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Executives

William J. Moss – Vice President and Treasurer

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

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

Eric Claus – President and Chief Executive Officer

Analysts

Karen Howland – Barclays Capital

Karen Short – Friedman, Billings, Ramsay & Co.

John Heinbockel – Goldman Sachs

Robert Summers – Pali Capital

The Great Atlantic & Pacific Tea Company, Inc. (GAP) F2Q08 Earnings Call October 14, 2008 1:00 PM ET

Operator

Welcome to The Great Atlantic & Pacific Tea Company’s conference call. (Operator Instructions) 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, Vice President and Treasurer, who will read A&P’s Safe Harbor disclosure.

William Moss

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 our Executive Chairman, Christian Haub.

Christian Haub

The key themes coming out of our second quarter are the following: The integration of Pathmark and synergy realizations are on track. Our core AP business is making solid top and bottom line progress. We are experiencing some transition related issues with our Pathmark business which we are in the process of addressing. The economic and competitive environments remain challenging and our stock price suffered an unprecedented decline which we believe is not all based on the fundamentals of the business but is driven by exogenous circumstances in the financial markets.

Let me discuss these themes in more detail. The strategic rationale for the acquisition of Pathmark remains intact. The integration remains on track and the benefits from the acquisition continue to build during the second quarter. We accelerated our synergy achievements from the acquisition and realized approximately $25 million of synergies during the quarter comprised of reduced administrative costs, reduced merchandise costs as well as reductions in store operating, marketing and advertising costs.

At the end of our quarter our run rate of synergies was approximately $120 million or about 80% of our original target of $150 million. We remain very confident we will achieve our stated synergy targets.

We made very good progress in our core A&P business. We maintained very strong top line momentum in our fresh, gourmet and discount formats and all of them delivered strong earnings growth during the quarter. The format strategy we had been pursuing in recent years continues to succeed in our markets as evidenced by our strong comparable store sales growth and our advances in market share. At the end of the second quarter we recorded our highest combined market share yet in our three key markets of New York, Philadelphia and Baltimore/Washington, even including alternative formats such as warehouse clubs and discounters.

Now, some more about our transition problems at Pathmark. During our second quarter we experienced some challenges with the Pathmark business which has negatively affected our overall bottom line results. Once we identified the issues, which Eric and Brenda will go into more detail about, we took immediate and corrective action to address the problems. Our most recent results at the beginning of the third quarter already show improvement. As much as we would have liked to avoid such problems it is not uncommon to go through these temporary transition problems while you add such a huge new business to your operations.

Now turning to the more challenging environment. While cost inflation continues to advance at the highest level in almost 20 years the company is well positioned to react and compete effectively due to our diverse and strategically targeted retail formats. We have been able to successfully steer our core A&P business through these external challenges and should be able to accomplish the same with our Pathmark business once its transition problems are behind us.

In light of the current market conditions we have shifted more capital dollars towards conversions, refreshes and mid-store initiatives in the discount and Price Impact formats which we believe will fare better during the economic downturn. Given the current instability of financial institutions and the tight credit markets we have taken a conservative approach to capital spending and continue to closely manage liquidity. The company is prepared to react quickly and effectively with merchandising, promotional and pricing strategies as the economic and competitive environments dictate. Overall, I am staying positive on the outlook for the remainder of fiscal 2008.

Let me finally speak to our stock price performance in the last three months. Clearly A&P experienced an unprecedented decline in its stock price which from our perspective has more to do with the external factors outside the control of the company than the actual performance of the company itself. Factors we believe contributed to the share price decline include enormous amounts of short-selling our stock. More than 1/3 of our actual free flow has been shorted during the quarter. We have experienced forced liquidation of a multitude of hedge fund positions and by other investors in our stock due to their exposure to the general financial crisis.

We have heard about a number of unsubstantiated rumors and speculations of our exposure to the Lehman bankruptcy and our liquidity situation that circulated in the markets. We appreciate that in this environment investors have become very risk averse and that A&P going through the integration of a major acquisition and with higher leverage does therefore not fit the profile of most investors looking for a safe investment. However, we believe that our stock is very much oversold. We have no liquidity concerns and our balance sheet is constructed in such a way to give the company ample time to complete the integration of Pathmark and realize all the associated benefits.

