克羅格 (KR) 2001 Q3 法說會逐字稿

Good morning! My name is Heather,and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Kroger third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's 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 key pad and questions will be taken in the order they are received. If you would like to withdraw your question, press the pound key. Thank you. At this time, I would like to turn the conference over to Miss Kathy Kelly. Miss Kelly, you may begin your conference.

Thank you. Good morning. Before we begin today's call, I want to remind you that the discussion today will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. The detailed discussions 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. With that, I'd like to turn the call over to Joe Pichler.

Thank you, Kathy.

Good morning and welcome to Kroger's third 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 Michael Heschel, Chief Financial officer. We will cover three areas during our call. The first, will be our brief review of Kroger's third quarter earnings results. The second, will be our expectations for the fourth quarter and full year. The third, will be a review of Kroger's strategic growth plan, including our new, long-term EPS growth model and expectations for fiscal 2002 and 2003. We will then be happy to answer your questions. We will begin with a discussion of Kroger's financial results for the third quarter of fiscal 2001. Earnings per diluted share before cost related to a merger and one-time expenses totaled 32 cents, an increase of 14.3% over results for the third quarter of 2000. Including costs related to a merger and charges, Kroger earned 16 cents per diluted share in the third quarter. Total sales were $11.4 billion, an increase of 3.8% over the third quarter of 2000. Food store sales rose 4.3%. Comparable food store sales, which include expansions and relocations, rose 1.4%. Kroger's identical food store sales, which exclude expansions and relocations rose .8%. If we include expansions as some Kroger peers do, [idents] rose .9%. We estimate that annualized product cost inflation was 70 basis points during the quarter. I will discuss our plans to accelerate same store sales growth in a few minutes.

The FIFO gross profit rate, excluding one-time items was 27.46%, up 42 basis points from a year ago. The increase was driven by corporate brand sales and savings from centralized purchasing. OG & A expense without one-time items increased 11 basis points to 18.86%. This increase was driven primarily by two categories. Healthcare costs rose 15 basis points and utility costs rose 7 basis points. Excluding these increases, OG & A declined 11 basis points because of continuing productivity improvements. Kroger remains committed to reducing OG & A costs as a percent of sales year-over-year. You will hear more about our cost reduction plans shortly. EBITDA totaled $834 million, an increase of 10.2% over a year ago results. On a rolling four quarter basis, ERONOA our EBITDA return on net operating assets, before one-time items was 25.93%, versus 24.34% a year ago, an increase of 159 basis points. This represents Kroger's best ERONOA performance since the merger with Fred Myer. We continue to make steady progress toward our goal of being at the top of our industry peer group on this measure. During the quarter, Kroger repurchased 5.1 million shares of Kroger common stock at an average price of $25.23 per share for a total investment of $128 million. Since January 2000, Kroger has invested $1.2 billion to buy back 52.6 million shares. The company has $766 million remaining under the $1 billion repurchase program, authorized earlier this year.

At current prices, Kroger continues to buy back shares. Net total debt was $8.6 billion, an increase of $212 million as compared to the third quarter of 2000. The increase is a result of stock repurchases over the past 12 months. Net total debt improved to 2.28 times EBITDA as compared to 2.50 times in the third quarter of 2000. This represents Kroger's lowest net total debt to EBITDA ratio since the merger with Fred Myer. Our goal remains to reduce net total debt to two times EBITDA. Net interest expense totaled $149 million for the third quarter, a slight increase from the year ago period. Kroger invested $530 million in capital projects during the third quarter, including acquisitions. During the quarter, Kroger opened, acquired, expanded or relocated, 33 food stores versus 35 a year ago. We completed 31 within the wall remodels and closed 15 food stores. Total square footage in food stores increased 4% over the third quarter of 2000. Costs related to a merger totaled $10 million pre-tax. Most of this was related to systems conversions. Year to date, these costs have totaled $37 million pre-tax. Kroger incurred two other one-time charges in the third quarter. The first was a charge of $110 million pre-tax, related to assets impairment and store closings. Let me give you some background on this. You will recall that Kroger took an impairment charge in the first quarter of 2000. This was -- this was for stores mainly in the west that had a sufficient operating history to assess their future.

