克羅格 (KR) 2001 Q1 法說會逐字稿

KROGER FIRST QUARTER CONFERENCE CALL

Welcome everyone to the Kroger earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press the number '1' on your telephone keypad and questions will be taken in the order they are received. If you would like to withdraw your question, press the '#' key. Thank-you. Ms. Kelly you may begin your conference.

Thank-you Sandy. Good morning. Before we begin today's call, I want to remind you that the discussions today will include forward-looking statements. We caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filing. And now I will turn the call over to Joe Pichler.

Thank-you Kathy. Good morning and welcome to Kroger's first quarter conference call. Thanks for joining us. With me today are Dave Dillon, Kroger's President and Chief Operating Officer; Rodney McMullen, Executive Vice-President; and Mike Schlotman, Chief Financial Officer. I will review Kroger's first quarter results and briefly outline a few of Kroger's future growth opportunities. Rodney will discuss the impact of rising utility rates on Kroger's OG&A and the measures Kroger is taking to reduce energy consumption. He will also discuss merger-related costs and working capital. We will then be happy to answer your questions. This morning Kroger released financial results for the first quarter of fiscal 2001. I am very pleased with Kroger's solid operating results and earnings performance during the quarter. Sales and earnings increases were driven by additional synergies from the Fred Meyer merger, strong expense controls, continued growth in corporate brand sales, an improvement in warehousing and transportation expense, and another outstanding performance by our manufacturing plants. Kroger's corporate-wide category management strategies and savings from centralized purchasing are producing solid improvement in gross profits. We continue to be comfortable with achieving annual earnings per share growth of 16% to 18% through fiscal 2002 from an adjusted base of $31 per share in 2000, and 15% EPS growth annually thereafter. Earnings per diluted share before one-time items totaled ¢38, an increase of 19% over results for the first quarter of 2000, including one-time items Kroger earned ¢36 a share, per diluted share, in the first quarter.

Total sales in the first quarter increased 5.4% to $15.1 billion. Comparable food store sales, which include relocations and expansions, rose 2.5% for the quarter while identical food store sales increased 1.9%. We estimate that there was no food cost inflation during the quarter. So once again Kroger exceeded our target for identical store sales growth of inflation plus at least 1%. We have achieved that target in 8 of the 9 quarters since the Fred Meyer merger. The strength of Kroger's core supermarket business enabled us to achieve our first quarter expectations despite some softness in cyclical nonfood merchandise at Fred Meyer stores and jewelry. EBITDA totaled a record $1.5 billion; an increase of 8.1 % over year ago results, excluding one-time items on a rolling 4 quarters basis. ERONOA, our EBITDA return on net operating assets before one-time items was 25.5% versus 24.1% a year ago. This represents Kroger's best ERONOA performance since the merger with Fred Meyer. Kroger's goal is to be at the top of our industry peer group on this measure. FIFO gross profit rate excluding one-time items was 27.03%, up 12 basis points from a year ago. Corporate brands had another strong performance in the first quarter. In the East, we have achieved a market share of 26% of grocery dollar sales and 32% of grocery units. In the West region, corporate brand market share is increasing toward Kroger East levels and currently stands at 20% versus 16% to 18% at the time of the merger.

Kroger introduced 218 additional corporate brand items in the first quarter. As we have often noted, increases in private label market share have a dampening effect on sales. But enhanced grocery gross margins by an average of 10% per item. OG&A expense without one-time items decreased 3 basis points to 18.7%. Productivity improvements resulting from Kroger's OG&A initiatives offset the negative impact of higher utility costs. Excluding the impact of the utility increases, Kroger's OG&A declined 16 basis points to 18.57%. Kroger remains committed to reducing OG&A costs as a percent of sales year over year. Our productivity initiatives are beginning to work as expected and the benefits are reflected in store labor expenses. Kroger has implemented a number of energy conservation measures to help offset some of the utility cost increases. Rodney will discuss this in more detail later. We believe that our 12 new corporate wide initiatives will drive additional improvements in margins. Combined synergy savings at the end of the first quarter reached an annual run rate of $366 million, an incremental increase of $36 million over the end of fiscal 2000. We are closing in on our goal of $380 million, well ahead of our estimate at the time of the merger. During the quarter, Kroger repurchased approximately 12.9 million shares of Kroger common stock at an average price of $23.59 per share for a total of $304 million.

