Great Atlantic & Pacific Tea F4Q07 (Quarter End 2/23/08) Earnings Call Transcript

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Great Atlantic & Pacific Tea Company, Inc. (GAP) F4Q07 Earnings Call May 6, 2008 11:00 AM ET

Executives

Christian W.E. Haub - Executive Chairman of the Board

Eric Claus – President & Chief Executive Officer

Brenda M. Galgano - Chief Financial Officer & Senior Vice President

William J. Moss – Vice President & Treasurer

Analysts

John Heinbockel – Goldman Sachs

Karen Howland – Lehman Brothers

Karen Short – Friedman, Billings, Ramsay & Co.

Karen Short – Friedman, Billings, Ramsay & Co.

Robert Summers – Bear Stearns

Operator

Good morning and welcome the A&P conference call. All lines will be in listen only mode until the question-and-answer session. Today’s conference is being recorded. If you object please disconnect at this time. For your information a webcast is available on A&P’s website at www.APTEA.com. Chairing today’s call will be Christian Haub, Executive Chairman. Also participating on today’s call will be Eric Claus, President and Chief Executive Officer and Brenda Galgano, Senior Vice President and Chief Financial Officer. I would now like to introduce Mr. Bill Moss, Vice President and Treasurer who will read A&P’s Safe Harbor disclaimer.

William J. Moss

Thank you and good morning everyone. This morning’s conference call may contain forward-looking statements about the future performance of the company and is based on management’s assumptions and beliefs in light of information that is currently available. The company assumes no obligation to update this information. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements including but not limited to competitive practices and pricing in the food industry generally and particularly in the company’s principal markets, the company’s relationships with its employees, the terms of future collective bargaining agreements, the cost and other effects of lawsuits and administrative proceedings, the nature and extent of continued consolidation in the food industry, changes in the financial markets which may affect the company’s cost of capital or the ability to access capital, supplier quality control problems with the company’s vendors and changes in economic conditions which may affect the buying patterns of the company’s customers.

I will now turn the call over to Christian Haub, our Executive Chairman.

Christian W.E. Haub

Good morning everyone and welcome to our fourth quarter conference call. As usual I will give an overview and then you’ll hear more about the details from Brenda and Eric.

To start with the fourth quarter in 2007 it definitely has been a momentous year for A&P. Not only did we deliver improved results from our operations but we also completed our strategic transformation and the completion of the Pathmark acquisition certainly was the highlight of the year and served as the capstone to our strategic transformation. With the transaction we have now achieved the number one position in the Northeast region and have become the market leader and the country’s largest consumer market right here in metro New York. The results in our retail operations have steadily improved during the last three years and we continue that trend in the fourth quarter. This past year has seen the strongest top line sales trend in many years. Our overall improved performance and momentum is directly attributable to the skills of our proven leadership team and the new operating strategy this team has been implementing since 2005.

Today we are successfully developing our business following our format driven strategy. This effort is led by a centralized organization focused on driving top line sales growth and achieving improved profitability. I am pleased with the overall progress we made during the fourth quarter. Results from our retail operations continue to improve despite a more uncertain economic environment and the first several months of integrating the Pathmark acquisition have gone very well. We have accomplished all key integration milestones so far and are right on track to deliver the $150 million of synergies we have targeted. Even though it is still early in the process I am very optimistic about Pathmark. It will clearly deliver on its promise. The additional Pathmark skills talent expands the store portfolio, formidable brand strength and proven consumer reputation complements our consumer centric go-to-market strategy especially as we are facing a more difficult consumer environment and therefore this deal could not have come at a better time for A&P.

Looking ahead to 2008 our focus will be on the successful integration of Pathmark while at the same time weathering the challenges of a changing economic backdrop. We have moved quickly and effectively to integrate the business based on a comprehensive plan developed by our integration team. To date the company is on track with its integration activities and the early realization of synergies makes me confident that we can achieve our targets. I’m also very encouraged by the positive sales trend we’ve been able to generate in the first few months at Pathmark.

Looking at the economy it is clear that the environment has deteriorated including in the Northeast region. Even though we have not experienced any significant trading down impact in our business yet we are nonetheless prepared for what’s coming. I expect that the new A&P will compete successfully during this time and weather the storm. We are well positioned to deal with the effects of a slower economy with our differentiated formats, the lower cost base of the combined company and our exceptional portfolio of store locations close to the consumer.

Furthermore sustained food price inflation is another adversity we are facing and again I believe we are in a much better position to deal with this problem in a market that is now more consolidated. I expect we will continue to manage through this successfully as long as the rate of increases doesn’t exceed current levels significantly. Altogether I am confident in our strategy and in our management team which is fully capable of delivering on the potential of the Pathmark acquisition and to successfully steer the company through a more challenging external environment we will be facing in 2008.

That’s my overview and I’ll now turn it over to Brenda.

