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Executives

William J. Moss – Vice President & Treasurer

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

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

Eric Claus – President & Chief Executive Officer

Analysts

John Heinbockel – Goldman Sachs

Karen Howland – Lehman Brothers

Alexandra Jennings - Greenlight Capital

Karen Short – Friedman, Billings, Ramsay & Co.

Gary Lenhoff – Ironworks Capital Management

Great Atlantic & Pacific Tea Company, Inc. (GAP) F1Q08 (Qtr End 06/16/08) Earnings Call July 18, 2008 11:00 AM ET

Operator

Good morning everyone and welcome the Great Atlantic & Pacific Tea Company’s conference call. (Operator Instruction) 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 Bill Moss, the 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 presentation 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 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

Thank you, Bill, and good morning everyone and welcome to our first quarter conference call.

We had a very good start to our new fiscal year. The integration of Pathmark is proceeding right on track and our operating momentum continues to build. The Pathmark acquisition is delivering all the benefits we had anticipated and we are very confident about delivering our $150 million synergy target. Also, the costs of the integration arrived where we planed them to be, further evidence of how well we are executing this integration.

I am also excited about our operating momentum. Our core A&P business generated comparable store sales of over 3% for the fourth quarter in a row and even more exciting, Pathmark’s comparable store sales climbed above 3% for the first time, and this represents their strongest top line trend in many, many years.

Our format strategy is clearly working, with all our formats delivering strong sales, gaining market share, and improving their bottom line contribution. We are very well positioned in this more difficult economic environment. Especially the improvements we made at A&P a year ago with our new pricing strategy are paying off, as the consume is seeking more value today. And since Pathmark already enjoys a strong price reputation, their resurgence is no surprise. So I believe that the current environment and change in consumer behavior is actually good for our business.

We are in a great position to take advantage of consumers trading from restaurants to grocery stores, consolidating their shopping trips due to higher gas prices, and seeking those stores that offer great quality and service at competitive prices. Even the presence of food price inflation is not really detrimental to our business as we are able to pass along cost increases in a more rational market, while at the same time working very hard to provide our customers with ways to stretch their food budgets and offer exceptional values throughout our stores without sacrificing gross margin unnecessarily.

Looking ahead to the rest of 2008, I am confident that we will be able to maintain our operating momentum, capture more and more synergies, and continue to roll out our format strategy with a particular emphasis on our price-impact format at Pathmark and existing A&P banner stores.

Another important objective we now have in our sights is achieving sustainable profitability and generating positive cash flow, which we believe we should begin to see before the end of this fiscal year and going forward into fiscal 2009, once the cost for the integration is behind for good.

As long as the economy doesn’t deteriorate meaningfully from current levels, I am quite optimistic about the prospect of our business. We have a lot of good things going for us right now and 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 are facing this year.

And with that as an overview, I will turn it over to Brenda.

Brenda M. Galgano

Thank you, Christian, and good morning everyone.

Before I get into the details of our results, I would like to provide you my perspective on our operating progress. It has now been just over seven months since we closed on the Pathmark acquisition and I am more confident than ever that this was a great deal for the company. Pathmark sales are stronger than our expectation, the integration went very well, synergies are falling to the bottom line, and early results from our two Pathmark refreshes indicate that we have potential to grow the business above our original plan.

At the same time, the A&P business continues to improve. Although we have our challenges, such as dealing with the difficult economic environment, more aggressive competitive activity, and of course, rise in cost, I believe as a combined company we are well positioned to weather the storm.

Now, on to the numbers. First, I would like to remind everyone that Pathmark’s results prior to the date of acquisition are not included in our financial statements. Also note that Pathmark’s prior year first quarter results were for a 13-week period that ended May 5, 2007, whereas A&P’s first quarter was for a 16-week period ending June 16, 2007.

In order to help investors with prior year comparisons, we have separately provided and posted to our website adjusted prior year results for Pathmark on a basis consistent with A&P’s calendar.

For the first quarter, the combined results would have been approximately $78 million. This morning we reported first quarter sales of $2.9 billion and income from continuing operations of $4 million, or a loss of $0.48 per diluted share, due to the adjustment for our convertible instrument. Comparable store sales were positive 3.2% in the quarter, excluding Pathmark stores. Comparable store sales for Pathmark were 3.1% for our quarter. For the first five weeks of our second quarter, we continue this positive sales trend in both businesses.

Excluding non-operating items of approximately $14 million, ongoing EBITDA was $96 million this year, which compares to EBITDA of $39 million last year. The current quarter results include $22 million of integration synergies. Schedules 3 and 4 of our press release details the non-operating items for both years.

First quarter ongoing gross margin, which excludes a LIFO provision of $1.4 million, decreased 66 basis points to 30.21%, driven primarily by the inclusion of Pathmark’s results which have lower margins than A&P. Pathmark is a more price- and promotionally-driven format and generates a lower gross margin than A&P. In addition, we have begun to invest in the business to reinvigorate their top line momentum and we are very pleased with the results thus far.

First quarter ongoing SG&A expenses totaled 29.65% this year versus 31.36% last year, a decrease of 171 basis points. This decrease is driven by higher sales productivity, primarily attributable to the acquisition of Pathmark and the realization of synergies. Non-cash stock compensation expense was $1 million higher in the first quarter versus last year.

