not in Florida but well that’s often talked about as having a big foreclosure. So that does -- it does have an effect and it’s interesting for me having lived in California for some 30 years that this is the first time I have ever seen home prices decline in Northern California, but it’s not true in Southern California. In Southern California, over the last 30 years, they have actually gone up and down, because this is the first you have seen in the north but sometimes it’s hard to see the economic effect because you might have particularly strong operations in one market versus another and there could be some competitive things going on. So I think there are pockets within geographies but we don’t sit here and wring our hands about any particular geography and in fact, I can't remember how many consecutive quarters now. I think it could be four or five now, all then operating ten areas of the company have positive IDs. I have said before I don’t think that occurred in the mid-90s because we always had some competitive system trends happening and so there is a general economic decline and I know when I said that on the fourth quarter report the reaction I got was as if I was the first person to say in soft economic times. I think all the data suggest that it’s been true now for at least a quarter.

John Heinbockel – Goldman Sachs

What do you think – you obviously hit your budget but what do you think is the lowest -- the weakest ex-fuel ID to put up and still do something closer to the middle of your earnings guidance range? I imagine it’s not flat but what do you think is the weakest number?

Steven Burd

I did a presentation publicly recently where I showed some numbers. I said if we dip from our guidance by 0.5, it’s a walk in the park, if we dip by 1% it was not a problem and I was going to continue that presentation, then Robert advised me against it because he said someone is just going to conclude from that, that that’s going to be a reduction in IDs. I think that we would stand fast on the notion that -- we think the guidance that we have given is reflective of the economy not improving between now and the end of the year and we are confident that our earnings guidance would suffice and that confidence comes from a very robust process improvement cost reduction effort and think that we keep adding to it, so and at the same time playing towards that on corporate brands, we believe that we will attract consumers to our store.

John Heinbockel – Goldman Sachs

And then finally do you think you will get any tax check benefits or no. I assume it’s on your guidance.

Steven Burd

No that we look back at the last time which was done by the US governments and was not a noticeable event; I mean we and others kind of gear up to take advantage with whatever additional money is out there but you probably seeing some of the same surveys that we have seen people are not likely to low that up on food. They might pay down some debt, they will some of that on food we think we have a program to capture some of that but I don’t think that this money just automatically flows in the foods. I mean people are squeezed across the boards and so they will just appreciate the money and I think use it general.

John Heinbockel – Goldman Sachs

Okay thanks.

Operator

Thank you. Our next question is from Scott Mushkin and please state your company name.

Scott Mushkin – Bank of America

Yeah Bank of America. I just want to the return to the sales team trying to reconcile little bit of what’s going on, what’s been said. Government had out this week I guess the first quarter food at home spending was up 8%. We get inflation running I guess some people say three to four may be even a little bit over for at this stage and then kind of looking at your corps and trying to put it altogether; I guess it’s where -- I don’t know if you can try to reconcile that for me.

Steven Burd

I am not really -- I am not a follower of the government before. It seems a little inconsistent with all the food retailers at the close. It would suggest that they all have large gardens, if you are saying that eating at home was up 8% because nobody in this business is up 8% and I think that what most people seem to miss and I am not really talking about consumers I am thinking about people who are trying to figure this equation out of that investor is that of the $30 million customers that shop our stores per week, it will be nearly different from our competitors. In the main they live pay check to pay check and I can remember since the time in courier were I did exactly the same thing and it doesn’t really make any difference to make 30,000 a year or a 150,000 a year; when prices go up demand dampens. That’s what we all learned in eco 101 and it actually happened and so I think that it could be -- if you are at the far upper end of the income scale, it’s easy to forget but that’s what happens, but It happens every time and so I think you are seeing you cant take inflations very well, gosh shouldn’t that be an add-on to sales because there’s a demand effect of higher prices, so we would much rather see zero or a little inflation than to see kind of inflation. We will find this to be particularly helpful and we have always subscribed as a challenging mutual. We are recruiting our inflation but it is down from demand.

Scott Mushkin – Bank of America

Two other quick one‘s; property disposition I know it’s always been something you guys have done as a regular course of business is that in guidance this year and do you expect that to be a little bit more difficult?

Steven Burd

Yes Scott it was -- I mean it was included in the guidance and based on the plan that we put together to start off the year, we are not saying at this point any changes in that based on the economy.