Brenda M. Galgano

Good morning everyone. Before I begin I’d like to note two items. First results for Pathmark are reported based on our fiscal calendar. As such this year’s fourth quarter for Pathmark is a 12 week quarter and our results for last year do not include Pathmark. If you do compare Pathmark’s results for this quarter against what was reported last year please note that last year represented a 14 week quarter starting in November and ending in January versus this year’s 12 week quarter starting in December and ending in late February. Second please note that our 10-K has not yet been filed. We plan to file this Thursday, May 8th.

This morning we reported fourth quarter sales of $2.2 billion and a loss from continuing operations of $1.40 per diluted share. Note that the per diluted share amount is computed on an if converted method as required by GAAP. This method treats the convertible debt as equity and excludes any P&L impact of the debt being outstanding. Comparable store sales were positive 3% in the quarter excluding Pathmark stores. Comparable store sales for Pathmark were positive 1.5% for our quarter ended February. For the first 10 weeks of our first quarter we continued to see positive sales trends in both businesses. Excluding non-operating net losses of approximately $29 million and net gains of approximately $2 million respectively ongoing EBITDA was $72 million this year which includes $7 million of integration synergies versus $24 million last year. Schedules 3 and 4 of our press release detail the non-operating items for both ears. I’d also like to note that last year’s EBITDA excludes $4 million of income related to the expired IT contract with Metro.

Fourth quarter ongoing gross margin decreased 24 basis points to 30.46% driven primarily by the inclusion of Pathmark this quarter which had lower margins than A&P of approximately 50 basis points. We have not experienced a significant change in margin rates due to inflation. Fourth quarter ongoing SG&A expenses totaled 30.10% this year versus 31.62% last year a decrease of 152 basis points. This decrease is driven by the inclusion of Pathmark this quarter which had a lower SG&A rate than A&P due mainly higher sales productivity as well as the early realization of synergies. In addition non-stock compensation expense was $1.6 million lower in the fourth quarter versus last year.

I’d like to point out three additional items in our P&L this quarter, non-operating income, interest expense and outstanding shares. Non-operating income of $37.4 million reflects the non-cash mark-to-market adjustments related to the Pathmark Series A and B warrants, the conversion feature of the convertible notes and the financing warrants related to the convertible notes. I will provide more detail on the related liabilities recorded in the fourth quarter during my balance sheet discussion. Interest expense in the fourth quarter totaled $63 million. This includes a one time expense of $27 million related to the temporary bridge financing used for the Pathmark acquisition and later refinance with the convertible notes offering. In addition approximately $8 million is non-cash interest which is comprised of the amortization of financing fees, the amortization of the discount on the convertible debt as well as other one time charges. Excluding these amounts fourth quarter ongoing cash interest totaled approximately $28 million. We expect non-cash interest to be approximately $20 million in fiscal 2008.

As a reminder in connection with our convertible debt financing we loaned approximately 8.1 million shares of our stock to our financing bank who then sold approximately 6.3 million shares to the public in a public offering which was consummated on December 18th of 07. We did not receive any proceeds from the sale of these shares other than a nominal lending fee. Because the shares will be returned back to the company under GAAP they are not included in the EPS calculation even though they are considered outstanding.

For the fourth quarter capital spending totaled $25 million with deprecation of $64 million. This compares to $24 million of capital expenditure during last year’s fourth quarter with depreciation of $42 million. With respect to depreciation we have completed our detailed asset-by-asset valuation and the $64 million reflects more precise purchase accounting as compared to that estimated and disclosed in our December pro formas. The decrease in depreciation versus the amount in the pro formas is driven mainly by an increase in the useful lives of the depreciable assets as well as lower leasehold values versus our original estimates. The details of this will be provided in our 10-K.

During the quarter we completed the renovation of the Jersey City Pathmark store, worked on projects to be completed in 2008 including the Homedale Fresh store which was completed last month. The remaining cap ex was primarily related to maintenance. Our total cap ex in 2007 was $123 million which includes two Gourmet remodels, one Good Basics remodel, the completion of the Pathmark remodel and nine fresh remodels. Capital spending has slowed in the quarter as we completed the acquisition of Pathmark and began the integration process. We expect this lower level of spending to continue into the first part of fiscal 2008 as we finalize the integration. Overall returns from our remodel program continue to exceed our cost of capital and ID sales for capital stores continue to be strong. For the quarter average IDs from all capital projects completed in the last year was in the high teens. Average IDs from 2006 capital projects completed over a year ago was in the mid single digits. In fiscal 2008 we expect to spend approximately $200 million which includes primarily enlarging or remodeling stores and converting stores to more optimal formats.