The third quarter impairment charge relates completely to stores in the western divisions that had recently opened or were in the process of being built in the first quarter of 2000. Therefore, it was not possible at that time to assess the long-term prospects of these stores in the first quarter of 2000. These stores were approved before Kroger's stringent capital review process was implemented at the former Fred Myer divisions. The other charge in the third quarter, totaling $81 million pre-tax, relates to certain contracts to purchase electricity in California. The company entered into these contracts earlier this year. Estimated energy usage under the contracts was originally based on energy usage in California last year, expected storing program growth and historical peak needs. Since the contracts were signed, the company has significantly reduced its energy usage in California, and wholesale energy prices in that state have fallen substantially. The charge is for excess energy that we are required to purchase under the contract. Under generally accepted accounting principals, a company is required to set up a liability if it has supply contracts that are in excess of current needs and the current market price is lower than the contract price. Accounting rules will require these contracts to be revalued each quarter. On a more positive note, Kroger's remaining energy contracts, cover our expected energy usage in California at prices below current retail rates. Networking capital totaled $546 million in the third quarter, an increase of $67 million from the third quarter of fiscal 2000.

Kroger is committed to reducing networking capital by $500 billion from the benchmark we set in the third quarter of fiscal 1999. Third quarter results reflect an improvement in working capital trend as compared to the increase in the second quarter of 2001 versus the prior year. After two years, networking capital has declined by $44 million versus the third quarter, 1999 benchmark. It is clear that we still have a lot of work to do, but we're headed in the right direction. We have told our divisions that we will reduce their capital investment budget, dollar for dollar, if their networking capital increases next year. That wraps up our review for the third quarter. Now let's turn to the fourth quarter. In our second quarter conference call, I mentioned that Kroger was facing the most challenging economic and competitive environment of the past 20 years. As I said earlier today, we are not satisfied with Kroger's sales. As a result, we believe that the fourth quarter earnings per share will be in the range of 46 cents to 48 cents, excluding one-time items. On the same basis, that translates to EPS of $1.48 to $1.50 for the full year, an increase of 13 to 14.5% from $1.31 per share in 2000, after adjusting for the 53rd week last year. I will now review the strategic growth plan that we outlined in the press release this morning. The merger integration is now largely completed and most of the benefits have been realized. Over the past two years, Kroger has exceeded our cynergy goal of $380 million, ahead of schedule.

We have extended the centralization of purchasing for many major categories to all of our divisions, including the former Fred Meyer divisions. We have launched a highly successful three-tier approach to corporate brands, leveraged the general merchandise expertise of Fred Meyer to strengthen Kroger's promotional and seasonal sale's programs, and completed most of the consolidation of our information systems on schedule, and below budget. By February 1st, Kroger will have two data centers, down from approximately 20 a few years ago. Every division will be on the same accounting system with the exceptions of Ralph's and Fred Meyer. Ralph's will be converted in 2002. As anticipated, the merger has helped Kroger to operate more efficiently and to capitalize on our leading market shares in major metro areas, geographic diversity, outstanding corporate brands, and financial strength. However; the economic and competitive landscape has changed dramatically since the merger. The economy is in a recession, and unemployment has increased, impacting several Kroger markets. As we have already discussed, consumers have become more cautious in many of their purchases. Competition has grown more intense as supercenters continue their rapid expansion, and traditional food retailers lower their prices in an attempt to maintain sales, and stop losing market share. Supercenters, mass merchants, drugstores, and nontraditional operators are using food as a lost leader to attract shoppers. They are generally doing this at the expense of their own EPS growth. Meanwhile, dramatic increases

in variable costs, such as utility rates and health benefits, have driven up our operating expenses as they have for all of our competitors. While food retailers have weathered recessions before, we believe that this is not just another downcycle. We are convinced that the industry has fundamentally changed and Kroger must stay ahead of those changes. We're not going to wait for the economy to recover. The timing is right for Kroger to capitalize more fully on our advantages as a large company with significant economies of scale and a strong balance sheet. The rapid pace of supermarket consolidation is releasing market share into the system and we will go after it. Our strategic growth plan accelerates the course that Kroger has been on since shortly before the merger. The plan has four elements: The first is to increase our identical food store sales growth target.