We have all the adequate financial resources to implement our business plan and at the same time we remain flexible in this more challenging environment to deal with any unforeseen issues and ensure the viability of the company long-term.

Looking ahead to the rest of 2008 and next year, I am confident we will be able to recover from the short falls of the second quarter. We will capture more synergies as we get closer to reaching our ultimate target and continue the rollout of our format strategy with a particular emphasis format at Pathmark and more food based discount locations. We are committed to generating positive cash flow in the fourth quarter of this fiscal year and going forward in fiscal 2009 which is our next fiscal year.

We do not believe that today would be the right moment, however, to launch more detailed forward-looking earnings guidance for our business. Considering the unprecedented turmoil in the financial markets and the resulting uncertainties about the future direction of the economy and the consumer. We are concerned obviously about the current economic environment and the potential for meaningful deterioration in consumer spending that could affect our business as well. We are prepared to deal with such changes and believe we are well positioned with our format strategy.

In summary, I remain confident in the longer-term prospects of the new A&P as our strong strategic position in the Northeast and our successful format strategy positions us well to weather the economic storm and to emerge as a much stronger competitor once the economy recovers and I remain convinced we will fulfill our objective to achieve EBITDA performance in the 5-6% range.

That concludes my part of the remarks. With that I’ll turn it over to Brenda.

Brenda Galgano

This morning we reported second quarter sales of $2.2 billion and a loss from continuing operations of $3.6 million. Comparable store sales were positive 2.8% in the quarter excluding Pathmark stores. Comparable store sales for Pathmark were positive 2.9%. Excluding non-operating items of approximately $18 million, ongoing EBITDA was $67 million this year which includes $25 million of integration synergies. Excluding $1 million for FTC store divestitures, second quarter 2007 EBITDA for A&P and Pathmark was $50 million on a comparable basis. Schedules three and four of our press release speak to the non-operating items for both years.

The $25 million of synergies is comprised of $16 million of administrative cost reductions, $5 million of cost of goods savings and $4 million of store operating cost savings. At the end of the quarter our annual synergy run rate was approximately $120 million.

Second quarter ongoing gross margin which excludes a LIFO provision of $1.5 million decreased 130 basis points to 29.9% driven primarily by Pathmark. Overall, Pathmark’s more price and promotionally driven format generates a lower gross margin than A&P. We also experienced further margin compression in Pathmark’s business during the second quarter mainly from two items. First, we had an acceleration of cost inflation which was in excess of 5% and which was not immediately passed along in the retail. This occurred while we were converting systems, people and processes which created more problems in evaluating results.

Near the end of the second quarter we changed our strategy and processes for passing along increases and have since realized margin improvement. I estimate the impact of this in the quarter to be approximately $5 million.

Second, we experienced decline in incremental income due to a change in processes which led to a decline in forward-buying activity at the store level. This change was initiated by Pathmark prior to the close of the acquisition but not fully implemented until the end of our fourth quarter. There was a lag between the change in the process and the resulting store-level buying behavior which delayed impact until this quarter. Changes, including centralizing forward-buying, were made at the end of the quarter to fix this issue. Eric will provide more details in his presentation but the impact in the quarter was approximately $12 million.

For the first five weeks of the third quarter average weekly incremental income from forward-buying has increased approximately $1 million per week higher than in the second quarter due to fixes we put in place.

Excluding the Pathmark business, overall gross margins experienced an increase of two basis points in the quarter. Second quarter ongoing SG&A expenses totaled 29.62% this year versus 31.69% last year, a decrease of 207 basis points driven primarily by higher sales productivity, primarily attributable to the acquisition of Pathmark and the realization of synergies. Non-cash stock compensation expense was $2 million in the second quarter versus last year.

Capital spending totaled $30 million including $2 million of integration capital. Depreciation expense was $61 million. This compares to $29 million of capital expenditures during last year’s second quarter with depreciation of $34 million. During the quarter we completed the renovation of two Fresh stores and two Pathmark stores. We were also working on a number of refreshes and conversions in the Philadelphia market which were completed in the first few weeks of our third quarter.