Turning now to our balance sheet we ended the quarter with net debt of $1.285 billion including capital leases and real estate liabilities and net of $2 million in short term investment and $23 million of restricted cash. The components of debt are as follows. $12 million in uncommitted line of credit, $170 million in revolver borrowings, $13 million of the 2011 notes, $140 million of the 2011 convertible notes, $234 million of the 2012 convertible notes, $200 million of the 2039 notes, $3 million in miscellaneous notes, mortgages and other, $169 million in capital leases and $370 million in real estate liabilities. We ended the year with net debt of $1.285 billion which is an increase of 1.292% during the quarter. Of this increase $1.310 billion was spent as part of the Pathmark acquisition including Pathmark leases acquired and $24 million was spent on integration costs. The remaining $42 million reduction in net debt consists of the following, adjusted EBITDA of approximately $72 million, real estate proceeds of $32 million and a net working capital decrease of approximately $6 million. The change in working capital is primarily driven by a seasonal decrease of inventory partially offset by a decrease in accounts payables and accruals which is partially seasonal and partially due to the pay down of certain aged Pathmark payables. This was offset by a net cash interest expense amount as well as taxes of $28 million, cap ex of $23 million which excludes $2 million of integration cap ex included in the integration costs I mentioned above, as well as dark store occupancy payments of approximately $17 million.

Availability under our revolving credit agreement was $259 million at the end of the quarter with outstanding loans of approximately $170 million and letters of credit of approximately $235 million. Included in our total non-current liabilities are other financial liabilities of approximately $225 million which is new for this quarter. Other financial liabilities include $151 million for the Pathmark Series A and B warrants held by [Ukipa]. Under GAAP these warrants are recorded as liabilities and mark-to-market each quarter. As a reminder the Series A warrants representing 4.7 million units at an exercise price of $18.36 expire next month on June 9th. A&P has the right to settle in cash, equity or a combination of the two and we are currently evaluating the best alternative for our shareholders. $43 million for the convertible notes feature which is accounted for as free standing instruments. The notes were recorded at a discounted amount equal to the value of the conversion features at the transaction date which was about $49 million at that time.

The discount will be amortized to interest expense over the life of the notes which increases the outstanding balance of debt every quarter up to the face value. Separately this conversion feature will be mark-to-market every quarter and is $43 million at the end of the balance sheet date. We also have $31 million related to financing warrants for the convertible debt. The financing warrants allows the holders to purchase common shares at $46.20 and $49. Note that the call option which is the other side of this call spread overlay allows the company to purchase shares at $36.40 and $37.80. This feature is included in equity. The value of these liabilities were determined using the Black Shoals pricing model and may change as a result of changes in A&P’s stock price, the remaining time to maturity and the current interest rate. The change in value of these liabilities is recorded in non-operating income on the P&L.

As of the end of the quarter we had tax net operating loss carry forwards of $365 million to offset future tax profits including operating profits and capital gains. With respect to integration we are right track and continue to be confident in achieving $150 million of annualized synergies within 18 to 24 months of the acquisition. During the quarter we realized $7 million of integration synergies which is included in our adjusted EBITDA. This $7 million represents namely administrative costs reductions but also does include some cost of goods and operating cost savings. As of the end of the fiscal year we achieved an annualized run rate of synergies of approximately $50 million and expect to achieve an annualized run rate of over half of the $150 million by the end of our first quarter. Eric will cover more accomplishments of the integration during his discussion.

Our current estimate for integration costs is approximately $100 million which is $15 million less than our original estimate. Of the $100 million approximately $20 million represents capital expenditures, approximately $45 million represents expense and approximately $35 million was included as liabilities on Pathmark’s opening balance sheet as part of the purchase accounting and will not therefore be reported as expense in our income statement. The $45 million of expense includes $10 million of non-cash costs associated with the integration stock compensation program. Through the fourth quarter we have spent $33 million of integration costs which consists of $3 million of capital expenditures, $23 million of expense and $7 million of costs included in purchase accounting.

In closing I am pleased with our continued progress both in the A&P business as well as with the Pathmark acquisition. Comparable store sales for both A&P and Pathmark continue to trend positively and we have been reporting a steady improvement in EBITDA. Integration and the realization of synergies is progressing right on track and we remain financially strong and continue to focus on maintaining sufficient liquidity.

I’ll now turn it over to Eric.

Eric Claus

2007 has gone and we’ve yet another momentous year behind us. As Christian mentioned this has been a very transformational year for our company with the highlight really being the acquisition of Pathmark. Once again this year I’m so very proud of our team’s accomplishments. Managing an acquisition and an integration of a very sizable business this team has delivered a full year of top and bottom line growth. This team has now delivered nine straight quarts of improved momentum in our business.

Over the last 12 months we’ve completed the acquisition of Pathmark, planned and commenced the execution of an almost flawless integration and synergy attainment process, completed a year long negotiation of a very new and innovative think company model, logistics contract with C&S, successfully divested of non-core markets in Michigan and in the South, successfully grew the fundamental key performance indicators of our business such as customer count, sales per square foot, unit sales, basket size, market share, etc. We’ve invested capital in each of our store formats capturing incremental market share in each. We aggressively grew and commenced a massive overhaul of all of our private label offerings. We acquired Best Cellars to capture a concept and knowledge base for our new wine, beer and liquor business. We signed an agreement with Starbucks for locations in our Fresh format and launched several over the past few months. We grew our existing online business and launched our Long Island branch of this business and we have produced the company’s strongest comp store sales in the last eight years. It has been a busy year.