Kroger recently completed the $750 million stock repurchase program that was announced in April 2000. At current prices, we continue to repurchase Kroger stock under the $1 billion authorization announced earlier this year. There were approximately 833 diluted shares outstanding at the end of the first quarter. Net total debt was $8.7 billion at quarter end. Compared to the first quarter of 2000, net total debt increased $267 million, primarily because of the increased investment in working capital. Net total debt was 2.39 times EBITDA as compared to 2.61 times in the first quarter of 2000. Our goal remains to reduce debt to 2 times EBITDA. Net interest expense totaled $206 million for the first quarter, a decrease from a year ago. Kroger invested $645 million in capital projects during the first quarter, including acquisitions. During the quarter, Kroger opened, acquired, expanded or relocated 46 food stores versus 57 a year ago. We completed 26 within the walled remodels and closed 14 food stores in the first quarter just completed. Kroger ended the quarter with 2380 food and multi-department stores, 788 convenience stores, 407 jewelry stores, and 109 supermarket fuel centers. Total square footage in food stores increased 4.3% over first quarter 2000. Excluding acquisitions and the effect of operational closings, square footage increased 3.7%.

Based on current capital expenditure estimates, we believe our square footage growth for 2001 will be in the 4% to 4.5% range, excluding major acquisitions. We continue to see effective opportunities to expand our sales through several rapidly growing categories. Corporate brands, pharmacy, expanded general merchandise, natural food departments, and supermarket fuel centers. Format extensions also offer significant opportunities for sales growth. Food 4 Less has added stores in 10 new California markets since 1999 with more to come. Kroger has allocated $100 million of capital in fiscal 2002 to expand the Fred Meyer and/or the Food 4 Less formats into additional markets. In addition, we are excited about the opportunities ahead of us in Georgia where we have reached an agreement to purchase 15 supermarkets from Harris Teeter, 14 of these stores including one currently under construction are located in Atlanta, which ranks among the 10 largest metro areas in the nation. The other Harris Teeter store is in Athens, Georgia. The stores will become part of Kroger's Atlanta division, which currently operates 107 stores in metropolitan Atlanta, and 3 stores in Athens. Our success in achieving merger synergies has energized the entire organization. Kroger teams are now focused on a dozen new initiatives that are expected to drive sales, improve gross profit, and reduce OG&A. These initiatives are supported by a $200 million capital budget targeted to investments and technology and equipment. A brief update on labor - so far this year, new contracts have been ratified in Las Vegas, Michigan, Seattle, Rowan Oak, Atlanta, Phoenix, and Dayton.

We will continue to negotiate the smaller contracts that remain during the year, but all of the major contracts are now finished, early in many cases. With that, I will ask Rodney to provide more detail on our utility costs, and the measures we are taking to reduce energy usage. He will also discuss merger synergies, merger-related costs, and working capital, Rodney?

Thanks Joe, and good morning everyone. As Joe said earlier, improvements in Kroger's productivity program offset the negative impact of higher utility costs. Increased utility costs negatively affected OG&A by 13 basis points in the quarter. Kroger has implemented a number of energy conservation measures to address the utility cost increases, particularly in California. We have installed new energy-efficient lighting in nearly all our stores and reduced the lighting level in some. We are ordering air-conditioning, refrigeration, and other store equipment to ensure that it is operating as efficiently as possible. There is also much more to our energy conservation program, but these are just a few examples. We are starting to see improvements in our energy usage measures on a weekly basis. California continued to have a lot of change in the marketplace. Turning to merger synergies - merger synergies in the first quarter reached an annual run rate of $366 million, an incremental $36 million gain from the end of fiscal 2000. We continue to achieve synergies faster than originally expected. Kroger recently completely the conversion of the information systems and accounting at QFC, on budget, and on time. In addition, 2 former Fred Meyer manufacturing plants have been converted to Kroger Enterprise Systems, and their accounting functions were moved to the manufacturing and accounting center. Now I would like to explain the merger-related costs and one-time expenses that we have recognized in the first quarter and estimated merger-related costs going forward. The combined total of the cost related to the merger and the one-time charge was $16.2 million pretax. A larger potion of the cost was related to the system conversions and severance payments.