As Christian already discussed, we have shifted more capital towards conversions, refreshes and new store initiatives from the Fresh format to the discount and Price Impact formats which are generally lower cost projects. Given the tight credit market and declining economic environment, we have taken a conservative approach to capital spending and continue to closely manage liquidity. As such we have decided to reduce our rate of capEx spending and expect to spend a total of $100-125 million for the full year.

Turning to our balance sheet we ended the quarter with net debt of $1.387 billion including capital leases and real estate liabilities and net of $17 million in restricted cash and short-term investments. The change of $38 million from last quarter consists of the following: Adjusted EBITDA of approximately $67 million and real estate proceeds of $3 million offset by net cash interest paid of $36 million and taxes of $1 million, capEx of $28 million which excludes about $2 million of integration capEx, dark stores occupancy payments of approximately $17 million, integration cash payments of $11 million which includes the $2 million of severance and acquisition costs we charged to good will and other which is primarily working capital timing change of $15 million.

To date, integration cash payments totaled $74 million and are comprised of approximately $11 million of capital, $22 million of acquisition related costs charged to good will which is primarily severance and $41 million of costs charged to the P&L. We continue to expect total costs of approximately $100 million which includes about $10 million of non-cash stock compensation for the integration incentive plan.

Availability under our revolving credit agreement was $167 million at the end of the quarter with outstanding loans of $278 million and letters of credit of about $230 million. With respect to the Lehman bankruptcy we have two outstanding matters. First, Lehman Europe is party to a $3.2 million share-lending agreement with A&P. We are working to obtain more information regarding the bankruptcy and until then cannot properly assess whether Lehman will be able to fulfill its obligation and return the shares. Second, Lehman OPC derivative, which filed for bankruptcy on October 3rd, is counter-party to 50% of our call spread overlay. This is the call auction of financing warrant transactions that effectively increased the conversion prices on our convertible debt instruments from 3640 to 4620 for the 2011 notes and from 3780 to 49 for the 2012 notes. Although the economic value of the instrument is currently not significant we are evaluating the situation and we may, among other things, seek to terminate these transactions with Lehman.

As of the end of the quarter we had a cash net operating loss carry forward of approximately $480 million to offset future tax profits including operating profits and capital gains.

In closing, I would like to provide you my perspective on our operating results and provide you some insight on our third quarter. Comparable store sales continue to trend positively. The second quarter, however, proved much more challenging with respect to margin compression in the Pathmark business. The issues contributing to the shortfall have been addressed and we are seeing improved margins during the first five weeks of our third quarter.

Our Fresh, Gourmet and other business segments experienced solid growth during the quarter both in sales as well as operating profits. In the first part of the third quarter our comparable store sales are running lower than the second quarter levels but are still positive across the board. With respect to synergies we continue to increase the run rate of synergies and still expect to achieve the $150 million annual run rate most likely by the end of this fiscal year.

Although we have our challenges going forward such as dealing with the difficult economic environment, more aggressive competitive activity and rising costs, I believe as a combined company we are well positioned to weather the storm. We remain financially strong and have and will continue to maintain sufficient liquidity to run the business. None of our debt instruments have operating covenants. Our availability under the revolver was $167 million at the end of the quarter and we have no debt maturities until 2011.

We continue to expect to be cash flow positive for the fourth quarter and fiscal 2009 and remain focused on reducing our leverage. On a final note, it was our intention to host a fall investor conference primarily to discuss guidance and our longer-term view on the business. This is not the time to launch more specific guidance given the unprecedented economic uncertainties and our focus is fully committed to the business during this time. We believe it would be more appropriate to address our long-term value generating perspective once the dust has settled a bit.

I will now turn it over to Eric.

Eric Claus

Before I get into the quarter view, I should say that I completely concur with Christian’s commentary on the markets and the economic environment. It has been very frustrating to say the least to see our stock trading at the low levels we have seen of late. But, we are in this for the long haul and I believe over time as markets improve and as we continue to make progress and deliver the results that our stock will trade at a higher value. Enough said on this.