Let me get into a little bit more detail around some of these initiatives and I’ll start with Pathmark. The integration of Pathmark is very well underway. There are no major issues that have surfaced that could not be quickly resolved and that’s testament to our planning. And I’m very, very pleased with our team’s outstanding execution. The Carteret offices are now closed and those associates that joined the A&P family are integrated into our company at our corporate headquarters. We have genuinely welcomed the Pathmark team into our fold and I can say this with certainty that this was done in a very welcoming and inclusive manner. Synergy target attainment is on track and we are projected to be at better than 50% of our stated total goal by the end of the first quarter of this year.

We’re well on our way to launching our new combined Pathmark and A&P private label programs. This launch will take place in the next few months to come and I’m pleased to report that the initial reaction to those lines already launched have met with great acceptance by the consumers who of course have voted with their wallets. We will launch the first of our new remodeled price impact stores at the end of May. This will be the template for a massive Pathmark refresh to be rolled out between now and the end of 2009. These stores will look super impactful, will be truly price impact stores and they’ll be cost efficient to execute and deliver a more modern and today experience. We’ll be enhancing the Fresh experience particularly in areas such as produce and bakery.

We’re very pleased that Pathmark stores with renewed energy and aggressive merchandising plans are experiencing continued positive comp store sales, momentum is really building. I’m extremely pleased with our progress thus far and am very impressed with what the team is accomplishing. There’s really a lot of positive energy and excitement within the Pathmark teams.

I’d like to speak a little bit to the new C&S logistics contract. As previously announced this contract is a significant milestone for both A&P and C&S. For the first time in our very long relationship and I think that dates back about 27 years we’re truly aligned with the common objectives and we’re very strategically positioned to benefit from a new big company model. The bigger benefits will take some time to realize. However the immediate benefits are clear given our new strategic alignment. This new alignment allows us to procure and distribute far more efficiently than in the past improving service levels and a host of other issues that will help us maximize sales and better control inventories. All of this will assist us in ensuring the attainment of our financial targets.

Both companies are really committed to making this new deal work and the change that we’ve already started to see in our working relationship is extremely encouraging. My thanks and praise goes out to C&S’s Rick Cohen and his team as well as any people in our company who worked very hard and long to make this happen.

Let me speak a little to the [North] format progress in capital. Of course I’ve already talked about Pathmark. We continue to be on track with regard to capital investments in our stores. As previously stated we’re now including Pathmark stores into this initiative. In the fourth quarter we continued to see tremendous progress in our new Food Basics discount format. These stores continue to experience very strong double digit year-over-year sales growth. Now for a fourth quarter in a row we can report a much improved bottom line from stores that were major money losers in their previous lives as conventional supermarkets. Our Fresh store remodels continue to be positive and continue to gain momentum every period. We continue to experience solid sales growth as Brenda previously noted and overall returns are exceeding our cost of capital. Our new Fresh prototype in Park Ridge has been expanded to Homedale, New Jersey with great success and sales continue to be very strong. More of these to come later this year. Overall we continue to be pleased with our Fresh store financials as the mix growth to Fresh continues driving increased sales in both Center Store and Fresh and driving margin dollars. Once again this quarter I can say that we’re very pleased with our Fresh store progress.

When it comes to our Manhattan Food Emporiums overall sales in the Manhattan market have really taken off and our Gourmet concept is producing strong results exceeding the total company comps. More capital will also be spent in this market in this year. Starbucks, we’re very pleased with the results thus far and we now have seven locations open with more to come this fiscal year and Best Cellars, things are progressing well and we’ll have our first free standing prototype open in about three weeks in Westwood, New Jersey.

Although Brenda has reviewed our fourth quarter results I’d like to mention a few of the highlights. We are now the number one player in the number one market in the country as Christian mentioned earlier. It’s also one of the hottest competitive markets in the country. The market is red hot and we continue to play in that arena to drive hard in order to attain our fair market share. That said we continue to be pleased with our top line results and price positioning. Again this quarter our comp store sales topped the 3% market, the market A&P and 1.5% for Pathmark. Our adjusted EBITDA of $72 million exceeded last year and is line with our performance goals. Given the market intensity and the dual focus of running and growing the business while integrating Pathmark we are very pleased with the quarter’s results. Our competitive pricing strategies and aggressive promotional programs continue to improve our price perception with our customers.