For the first quarter capital spending totaled $30 million with depreciation of $80 million. This compares to $51 million of CapEx during last year’s first quarter, with depreciation of $48 million. During the quarter we completed the renovation of our Homedale Fresh Store and two Pathmark stores. We are encouraged by the success of our first two Pathmark remodels in Irvington and Edison, New Jersey, which incorporate the best practices of our fresh and price-impact formats. As I noted earlier, these stores are so far exceeding our expectations. We are excited by the prospect of this format going forward.

We expect capital spending to total between $180 million-$200 million this year. Based on the project’s performance in the last two years, and through our first quarter, we are projecting our overall returns on the 2006 and 2007 projects to exceed our cost of capital. Our best performing project has been the large Fresh store and Food Basic remodels. As we have discussed previously, smaller Fresh store and Shore store remodels have not been performing as well. A majority of these projects were in our Super Fresh business, which has struggled to improve performance in the last two years but began to show some improvement in the first quarter. In the A&P and Waldbaum’s markets, however, the Fresh renovations have contributed significantly to the performance improvements we have realized in these areas.

We will continue to closely monitor the results on all our projects and going forward we expect to allocate more of our capital towards Pathmark remodels as we anticipate the returns of the Price Impact remodels and conversions to be superior to all other projects. However, we do not expect to increase capital in total.

With respect to our Super Fresh business, which has been a challenge to us, and as announced earlier this month, we plan to convert the majority of our Super Fresh stores in the Philadelphia market to the Pathmark Price Impact format as well as remodel the existing Pathmark stores in that market. Eric will further cover this next.

Turning now to our balance sheet, we ended the quarter with net debt of $1.349 billion, including capital leases and real estate liabilities and net of $2 million in short-term investments, and $22 million of restricted cash. The increase of $88 million from year end consists of the following: our adjusted EBITDA of approximately $90 million and real estate proceeds of $3 million offset by net cap interest expense of $32 million and taxes of $1 million, CapEx of $24 million, which excludes about $6 million of integration CapEx, stock store occupancy payments of approximately $18 million, Pathmark integration costs of $32 million, payoff of the Series A warrants of $46 million, and a networking capital and other increase of approximately $35 million. This $35 million includes an increase in our cash of $28 million and that cash is excluded from our net debt calculation. Most of this increase in working capital and other is timing related, given that large annual payments such as bonuses are paid in the first quarter. Excluding the integration costs of $32 million and warrant payment of $46 million, net debt would have increased by $10 million.

Availability under our revolving credit agreement was $178 million at the end of the quarter with outstanding loans of $251 million and letters of credit of $236 million. I would like to note that beginning this quarter we have included an interest expense payable in Note 11 in our 10-Q, which will be filed shortly.

As of the end of the quarter we had a tax net offering loss carry-forward of approximately $400 million to offset future tax profits, including operating profits and capital gains.

The Pathmark integration continues on track. During the quarter we realized $22 million of integration synergies, which is included in the adjusted EBITDA. This $22 million represents $14 million of admin cost reductions as we completed the transition of the Carteret facility in May, $6 million of profited savings, and $2 million of store operating cost savings.

At the end of the quarter our annual synergy run rate was approximately $100 million, exceeding our original estimate of about half of our $150 million target within the first six months. I am very encouraged by the integration progress and the synergy run rate as it demonstrates our success in bringing the two companies together and realizing the benefits as we had anticipated.

We incurred $12 million of integration expense in the quarter and approximately $6 million of integration CapEx, which is in line with our original plans.

Cash came in the quarter totaled $32 million and included approximately $13 million of severance payments which were charged to good will.

To date we have paid $64 million, which includes approximately $9 million of capital, $19 million of acquisition-related costs charged to good will, which is primarily severance, and $36 million of costs charged to the P&L. We continue to estimate total costs at approximately $100 million.

So 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. Physical integration is substantially complete and the realization of synergies is progressing as planned. We remain financially strong and continue to focus on maintaining sufficient liquidity.

Based on our current operation trends and the realization of synergies ahead of schedule, we expect to be cash-flow positive in the fourth quarter and fiscal 2009.

Before I turn it over to Eric. I want to cover one more thing. I would like to let you know that we are planning to hold an investor day on October 15 of this year. The day will include store tours in the morning with lunch and management presentations to follow at the Sheraton in Newark, New Jersey. Investors should expect to receive further details of this event in the near future.

I will now turn it over to Eric.

Eric Claus

Thank you, Brenda, and thank you, also, Christian.

Well, good morning to you all. This is now our first full quarter with Pathmark operations integrated into the company and I have to say that we are very pleased with the progress and momentum and we are definitely on track with our short- and long-term expectations. We are now pretty well done with the integration of Pathmark which is a very sizeable business, to say the least, and I am very proud of the exceptional planning and execution of our integration teams. This team has now delivered, and by this team I mean this management team, has now delivered ten straight quarters of improved momentum in our business.

Top line sales in all four of our formats were very strong and I will speak to each of these formats in a moment.

EBITDA is where we planned it to be for the quarter and in line with our expectations for the year. I strongly believe that our format, merchandising, and pricing strategy positions us well to weather the fragile economic outlook and also the consumer mind set.