Scott Mushkin – Bank of America

One final one; I know you guys have talked about pricing and investments you are making a little bit. Any comments on merchandizing and especially in particular in the center of the store where you may be adjusting a little bit. I know it’s something Steve that we talked about before but I was just wondering if there is any update there?

Steven Burd

I think we are -- I think that in soft economic times, merchandizing can have a powerful effect on sales and so whether it’s the center -- the center of the store merchandizes as you know often gets merchandized as a perimeter to draw attention to some of the best value that we bring to bear with just merchandized on the in caps but I don’t think you are going to see any changes in fixtures or anything. You will see evidence in some of our markets of some everyday value pricing and some price changes that are giving the customers a much better value than they were getting six months ago at Safeway, and not really is the source of that heavy price investment in the first quarter.

Scott Mushkin – Bank of America

Great, thanks.

Operator

Thank you very much. Question is from Mark Wiltamuth. Please state your company name.

Mark Wiltamuth - Morgan Stanley

I am Mark Wiltamuth from Morgan Stanley. I wanted to dig in a little bit on the O ORGANICS, if you can give us an update if you have had any new movement there and are you contemplating selling that into some non-Safeway markets?

Steven Burd

In terms of the updated O ORGANICS, it continues to go at a very rapid rate. We did just north of $300 million last year. That was $310 million and we will break the $400 million number this year with ease and in fact in the first quarter, we were up O ORGANICS sales about 50%. We continue to add items to the O ORGANICS offering and as you know, we are working with some partners who want to take different pieces of the ORGANICS offering and take those into other markets. So I think you will see them -- you will see O ORGANICS I would expect by the end of year in supermarkets beside Safeway and that would also be true of our Eating Right brand.

Mark Wiltamuth - Morgan Stanley

Okay. And then I will just shift gears a little bit. At the analyst meeting, you talked about a $0.27 a share a boost that you could get to your earnings from the end of the remodeling program that’s going to occur. Are you anticipating all of that really flowing through or do you think some of that may just fall back into reinvestment in the price?

Steven Burd

Well, I think it’s just kind of flow through. We will have investments in price but that would be carried by sort of normal course of business, planning. I want to make sure that no one thinks that the process improvement efforts that I have been talking about is -- it is something we always do and what I'm talking about when I refer to the October, November ’07 effort, is sort of added there and so I think the normal course improvements that we make together with our marketing programs to grow sales and leverage cost, that will carry today, that will carry some baseline earnings projections so we view the $0.27, it’s additive to that. If you go back to that investor conference and we laid out a 12% to 15% growth rate. We were saying that baseline growth rate will be impacted positively by that $0.27. So if you want to pick the low end to that range you are free to do that. And use a map you could then add $0.27 in 2010 and so you see at the right guidance in December of ’09. It will reflected at those numbers.

Mark Wiltamuth - Morgan Stanley

Okay thank you.

Operator

Thank you our next question is from Chuck Cerankosky and please state your company name.

Chuck Cerankosky - F T N Midwest

FTN Midwest, good morning everyone nice quarter. Couple of things Steve I just want to circle back on first continued explain it all -- is this are we going to see this kind of pressures throughout the year or is it just more of the one quarter event.

Steven Burd

Chuck I would view as a one quarter and these were tax related items mostly miscellaneous in nature related to some prior years so I would view this at one time later.

Chuck Cerankosky - F T N Midwest

Okay and Steve you mentioned that sales at -- I think that were the term used Blackhawk were up 90%. Is that the face value of the gift cards.

Steven Burd

Chuck it’s the face value of the gift cards but it is gift card it is retail partner cards okay.

Chuck Cerankosky - F T N Midwest

Right

Steven Burd

It is not open little bit and it’s not Telecom.

Chuck Cerankosky - F T N Midwest

Got it and those growths, I mean are those last to growths at slower rates.

Steven Burd

They would grow slower but we are still talking about something just after 50% I mean so it‘s not like they are no growth businesses.

Chuck Cerankosky - F T N Midwest

Got you and turning to comps again, could you give us an idea what your price investments are doing to the compa, are they identical steps are sales growth rate.

Steven Burd

I think that sort of clauses into sort of the competitive arena, so I don’t want to talk about that. You expect us to continue to do that, that’s probably the clue I will give you.