There’s a lot of talk and even dramatization in my opinion about food inflation. Although costs may have gone up in the 4% to 5% range overall real inflation at A&P stands at about 1.5% and is probably less prevalent in our company given the level of competitive activity in our market and our new pricing strategy. You have to remember that real price inflation is driven by what the consumers buy, not necessarily what the costs have gone up because the consumers shift their purchases. Our real gains however are evident in increased basket sizes, customer count, sales per square foot and market share. The key market indicators in our businesses are and continue to be strong. Private label penetration continues to grow at an aggressive rate and we’re on track to attain our penetration targets that we set for ourselves for 2008.

When it comes to our cost control our administrative run rate continues to be on track including the integration of Pathmark and the Carteret office as I mentioned earlier is now closed other than a few building maintenance people that are cleaning up. Utility costs were higher for the quarter and we continue to aggressively pursue and implement systems to mitigate some of the energy price increases and we have been quite successful at that in the last quarter. Our store operations teams in all formats continue to do an outstanding job as they focus on cost control. Labor productivity once again and sales per employee hour were again better than last year in all formats demonstrating the commitment from all of our teams at retail. Stock losses in Center Store were again higher than last year and is still an area of concern but an area that our operators continue to focus a lot of energy on. This was once again however offset by much improved Fresh shrink which is a company wide initiative driven by the retail and merchandising teams.

In conclusion we stay very, very focused on our game plan and the strategic direction that we’ve chosen. We’re very focused on and are reaching our projected synergy savings as planned and are very confident of attaining them on time and on the money. This has been a great and challenging and rewarding year and we’re well into another exciting one in 2008. So in closing I’d like to once again thank our Board of Directors for their guidance and support and to my executive management team which is a small group of very hard working and very dedicated people and to the whole A&P and Pathmark teams who are all doing so, so much in order to deliver on our expectations.

I’ll now pass it back to Christian.

Christian W.E. Haub

I will close with a brief summary of what you’ve heard today. 2007 has been a very meaningful year for the company. We delivered improved results and completed our strategic transformation begun three years ago. I’m looking forward to continued progress in 2008 and beyond as we fully integrate Pathmark, further implement our format driven strategy and look for additional ways to grow our business and create value for our shareholders.

To recap our key points the integration of Pathmark is on track to deliver synergies of at least $150 million, we are very well positioned to deal with the challenges of a more difficult economic environment, our formats are winning in the marketplace, we’ve improved our price position in the A&P business and Pathmark already commands a strong price position in the market, our new company wide private label strategy will deliver value to our customers and in turn contribute additional profits to the company. Our top line momentum demonstrates our ability to capitalize on the consumers’ changing shopping behavior and food consumption trends. We are poised to deliver significantly improving results in 2008.

Thank you. This is the end of our presentation parts and we are now pleased to take your questions.

Question-And-Answer Session

Operator

(Operator Instructions) We’ll have our first question from John Heinbockel – Goldman Sachs.

John Heinbockel – Goldman Sachs

A couple of things, at this point what do you have to do to start to get the C&S savings flowing into the P&L and when do you think that will be? Is it six months off? A year off? Do you have a sense of timing?

Eric Claus

I think that we’re already in a mode where it’s certainly helping us to attain what our targets are. I think there’s some long term more strategic initiatives that can happen over time but we didn’t build a lot of additional synergies into our model and have basically built our whole business plan around a more aggressive sales income and just a stronger P&L going forward and a lot of that is predicated on the fact that we can operate the way we should have been operating with C&S which now if our centrally aligned procurement, the way in which we manage our distribution centers on a cost plus basis means that we’re working to bring down costs which will probably just mitigate some of the things such as higher fuel. So we haven’t built a whole lot of upside into this. There might be a little bit more upside than what you think, hopefully there is but I wouldn’t bank on that for now. We’re sort of saying let’s use this to just get to the place that we want to be and mitigate some of the downsides such as the cost of fuel.

John Heinbockel – Goldman Sachs

When you’re talking about deploying those savings, those numbers are not in the $150 million. Is there a thought that you might want to take more of whatever the savings end up being, putting it back into the market in terms of pricing or promotion to drive market share? Is that a good use of those dollars and is the market share out there to be had today?

Eric Claus

If I understand your question correctly, John, you’re basically saying if we over-achieve on synergies are we going to invest that into our pricing and into the market. Is that correct?

John Heinbockel – Goldman Sachs

Yes.

Eric Claus

It’s a complicated question because I think you’ve got to invest based on how everyone else is reacting in the market. We definitely have a plan and we have a plan to attain a certain sales per square foot which by definition will change our market share and we will do whatever we need to get there while at the same time making sure the mix allows us to be profitable. You might see some of the additional, if there are additional synergy savings, be reinvested in the business to ensure that we get to where we need to be. Because certainly this deal is not about increasing margin percents, our margin percentages are already one of the highest in the industry. So I think this is about getting our costs in line, becoming much more efficient in driving the top line and that probably will require some investment.

John Heinbockel – Goldman Sachs

Secondly, what has your consumer research told you about Pathmark’s positioning in the marketplace as you took it over particularly with regard to price perception and what work you may need to do there to maintain a very strong pricing view in the marketplace?