Of this amount, $2.3 million was non-cash and $13.9 million was cash. As we have said during the yearend conference call, we expect merger-related costs to range between $90 to $100 million in total, over the next 2 fiscal years, approximately $70 to $80 million is expected to incur in fiscal 2001. These costs are primarily related to system conversions. Net working capital totaled $700 million at the end of the quarter, an increase of $264 million. The increase is primarily because of cash purchase of inventory resulting from the acquisition of 16 Baker Store at Omaha, duplicate inventory at a new warehouse that replaces the Smith's general merchandise distribution center, and increasing amount of import merchandise purchased at much better pricing but without terms and other increases in inventory. The decision to import this product without terms was appropriate because of the favorable pricing. Separately, you will notice that we have reclassified several items on our balance sheet. As Kroger continues to convert divisions to a common accounting system, differences in historical classification of similar items will continue to take place. We have reclassified these items to confirm to current year presentation. The reduction of working capital remains a high priority at Kroger. We are not happy with the results in the first quarter. We intend to sharpen our focus and charge our divisions 15% interest against their bonus potential for working capital that exceeds budget. We remain committed to reducing working capital by $500 million from the benchmark that we set in the third quarter of 1999. Now, I would like to turn it back over to Joe. Joe?

Thank-you Rodney. In summary, I am more confident than ever in Kroger's strategy to increase sales, improve gross margin, and reduce OG&A expenses. The majority of the merger integration has been completed, and we will exceed our original synergy goal of $380 million. Kroger teams have identified a dozen additional initiatives that will drive sales and reduce OG&A expenses, and our productivity improvement programs are meeting expectations. Our operators are working hard to reduce working capital, and we are implementing measures to reduce energy costs. We believe that our targeted EPS growth rate of 16% to 18% per year through fiscal 2002, and 15% thereafter will create shareholder value in the future as we have done in the past. We will now be happy to take your questions.

At this time, I would like to remind everyone, in order to ask a question, please press the number '1' on your telephone keypad. Your first question is from Debra Levin of Morgan Stanley.

Good morning, could you give us a little more information about the 15 stores you'll be buying in Georgia. When do you expect that to be completed? Do you expect it to be accretive within what type of timeframe, and is the 4.5% square footage growth reflect that acquisition?

Debra this is Rodney. In terms of completion, we would expect to complete it within 30 days. The square footage from that would be included in the 4% to 4.5% range, and in terms of impact on earnings for 2001, we would not expect there to be any impact just because of the conversion cost and product cost, and changing the banner and that would be positive in 2002 and thereafter.

And can you give us a sense in terms of how positive, or do you think this was, a particularly good price you got, particularly a good facilities.

The facilities are in fantastic shape. We are very pleased. Harris Teeter always does a good job of taking care their assets, so we are very pleased with the condition of the stores, and obviously we are very satisfied with the price that we paid or we wouldn't have done it. As you know, in the merger or acquisition that we take on, has to achieve an after tax internal rate return of at least 11% to 13% after tax.

Okay, and do you think this will be one of your better ones, should it be significantly more than that?

I don't think it will be significantly better than that, but I think it will be good for us, always and market works well for us and we have such a strong presence in Atlanta and these stores fit in well about half the stores we worked in the trade areas, so these will be new trade areas for us so I think that will work well for us.

Okay, thank-you very much.

Your next question is from Mark Husson of Merrill Lynch.

Yes, good morning. I wanted to ask about the gross margin. The first quarter was an awful quarter for gasoline margins and you are a huge gas retailer. Can you just talk briefly about whether that had a meaningful impact on gross margins in the quarter? And, then secondly, could you just review how you are compensating your divisional teams now, and the role of SG&A reduction within that compensation and working capital reduction in that compensation?