We are raising the bar significantly on our topline sales growth goal. Kroger will make substantial gross profit investments to achieve identical food store sales growth of 2 to 3% above product cost inflation within the next two years. For competitive reasons, we are not going to share specific details of the plan, but we expect that, beginning in the first quarter of fiscal 2002, Kroger's identical food store sales growth will show modest improvement over results for the third quarter of 2001. We expect that our [idents] will improve until we reach the annual run rate of 2 to 3% above product cost inflation within two years. If economic conditions improve, we would expect to achieve that goal at an earlier date. As we begin to execute this plan, we will provide you with regular updates on our progress. The second element of Kroger's strategic growth plan is to release operative and administrative costs. We plan to take out more than $500 million in structural costs over the next two years by improving productivity, reducing shrink and cutting other administrative costs. These savings are incremental to the $380 million of cynergies already achieved by the company. Most of the $500 million in cost reductions will be achieved in fiscal 2002. As you know from earlier conference calls, Kroger has already begun to initiate productivity improvement programs such as one touch produce. We are pleased with the results and look forward to initiating additional productivity improvement programs. We've learned a great deal from the Ralph's organization, which has shown that improved productivity can reduce store labor hours without compromising service or impacting the customer.

Kroger has an opportunity to remove substantial costs by adopting these and other best practices, company wide. As part of our plan to reduce administrative costs, Kroger will eliminate approximately 1500 positions, primarily management and clerical, over the next 12 months. We have identified our best practices from across the company and will begin to implement the most effective and efficient operating structures from store level to corporate office. We will merge one division into two adjacent marketing areas. Earlier this morning, we began meeting with employees in the division office that will be affected by this decision. Kroger will make a public announcement later today, once we have told our employees in that division. We deeply regret having to announce staff reduction plans, especially at this time of year, and we understand this news will be painful for some of our associates. However; economic conditions make it necessary for Kroger to implement these actions quickly, in order to maintain Kroger's long-term competitive advantages. We will communicate fully with employees about their individual positions and treat everyone with fairness and respect. Some employees may be able to transfer to other positions within the company. For those who cannot, Kroger will provide a comprehensive and generous severance package, based on years of service. The third element of our strategic growth plan, is to leverage our size more fully to achieve even greater economies of scale from Kroger's $50 billion annual sales volume.

We will accelerate the centralization of merchandising and procurement, which began years ago, by consolidating more functions in the Cincinnati area. We believe that this will better align us with vendors that are set up to serve one primary contact point at large retailers. Our investments in new technology make this consolidation possible. Consider the results we have achieved through global net exchange. We have purchased more than $500 million worth of products and supplies through 300 reverse auctions with GNX this year. Those auctions have saved Kroger more than $30 million. This is a huge strategic advantage for Kroger and we will leverage it even further next year and in the years to come. The fourth element of Kroger's strategic growth plan, supports additional investment in our core business to grow sales and increase market share. As I said earlier, the economic and competitive environment has fundamentally changed. We must adapt our business accordingly to take advantage of these changes, competing even more effectively against the strong players and against others who do not have our economies of scale. We have established a long -- a long-term sustainable EPS growth target of 13 to 15% per year, beginning in fiscal 2004. We believe this is the appropriate balance point between current financial performance and long-term value creations for our shareholders. For fiscal 2002 and 2003, the target will be 10 to 12% growth as Kroger implements the plan I just outlined. The adjustments to goodwill required by new [FAZBY] rules should actually improve our fiscal 2002 EPS by another 7 percentage points beyond that target.

The 10 to 12% target for 2002 and 2003 reflects the softer economy, increased competition and the investments required to drive the increased same store sales growth that we are seeking. We have assumed that for the next two years, the economy and competitive situation will not improve. If they do improve, Kroger's EPS growth may exceed the 10 to 12% target. Here is a breakout of Kroger's long-term EPS growth rate of 13 to 15%. We expect to continue our square footage growth of 4 to 5% per year. Our new target for identical stores sales growth is 2 to 3% above product cost inflation. Together, these should produce sales growth of 6 to 8% per year. This sales growth is expected to generate EPS growth of 11 to 12% per year, because most of our capital investment will be in existing markets. Any additional margin improvements beyond our capital investment program will be invested to drive sales. Deleveraging, refinancing, and stock repurchases are expected to generate EPS growth of 2 to 3% per year. This should give us sustainable high quality earnings growth of 13 to 15% per year, beginning in fiscal 2004. Kroger will incur a pre-tax charge of 85 to $100 million to reflect severance and other costs associated with implementing this strategic growth plan. The majority of this charge will be taken in the fourth quarter of 2001. Even with substantial investments to drive sales growth, Kroger's free cash flow is expected to be 550 to $650 million in fiscal 2002.