Christian W.E. Haub

At A&P as you know we’ve still got a long uphill battle to fix our price perception because it’s the kind of thing that takes, you can destroy it in a year and it can take five years to build it back. We’ve really just focused on building at the A&P piece back and we’ve had significant progress on our weekly specials, that kind of perception. When we look at the Pathmark one, the Pathmark price perception by consumers is still very good. It’s certainly significantly better than the A&P, whether that’s rightly or wrongly so, but it is what it is. I think the last year at Pathmark and again I give a lot of credit to the management team that was there because they really kept the wheels on the bus as the wheels didn’t fall of the bus in the last year. But when you’re holding a company together obviously you’re doing things a little differently and I think there was a price creep upwards that we want to be careful that we don’t do what others have done is to allow that to permeate into a higher price perception business especially now with Pathmark. If you look at the early results that we have with Pathmark they’re exactly a reflection of us being more aggressive and actually pushing prices down and we have a very, very well defined plan of what a price impact concept is and what we need to do to deliver a price experience in those stores and that’s exactly what the launch at the end of May of our first price impact renovation will be. It’s going to be an extremely powerful store with a powerful flyer and it’s going to be an experience that really delivers on exactly what Pathmark was built on many years ago, what made it so successful at the time. We’ve spent a lot of time actually with folks that have been around Pathmark for 20, 30 years and said what made you guys great 20, 30 years ago and what can we bring back? So there’s a lot of exciting stuff coming to that end.

John Heinbockel – Goldman Sachs

Finally on that format, what is that going to look like when you think price impact not Food Basics you think of [inaudible], you think of the warehouse aisle, the power aisle, drug, grocery. So what is it going to look like physically? Is it more signage and physical change or actual pricing changes and then is any thought of bringing back the no frills brand that I think a lot of people remember fondly from years ago at Pathmark?

Christian W.E. Haub

Without spelling out our whole competitive strategy for obvious reasons the stores are going to be a combination of a lot of things that you said. There’s going to be a small change in the layout of the store, there’s going to be significant change to signing, coloring, price impact within the store, but I mean significant. It’s going to be very, very, very impactful when you walk in. But that in itself that’s image. So image has to support something. Unless you support a better experience then you’re not going to be successful with it so we’ve completely realigned our pricing strategy to a new one, what it should be. We have completely worked on the merchandising mix and we’re not going to make the mistake of cutting back the assortments. The idea here is to change the assortments to make sure that you have the right assortment which is a good combination of brands because they’re brand shoppers with a very strong private label, a very, very strong in store merchandising program. A complete revamp of the flyer, there’s going to be something very, very new and then without speaking of the school, we’re going to relaunch some of the things and some of the programs that Pathmark was known for a long time ago that were extremely successful and we’re going to sort of bring back those years of Pathmark was the price leader in the market. To do all this, John, what’s interesting also we actually researched what’s a price impact store? Because I don’t think there’s a definition in this country of what it is so we’ve been looking for one. We couldn’t really find one and we had to define something because we didn’t want to be just another conventional supermarket that we call price impact. That you have to be something different. So we defined it and I’ll read it to you quickly. We defined it as the price impact format is a destination price leader where the customer basket is impressionably less expensive than conventional supermarkets. It offers a full selection of the products customers need most at low prices with national brand products and own brand alternatives with designated deal zones and treasure hunt items throughout the store it delivers value and an impactful shopping experience. Now that said you could ask me your next natural question could be well are you going to sell a box of Tide cheaper than everybody else? That’s not the point of this. The point is that if Mr. and Mrs. Jones goes into the store and does their grocery shopping that they should come out saying you know when I did this at a conventional store it was X number of dollars and when I do it at the Pathmark store it’s X minus Y and that’s just because of the product selection, the way the products have been merchandised and you need toothpaste, you need paper products, but we’re going to merchandise it and buy for such a sense that there’s enough of those deals around that your overall shopping basket between private label, special deals and brands ends up being significantly less than what it would be in a normal supermarket.

Operator

We’ll have our next question from Karen Howland – Lehman Brothers.

Karen Howland – Lehman Brothers

I was wondering if you could clarify one of the comments that Christian made at the beginning of the call as far as being able to pass through food inflation. So far it seems like you’ve been able to, he was indicating that as long as it doesn’t get any worse, have you seen any change in the competitive environment that would lead you to think that it will be difficult going forward?