Let me take the second part first, on compensation, we utilized a plan that begins with shareholders and in case of this year starts with the goal of 16% to 18% increase in EPS, convert that to an EBITDA total as a corporation and then we allocate that EBITDA across divisions, based upon fast performance, competitive changes, and add to it the returns that those divisions expected to achieve when they received capital allocations in the corporations, so if divisions says they can earn 14% on an investments, we add those returns to the bonus-based requirements for the next year, and finally we adjust the EBITDA portion up or down, currently for the 15% cost on the use of working capital of any working capital used above budget. We also have a sales component. Sales is 30% of bonus potential, the EBITDA is 70%. Sales are based upon our beginning mark of inflation plus 1%, and then we allocate that among divisions on a basis that includes current performance plus square footage that has been added minus stores that have been closed and then adjust it for competitive changes. So that when we hit, if we hit the 16% EPS increase, we do modestly well, if we hit the 18% or better, we do very well, and there is no limit on bonus on anybody's bonus at the Kroger Company. Indeed if either the sales or the EBITDA portion exceeds the 100% mark, the bonus goes up at an accelerated rate, so we encourage divisions to do very well.

In order to get the acceleration in EBITDA, the division has to hit a certain level in sales and conversely they get it above a 100% in sales we have to hit a certain number in EBITDA. So that's how the bonus plan works Mark, and as you can see that we are compensated internally in the same way. The shareholders are compensated based on EPS, EBITDA, and sales. Rodney you want to comment on gasoline margins.

In terms of, if you look at gasoline margins, gasoline margins were above ¢1.7 lower this year than last year in the first quarter. It extrapolates that in terms of impact on total growth, it's a very immaterial amount. It's a couple of basis points negative impact when you look at the numbers overall approximately.

Okay, just to follow backup on working capital, and historically, I mean, last year when you had a big focus on working capital you had put in place I still remember specific incentives which weren't just charging people 15% or low. I think you did increase that internal charge from a lower number didn't you?

Actually we did increase it to 15%, we have always calculated it in the same way and incentified people in the same way. As we noted in the press release, we had some moving pieces this quarter that were a bit unusual and that would work through. First, we bought the Baker's inventory for cash and did not have any accounts payable at the time of the purchase to help carry that cost. Of course, as we sell it through and begin to buy new inventory to replace the sold inventory, we will begin to cover a portion of that with accounts payable. Secondly, we are beginning to service the Smith's division from the [________________] warehouse. In order to do that we had to build the inventory at [________________], before we had completely worked down the inventory at Smith's general merchandise warehouse. So there was a bit of an inventory increase there that will be worked through the system and we have got that targeted. Having said all that we had some inventory increases in divisions that we think were excessive and we are going to focus very hard on those.

The other thing Mark, last year as you recall we did reduce capital allocations because of the usage of working capital. At some point if we continue to use working capital, it will affect on the capital that we can afford to spend and will adjust accordingly.

Thank-you very much.

Very good.

Your next question is from George Thompson of Prudential Securities.

Good morning.

Good morning George.

Just a couple of things. Number 1, I am wondering if there was any significant impact on identicals as a result of gas price increases? And, secondly, what impact if any that might have been as a result of higher private label sales on identicals? And, the second thing I am wondering about is you talked about excessive inventories in some divisions, was that confined to any particular product group within those divisions or was it just sort of scrambled, and how much did it amount to. Could you quantify that for us?

Well, I can't quantify it in numeric terms. We look at each division individually, and it was fairly scrambled, we had, just for an example, one division that year ago had run down it's inventory, I believe to a level that was far too low. We made an adjustment there, and I think that was appropriate and so was it's variances in performances across divisions. There is no systematic pattern that I can see George, and that's one that we need to net out the effects of the imported merchandise that we pay cash for the Baker's, as I indicated a minute ago, in the double warehouse who has got a bit of a job to do in certain divisions and we will adjust that. We have puts and takes in different divisions at different times. Net, we are not satisfied within the first quarter, and we know how to do this and we will get that excessive inventory out. Identicals and private label you are dead on and that flattens the top line. I am delighted by the very rapid growth in our private label market share and private label sales, and the margins that it adds to bottom, going the other way of course with increases in gasoline prices that added a bit to the top line. Rodney you want to comment on that.