This reflects a capital spending program of $2.1 billion, which is consistent with prior plans. And a working capital reduction of $100 million. As I said earlier, this strategic growth plan reflects an acceleration of the course Kroger has been on since shortly before the merger. Not a departure from our previous strategy. We will extend the economies of scale that Kroger has generated from centralization and coordination. We've been taking costs out of the business for years and Kroger has the discipline, technology, and financial strength to drive change at a faster pace. Our philosophy has always been to increase market share. This strategy will accomplish that goal by positioning Kroger ahead of industry changes, rather than reacting to them. Most of the actions we have announced today will be invisible to our customers. Our store banners will not change. Our divisions will continue to make their own decisions about what merchandise to carry, based on consumer preference in each market. As always, our customers will see high quality stores that offer outstanding service, selection, and more value than ever. One other thought before we open it for questions: It is an enormous strategic advantage to have the financial strength to be able to make investments necessary to build our business, remodel a nd expand our store base, and continue to generate strong, free cash flow that can be used for stock repurchases or debt reduction. Again, Kroger has $766 million remaining under our $1 billion

repurchase authorization. I firmly believe that by executing the strategic growth plan we have outlined today, Kroger's business will be healthier than ever and the company will be well positioned to be among the best, and create substantial shareholder value, in the years ahead. We will now be happy to answer 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 key pad now. First question comes from John Heinbockel.

Hi, John.

Hey, Joe. Two things. You know, when you look at the -- and I appreciate, always, the most conservative outlook, but when you look at -- the consumer, you know, where they are today, the fiscal and monetary stimulus we've gotten, most people believe the consumer will see an upturn in the next quarter or two or three. When you look at that and the possible fallout from folks like Winn-Dixie and others in some of the markets you're in, I'm a little curious about your dower forecast, particularly in 2003, are you simply being overly conservative or are there things out there you've seen in the last two or three months that really concern you that are kind of new?

Well, we have been developing this plan, John, for four to five months. And as we did, we set ourselves a baseline at the very beginning to assume that the economy would remain on the course that -- that it is on currently. Now, you're right, that could turn out to be a more dower or pessimistic approach than we have stated. Nevertheless, we built the plan on that set of assumptions and we believe that executing it will achieve the projections that we indicated and, if you're right, and if the economy turns around, we would expect to see better results faster. That's the way we built it.

Do you see anything differently out of the super- centers than you saw before, ie, you take a hit, rebound a year later, and you're back to growth, or are they hitting you for longer than you experienced in the past?

I think the effects are much the same. The point I would make, is that perhaps in some areas we have not maintained the price competitiveness against them that I believe we need to maintain. And the program we've outlined provides us with a fund of some $500 million in capital -- $500 million, excuse me, in cost reductions, plus a refocus -- or additional focus, following the same strategy we've been on in merchandising to achieve the economies of scale. Plus, some investment in EPS, and when you take that fund together, we're going to use that to drive our price competitiveness to levels that we think are appropriate against supercenters and which utilize our economies of scale against some competitors who do not enjoy those economies. And, so, that's the underlying strategy in the development of the plan.

All right. And then just finally, you're looking at a level of real growth in -- in I.D.s, and that number you gave, the two to three was comper I.D.

I'm sorry, I.D.

Okay, that's two to three times what you have normally targeted, you targeted 1% over inflation, two to three, can that be done with a good [RY]? Do you have to invest, to get the 2 to 3, is that going to cost -- I mean, it suggests if you want to get to two to three or 10 to 12% earnings growth is a little optimistic given how much it may cost to move the dial that much. How do you look at that?

John, we don't think so. This plan has been under careful study. Has been under careful preparation. We've gone through every line of the income statement, identifying opportunities, and we believe that this fund targeted in the way that we intend to target it, and I'm not going to talk specifically here, will give us the -- the lift that we need to get that two to three percent. I might remind all of us that we were at 1.9% at the end of the first quarter, in our first quarter earnings this past year. The economy was in a little better shape. We did not have 9/11 and so fourth. And so I don't see the two -- I believe the two to three percent at the earnings growth that we've outlined is a good balance. And, as you point out, if the economy improves, things should improve faster than the timetable we've set.