Our store portfolio is also geographically well-suited for the rising fuel costs as we reside close to our customers. We manage to keep inflationary pressures relatively in check and the fundamental key performance indicators in our business all remain positive. Notably, our customer account is up, our market share is up, and comp store sales are up.

Our private label renewal program, which is so important to us, is on track and will be ready for the launch of our consolidated brands for the third quarter of this year. Private label penetration continues to grow at an aggressive rate as we better the product, the packaging, and the price points. Consumers’ acceptance of the America’s Choice brand at Pathmark has so far exceeded all of our expectations.

Our plan is to be at the high end of the penetration ranges for American retailers when all is said and done. Our relationship in our new contract role with C&S is working very, very well. Service levels, particularly in the Pathmark stores, continue to improve, costs are in line, and buying opportunities are being created daily.

Now, let me give you a brief update on our format progress. And I will start with the Fresh format. Our Fresh stores continue to trend positively and continue to gain momentum every period. We continue to experience solid sales growth and has been previously noted, returns on our Fresh store remodels are exceeding our cost of capital.

Consistent with our capital plan, we had slowed our spend and number of capital projects to accommodate the Pathmark integration. This is now back on track and we have several projects underway that will be launched in the second quarter. Overall we continue to be pleased with our Fresh store financials as the mixed growth to Fresh continues, driving increased sales in both center store and fresh, while driving margin dollar growth.

We have a considerable amount of knowledge now, given the number of stores that we have renovated over the past years, and our ability to forecast and select great new projects has increased exponentially. We now have better than one third of our former A&P stores that are in great capital shape, and that is obviously the worst third in terms of capital structure or capital condition, as well as the most likely to succeed.

That said, we will see, however, more stores convert from our former A&P store banners to the new price-impact format that we had originally anticipated. The better price image of Pathmark and the lower cost of Price Impact remodels, and by that I mean the lower capital cost of those Price Impact remodels, and conversions should drive superior returns and are compelling factors to accelerate the roll out of the price-impact format going forward.

So that’s a natural segue to talk about Pathmark. As I previously stated, integration of Pathmark is for all intents and purposes complete. There were no major issues that surfaced that we could not resolve. That said, we did have some minor process issues and did leave some money on the table, notably it would be about $5 million that was in our merchandising income area of Pathmark, and we did leave that on the table the first quarter. We are very well underway in having a good handle on those issues now so we see that as a one-time effect for the quarter which we should be able to recover in subsequent quarters.

Like I said earlier, I am very pleased and impressed with our team’s outstanding execution of a series of very complex tasks in this integration. And has Brenda has previously mentioned, we are also in good shape in attaining our synergy goals. We will deliver the $150 million of synergies that we had expected to our bottom line. With that as our goal and expectation we will, however, invest at least some, if not most, of the excess synergy dollars we expect to realize back into the business.

Improving our price perception in the current environment is clearly the right thing to do, particularly in the price-impact format, as this is the format that should benefit the most from a more price-conscious consumer and we expect superior returns from our investments in this concept.

We are really pleased with the Pathmark acquisition and see big potential in this format. This is clearly an acquisition that is working and will continue to provide great benefits to our overall performance.

In the first quarter we launched, with tremendous momentum, the first of our new remodeled Price Impact stores. This will be the template for a massive Pathmark refresh to be rolled out between now and the end of 2009. We are starting in earnest at the end of August and will complete quite a few projects by mid-November of this year. These stores look super, super impactful and they’re truly price-impact stores. They are cost-efficient to execute and they deliver a more modern and today impact experience.

We did enhance the Fresh experience, particularly in the areas such as produce and bakery. We are very pleased that the Pathmark stores with renewed energy and aggressive merchandising plans are experiencing continued positive comp store sales as momentum keeps on building.

When we first spoke about the benefits of the Pathmark transaction, we talked about the potential to convert stores from one format to another, and this based on demographic data. Well, that time has come. We recently announced a market strategy, which Brenda just reviewed in short, for the Philadelphia market and we will see the majority of our Super Fresh stores convert to the price-impact format, Pathmark Save-a-Center.

We are really pleased to see how this change was embraced by our associates and their union. We clearly all see the tremendous upside and opportunity in converting to this price-impact format. This market will also see the refresh of all existing Pathmark stores to the new Price Impact look, as well as the remodeling of the few Fresh Stores that clearly are in more upscale locations.

So that means in this market, again, we are consistent with our objectives to move into the number one and number two market share positions by regions in which we operate. So all in all, we are very, very pleased with our progress thus far with Pathmark and are very impressed with what the team is accomplishing.

When it comes to food basics in the discount format, these stores once again continue to experience very strong double-digit, year-over-year sales growth. Now for the fifth 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.

In this first quarter Food Basics, as a group, had positive store contribution for the first time in our history in the U.S. They are now very much in the same trajectory as our former Canadian Food Basics success story. My congratulations goes our to our merchandising, marketing, and operations team for that success.

Last by not least when it comes to formats are Manhattan Food Emporiums. We are finally firing on all cylinders; all formats are working. Overall sales in the Manhattan market continue to exceed total company costs as does increased store contribution. The Food Emporium team is doing a super job of getting the stores cleaned up, bettering service, and really leading the market in new product development. Some capital will also be spent in this market to finish some of the store projects previously commenced and take on one new project.