Well in terms of on the gasoline prices there is very little affect on the supermarket identicals because the convenience stores we exclude from that. In terms of price of label increase in share market that negatively impacted total identicals by bout a quarter of a percent and that's a rough estimation for a number.

Great, thank-you.

You can see that's measurable on the identical from the far of the label piece.

All right, thank-you.

You are welcome thank-you.

Your next question is from Meredith Adler of Lehman Brothers.

Hi! congratulations.

Thank-you.

I've got a few questions for you. First, I was wondering whether you are beginning to see any increase in retail prices in places where energy costs have gone up a lot and what is your sort of best sense of how that's going to develop over time?

Well, I visited a couple of divisions three weeks ago, and it's becoming apparent based on our price surveys that in some markets there has been an increase, and we track that very carefully. I can't give you a sense of a corporate-wide percentage, Meredith. I just don't have a good sense of that but if you look market by markets, particularly in the West, you are beginning to see the effects of it in moving the retails.

Will that mitigate against some of the pressure you are seeing in OG&A, you think in future quarters, or do we expect to continue to see pressure for a while?

It was interesting, one comment that one of our division presidents made is, we had a pretty good estimate from our monitoring service what is going to happen to our energy cost. His comment was this way will competitors see their first bill next month. So, I think it was a bit of a lag in getting the retails up. On the OG&A piece, I am delighted by the progress we are making in OG&A, and of course any increase in prices assuming sales stay constant would have been improvement in OG&A ratio, but shut that aside, that's simply an algebraic result. The importance thing from my point of view is that we began a process some 12 to 15 months ago of identifying OG&A opportunities and studying in motion specific targeted activities to reduce OG&A in terms of work processes, targeted to certain areas in terms of substituting technology and equipment for a labor, and it is working out just as we had planned, and solid productivity improvement measured not in dollars as a percent of sales but in output per employee, and that's very significant I think and there is lot more to come.

Great. Another question I have for you is, we have seen we are seeing some weaker players in markets exit this market, we saw Atco close stores or sell stores in Phoenix. We saw Winn-Dixie close a bunch of stores in Louisville and Lexington and other places, and now we have got Harris Teeter leaving Atlanta. Do you expect or have you seen in some markets where you have player's leave, and the competitive environment will cool off to some extent and do you expect that to help you generally?

Well, we have been saying for several years that consolidation will continue in our market areas, some of that consolidation takes place by merger and acquisition. As you point out in you key item is often missed, there have been a significant number of closings in many markets, just this past quarter for example some closings were announced in Indianapolis.

Right.

And the effects of that you can never entirely project over time. What generally happens initially is those of us who remain in the market go scrambling for that business and things heat up for a while, where it shakes out can vary, and I would remind as all of you, we are industry that's pretty easy to enter and so, the question that if there is one into the given time does not last for long. Somebody moves in or somebody makes a move and sees an opportunity for market share.

Okay, and there's one final question. You talked about the impact from growing private label on comp. Could you talk about cannibalization in this quarter? What was the impact on comps?

Rodney, we did this calculation on...

It's a pretty small number. I think it was.

0.25. I think it was 0.25.

Yeah, it's about a quarter or a percent in total, and this is the smallest number that it has been for a while.

Okay. Great. Thank-you very much.

Okay Meredith .

Your next question is from Lisa Cartwright of Salomon Smith Barney.

Good morning.

Good morning.

Your comp-store and identical store sales looks really strong. You mentioned I think strength in general merchandize, and I think you mentioned rolling out fuel centers. Can you highlight, maybe, some of the programs that I know that there are some competitive issues, but I think you were rolling out a one touch program with your produce throughout the chain? I mean can you just highlight some of the things that you are working on, and perhaps what they contributed to the comps this quarter?

Yeah. Pretty good information. I am impressed Lisa.

I talked to my mom down in ...