Okay, thanks.

Your next question comes from Mark Husson.

Good morning. It's a pretty exciting series of announcements you've come out with this morning. The one I wanted to go into a bit more detail on, is a $500 million of cost savings. That's like a whole nother Fred Meyer plus another large acquisition in terms of cynergies, it's a huge number. Are there structural reasons why you may not be able to get that number? I'm thinking in particular of the union situation and work rules and if Ralph's been able to negotiate over time more favorable or more flexible work rules inside the stores which don't exist in the rest of the country. How are you going to address that?

Right, well, first of all, with respect to the staffing, one of the great things about having a company of our size, having new partners as a result of the Fred Meyer merger, and having the traditional, you know, Kroger expertise, when you put those together, what we have done, now that the $380 million is fully realized and ahead of schedule, we sat down four or five months ago and said, let's take a look, line by line and structure by structure, across our division and across our divisional headquarters, and let's take a look at some of the variances here and identify --- see if we can identify some best practices, which can be taken from divisions that are achieving those best practices and -- and initiate them throughout the company.

Most of the reductions in the changes that we're talking about take place at the management level, and they will not be affected by labor union contracts. First we will continue to work hard with our unions on the LH & A issues, which is an indicated is growing rapidly for us, as it is for all companies, union or non-union. We will continue to address that. But most of the administrative -- most of the position reductions involve management positions. The best practices that we've identified for operations, some of those have already been initiated in certain divisions, and will be rolled through, and those are such that they are not affected by work rules, and we've worked hard and had real success, incidently, in reducing some of those work rules. We also now have reached a point, where through our technology and with the technology rolled through the entire company, down to two platforms, and with the enterprise accounting systems everywhere except Ralph's and Fred Meyer, by the end of this

fiscal year, we're now able to take another step and identify opportunities, which we have done, to utilize our technology to drive improvements in everything from staffing and the use of store hours, within our union contracts, to reduction of shrink. So, it's a very exciting time. You know, it's -- we have -- as you point out, this is a bigger -- bigger number than cynergy and we believe it is absolutely achievable.

Okay. Just a follow-up. Can you just tell me what LH & A is? I'm being dense.

It's life, health, and accident insurance.

Okay, great. And when you're seeing this kind of stuff in terms of sales growth, presumably you've got some vendor partnerships where you're going to be focusing a lot of that effort. Are there extra moneys available from vendors to help support this kind of sales growth program that you can access now?

Yeah, one of the changes, you know, we identified over the past couple of years as we were completing the integration of Fred Myer, is that many vendors are now organized in such a way that they can offer additional opportunities and efficiencies through a one-point contact with corporations. And we've observed that in the categories that we have already centralized and as you know we've done -- some of those are several years old, some of them are more recent. And as we have looked at those recent centralizations and coordinating activities, we've come to the conclusion that we can achieve better cost for product by having that one point contact on additional functions, and so, that's the reason we intended to go that route. Plus, with our technology as it is today, and moves through the organization, we're able to conduct certain merchandising activities with fewer people. And at a more coordinated fashion. I'm very pleased with the state of our technology, I believe it is a strong competitive advantage for Kroger-- strategic advantage.

You also offer a lot of private label general merchandise in the food retailing stores, how is that performed and what are your expectations for that going forward, as well?

That's done very well. It is an area of rapid growth. Now, some of that growth has occurred as we have moved it into the additional divisions, so, you get some growth from the fact that you're just taking merchandise through more of our 2400 stores. But in addition to that, this is a solid area for us, and we have the buying expertise out at Fred Meyer as we knew we had at the time of the merger and we're seeing it now, rolling throughout our stores, and we have actions under way that are going to enhance that and I think will be positive for us, even if the cycle remains bound because it is such a good value for customers. And we can take that throughout our combination stores.

Thank you very much.

Yes, ma'am.

Your next question is from Meredith Adler.

Hi, Meredith.

Hi. Some questions for you, one of the impressions I had from reading your announcement is that you think that you are going to put some people out of business. I know that's not the way you guys talk about it, but I was wondering if part of what you're doing here is accelerating the rationalization process that happens whenever there are a lot of competitive openings. Is that one of the things you're trying to do here?