When it comes to best sellers our wine, beer, and spirits concepts, things are progressing well. We’ve just opened our first prototype freestanding store in Westwood, New Jersey. It’s a great and exciting concept and well worth a visit because it’s a whole new experience in buying wine and beer.

Got to talk a little bit about cost control, also. Our administrative run rate continues to be on track, including the integration of Pathmark. The Pathmark Carteret, as previously mentioned, is closed, or officially closed I should say. We are realizing those administrative costs and synergies and we speak.

Utility costs continue to remain a challenge and we continue to aggressively pursue and implement systems and tactics to mitigate some of the energy price increases. Although overall costs are a challenge, we are very, very determined on resisting increases, finding ways to reduce usage of supplies and other materials, and generally be creative in finding ways to curtail rising costs. Our store operations teams in all formats continue to an outstanding job as they focus on cost control.

Labor productivity and sales per employee hour, once again, better than last year in all formats, demonstrating the commitment from all of our teams at retail. Stock losses and center store were again higher than last year, an area, as I said before, our operators continue to focus on. We believed the economic environment plays a role in this as does our aggressive attack on product code dating. This is once again offset by improved pressuring which is company-wide initiative driven by the retail and merchandising teams.

So to conclude, we continue to stay very, very focused on our game plan and the strategic direction that we’ve chosen. The strategy remains the same but our game plan is nimble, flexible, and non-bureaucratic. This is evidenced in the shift of our capital strategy with more emphasis on price impact going forward. We are proactive and reactive to the economic times, ensuring our continued progress and drive to profitability and that in the time frame that we had set out for ourselves. We are on track for the operating cash-flow positive for the first time in year in the fourth quarter of this year and plan to be cash-flow positive for the full year 2009. And this while executing our capital spending plan objectives. We are pleased with the continuity of management and our teams and at the consistent progress that we have demonstrated over the past ten quarters.

In closing, once again, my thanks goes our to our Board for their guidance and support, to my executive management team, a small group of very hard-working and dedicated people, and to the whole team who are doing so much in order to deliver on expectations.

I will now pass it back to Christian, and thank you.

Christian W. E. Haub

Thank you, Eric, and I want to close with a brief summary for you have heard today. We had a very good start to our fiscal year in our first quarter and our results demonstrate that we are on track to achieve our longer-term targets.

To recap our key points, the integration of Pathmark is on track to deliver synergies of at least $150 million. Our key performance indicators are all pointing in the right direction. We are very well positioned to deal with the challenges of a more difficult economical environment and our formats are all winning in the market place. We are poised to deliver significantly improving results in 2008. Sustained profitability and free cash flow are now clearly in our sights.

Thanks as always for listening. This is the end of our presentation part and we are now pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Heinbockel with Goldman Sachs.

John Heinbockel – Goldman Sachs

If you guys can talk to within the comp number, maybe with both A&P and Pathmark, what are you seeing with regard to traffic and ticket, item per basket. It doesn’t look like there’s whole lot of trading down that you’re seeing, but can you dissect that a little bit?

Eric Claus

We don’t see very much change in our Fresh, or in our Food Emporium even, but we do see more it the Pathmark. And I think that the mid-to-lower income consumer is buying less, so there is some inflationary pressure in those stores, also.

But we’ve seen, you know, what’s important is you can’t just look at inflation, you got to look at all the different factors that go around it. With that we’re getting more customers, the market share of Pathmark is up, but the customers are buying a little less. So we’re still maintaining our momentum through the additional customers coming in the door. But the definitely are buying less items.

John Heinbockel – Goldman Sachs

You measure inflation but you are taking pricing down, so as you measure it on the retail side, inflation is much lower than what some other people are seeing, is that fair?

Eric Claus

Yes. Because I think you see a lot of people that quote the cost inflation, so they look at all the items and they take the cost across the board for what was sold. The real measure of inflation at retail is to take the item and the velocity for what you sold versus what you would have sold last year. So what we’re seeing is, when you see people buying more on promotion or buying more private label, etc., etc., they can bring their basket dollars down and they can realize less inflation than what our cost inflation input is.

John Heinbockel – Goldman Sachs

So your transaction count, the number of transactions, would be up half of your comp, maybe 1.5%, or not that much?

Brenda M. Galgano

It’s more than that but there’s also in each transaction the number of units that are being sold. That’s down for Pathmark.

John Heinbockel – Goldman Sachs

Things have been good the last five weeks, but things are moving pretty fast here. Do you think there’s going to be more pressure from a consumer looking to trade down? How are you staying on top of that that the market doesn’t move around here on you?

Eric Claus

We’re fortunate just with our geographic locations. So we probably have less pressure than other areas of the country and when you hear the job losses on Wall Street, sure those are big number, but by and large the job losses in our market are not excessive to any great degree. It’s more the mind set of the consumer.

The price of gas, we saw that very clearly in the first two long weekends where the traffic in our Shore stores was down, although we are kind of fortunate because we’re also in the City so if it’s down in the Shore we’re getting it in the City and vice versa. That actually reversed itself for July 4. But we are very well positioned because of our formats and even at A&P, starting three years ago we really, really put emphasis on trying to change our price perception. That’s a long road to go down.

But we basically, and not because of super-intelligent design, but I guess we kind of, I wouldn’t say lucked into it, but that was just our strategy anyway, was to bring our price perception for A&P. That was our strategy for Pathmark so it kind of fits the economic times.