That's a witty answer. When is doubt, ask your mother. Yeah, that's a progress we have place forward for well over a year or two years and [_______________] and his team have a great job on that, and that's one example of merchandizing products in a way that in fact is more appealing to customers at reduced cost. The seasonal area is an interesting area for us because we are starting to see the real potential there in our combo stores. This year, for example, drawing on Fred Meyer, we had expanded seasonal items that were improved both in terms of quality and in margin. I will give you one example. We have these glider swings that sell for 150 to 200 bucks a pop. We sold 10,000 of those so far this year. It's amazing to me that when it's merchandized right, people will buy glider swings in the supermarket, and it is because the quality is terrific. Fred Meyer buyers and merchants do a great job of identifying items that will be successful not only in their stores, but in our combination stores and the marketplace stores down in Arizona, and that we had always said would be one of the synergy areas from the merger and indeed that in fact is the case. So, seasonal is an area that's growing, and growing in profitability. Private label, I can't say enough good about that, in the expansion of the items, we talked about grocery, there is also a significant development in HPC GM, and if we look at the margins in that area, there are very high to begin with, and we are putting out products that match or beat the national brand at price savings to customers that are very significant. I think we are running now about 8.5% market share in HPC.

At savings that are tremendous savings to customers and vastly improve gross profit dollars to Kroger. This is a win-win area. I will give you an example. You know, lots of our stores, and look at the suntan lotion display. Terry Cox and his team has done a great job on that in revisions and rolling that through and what you see is the number one item when you hit that isle at price that you can't afford to miss. So, that's a significant area of development for us on the HPC side as well as on the seasonal GM. So, those would be some examples I would say at least.

Great. So, basically without the cannibalization and the effects of the private label, just to get this right Rodney, the comps would be more like 3%?

Yeah. Approximately.

Okay. Just switching gears. One other quick question and I will leave you guys. With the labor contracts, in general, across the board, did you get any improvements in productivity the kind of spend, the chain in all the contracts, and also can you just comment on the average link that the contracts across the different areas where you signed new labor contracts?

Yeah. Some of our contracts have run for several years to 5 years, and we like that. It's good for us, it's good for our employees, it's good for the union, it gives us some stability, and what I think we have been to able to achieve in many, many area are some tradeoffs in return for improvements in wages to get some offsets in terms of productivity improvements, reduction in work rules, expansion of flexibility and that's a win-win for us and for our employees and they do better in their pocket books, we do better on the productivity side.

So, anything incrementally that we could expect to see impact O&A over the next 6 months or so?

Well, fuel remains a bit of an unknown because particularly on the West Coast, the market structure in California that will be in place, is not clear at this time. We have done some things, as Rodney pointed out to conserve and utilize energy in an intelligent efficient way. We have also signed some long-term contracts that will help us in California and so one never knows what tomorrow may bring in the energy scene in California, but that's the one I would point to. It's probably the most likely unknown.

LISA CARTWRIGHT. Okay. Well, thank-you very much.

Okay Lisa.

Your next question is from Ed Comeau of Credit Suisse First Boston.

Good morning.

Good morning Ed.

I have a question. You mentioned you are allocating more capital for the expansion of Fred Meyer and Food 4 Less. Can you talk a little more about what your thinking is on the multi-department stores? And where you are planning to take them? And how aggressive you will be in rolling that out? Just to rollout thoughts on that business?

There are number of opportunities. One of them is the Fred Meyer store that exists in the Northwest. The other is the marketplace format that we introduced into Arizona, in Phoenix, last fall. And of course, it's too early to tell yet how that format will shape up. We are doing some cutting and trying on merchandizing. I would tell you that I am very pleased with the results so far. We are learning the dynamics of that format where you have 110,000 and 140,000 square feet store that is food plus an expanded general merchandize, and it makes a significant laboratory for us. We see that as an expansion opportunity. At this point, we are not prepared to talk about locations where we will go, but as we have indicated we have allocated significant capital to do the extension of that format into new markets in 2002.

I guess I am going to ask this then, Joe. The expansion you have for the Fred Meyer and the marketplace. Are you really just focusing you think for the near term anyway on existing markets where you currently operate that format or I guess my question was whether or not you are looking at the other new markets?

Yeah. We have not rolling out on that Ed. Again, on that format, the marketplace format, we are only into it, now about 8 months, haven't gone through a full seasonal cycle yet. We will know a lot more as the Christmas season go past that's when we see a full year, but I would not limit our vision here, our horizons on either Fred Meyer or Food 4 Less to existing markets.