Chuck Cerankosky - F T N Midwest

Okay. How about response gasoline promotion? Is that -- it’s obviously a very sensitive category for customers and is it working better now I given the three things you mentioned in fact in consumer equity loss, inflation, food and the higher fuel prices.

Steven Burd

On the fuel side we typically have some kind of promotion working in virtually all of markets, we change those promotions from time. You are correct to think that it’s a real value to get consumers and they respond to it. The whole logic behind having all these billing stations is to get people the geography of the store and so -- and not only does it invite a value for them. It gives them near the store which often get them in the store. So that’s continues to be a part of our marketing plan.

Chuck Cerankosky - F T N Midwest

Thank you.

Operator

Thank you our question is come from Karen Short and please state your company name.

Karen Short - Freidman Billings Ramsey

Hi, Freidman Billings Ramsey. I just want to ask a couple of questions on cost cutting. I mean I guess may be elaborate at least why you are confident that your cost cuttings will negatively impact to retrievals on the customer experience, can we just talk about that a little bit.

Steven Burd

Sure first of all if I take it a little back in time. This has been a core competency of the Company and at personal strength at mine 30 years and as we managed by a first rate entrepreneur whose strength is in building businesses organically and it’s not to say that there isn’t an opportunity down the road but when you build on organic businesses, I think you would conform, you really have to stay focused on that business and you have often heard me saying when people ask me about supermarket acquisitions, we were focused on the quality changes, the Lifestyle capital investments and didn’t want to get distracted by an acquisition and so I think that when you think about black hawk and all that it has on it’s plate and how you manage that kind of growth, you need to stay focused on.

Karen Short - Freidman Billings Ramsey

Okay. Great, thanks a lot.

Operator

Thank you. Our next question is from Meredith Adler and please state your company name.

Meredith Adler - Lehman Brothers

Thanks; Lehman Brothers. I was wondering just to talk a little bit more about the cost cuts. You guys are really good at it and if you are able to do more to offset the impact of say slightly slower sales if that would happen, why wouldn’t you do all the cost cuts you are capable of doing? Why would you do incremental or is it just a function of how quickly you move the organization ahead to do those things?

Steven Burd

I think it’s really a question Meredith of how much a management team can possibly handle. You can't do hundreds of it and most people can only do a handful of things and because all of those new things that we ask people to do, we can't say stop doing the old things and so it’s really your management limited, we are not limited on the ideas. We are limited by our ability to execute and so that’s why -- you go back to our shrink reduction effort. It’s an ongoing effort over a period of years. The cost reduction effort is over a period of years and one of the beauties of this business -- I have been in lots of businesses, in the retail business where you have over 1,700 like units. If you can crack the code on one small item in a store, which could be cracked by a single store manager and his team, you can multiply that benefit on 1,700 and so those are the kinds of things that we focus on and so it’s -- I think that sometimes when you think you are at the near bottom, it all comes from technology. Think about what we have done in healthcare. The world assume -- in fact most of the world still assumes that healthcare costs are destined to go up 7% to 8% and no one can do anything about it. We did start a gain pack of that and said “lets take a fresh look” and we found a way to make healthcare costs go down. That’s not fully ruled out across all of our operations. We are working very closely. We have union leaders in various markets to effect some of the things for prevention and wellness things and better a lot of that in our California contract and in contracts in the Northwest and that will continue to happen and that probably -- full execution of that one piece and as we launched into the lifestyle remodel effort it was sort of all hands on deck and really focused on that. If you think where we now are in the effort we are more than 60% complete we do about 15% of the store each yea. Virtually all of this stores that we have intent to get down over the next two years with thick planning effort is behind it and that frees up a lot of resources inside the company to focus on what is historically been a core competency. We started getting back to cost reduction in 2005. We did it throughout 2006, we did it in 2007 and then we decided to sort of turn on the afterburners in the fourth quarter of 2007 and we are very careful not to do things that would either negatively affect sales or in our case service. I mean service was an effort where pointed difference that we launched in 1994, we have gotten better and better over the years, we know how we stack up to our competition we stand tall we measure every conceivable aspect of service, we know how our front end is performing, we know how each department is performing. Our front end performance things like you know line like you know mark that weekly in every store of the company those performance numbers got increasingly better over the last two years while we have got down you know very thoughtful things to reduce cost. So we are very, very careful not to do things -- we always tell people that you know bit of a golfer not a great golfer but in golf you want to have a minimum number of swing thoughts but in our company you want a thought with sales and profits and so we always thing about those things and poor service leads to bad sales and therefore bad profits and if you are not careful on your shrink reduction effort leads to bad sales and bad profits. So we are getting it all down right now and we think we will continue to do that.