And you know, we’ve got good real estate. We’re in a very high-dense market and we have said, since I’ve been here for three years, we’re not going to blame the weather and the economy for a whole lot of things and whatever the weather and the economy is we have to tailor our formats and our strategies to be able to succeed and deliver the numbers that we set up for ourselves.

John Heinbockel – Goldman Sachs

It sounds like you do think you’re going to exceed $150 million of synergy gross, but the net number will still be about $150 million?

Eric Claus

Yes. I think we would be, you know, we know, and we have looked at other retailers and seen some that have been aggressive in raising their prices, and we’ve seen some of the larger ones that have been very aggressive in reducing their prices over many years, and you see who the ones who are successful are today. And I think, in particular with a format such as Pathmark, where we do have to reinvest in price, and we do have to become the price leader again in the Northeast and take the position that this banner once had.

And, you know, it’s a short-term gain if you try to just take everything into one year. It looks good for the year but it doesn’t do anything right for you strategically as a company. So we want to make sure that we’re solid and progressive and deliver the numbers that we’ve set up for ourselves, but we’re at the same time doing what’s right for the long term, and that’s really investing in price, also.

John Heinbockel – Goldman Sachs

Have you been able to quantify your P&S benefit yet or no, and if you have, I take it that will get reinvested as well?

Eric Claus

I think for right now, John, it’s still a little early because some of the big benefits are going to come down the road with ES3 and some of the projects that we’re going to start working with them. So I would rather I just put that in our back pocket and when we get closer to, we have a better handle on it, then we can talk about it. But we’re certainly not banking on that now. We’re going that way.

I think the biggest thing with P&S right now is that it’s working. The relationship is working, the service levels are better, the two companies are working much, much better together. We’re taking opportunity buys together, which will help us, again, keep costs down. So all of those things are working and that’s because it’s the right contract now and we both have the same incentives, goals; we’re not working against each other.

John Heinbockel – Goldman Sachs

And do you think in a tough economy like this, is it better to invest in shelf pricing or promotions? Where do you think you get your best ROI?

Eric Claus

Well, we live in a part of the country where people are addicted to flyers. I think it’s almost sport. So you’ve got to be strong in the high/low, to go from a high/low strategy to an EDLP, and I think EDLP is a great strategy. It takes a long time to get there, it takes a lot of convincing to the consumer and I think you just can’t get there by doing it. I think we tried that five or six years ago in Detroit and it really backfired on us.

I think what we’re doing, for example with A&P, is you slowly start massaging your prices down through the red-tag specials. You’re seeing our launch of the yellow-tag specials, which are thousands of items that stay on shelf at a lower price and get rotated over time. But you sort of have to work your mix there because otherwise you just blow your bottom line and you’ve got to move your consumer toward that. So we’re very much more focused right now on the high/low strategy, with a strong, several thousand, I think it’s five thousand items that we have in center store and elsewhere that we maintain for periods of four to six weeks on special.

Operator

Your next question comes from Karen Howland with Lehman Brothers.

Karen Howland – Lehman Brothers

Looking at the Pathmark sales, obviously they accelerated quite a bit. You’ve only remodeled one of the locations at this point. Can you talk at all about what you think is actually driving that? Have you, at this point, lowered the prices already, is it just a more refined circular?

Eric Claus

We’ve done two stores, which obviously isn’t enough to affect in any significant way the whole chain. We spent a lot of time listening to the folks at Pathmark before making any changes there. And they’ve got a lot of very talented people that have been there for a long time and these guys will tell you, “Give us the tools to do volume.” And we asked them what they needed and what had worked in the past. And we tried to focus on what fundamentally made Pathmark what it was.

And a lot of that was being driven through the flyer and also there is a whole slew of very identifiable items. In other words, items that the consumers can relate to that were really, I won’t call it a seemly price, but they were certainly more expensive than the competition. So we’ve worked at bringing those prices down, we’ve worked at stabilizing a lot of the shelf pricing that was too expensive. We cleaned up the flyer; we got much more aggressive with the flyer and we’ve involved our store management people in helping us determine, for each market, what the right items are. So we have a lot of versions of different flyers, more so than what Pathmark had before, that’s really driving this business.

Christian W. E. Haub

In addition, Karen, we put together a list of merchandising quick hits that we implemented across all the 140 Pathmark stores and they were expressed throughout the store, introducing more cut fruit into their produce section, and introducing a private label poultry program, and there were a number of those. It took a lot to roll out. They are now fully in place and they are all adding a little piece to the department and to the overall store success.

Karen Howland – Lehman Brothers

Talking about the gross margin that you said you left on the table with the Pathmark integration. You kind of brushed over that and $5 million obviously is a decent amount of money on an EBITDA basis. I was wondering if you could go into a little bit more of detail of what that was and how you’re making sure that that doesn’t reoccur.

Eric Claus

That’s a good question and certainly one that we beat ourselves up on. That was really when you’re taking north of 130-140 merchandising people, integrating now only 1/3 of those people into this company, with different systems. So there were different people, different responsibilities. So for example, at Pathmark the promotional spend was directed by people in marketing. Here it is directed by the merchant. So there’s a whole shift of responsibilities and there’s no real justification for it; it’s a mistake on our part in that the responsibilities of some people weren’t clear relative to what they did before.