Eric Claus

Not really and the funny thing is we have meetings with our operations people every single Monday and I spend a fair amount of time in the stores. You don’t hear a lot other than when the news blew up the rice story and it was funny, call me a liar it was on Bloomberg the day before saying no, we’ve had no run on rice. We’ve got tons of rice in the warehouse. The very next day our shelves get emptied out. So this became a media event that’s almost when you get a snowstorm and people stock up and they fill their cupboards in their kitchen but there’s only so much rice you can put in. People have talked about food hoarding, we haven’t really seen it and we haven’t seen any real trading down in our stores. To be really candid things just seem to be progressing the way that they are naturally, but I would say that the strategies that we’re employing and this wasn’t planned we just sort of fell into this is that we knew that with A&P we had a high price image so we had to fix it. That by definition is a great position that you want to take if you’re getting into recessionary times when people are looking to save more money. The same thing with Pathmark as we’re looking to make that much more of a price impact store. I think just by, almost by accident, as part of our strategic plan it just fits with the economic times. Again long answer is no, we haven’t seen any major trading down and when you talk about passing on food inflation, it’s an interesting concept because like I mentioned before you could take food inflation the 5% and up all the prices in your store. That doesn’t mean that you’ve passed it on. It’s what the consumers buy so the consumers shift what they buy and the example I’ve used of late is that the price of pork hasn’t gone up but chicken has so you see the chicken unit slow down, the tonnage and you see the pork increase. So people shift the way in which they’ll buy product if you have inflation in those particular items or categories. If the price of oil goes up will they buy something else? Now obviously if you have rampant inflation across the board that’s going to affect the basket so far we’ve done a fair bit of study on this and all the studies that we conducted within our own business in the last quarter really indicate that our real inflation, that’s the output inflation, that’s what the consumers are buying is about 1.5%.

Karen Howland – Lehman Brothers

Looking at the Pathmark sales obviously there was a significant swing quarter-over-quarter. I know the quarters aren’t exactly aligned up as they should be as they would, but is that swing, you haven’t remodeled any of the stores yet or refreshed any stores primarily to do with this pricing strategy that you’ve implemented. Were you able to implement that at the get go? Do you first acquire some of the stores?

Eric Claus

The very first thing we did was the flyer strategy so we changed that and over time we’ve been implementing the pricing strategy. We’re not quite done with it, but we’ve been very aggressive from a promotional point of view, we’ve changed the mindset of the company from being in a whole maintenance mode to being in an aggressive we want to win mode. We’ve allowed for things that weren’t allowed prior to our acquisition such as shippers in the aisles. We’ve got the store managers much more involved in what’s going to go on the end caps. We’ve got a whole new cultural change with a marriage between operations and merchandising as they’re working together to drive sales and income and you’ve got a lot of energy going on there. You’ve got people that want to drive the top line and want to make some money and have some fun. If you walk through the stores you’ll see that energy. Talk to the store managers, you see that energy but it’s all part and parcel of stronger promotional programs. We’re giving them what they want really. Give us the tools to drive the business and we’ll get the people in here and we’ll sell it for you and that’s what we’re doing.

Karen Howland – Lehman Brothers

Did you see the progress throughout the quarter of continual improvement or was it pretty steady at the 1.5%?

Eric Claus

It’s been good. It’s been good. It’s better.

Operator

We’ll have our next question from Karen Short – Friedman, Billings, Ramsay & Co.

Karen Short – Friedman, Billings, Ramsay & Co.

A couple questions, just to clarify, obviously you gave us some color on sales trends in the 10 weeks of the first quarter but have they accelerated, decelerated or are they just in line with what we saw for the fourth quarter? Could you elaborate a little bit?

Brenda M. Galgano

We have seen an acceleration from what we saw in the fourth quarter in both businesses.

Karen Short – Friedman, Billings, Ramsay & Co.

I don’t know, Eric, if maybe you could elaborate a little bit on your comments on, I think you’re alluding to the fact that shrink and perishables improved but was a little higher in the Center store. Is that what I should take away?

Eric Claus

Yes, and I think in economic times they’re a little more difficult. You either tend to see higher shrink also. I think maybe there were some things done in part of the business to cut back and save some costs that maybe created a little bit of extra shrink. The operations teams, they’re all over this and actually the fourth quarter the increased rate decreased to as to, from where it was before so the run rate is actually a little bit better and there’s been a company wide initiative on Fresh shrink which is now being rolled out in Pathmark also that’s been extremely, extremely successful and that far exceeds the incremental shrink that we’re seeing in Center store.

Karen Short – Friedman, Billings, Ramsay & Co.

Switching gears to private label, Brenda, I heard you make a comment in the presentation I guess a 1% increase in private label is about a $5 million benefit?

Brenda M. Galgano

Yes.

Karen Short – Friedman, Billings, Ramsay & Co.

Is that $5 million, if it’s a 1% increase across both A&P and Pathmark or is that just A&P?

Brenda M. Galgano

That would be across the company.

Karen Short – Friedman, Billings, Ramsay & Co.

So what is the blended penetration now?

Eric Claus

We started out pre-2007 we started like in the 14% range. We brought it up to the average of 2007 was about 16.5%. Our actual run rate at the end of 07 was over 17% and we’re projecting a run rate at the end of 08 to be over 19%.

Karen Short – Friedman, Billings, Ramsay & Co.