Well, let's be clear up front. The consolidation is -- is proceeding at a -- as fast or faster than it has over the past several years, and it's been a trend as you know in the industry. Our goal is -- anytime that there's consolidation, there's market share that's freed up. Even if the stores are repurchased by somebody else, some of the stores, there's market opportunities during that period of flux. And our -- our strategy is to utilize the economies of scale that we have and to make the investments that I talked about this morning from this fund that we have built from cost reductions and EPS moderation, to enhance our market shares under those circumstances. We also believe that as I intimated earlier, we're not as competitive as we would like to be, these as even the supercenters,certain lines and we're going to address that with this fund. So, the goal here is -- the state of the world is one of flux and consolidation and we see that an an opportunity for us, a very positive opportunity, that we can now capitalize on now that the $380 million of cynergies is fully completed and that we've rolled our systems throughout almost all the company.

But does your strategic plan, like John Heinbockel, I was most surprised by the number for '03 because it seemed to remain very conservative. Is there a set of assumptions in your strategic plan about market share being freed up or actual seeing closure of stores, and is that an opportunity with -- could there be some upside there?

There could be some upside.

Okay. Another question I have, I have to admit, I didn't understand at all what you were saying about -- what, $110 million, the first set of charges you were talking about, 110 pre-tax, something to do with stores you already closed? I didn't quite understand that. And I really wanted to ask you whether you feel like there is a need to close any more stores or exit any more markets. You've gotten out of El Paso. Do you feel you're poorly positioned anywhere else?

I will ask Rodney to respond on the charge.

The $110 million impairment charge relates to some stores that will be closed, other stores, it's the write down of the assets in terms of their current book value is higher than what their current operating value is from an economic standpoint. The -- the -- this is a process that we have gone through over the past couple months. What we tried to do is let people understand, as you know, we had an impairment charge in the first quarter of 2000. The stores that are part of this charge, they're all related to the West, primarily they're stores in Northern California, that is completely independent from before, and these stores have not been operating long enough or hadn't even opened yet, at the time we took the last charge.

Now, under the rules simplified, which is the only way I can understand, is when you have stores, you know, who's present value, if you take the cash flow and add it up and compare it to book value, if book value is higher, you have to write it down, if you believe that's going to be the state of the world. These particular stores, and I think it is important to -- to reinforce my comments, these stores were in the process of being built or had just opened at the time we took the earlier impairment charge. So, we didn't have a run rate history on those to evaluate. As far as we knew, they would be successful. We always follow the practice. When we know something, we build it in, and we have watched those stores now for a period of time and believe that their value is less than the value that's on the books. Most importantly, those stores were acquired before Kroger's capital review process was initiated in the West. Today, I would hope, and believe our track record is very good on this, that those stores might be treated, priced or perhaps not bought, but priced differently.

This is Sacramento you're talking about?

The key point is we have now initiated that capital discipline throughout the organization and all parts of the organization.

Okay, this is Sacramento, mostly, you're talking about?

This would be the Northern California stores we've bought from Albertson's. It is more than Sacramento only.

Okay. And then -- then that leads to my other question, when you look anywhere else, you don't have to give me the names of the market, but are there any other areas where you look at your position and say, you know, we just don't have a great future here?

Well, we follow the practice, each quarter of reviewing the set of underperforming stores. And we make a decision and make an analysis to determine are they on a trend of improvement or can we put them on a trend, can we fix them? And if not, then we either close or dispose of them. We have a disciplined process of doing that and it's done by the same capital committee that makes the investments. At this point, we don't have anything significant in terms of markets to -- to, you know, identify, and as you point out, you know, El Paso is a troubled market and we sold it and got out of there. That's the way we function.

Great.

We don't have any nagging toothaches.

Okay. Just a couple of quick more questions. You talked about getting the 2 to 3% comp and were you saying it would go gradually?

Yes, it will go gradually because, you know, we -- one of the things we decided and from long years of experience of all of our people here, is as we develop the fund itself, from which we're funding the investments, builds over the next four to eight quarters. And we want to make sure that the investment in lower prices to drive sales correlates with the availability of those funds. We're not going to go out and surge the market. That's not a good way to operate. And, you know, as we go, and as we learn, we will then feather in and add on to our initial activity. So, this is -- this is not something that is, you know, a sudden lurch. We don't behave that way.

Great, I won't take up more time, thanks.

Your next question comes from Lisa Cartwright.

Hi, Lisa.