Let me discuss a little bit our operating performance for the second quarter. We looked at this quarter with some mixed feelings. Although the top line results and retail fundamentals were quite good with very solid market share increases in all formats and customer accounts stable, overall earnings were below our expectations driven mostly by the transition issues for the most part that were one-time in nature and the inner Price Impact of Pathmark format.

That said, tremendous progress was made on many fronts. I will try to break the results down into bite-sized pieces that will give you a better understanding of these results and assist you in understanding the go-forward implications. As evidenced in our segment reporting results, our Fresh, Gourmet and discount formats all showed strong growth both in top and bottom line. The team has transformed these formats in stores into solid growth vehicles, improving their performance now for twelve quarters in a row.

The same team now needs to deliver the same kind of improvements and results in our recently acquired Price Impact stores or Pathmark, and this on a consistent basis going forward. Price Impact results demonstrated strong top line momentum contrasted by a sharp decline in bottom line results. Cost inflation events are at the highest level we have seen in our recent history and as Brenda mentioned it was in the 5-6% range.

On the synergy front we made great strides with synergies at the $120 million run rate mark at the end of the second quarter. We feel very confident we will attain and/or exceed our $150 million annualized synergy target. Business strategy and market conditions will dictate whether we bank or invest any excess synergies we may realize. Our relationship with our distribution provider and partner, C&S, is advancing extremely well as we each learn to manage our individual businesses under a new contract. This new contract and model was clearly the right thing to do.

Cash was well managed during the quarter with revolver availability at the end of the second quarter standing at $167 million.

When it comes to our Fresh format we made very much headway in the quarter with strong comp store sales lapping last year’s positive 3.2% comps. This was driven by an improvement in the base business as well as by stores with capital investment. The second quarter EBITDA before synergies in our Fresh format was about 30% better than prior year. Improvements in the base business, private labels, fresh mix and effective pricing strategies were big drivers of this improvement. Several new projects were completed during the quarter including Branford and Greenwich, CT.

Return on capital performance continues to exceed our cost of capital and our initiatives to improve on our SuperFresh results is paying off with improved bottom line performance. This is the result of focused merchandising and management changes in the Baltimore and Philadelphia markets.

Now, when it comes to our Price Impact, our Pathmark stores also experienced very strong top line performance with strong comp store sales and improved market share. The miss to our earnings expectations came completely from the Pathmark stores and are attributed to the following four factors, and I’m expanding upon Brenda’s two factors.

First, we underestimated the cost in delaying record inflationary cost increases. This has been corrected going into the third quarter as costs are now passed on as they are realized. Secondly, systems process issues related to the transition came to light in the second quarter. These issues caused significant out-of-stock issues and basic turn, private label as well as some secondary ad related product. Again, declining gross margin dollars and rate. I’d like to point out that this was not a C&S issue but this was an in-house, process people issue. This has also been addressed going forward into the third quarter. Thirdly, a change in process moving us away from retail driven promotional forward buys caused a significant margin miss to plan. We did not have visibility to the effects of that change and its effect on income until very late in the quarter. Once again, the process has been remedied going into the third quarter. Fourth and lastly, we have seen a consumer shift in buying patterns to more promotional, lower ticket goods versus regular turn and higher margin goods. This was exacerbated by the higher than normal out of stocks that I referred to a moment ago which would include our yellow tag specials, private label and other turn merchandise.

We have adjusted our mix to reflect this change in consumer behavior and have seen improvements as we move into the third quarter. I’d like to note also that none of the aforementioned issues are related to the $5 million vendor allowance issue we spoke to and corrected in the first quarter. Our Pathmark merchandising income run rate in the third quarter after one period positively reflects the fact that most of these issues have been corrected. We are very excited also to have completed our first Price Impact refreshes in this quarter. In this quarter we also commenced our Philadelphia initiative, converting our first SuperFresh stores to Pathmark Sav-A-Centers with early indications very positive.

Several other Pathmark refreshes in this market have since been completed and the entire Philadelphia region refresh strategy should be complete by year-end, giving us a dozen or so strong, powerful Price Impact stores in that market.

When it comes to our discount business, operating under the Food Basics banner, it is realizing tremendous growth in both top and bottom lines. In the last few years we refined the concept and have taken severely under performing, money-losing stores in targeted markets and moved them into the black. The current market environment is certainly helping to drive this format as it realizes its second year in a row of year-over-year double digit comp store sales growth. We are currently in the planning stages for more store conversions to this format as well as some new sites in urban markets.