We didn’t right some of the contracts on ad merchandise that should have been written. So in other words, if you wrote a contract on an ad for x hundred thousand cases and you needed to get so much per case, that contract for the monies per case wasn’t written.

We’re certainly looking at going backwards and trying to recruit some of those monies, but we’re not banking on it. What was more important to us was to fix the process and make sure that doesn’t reoccur in the second, third, and fourth quarters. And I think we’re pretty comfortable that we have.

And it’s a significant number, but in the whole scheme of things in the size of this transaction, honestly, it’s miniscule. We did a lot of studying and meeting with people. We went to Proctor and Gamble and met with their senior management team and talked abut how the Gillette transaction went, we talked to a lot of people; we brought in a lot of people because this team had never done this kind of an integration. We spent so much time studying it and we read about horror stories of what could go wrong and I think we protected ourselves pretty well and if this is the worst of what we got I would say it’s a pretty inexpensive bill to get out with for an integration of this size. But we’re in good shape for Q2, Q3, and Q4 on that.

Karen Howland – Lehman Brothers

Looking at the free cash flow, I am a little surprised to hear that you will be free cash at the end of this year. We had expected it to happen next year. Is it because synergies are coming earlier? Do you actually expect to achieve that $150 million run rate, I know initially you were saying 18-24 months after the transaction, do you expect to achieve more of that? Obviously you did more this quarter. Do you think that’s coming earlier now?

Brenda M. Galgano

Although we’re not raising our $150 million estimate in term of what will flow to the bottom line, we are ahead of schedule. So that obviously factors into our fourth quarter numbers. At the same time our integration costs will be almost zero at that point. There may be a few costs coming through but it will be minimal.

And that’s when I spoke when I went through the cash flow I noted that if you exclude the A warrant payments as well as the integration costs, we were cash flow negative by $10 million. So as we continue to realize more synergies then you can see how we can get to being cash-flow positive in the fourth quarter.

Karen Howland – Lehman Brothers

I was off in my modeling on the DNA and I think quite a few people were expecting the DNA to be a little bit higher this quarter. If I would look at the numbers of what you reported last year on an EBITDA basis and take your numbers, add the Pathmark suggested for your calendar, and then add the synergies, I get to an EBITDA of 100. Obviously you guys reported an EBITDA of 96. If I do that on an operating income basis I get to the number actually improving by $4 million this year. Is there something funky going on in the DNA this quarter? Is the run rate that we’re at now reasonable going forward? Just for modeling and operations purposes?

Brenda M. Galgano

It’s a good question because when I looked at that I asked the same questions of my team. If you take the fourth quarter DNA and trend that out for the first quarter you would expect a higher DNA number. But there are some assets that were being depreciated that came off. Back several years ago we significantly invested in technology and a lot of that is winding down. So to answer your question, yes, you can now trend the first quarter, use the first quarter DNA to trend out the rest of the year. There’s obviously puts and takes of additional assets come off and we invest in capital but overall the first quarter is a good gauge for the rest of the year.

Operator

Your next question comes from Alexandra Jennings with Greenlight Capital.

Alexandra Jennings - Greenlight Capital

Just going back to Karen’s question, looking at the DNA last year for the A&P and the Pathmark and adding the synergies, you end up with 100 million of EBITDA last year plus the synergies and 96 this year. What really happened to cause the 4% decline?

Brenda M. Galgano

I’m not sure I understand your question.

Alexandra Jennings - Greenlight Capital

I’m sorry, I said DNA and I meant EBITDA. Last year Pathmark’s was 38.8 for the appropriate weeks and A&P’s was 39.4. That’s 78. And if you add 22 of synergies you get to last year on a with synergies basis of 100.

Brenda M. Galgano

There’s a couple of things. One is we spoke about the $5 million of transition-related costs with respect to the Pathmark merchandising income. That would explain $5 million. In addition to that, as I noted when I was speaking, we had a $1 million increase in stock comp so that’s $6 million right there.

Alexandra Jennings - Greenlight Capital

Now, why is that $5 million relevant because that’s really synergies foregone and so if you had gotten that the way to do this comparison would be 101 this year and 78 plus 27 is 105 last year.

Brenda M. Galgano

No, I disagree with your math on that. I mean, you can look at it two different ways. You could either say the synergies were really $16 million and the core results were actually higher. It’s one bucket versus another. But the comparative don’t change.

Alexandra Jennings - Greenlight Capital

Okay, but we’re still looking at a little bit of a step down here, right?

Brenda M. Galgano

Not if you include the $5 million and the $1 million, no. It’s actually slightly positive.

Operator

Your next question comes from Karen Short with Friedman, Billings, Ramsay.

Karen Short – Friedman, Billings, Ramsay & Co.

A couple of questions. Just on sales trends in the second quarter. I know you’re saying they’re strong. Are they in line with what you’re seeing at both centers with what you saw in the fourth quarter? Have they accelerated or decelerated? Can you give a little color on that?

Brenda M. Galgano

I would say they’re in line. Certainly not lower. If anything, maybe slightly positive. Especially in Pathmark. We’ve seen even a little bit more. But in general I think it’s fair to say they were in line.

Karen Short – Friedman, Billings, Ramsay & Co.

Can you give a little more color on the competitive landscape. I think in the prepared remarks you said it had intensified.