Okay. And then a question for Rodney, I guess, just to sort of bring up a past subject on the home delivery grocery business. I am sure you saw the alliance with Safeway and Tesco, and obviously, our hold is continuing to push their growth within PPOD. How do you guys look at all of that and has any of your thinking changed or where does it stand in terms of order of importance internally? And whether you will plan to do anything in the future?

Well, we continue to focus a lot of attention on trying to make sure we understand all of the economics of the model. We continue, as you know, we have actually been into it, 10 years total, but we continue to make modifications to our operation in Denver in Soopers trying to come up with an economic model that is actually profitable that you can roll out and that's were our attention is focused on, in terms of what each one of our competitors do, obviously, we listen and watch, but it wouldn't be appropriate for me to comment on my opinion of those.

Yeah, I wasn't asking for your opinion on them really, just what plans you may have or what your thinking is? Is it still pretty much just wait and see no real apparent plans to do much of anything?

Ed, we've never said that we are just going to wait and see. What we've also said, is that we will continue to work with what we have in King Soopers to try and improve what we already have, to see if we can get something that we can actually roll out profitably.

As we've said, our belief is that there are certain markets with certain demographics where this can work. And, that the most likely model is the [Brooks & Clicks Model] to build on the existing franchise. We've been saying that for sometime. We're paid to take reasonable risks, and I would reemphasize the word reasonable. I am pleased that we haven't done anything thus far, because if you look at the body count it is not very good. I am pleased by what we've learnt, and we continue to come at this in a prudent way I think working on our knowledge base out in Denver.

Okay. And, then one final question, you have completed one acquisition, I guess Bakers, and then you have got Harris Teeter closing relatively soon, I believe. I am not looking for you to bump up earning's guidance or anything like that, but you know, would you anticipate that those acquisitions would be accretive to your earnings outlook in the current year or next year and what if any impact you might expect from them?

In terms of, when you look at our objectives over all, the smaller acquisitions, we really would not change our earnings guidance relative to the smaller acquisitions, when you look at it in the 16% to 18% through next year, and 15% in 2003 and beyond. The size of these, they are positive but they are not to the degree that actually impacts our total numbers that change our guidance going forward.

Okay. Thanks.

Thank-you Ed.

Your next question is from Deborah Weinswig of Bear Stearns.

Good Morning. Rodney, could you talk about systems that you have in place such as EAO, and the opportunities these technologies will give you to help you meet or beat your long term capital goals?

Yes. The area of technology is of strategic significance to us and I am delighted by a number of aspects here. One is by the conversion of the Fred Meyer's systems to the Kroger systems. We're on time, we're on budget, in going to an enterprise system. As you probably will recall, this year, we have just completed QFC's. We indicated by the end of the year, we will have completed the enterprise, completion of the enterprise systems at Dillon, King Soopers and Fries and then next year we will complete Ralphs. So, that conversion process that we mapped at the time of the merger is on time and on budget, and I am very pleased by the way in which Mike [________________] and the team has carried that out. Secondly, we're seeing the benefits of really sophisticated technology. It is being much broader than I had even expected a few years ago. I mean, I became a believer about 5 years or 6 years ago in this, and what we are seeing is that once you have systems in place and associates become comfortable with those, they are secondary level applications that we didn't even foresee to which this can be put, and it's like walking into an expanding universe. You put in a system, you have a certain set of goals, timetables and as always we require that the return on that investment goes into the bonus base for everybody involved, and then, once it's in that initiative leads to additional initiatives, whether its in warehouse systems, in-store system, merchandising system,

and the speed with which this is expanding is breathtaking. And the effectiveness of it is very impressive to me. So, you know, we've impounded what we know about technology effects into our 16% to 18% earnings guidance to 2002, a scenario that will continue to have significant impact.

Joe, I have one other question. You'd also talked about the triple play in the past regarding share repurchase without reduction in capital spending. The stock at the current levels, how do you plan to prioritize and think about the triple play?