As far as Gourmet goes, this group of Manhattan stores continues to grow its top and bottom lines in an unprecedented way. The Food Emporium team in Manhattan has completed a merchandise mix revamp driving innovation and quality new merchandise lines. The source of capital investments have become a real trendy hit in Manhattan. Interestingly, this whole group of Manhattan stores is growing in a market that one would expect would be extremely hard hit by the Wall Street financial crisis. We are seeing local residents leave the city less frequently on weekends and they are evidently eating less at restaurants and more at home. Here again, we are on the lookout for more potential locations.

Additionally, we have opened our first A&P Best Seller stand alone wine, beer and spirits store in Westwood, New Jersey with more in-store revamps to come and we have also grown our portfolio of Starbucks in-store locations.

My outlook for the future? I think for the balance of 2008 we will remain on strategy with the fixes in place in the third quarter correcting the Pathmark transition issues that have adversely affected our earnings in the second quarter. In light of the current economic environment we have shifted more of our capital dollars towards the discount and Price Impact conversions and refreshes and new store initiatives. Given the current unstable economic outlook we are proceeding with a very conservative capital spending plan and closely managing liquidity, again as Brenda mentioned planning to generate positive cash flow in the fourth quarter of this year.

Going forward we intend on taking advantage of our various formats to make changes to stores in order to respond to local market demographics and economics in the most cost efficient and least capital intensive fashion possible. We are now a minimal company and are changing merchandising, promotional and pricing strategies as the economic and competitive environment around us dictates. We believe we are very well positioned with our diverse retail format strategy and our team to react to and compete effectively within whatever economic environment we will have to live in.

We are grateful to be in the supermarket business. Everyone needs to eat.

With that I’ll pass it back to Chris.

Christian Haub

I want to close with a brief summary of what you have heard during our presentations. We are on track with the integration of Pathmark. We are generating the acquisition synergies as expected. Our core A&P business is performing well and we are actively addressing the transition issues we encountered in the Pathmark business during the second quarter. We remain confident this acquisition was the right decision and strengthened A&P strategically and operationally. We are well positioned to deal with the challenges of the more difficult economic environment. Our format strategy is exceeding the marketplace. Our liquidity is solid. We are poised to deliver a significantly improved result in 2008. Positive cash flow and net profitability are now in our sights.

Thanks as always for listening. We are now pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Karen Howland – Barclays Capital.

Karen Howland – Barclays Capital

I was wondering if you could elaborate a little bit on your comment about how you are gaining market share in your markets. I know you have a comp of around 3%. Inflation is running at 6-7%. I imagine people are eating at home more often. It would seem to be that the 3% wouldn’t actually be gaining market share.

Christian Haub

We can only go by the information we look at and primarily we look at the Nielsen data that gives us both our market share development versus our supermarket competitors as well as how the formats by competitor is growing. Our market share has been up in the first quarter. Our market share has been up in the second quarter on those measures. Now there are still some competitors growing faster than us but we are up in all markets and have experienced growth, even absorbing a number of stores we had to divest during the acquisition in our New York market and we have taken that very positively.

Now you could probably look at that as because your analysis is fundamentally correct and therefore others must be losing more share than we are and we only go by the numbers and they are all showing positive for us.

Eric Claus

The actual dollar…there are dollars out of channel which also effects dollars out of market. Within the New York metro, Philadelphia and Baltimore, we would have the highest market share gain of any of the retailers except for one diner in Philadelphia that is with a competitor.

Karen Howland – Barclays Capital

When you say out of channel, meaning…

Eric Claus

Out of channel I’m talking about club stores, discount stores.

Karen Howland – Barclays Capital

Right. But you said overall you are gaining share in the market despite that?

Christian Haub

Yes.

Karen Howland – Barclays Capital

If I think about the integration of Pathmark, I know if I think back to last quarter and prior to that we talked about how it was a seamless integration and how it would be how the businesses were in place, no expected tick up…it seems like that hasn’t necessarily been the case. I was wondering if you can go into a little bit more detail as far as what happened to have these out-of-stocks occur this quarter. I know you said it was your fault compared to C&S and what you have done to alleviate the problem going forward.