Christian W. E. Haub

I won’t go into specific competitors but we have definitely seen a heating up of the market. And it’s a penny business, if one person takes market share, no one wants to lose it. So we’ve seen intensified flyer activity, we’ve seen more special story activity. We’ve seen people run certain categories that they hadn’t run in a long time. But like I’ve been saying for the last number of years: we used to follow, we don’t follow any more; we lead. So our game plan changes month to month. We’re not very predictable. We’ve got some great plans for the third quarter, we’ve got some great plans for the fourth quarter. We’ve been fairly consistent in what we consider to be [inaudible] the holidays, in terms of what we’ve set as our target.

So I think you’ve got a pretty fragmented market here, I think you’re going to see more of that. You’re going to see people that are finding it tough, getting more aggressive. There’s usually a cycle to that. They get more aggressive and then they back off. We’ve really taken our aggressivity as part of a strategic plan so we’ve worked that into the mix and to how we go to market and that way we haven’t eroded the bottom line to any great extent and we will continue being as aggressive as we’ve been, but again, in a very innovative way and that’s one of the things that we are going to absolutely continue with is innovation, change. Change our game plan. We don’t want to be predictable.

Karen Short – Friedman, Billings, Ramsay & Co.

And what are you thinking of CapEx for 2009 and what is the allocation on CapEx in 2008 and 2009?

Brenda M. Galgano

I’ll start with 2008. I know during the last call I walked the allocation and we have made some adjustments to that. I can walk you through where we are at this point. As Eric noted we are nimble when it comes to capital and we certainly are going after these projects that have the highest return. So it certainly isn’t set in stone but we are now well into the year so I don’t see this changing significantly at this point.

Overall we’re looking at two Fresh new projects and two Fresh enlargements. We’re looking at ten Fresh remodels, a few minor remodels, we’re looking at four of those. Potentially two new Food Basics and two Basics conversion. We are also looking at the Pathmark/A&P conversion, meaning that we will be converting the Super Fresh stores to Pathmark, there’s eight of those. We have a number of Food Emporium-to-A&P conversions, eight of those. We have approximately 25 Pathmark refreshes. A couple of Food Emporium projects. And then we have some Starbucks additions and some liquor stores. So that’s the projects we have in the pipeline as of now for 2008.

Going into 2009 I would expect that our capital will be somewhere in the $200 million-$250 million range. I know that’s a pretty large range there. It will probably be somewhere in the middle there, $225 million, but we won’t have that final amount until we finalized our capital plan, in the next few months.

Karen Short – Friedman, Billings, Ramsay & Co.

Obviously this is a story about execution. You know, your numbers on the top line were great and your EBITDA was decent. Not to detract from your accomplishments but there was obviously a slight blip with this $5 million. And given that the story is all about execution, how do you get us comfortable that you won’t have another blip? And then how do you feel about the consensus numbers out there?

Eric Claus

I will answer the first one. Like I tried to say before, think about how many transactions like this have failed, how many complications there are, the millions and millions of pieces of data. The fact that you take your top people, you take all your “A” players and put them on the integration, you completely stress an organization bringing two companies together. The top line is right there, the momentum is there. We’ve generated $22 million in synergies. Seriously? $5 million in that whole world of things that has happened over the last six months, is a blip. And if anything, we’re very, very positive about how this has all come down where we’re at and where we’re going.

I mean, it’s just a question of if something goes wrong, you fix it, you don’t hide behind it. And we’ve been open and said we left some money on the table. We’re going to go after it, we’re going to fix it and we’re going to go after more money.

We also are open about saying we think we are going to get more synergies than what we said and we will probably get them faster than what we said. We’re also going to use them to drive our business. We’re going to drive our prices down, we’re going to be an aggressive player in the market. We’re going to be exactly what we set out to be, number one or two in every market, and we’re going to set out to be profitable.

So I really see it as, I mean, $5 million is a lot of money in anybody’s books, but in the whole scheme of things, I see this as insignificant.

Christian W. E. Haub

Karen, in terms of comfort why that shouldn’t recur going forward, the transition of the merchandising organization occurred in the first quarter. That means people at Pathmark that were running kind business as usual since the closing of the business had a plan for how they were going to physically transition, and that’s packing up your entire office, moving all your files, learning the new systems. They spent a lot of time learning the A&P merchandising systems and then they had to physically move, had to physically get integrated and responsibilities had to get handed off, people were leaving.

And that’s a time where physical it is clearly more chancy to keep everything under control and run business as usual. Now that transition is behind us. Now everybody is working on the A&P systems, everybody is fully integrated, everybody knows exactly who has responsibility for what.

And we understand exactly where that money has gone missing and how it’s gone missing. We have a very clear understanding on it. And we’re not giving up on it. And we might be able to recover some of it going forward in the remainder of the year. But going forward I have no concerns about these issues reoccurring.

Karen Short – Friedman, Billings, Ramsay & Co.

Back to EBITDA margins, longer term.

Christian W. E. Haub

We see no reason from changing our expectations or changing our plans and our targets we have for this year or next year.

Karen Short – Friedman, Billings, Ramsay & Co.

Just wondering longer term in terms of your EBITDA margins. You have $150 million in synergies with the potential for upside on that, that will be reinvested. How do you bounce that to get your EBITDA goal?