Meredith Adler - Lehman Brothers

Okay and then just curies what is the time frame do you think for your EDOP or price investment initiatives or is it do you see it is ongoing?

Steven Burd

It is ongoing. I think when we lay down our strategy back in 2003 and 2004 to differentiate our offering it really stands the quality in the store, it decide the lifestyle the store is to create a come and look and feel a more pleasant shopping experience. We said that we wanted to become less promotional and we have made investments in that direction for the last couple of years, we -- that’s part of the reason for going back to our core competencies so that we can fund a more aggressive move in that direction and we will always be promotional and I think that’s true with vast majority of supermarkets but we just like to become a little less promotional because we think that it is better value statement to consumers.

Meredith Adler - Lehman Brothers

Okay, and then just the last question I guess may be do you have any comments on the acquisition environment within the Blackhawk network market and I guess its multiples are coming down are there any acquisitions in the Blackhawk Universe that might make sense to give Blackhawk a greater presence and may be accelerate value creation of the division.

Steven Burd

Here is what I would tell you that Blackhawk is a relatively young company growing at an extraordinary rate and that probably full execution of that one piece I would expect would take two probably two rounds of negotiation. In other words you get, you get some of it in the first opportunity and it proves to be effective because everybody wants to lower per capital health care cost because it frees up money to provide wage increase and so it’s the only explanation I can give you. We can only handle so much. Our idea are much boarder than what we have executed on this year.

Meredith Adler - Lehman Brothers

And then I would like to turn to the just talk a little bit about remodels because I was just playing around with the numbers and with the base of stores that you have got if you wanted to remodel the stores every 9 years you probably have to do about 200 a year. Now I don’t know whether the next set of remodels that you need to do need to be as major and as expensive but would you be planning -- can maintain that kind of schedule or can you slow it down because of what you have just done?

Steven Burd

Well as you know we repeatedly said that we have taken kind of a 10 year cycle, your 9 year numbers is not a bad number, we would typically say depending on how hard the store have to work in its volume 8 to 10 years is the right cycle and so we have taken what we think is a essentially a 10 year program and compressed it into 6. So that gives us an opportunity to back down from a normal rate say in the 2010, 2011, 2012 period and then somewhere in their turn to a more normal rate so -- and your corrective things that the next rounds or remodels we call them tune ups are not likely to be as expensive. I mean we don’t think we all have to go into lifestyle two but one of the things you will see we have learnt so much as the lifestyle lower the store and that there are stores that we will go back into and add features, but I think the basic look in field of stores will remain as they are for some time to come.

Meredith Adler - Lehman Brothers

Okay and then my final question is about the shift to consumer behavior, part of what I think the life style store did was bring some interesting assortment of may be more higher end products, but your customer is focused on the more value items. Do you have to make changes in the way you lay the stores out, the planet lames the way you do your ordering just to be able to handle the volume and the value oriented items that you don’t our stocks?

Steven Burd

No, we don’t I think that on an extreme case, you might provide a little more shell space but you might not because you might accommodate a lot of that business promotionally by end displays floor displays, you might have accommodated by taking those high moving items then when you have corporate brands growing at 6 times rate of national brands -- we have sky shelves in the vast majority of our stores and so you would be very cognizant in importing you know additional stock above that thing shelf so it can be easily restocked during the day.

Meredith Adler - Lehman Brothers

Thank you very much.

Operator

Thank you our next question is from Debra Winsleg and please state your company name?

Debra Winsleg

Good morning, obviously I want -- discussion with regard to increase in private level penetration; are you also seeing a greater portion of business being done on sale item and proms and if so how are you target marking the customer differently then you have in the past?

Steven Burd

I think that what we are trying to do is to emphasize instead of merchandizing and emphasize in some of our promotions are corporate brand and we already start from a pretty small and mix of promotion spend and over time we want that mix to be less strong. So I think the primary thing that we have done is to just really emphasize some of those corporate brands and people are looking for value.