Christian Haub

There were a few problems and it wasn’t the integration per se. The integration, per se, went very well. The systems and everything were done. But, it is when you marry the people and the processes in things get lost and I think we also set up some of our org charts in a manner that didn’t allow for clear accountability for certain responsibilities to one individual. They were shared and it was like I didn’t do it if you didn’t do it. Given the change in the systems we didn’t get visibility on that for awhile. So the out-of-stocks, just by way of example, ended up we found out it was a whole maintenance input problem that we couldn’t figure out because we had stock in C&S of particular items that were being shorted to the source. Then once we put a task force on this to really figure out what was going on it probably involved, we have a sheet we look at every week, maybe 30 different lines of different inputs, people and processes. It is just how those processes come together. It is not actually the systems themselves.

So, chalk that one up to we could have done a better job in how we set this up in terms of people and processes to ensure we didn’t leave any money on the table or even perhaps, in retrospect, should have perhaps kept some of the existing Pathmark systems running independently for a longer time that we didn’t.

The good news in all that, it is never good news when you deteriorate your earnings when they could have been better and it is really self-inflicted, we feel pretty good about the fixes we have in place. Brenda mentioned the dollars and I would say of the overall miss, call it a $20 miss in the Pathmark side of the business, we’ve probably got a fix on 80% of that as we went into the third quarter and we are seeing that already in the first period of period eight.

Karen Howland – Barclays Capital

$20 million then?

Brenda Galgano

$20 million.

Karen Howland – Barclays Capital

If I think about the share count I noticed it went up considerably. Did you actually include the shares that were contracted under Lehman Brothers or is that just from the convertible debt in the warrant?

Brenda Galgano

It has to do with the weighted average shares. So, you are comparing the share count from when to when?

Karen Howland – Barclays Capital

First quarter to second quarter. It looks like it went up by about eight million. I had it at 48 million in the first quarter and diluted share count of 55.8 in the second.

Eric Claus

We’ll get someone to look at that number and then we’ll address the question in a couple of minutes when we have the answer for you.

Karen Howland – Barclays Capital

I was wondering if you can give how much EBITDA Best Cellars is actually contributing.

Brenda Galgano

It is minimal. The Best Cellars or liquor overall?

Karen Howland – Barclays Capital

Best Cellars. I know that has added in over the last year.

Brenda Galgano

It is less than $1 million. It is probably a couple hundred thousand.

Operator

The next question comes from Karen Short – Friedman, Billings, Ramsay & Co.

Karen Short – Friedman, Billings, Ramsay & Co.

A couple of questions on your revolver. Do you have an availability for a delayed draw on your revolver to increase it to 775? Is that right or not?

Brenda Galgano

We would need the collateral under that so with the collateral we have today, mainly the inventory and receivables, we would not be able to do that. We would not have the resources to do that.

Karen Short – Friedman, Billings, Ramsay & Co.

What are your preliminary thoughts for capEx guidance for 2009?

Brenda Galgano

We are still evaluating that, Karen. In light of this market and the fact that as we mentioned we are shifting more capital towards Price Impact and discount we are still evaluating what the appropriate level should be.

Karen Short – Friedman, Billings, Ramsay & Co.

Turning to your comments on sales trends this quarter, you said they had decelerated a little bit. Are you seeing more of a deceleration at Pathmark or more at A&P? Can you comment on some trends with that?

Eric Claus

It is a little bit mixed. We also have the shift of the holidays. The Rosh Hashanah, Yom Kippur and Columbus Day shift so things are a little mixed up. It softened them a little bit I don’t think we’re going to see any major…we’re not looking at any major negative shifts in sales trends from where we have been at.

Karen Short – Friedman, Billings, Ramsay & Co.

Eric you said most of the issues have been remedied in terms of your list of four things. What has not been remedied? Also on your question, I guess you said that your not passing on cost increases was one of the issues. I guess I’m confused as to why that wouldn’t have negatively impacted A&P as well. You kind of started your comments by saying Pathmark contributed entirely to the miss.