Christian W. E. Haub

I think what people sometimes misunderstand is that when you invest you expect a return on that investment. And investing doesn’t mean these monies will disappear and therefore not show up on our bottom line anymore. They will not instantly drop to the bottom line as you realize the excess synergies but we expect that these investments will have good returns that over the longer term will lead to even a higher bottom line than if we just drop these synergies to the bottom line.

Eric Claus

And I think also, Karen, on one all those points, we had a very consistent story. I think we’ve had a consistent performance. Obviously there is a lot of volatility in the stock. Everyone has their speculations on how that is derived. Some of it is from short selling. I think some of those people are on these calls. But at the end of the day they just will see more consistency, consistent progress and this is how we build a business.

Operator

Your next question comes from Gary Lenhoff with Ironworks Capital Management.

Gary Lenhoff – Ironworks Capital Management

Brenda, what did you say dark store payment were in the quarter?

Brenda M. Galgano

I think that number is $18 million.

Gary Lenhoff – Ironworks Capital Management

In your efforts to rid yourself of some of those liabilities for obligations going forward, what impact, if any, has developments in real estate markets had either on the estimates of the $350 million present value on the balance sheet or can you talk a little bit about those efforts?

Brenda M. Galgano

We have a full time team dedicated to working down those liabilities. Over half of the liability relates to the Michigan market, which is a bit challenging. But we have had a lot of interest. We have two warehouses out there. There has been good amount of interest. So we are still sticking to our estimates. We have historically been conservative in the real estate liabilities, the dark store reserves. If you look over the many years, if anything, we have reduced those reserves over time. So I think given that we have historically been conservative, even though the real estate market has become a bit more challenging, we are quite comfortable with the liability we have on the books.

Gary Lenhoff – Ironworks Capital Management

And your forecast of being operating-cash-flow-positive in Q4 and 2009, is that before dark store payments or are those incorporated in that forecast?

Brenda M. Galgano

That’s incorporated in the forecast. But just to clarify, fourth quarter of this fiscal year. Yes, that does include the dark store payments.

Operator

Your next and last question is a follow-up from Karen Howland with Lehman Brothers.

Karen Howland – Lehman Brothers

Chris, I think you said you were standing by your guidance for this year. Have you given explicit guidance for this year.

Christian W. E. Haub

No, I didn’t say that we are standing by guidance, because we don’t as you know, don’t provide guidance. We are standing by our internal expectations that we have set out at the beginning of the year and there are very specific goals also for next year and we don’t see any reason from our first quarter performance and what we’re seeing in the business to change that.

Karen Howland – Lehman Brothers

And I was just wondering one other thing. You talk about it’s obviously a very price-sensitive environment right now, people are looking for value. How do you think, in your studies that you do, looking at the consumer, how do you think A&P is positioned? I know for a while it was viewed as high-priced? Have you changed that perception or is that still out there in the market place?

Eric Claus

We have had some success and some things that are really slow to turn. The overall perception is still that A&P is pricey and it’s almost funny sometimes. It’s not funny, it’s actually sad, we did a couple of surveys recently between two stores, ours and someone else’s, and the perception was that our store was higher than the other store. But overall we have seen a significant improvement in our promotion and perceptions of better promotions in our stores and that’s why you see our market share growing and we’re getting more people into the store, better experience. So, it’s been consistently improving, not to the extent we would like it improve, but it’s definitely improving.

And I think when we talked a little bit about our capital plan, and our shift in capital to more price-impact, I think that you will see in many, many markets where it’s kind of gray, where you can have a Fresh store or a Price Impact store, it will be a Price Impact store. Pathmark has a great price perception in the market place and it takes a lot less time and a lot less capital to convert something to a Pathmark than to go for a Fresh renovation in an iffy market that you hope is going to work, for more capital, than a sure buyer, quick switch, great price reputation and much bigger bang for you buck with a lot less capital.

Karen Howland – Lehman Brothers

Is there any risk to that? Only because, fingers crossed, the economy does pick up again and things do return back to the condition we were in two years ago, is there any risk to going through and doing an abundance of price-impact, given that you are, for the most part, in kind of higher end areas.

Eric Claus

If you really look at the demographics, there is black and white and there is gray. There’s a lot more gray than there is black and white. Now the black and white, and I’m really happy to say, are like the first third of our stores that we renovated are pretty well all in the black and white market. Then the other two-thirds, it gets to be fairly gray. And then the way in which we do our studies, if you draw a circle around the trading area and you do a demographic study and you know that the average person eats to the tune of, whatever, $2,000 per annum, so you figure out how many dollars there are in that trading market and then you look at the demographics and you say, “If I need $600 per square foot in a discount or price-impact and $500 per square foot in a Fresh,” and then you figure out what there’s room for and where there’s an appetite for these stores. So you could say that within that trading market that it’s over-stored in terms of Fresh, but completely under-stored in terms of discount or price-impact. And that’s the kinds of things we look at. So you are really looking at things that are a pretty safe bet, otherwise we wouldn’t be putting that kind of capital into them.

Operator

With no other questions remaining in the queue I would like to turn the call back to our speakers for closing comments.

Christian W. E. Haub

Thank you for your time today and we will speak to you again at the end of our next quarter.

Operator

This concludes today’s conference call. You may now disconnect.

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