Debra Winsleg

And then with regards to the competitive landscape, are you seeing competitors be rational in this environment and with the same regard do you feel that with the trade in from restaurants how are you also trying to capture that market share?

Steven Burd

I think the environment is quite rational and I have in gotten that question every year in 15 years but I feel a very rational market for 15 years and I don’t really expect to see any change in that and then in your second question was oh the restaurants. I think the way we capture is with our food and daily service offers and you might know that we have a meals program that we are working on that is still in pilot and as that as we started cheating the kind of metrics that we think weren’t roll out we will began to roll that effort out now will give it to you the better shot at some of the restaurant business.

Debra Winsleg

So the Citrine would still be in a kind of tough phase at the moment then?

Steven Burd

I mean Citrine to think of Citrine as a culinary lab if you will for a new product if you get a chance to come out and eat at Citrine its worth doing because you’ll find some extraordinary products many of which we think we can carry in our own Daily food service operation overtime. So the challenge is to figure out how they take that quality and provide a quality alternative like that inside a store. So that it’s a culinary lab it’s not a really restaurant chain in the making.

Debra Winsleg

Okay and the last question can you update us on your small format store launch?

Steven Burd

Say that say that again?

Debra Winsleg

The small format store launch.

Steven Burd

What we talked about in our investor conference is that we are experimenting with a new context. I think people are speculating it as a smaller store. We will have the store up and running certainly by June. If not probably we’re we won’t invite hundreds of people out to see it. We prefer to just work with it see if it works refine it tune it and then if it meets are expectations then and we think it could then it could become a concept it has much greater side to it, but we’re just going to kind of quietly do that and experiment with it so and that’s our approach I think a lot of people approach it that way I mean we want to let people know that we had a concept in the works but we weren’t that interested in expanding out it till we actually believe in it. There is no much point saying well we tried we failed. We are just trying something here and will we and we could see it well that.

Debra Winsleg

Okay well best of luck and thanks so much.

Operator

Thank you, our next question is from Jason Wilmer and please state your company name.

Jason Wilmer - Cleveland Research

Hi, Cleveland Research. Steve can you provide any examples on this process of improvement it seems like you have had a lot of incremental wins there and new ideas but is it all store level or is it buying the scenes from a regional or corporate level?

Steven Burd

It’s really a comprehensive. I mean the most visible thing that we did was the organizational moves that we made which reduced some staffing. That actually produced arguably no value in the first quarter okay but we produced values and moved through the year and then we’ll get out last installment in the first quarter of next year, but a lot of this is really just processes improvement that occurred in the store or in the back stage functional areas some of that would be just more efficient ways to spend promotionally more efficient ways to spend on advertising. The reasons we are reluctant to put a lot of definition on it is we would well we hate to identifying items that our competition had not yet focused on and then have them focused on that and kind of nullify the benefits that we get. So but I think if you look at stores at what we have done we have done extraordinary job of reducing expenses and we think we have done it in a very smart way and so we are going to kind of let our track record and this quarter result kind of speak for our ability to keep doing that and I think that often times people don’t think of cost reduction is sustainable. In our world given our core competency it’s just what we do and I think a good retailer constantly looks for opportunities particularly those in sectors that don’t have extraordinary top line growth because the leverage is so great.

Jason Wilmer - Cleveland Research

And as you look to reinvest fortune to this money what’s been your experience in the past as if there is some sort of lag effect in would you give credit for some of those investments and for compared to the better few might get on the list on that?

Steven Burd

I think that when you advanced in everyday price to improve the value perception on a day in and day out basis you don’t get the same kind of immediate spike in sales the way we get promotionally. But if you look over a reasonably period of time say a couple of quarters you do see it. And so those kinds of investments are not as spiky in nature as promotional but we still think it’s the right thing for us to do.

Jason Wilmer - Cleveland Research

Last question. With black cork even in some of the non seasonal time frames does that suddenly moved the need as yet for the consolidated results say once you do 3 Q on a net basis?

Steven Burd

Well it’s a highly seasonal business so the real profit flow in any series set of numbers its going to come in the fourth quarter for a lot time yet.

Jason Wilmer - Cleveland Research

Okay then thank you.

Operator

Thank you, our next question is from Mark Hodes and please state your company name.