Eric Claus

A&P pretty well had a pricing strategy that was very different to Pathmark’s. That was already embedded in our A&P run rate end plans and we have been working that way anyhow. That wasn’t the case in Pathmark. Pathmark traditionally would take the price increase when they received the increase. Then we shifted more to the way in which we were working with A&P which was moving that price increase to actually when the market moves a particular price up, because you have a significant lag, and we then moved back because it was just too much of a dramatic move to do at Pathmark at this time. We still have a lot of work to do at Pathmark to get to the right price positioning we want to get to but we are not going to do it doing silly things and that was actually doing a silly thing. So we reversed that.

I didn’t answer the other question. What haven’t we fixed? Of all the four issues I mentioned really the only one that hasn’t been 100% fixed, but is probably about 75-80% fixed, is the in-stock issue. Where I said there is probably 30 different inputs and different groups of people that have to do with inputs and sometimes if you need the same resources twice to fix the same problem so those were almost there. I think Brenda, we have a meeting on this every week, I think it is within the next 2-3 weeks that I think we will be completely solidified that problem is completely fixed.

So I would say again the lion’s share of it has been fixed but it is not 100%.

Brenda Galgano

We know exactly what needs to be done. It is a matter of having enough resources on it and we believe that in terms of the time table it will be a couple weeks out.

Eric Claus

Actually that wasn’t the lion’s share of the dollar miss. The biggest part of the dollar miss really came from the forward-buy.

Karen Short – Friedman, Billings, Ramsay & Co.

What is your private label penetration? Just remind me where it was again last quarter and where it is now?

Eric Claus

There are different levels. A&P we are running about 17%. Pathmark is at about 15%. Pathmark has seen a nice 100 basis point growth in the last quarter and Food Basics is up over 21% now.

Brenda Galgano

To address your question on the question regarding the number of shares, looking at the first quarter I see where your impression is coming from. On the fully diluted shares the reason why it is different in the first quarter is because in the first quarter it was anti-dilutive because of the significant gains we had on the mark-to-market. In the second quarter we don’t have that. It is very complicated but the 10Q, the footnote on the 10Q, goes through the exact calculation of how we derived the number. There is no change in terms of shares outstanding. No significant change in shares outstanding or basic earnings per share.

Operator

The next question comes from John Heinbockel – Goldman Sachs.

John Heinbockel – Goldman Sachs

So the difference between Pathmark and A&P pass along inflation, Pathmark simply took longer to do that? I wasn’t clear why. Was that sort of a pro-active decision or more of a systems issue or what?

Eric Claus

I think that is just the way it was before. I can understand last year that was the case as the company was being sold. So if I was running the company at that time I would probably be doing the same thing trying to pass on your costs as quickly as you can because it helps your income statement in the short-term. When it comes to what is the right thing to do in terms of raising your prices I think relative to cost inflation it should be with market and that is the way we work. With the amount of price changes we got in the second quarter, the amount of dollars involved was just too big. It actually put us off-strategy temporarily but we had to stop that practice for the short-term just to get things back on track.

John Heinbockel – Goldman Sachs

So if that is true, anything we saw this last year with the two companies you should recoup some margin then here in the third quarter, correct?

Eric Claus

That is right. Absolutely.

John Heinbockel – Goldman Sachs

Now when you look at Pathmark’s comp, the fact that you are now catching up on price is that a big factor in driving moderation in comp or is it just a macro?

Eric Claus

I think what we are going to do with Pathmark, although it has to be a different business than A&P or our Fresh concept for very specific, strategic reasons, we have to do it intelligently. You can’t just go and say I’m going to lower prices and we did this over the last three years. We really worked hard in the A&P banner to shift mix more to Fresh and private label and a whole bunch of things to allow us to have a better price perception and price reality and not erode our margin lines or either our top sales line and/or our margin rate and/or dollars and we’re going to do exactly the same thing. It is a different outcome because the strategy is different, but the process is going to be the same at Pathmark.

John Heinbockel – Goldman Sachs

Do you guys now think, last quarter there were some issues with Pathmark leaving some vendor money on the table. This quarter there are some issues with out-of-stock. How convinced are you something new won’t crop up in the current quarter that wasn’t there before? Are you pretty convinced that you have dealt with everything?