Well, the key for us here is to meet our EBITDA goals and working capital goals, and as I indicated earlier, we weren't pleased with the lack of progress on working capital in the first quarter and we will address that. We did, as Rodney pointed out, make significant share repurchases during the quarter. We are a strong free cash flow directed company, and the opportunity here from the working capital reduction goals that we've set is very substantial. And so, if you look at quarter-to-quarter results we did, I'd give us an 'A' on the repurchase, I'd give us good marks, pick your own, on the EBITDA generation. I'd give us a 'C' on working capital in order to get the triple play working right away to get that third leg on the mark, and we will.

Right. Thank-you very much.

Thank-you.

Our next question is from...

One other point I'd like to make is, excuse me, on the share repurchase. We buy on a grid that is based on a share price, so that as the price of Kroger's stock goes up, we buy less and obviously the reverse. So, it's a very disciplined program and we have a set of goals based upon the internal rate of return from the repurchase that we follow very strictly, and I should have mentioned it.

Your next question is from Chuck Cerankosky of McDonald Investments.

Good quarter.

Thank-you.

Joe, I have a question first of about the labor environment, you told us a little bit about that in general, but the UFCW at the beginning of the year seemed very adamant that they would organize Wal-Mart in similar shape or form, but it obviously has not happened and you and others in the industry are getting contracts settled earlier and negotiated early, fairly long contracts. You seem pleased with the outcome. What is going on here that we don't see? Is the union recognizing very clearly the level of nonunion competition out there?

Well, I couldn't comment on that. You know, I would not presume to speak for the UFCW. Our contracts of course are negotiated on a market-by-market basis, and I think what we've learnt and what our labor socials have learned over the years is that you have to be sensitive to the conditions in the market in which you are competing, and those conditions vary widely. Some markets are almost 100% unionized and that is one set of conditions. In many markets we are the only unionized competitor. And, so there is no doubt that that environment frames the negotiation and affects the outcome. The tradeoffs that have been initiated with respect to work rules and perhaps more effective use of fringe benefits and fringe benefit cost has helped both of us, I think, and you know there is a process in many markets where you work toward a mutual solution, and so, the outcome varies by market, varies by structure and varies by union president relationship with our division president. I could not characterize it as any unified system. But I am pleased with the way in which market-by-market, we've been working with the UFCW. Sandy, tells me there is time for one more question.

Okay, Joe, I have a followup.

Okay.

When you are using working capital like you did to forward buy that general merchandise, the imported merchandise because of the good price, how does that work into the management's compensation?

That's a great question, and it brings to mind the comment that the goals for Kroger is not to minimize working capital, it is to use it wisely. And so, for example, let me use an analog here with forward buy. There are forward buy opportunities where we can earn, I have seen them as high as 50% the first week of the forward buy and then down to 30%. We encouraged the use of working capital that brings you 15% and earns you 50% and our operators are good enough business people to see that. The way it would work as far as the bonus goes is the 50% return would increase your EBITDA by the gap between the 50 and the 15, and of course you get into the 15. So the economics are right to make smart use of working capital. In the case of the imports, the way in which we would approach that is to take a look at what is the interest costs on the working capital that is tied up and what is the rate of return on that cost from the lower product price. And so it's a mini-capital budget decision and it was made the right way. So that's a smart use of working capital.

Thank-you Joe.

We thank-you all and we appreciate.. we will add one more question since Chuck was a followup..

Your next question is from Tony Howard of Hilliard Lyons.

Congratulations. I guess I am glad I get the last question. Most of the question has been answered, but can you go back as far as what you learnt from the Ralphs fiasco situation, and given what's going on with the dollar in general, still not being able to restate earnings, what kind of systems have you put in place so that does not happen again?

Well, we have commented extensively on that in the past, Tony, and one of the points that we made was that all of the divisions that were merged into Kroger, now have either a Kroger controller or someone who worked with the controller in place, number 1. Number 2, the irregularities there that were caught as a result of our internal control system, we have a very strong internal control system, and that was a key factor. And the third thing is as we consolidate accounting systems, that in itself is a good control mechanism as we have consolidated accounting systems into [________________]. That enhances what was already a strong control system. So, I am very satisfied with the control structure of the company. We thank-you all for joining us this morning and appreciate your questions and support. Have a good day.

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