Mark Hodes - Copper River Management

Copper River Management. So I want to be the first to give you guys the credit you deserve because the people whoever you compete with constantly use excuses take charges play the blame game. All you guys do is just execute and people probe all over you in a quiet period and it is just absolutely fascinating to watch. If you do comps they want you to do more cut costs they don’t cut them enough and it’s just truly spectacular. So my question in all of this is what do you plan on doing with your cash flow once the spin peaks which really should be back half of this year or early next year?

Steven Burd

Yeah s its good question that we are generating increasing amounts of free cash flow and if you look at our recent history it’s to return majority of that to share holder either through dividends or a stock buyback and I think you should continue to expect us to do that and may be increasingly so.

Mark Hodes - Copper River Management

The other thing I noticed is we have had no questions on the call about Wal-Mart or Fresh and Easy. Can you explain why that is now? Why does no one ask about Fresh and Easy or Wal-Mart anymore?

Steven Burd

Yeah I don’t think I can explain that I think that on the small store concept I think that there has been some cracks about sort of people dropping back and taking us taking a refined look at that, we have not found a competitive back to that vehicle could be significant. I think we reported that in our investor conference but it had one tenth the effect and I think that news in combination with other news has caused questions about that I mean I think you pointed that when Wal-Mart started building super centers the super market sector was supposed to die a slow death. Not true, not true for us not true for others and I remember Weban is a an analysis and the ware house concept and my answer to that I think Mark is that while we operate the matured sector we are very resilient to economic downturns which I would encourage investors to focus on and then beyond that we think we are very innovative player in that matured sector which constantly finds out its growth and we believe that the others come against us competitively it’s our job to make adjustments and to make their impact ineffective and I think that the market place has come to accept that that and that’s probably why we don’t get a lot of questions.

Mark Hodes - Copper River Management

Excellent thank you.

Operator

Thank you, our next question is from Patricia Baker and please state your company name

Patricia Baker - Merrill Lynch

Sure Maryland. Just quickly see if I want to go back to your discussion on control level and the trends that you indicated to 4 to 1 ratio and then 6 to 1 in the centre of your store. But that was incredibly interesting and as you said compelling evidence that the consumers really managing their budget and trading down. Where would that trend has been because the Safeway got acceleration just for reference point perhaps a year ago or in the whole of ‘07?

Steven Burd

A year ago the numbers I think the -- didn’t bring them with me but its somewhere between flat and up may be 50% okay?

Patricia Baker - Merrill Lynch

Okay.

Steven Burd

So in other words I mean you have seen equal change.

Patricia Baker - Merrill Lynch

Am I correct in interpreting that you are suggesting that really you have seen that big change really kick in the first quarter?

Steven Burd

Yeah, you saw it in the fourth quarter and then you saw accelerate in the first quarter so if you go back in time it begin to take an effect you could see it in the fourth quarter and then I would say third to fourth was the first time of real acceleration and then fourth to first was further acceleration.

Patricia Baker - Merrill Lynch

And there I guess everything is pointing to continued trend like that probably for the rest of the year?

Steven Burd

I would expect that trend to continue.

Patricia Baker - Merrill Lynch

Okay.

Steven Burd

And that somebody just gave me the numbers in the first quarter of last year national brands and corporate brands were essentially equal.

Patricia Baker - Merrill Lynch

Okay.

Steven Burd

So call that slat and now differences of is.

Patricia Baker - Merrill Lynch

Pretty profound actually and then secondly may you won’t be able to give us much granularly on this but that consumer as you indicated shopping pay check to paycheck when they are shifting down or trading down to private level on average what was that price gap be?

Steven Burd

You know it’s going to vary.

Patricia Baker - Merrill Lynch

Yeah.

Steven Burd

That price gap could be you know in the range of 15 to 20%.

Patricia Baker - Merrill Lynch

Okay, thanks a lot that’s very useful.

Steven Burd

Thank you.

Operator

Thank you our next question is from Steve Chick, and please state your company name.

Steve Chick – JP Morgan

Hi, thanks JP Morgan I am Steve I was wondering if you could clarify a little bit with sales trends as I recall in the first seven weeks of the quarter as of last quarter you would say that you saw amount of softening and I think that was relative to the 2.7% that you had reported non-fuel identical sources last quarter so I guess ex easter and I know that makes it difficult can you speak how sales trends were you know as the quarter went on and if you saw kind of a continuous down shift and then I know it was asked to touch down earlier but post quarter end you know I was wondering if you could clarify what in fact you have been seeing in the weeks post quarter end?