Eric Claus

You can never say never. Companies integrate and talk about their integration process taking two years and getting to things. We have been at it for three quarters. I think we have done a really good job of doing a very well planned integration. I think we have our org charts in line. I would say we probably have most of it licked. I’m hoping nothing else jumps out at us. You can never say never. I don’t think there will be. I can tell you our first period eight, our P&L’s are looking the way they should have looked in the second quarter.

So, evidently we have picked up. The things we said we corrected we have corrected and the dollars are there. It is just like they magically disappeared to something else.

William Moss

I would add to this question that the integration and acquisition of a company this size even though it is within the market that we operate in, I always say you have to go through the cycle at least once. That means you have to get a business under your belt for a full year. Go through all the holidays. Go through all the seasonal shifts and the changes to get that level of experience. We have not been perfect and there is no guarantee we won’t discover some other things and we still learn in this business every day and so we hope the worst of it, so to speak, of these transition problems are behind us. Now our hope is really on execution and looking at what the environment is going to bring.

John Heinbockel – Goldman Sachs

Christian, what if anything can you say about in terms of where Tangleman sits in terms of buying A&P stock and taking the percent ownership up? What is the update there?

Christian Haub

Previously, Tangleman really doesn’t want to publicly comment on its plans, but obviously it believes the prices were attractive during the summer and they are significantly lower from there. So they continue to remain attractive.

John Heinbockel – Goldman Sachs

The credit market, where we sit, that would not hinder what Tangleman can do or would it?

Christian Haub

No it wouldn’t.

Operator

The final question comes from Robert Summers – Pali Capital.

Robert Summers – Pali Capital

Not to be remedial here but can you just walk me through again the forward-buying issue and the numbers around it? Maybe why it materialized this quarter and not in the prior one?

Brenda Galgano

The changes that were made at the store level had to do with the way the store managers saw their store P&L and under the old way there was more incentive for forward-buying at the store level. As that incentive declined over time there was less and less forward-buying at the store level such that in our second quarter we started seeing a decline in the rate which prior to the change was around $3 million more than where we saw it going in the second quarter on average per week. Then coming into the third quarter what we have done is we have now centralized that forward-buying process so it is all done out of the merchandising area and we are now back to the level we were before the change was made.

Christian Haub

I think it was a melt that was beginning probably already when they were going through this process change even before we took over and started accelerating and it accelerated to a level where it became very meaningful in the second quarter.

Brenda Galgano

The change was done by department and the most significant departments were done at the end.

Robert Summers – Pali Capital

Dovetailing off of John’s question in terms of what may or may not be next, clearly with the holidays coming up that is going to put stresses on the system that may not be apparent right now. What are the things you are doing right now to improve your ability to navigate through that?

Christian Haub

We have built up the inventory. Like I said, it wasn’t so much the system. The systems actually worked. It was process. It was input into the systems or change in the methodology in which we did things. Like what Brenda just described was the lion’s share of the margin dollar miss and that is fixed. That is just simply us giving a directive. So it’s not like it is broke down or a system could overload. The capacity of the system is not an issue at all even during the holiday season. It is really just people and processes and we believe we have those in place. They are working right now. Can we say for sure nothing will pop up? I hope not but typically it is the big stuff that hits you in the beginning and you kind of figure it out quickly.

William Moss

It has really been playing catch up. When these things happen and you put fixes in you have to understand it and make the changes. We have been striving to get ahead of things and looking at what else could potentially go wrong and right now quite frankly we are much more focused on trying to get ahead of the potential changes in the consumer behavior and the economy. That is very important that doesn’t kind of hit us unprepared. We will keep working on it and will address issues as they come up.

Eric Claus

We are pretty happy a lot of those people involved in the fix were also the merchants which are now focused on the holidays and focused on driving their business through the holidays, not focused on processes and procedures and systems. I think we will look pretty good for the holidays. We feel in good shape for it.

Christian Haub

Thank you very much for participating. We wish everybody a great holiday period and we’ll talk to you right after the New Year with our third quarter results. Until then thanks very much.

Operator

There are no further calls. This will conclude our conference.

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