Run rate at the end of 08?

Eric Claus

Yes, the blended average for 08 should probably be in the 18.5% range but the run rate will be over 19%.

Karen Short – Friedman, Billings, Ramsay & Co.

Just clarification relating to taxes, was the D&A associated with the acquisition? Do you include that D&A for taxes or is that not?

Brenda M. Galgano

No, the added depreciation is for book accounting purposes only, it does not accelerate depreciation for tax purposes.

Karen Short – Friedman, Billings, Ramsay & Co.

Just to clarify on the Metro IT agreement, you still have a hit I think it’s probably about $5 million, a negative hit in the first quarter.

Brenda M. Galgano

Yes.

Karen Short – Friedman, Billings, Ramsay & Co.

And then it’s what? Is it about $2.5 million or $2.8 million in the second quarter and then we’re done with it?

Brenda M. Galgano

Yes, that sounds right. Yes.

Karen Short – Friedman, Billings, Ramsay & Co.

My last question is, I don’t know if you’d be wiling to provide just for modeling clarity purposes, do you have Pathmark’s EBITDA throughout 08 in comparable periods? Clean, no one time benefits?

Brenda M. Galgano

No, we don’t.

Operator

We’ll have our next question from Robert Summers – Bear Stearns

Robert Summers – Bear Stearns

Just a follow up on the private label question, what are you thinking in terms of the drag associated with incremental penetration to comps?

Eric Claus

It’s going to drag it down some more and if you don’t, people will switch to a private label from some national brands and your retail sales will go down somewhat.

Christian W.E. Haub

But we haven’t planned in terms of our own internal forecasts. We think the other things that we’re doing will compensate for the little bit that’ll drag down the private label sales. The other thing I guess over the next couple years we’re going to have to keep our eye on is that the cost of private labels because as prime ingredients such as the grains and the corns increase their percentage of the product cost in the private label are far higher than they are at the brands. The brands you have much more product development, marketing, other costs associated with them that you don’t find in private labels. If we get to a point where the spread isn’t there, that could affect private label strategy. So far that’s not been the case but we’re going to have to keep our eyes on that.

Robert Summers – Bear Stearns

Did you give us the number of remodels, format conversions that you plan to do in 08?

Brenda M. Galgano

We did not, but I can give you some overall direction. Our capital plan for 08 is as I mentioned primarily on remodels and enlargements as well as conversions to more optimal formats or banners and as we look at the plan in terms of first on the conversions we’re looking at a combination of let’s call it 20 to 25 conversions from one format to another and then in remodels it’s a combination of Fresh and Gourmet as well as some Pathmark remodels in that on the Pathmark remodels those are really more the refreshes that Eric mentioned earlier. We could do up to 20 of those this year and then on the remaining remodels we’re looking at approximately 10 to 15.

Robert Summers – Bear Stearns

Just trying to re-clarify something Eric had said in terms of getting to 50% of the synergy target, is that by this upcoming first quarter? Is that what he meant to say or did I misinterpret that?

Eric Claus

Yes, that’s correct. That our run rate at the end of the first quarter.

Brenda M. Galgano

Which is mid-June.

Eric Claus

Should be higher than 50% of our total synergy target that we have stated publicly.

Robert Summers – Bear Stearns

Last thing and not to pick on this inflation idea too much, so you’re telling me input inflation is running 4% to 5%, realized is roughly 1.5%. That spread, what’s the historical relationship because you could argue that by the consumer trading their basket based on price trends that that’s a form of trading down. But you’re telling me there is no trading down in the store. If you could maybe frame that spread for me from a historical perspective that would be great.

Christian W.E. Haub

I’ll talk to the trading down in terms of recessionary environment which is I think something different than what we see in terms of inflation because we haven’t had a recession and inflation at the same time for quite a while. Trading down is, from a recessionary point of view, is really people looking to buy more items when they’re for example on sale rather than at regular shelf price or you see a slow down at the end of the month that is more pronounced because people are running out of money and those type of trading down scenarios or they’ve switched from fresh to something packaged because it’s cheaper to buy canned vegetables rather than fresh vegetables and that kind of thing we haven’t seen.

Eric Claus

I can’t really speak to the history of what the relation between one and the other is but I can tell you that we have inflation and deflation all the time in our business. You can use the word trading down but any time that the price of beef goes up then chicken sales go up and so do pork and vice versa. If the price of butter goes up you sell more oil. It’s just a common thing. People shift their purchases because they don’t accept all the price increases so in some format you could call it trading down but in reality it’s just a savvy consumer that shops smartly.

Operator

We have no further questions in the queue at this time. I’ll turn the conference back over to management for additional or closing remarks.

Christian W.E. Haub

I think then that concludes our call and we look forward to talking to you at the end of our first quarter which will be later in July. Thank you.

Operator

That concludes today’s conference. You may disconnect at this time. We do appreciate your participation.

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