Steven Burd

State the last part again Steve?

Steve Chick – JP Morgan

Yeah Post quarter end the.

Steven Burd

Okay, all right, here is what I tell you the softening that we referred to -- gosh I think we were I think you were correct it was 7 weeks into the year, we had a good sense for that and I would say that going a little bit from recall those numbers were down in that range of 0.5, 0.6 we ended down 0.7 from the fourth quarter the 28 instead of a 27 so that would suggest that we saw vast majority of that softening right there in the first seven week and you know and then you know in the first part of this quarter I think again it’s all I haven’t tried to isolate east are really kind of messes up the analysis here you almost have to about three weeks out but I think which you should expect from us is that you will see a soft second quarter and then and I am assuming no improvement in the economy no deterioration in the economy our expectation is that second quarter is going to be you know soft and then we will see some improvement because of what we are doing in the second excuse me third and the fourth quarter. Now I can’t tell you exactly where corporate brands are going to go so corporate brands go from you know 6 times national brands in the center of 12 times then you are going to see a further impact on ideas than that I don’t that generic drug thing will be much different in the second quarter as it was in the first quarter so I think that you know we are kind of looking in the range and keep them on reported number will be less than two because we have the 0.9 through in these things you are going to add that 0.9 to get a real feel for run rate in the second quarter but you know I expect you know continue you know softness in the second quarter.

Steve Chick – JP Morgan

Okay, I guess sorry but to understand that the -- are you saying that even when we adjust for Easter the second quarter might be a touch south of two or are you saying --?

Steven Burd

I don’t want to get that specific well let me try to restate it the softness in the first quarter you know turnout not to be materially different from the first seven weeks we expect continued softness in the second quarter and so that probably because you were going to be around that number and we think things will strengthen as we move into the third and fourth quarter because of action plans we have and all of that assumes that the economy does improve it assume the economy doesn’t get worse at the same time I don’t think anyone is forecasting dramatic changes in the economies in the negative direction and so we think our earnings guidance remains good regardless of what happens.

Steve Chick – JP Morgan

Okay, and then secondly if I could in your proxy you talk about a evaluation actually of Blackhawk and its per share and it actually increased you know a lot in the last year or two is that just to clarify that I don’t know if you know which number I am talking about but it’s about 376 per share is that evaluation per Safeway share that’s estimate or is it kind of more complex than that?

Steven Burd

See we have an internal equity program at Blackhawk and as part of that we do periodic evaluation and so that evaluation based on a the number of shares that we have available a Blackhawk internal equity if you will it is not a Safeway share equivalent.

Steve Chick – JP Morgan

Right, okay and I guess that’s the tough parts tough to extract it’s tough for us to extract what that might be imply for evaluation to the firm.

Steven Burd

Correct.

Steve Chick – JP Morgan

All right, you know thanks.

Operation

There is time for one more question. Thank you our final question is from Ed Kelly, and please state your company name.

Ed Kelly - Credit Suisse

Hi, Credit Suisse see in light of the what we are seeing at their can you just update us on what we are seeing at the most recently lifestyle stores you know is there any change in the list that we are getting in year one today versus what we have been in the last couple of years?

Steven Burd

The numbers that in the quarter are consistent with what we shown you in the past most of the first year as well as years one through four again the information we provided historically at the investor conference excludes competition because we think that’s the best way to look at what we think the stores are doing and the numbers that set for the recent quarter are pretty consistent what we showed you in the past

Ed Kelly - Credit Suisse

Okay great and lastly can you just update us on where we stand on remodels to Dominic’s and in the result you are seeing there?

Steven Burd

The, at the end of the year I think were 42% complete in Dominic’s. Dominic’s got a late start and we get results in Dominic’s that are just as good as they are anywhere else in the Company.

Melissa Plaisance

Right, well thank you everyone we appreciate you participating in the call. If you have any follow up questions David Ching and I would be available for the balance today.

Operator

Thank you and this concludes today’s conference; you may disconnect at this time.

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Source: Safeway Stores Incorporated Q1 2008 Earnings Call Transcript
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