Hi, Joe. Good morning, I have a couple of quick questions. On the cost reduction side, the $500 million cost reduction, is that coming entirely or almost entirely from the 1500 positions that you're eliminating as well as the division being brought into the other two marketing areas? Is that the correct way to look at that?

Those are certainly the key components. We also have some additional best practices that don't rely -- you know, don't require layoffs or consolidations, of an operating nature, best practice of an operating nature that you would see within the stores. Now, we also have some -- the very targeted activity on shrink. That, of course, would go into the gross line, but is part of the $500 million.

Can we assume by the fourth quarter, about 80% of that savings will be seen and -- in the fourth quarter? How -- how does it pan out?

Lisa, the fourth quarter is about almost half-finished now. There won't -- certainly the positions have been identified now and the process is going through the transition has started. I would expect it will be first and second quarters in terms of saying a large amount of it will be completed by.

So, by the end of the second quarter, say, 80, 90% of it will be completed?

Yeah, at least 75%.

Okay. And then switching to the competitive environment, Joe, you mentioned that it is a challenging environment and one of the most challenging you've seen in while. And Safeway recently mentioned something similar and in Safeway's comments, they talked a great deal about competitive openings and specific markets and once they cycle that, things should get better and they specifically mentioned that there were three markets, when you look at Kroger, in your opinion, is it a similar situation or are you seeing, you know, the economy and the competition affecting you throughout the country?

Well, the economy is certainly affecting us throughout the--

Well, obviously -- sorry!

-- 32 states we operate, there is no question. And, you know, in particular areas, you think a place like Michigan or Seattle or Portland, Portland is running a 6.6 unemployment rate. So, the economy is having a significant effect here. There is no question about that. In certain areas, yeah, we've had a couple of markets in which there has been, you know, a flurry of activity in terms of entry. When you've got 48 major markets as we do, we're No. 1 and No. 2 in 41 of those and intend to stay there. You know, you always have markets that are under fire. So, that's true. The key thing is we believe we have an opportunity through this set of practices here, to drive our sales across the -- the company, and preserve enhanced market share, but there are also some targeted geographic areas where we feel we should be sharper than we are or we feel we have an opportunity, because of the structure of the market, the consolidation that's under way, to pick up shares.

Well, in your -- in your assumptions or your goal for 2 to 3% I.D.s over a two-year period, are you assuming that other competitors like Safeway and Albertson's meet their goals and that the -- sort of the larger players win and the smaller players lose or are you assuming share gains from the larger players as well?

Well, we're happy to take market shares from anybody! We have not identified any individual companies, we would never do that. Our goal is to say, look, where can we have a competitive advantage against the whole market? And we see some areas that span almost all of our divisions as well as some of these markets MSAs that I talked about. And one of the great things about having the size and the balance sheet that we have and the free cash flow that we have, and the free cash flow that we have, is we can -- and having the merger behind us, we're now able to focus those in a very strong and directed and targeted area. It's not a peanut butter, it won't be a peanut butter approach here.

Okay, I guess the question, maybe it's just not something that can be answered. But five years ago there was room for all of you, Safeway, Kroger, Albertson's, everyone to take share, because there were so many smaller and weaker players. Now with other supercenter growth, with drugstores as you said, encroaching on the food channel, is there room for three large supermarket players to grow their comps at 2, 3, 4%?

Yeah, there is no doubt of that. Because at least all three have the potential for economies of scale that are significant competitive advantages. We know where our economies are and this program goes after them. The additional economies.

Okay. Thanks very much.

Yep. And one other point, Lisa, you know, in order to really answer that question, you need to look MSA by MSA. You know, at the end of the day, we're still a local labor market, local product market industry and we have done that. And we believe there is ample room for us to hit the 2 to 3% if we execute the plan we have, and we will.

Okay. Thanks, Joe.

Your next question comes from Jonathan Ziegler.

Good morning, Joe [ET AL].

Hi, Jonathan.

My concern is similar to Lisa's. Do you see -- you've talked in the past about going up against Walmart Supercenters and know if you brought prices down, they would come in lower than you. Do you see a spiral occurring here in pricing that may force the big chains, as Lisa mentioned, to do the same thing? We know Albertson's is back in the market. The west coast markets we've seen don't seem to be particularly aggressive on promotions now. I wonder if we're starting a spiral down, which is the first question. And secondly, is there a need now to roll out and accelerate Food 4 Less, which I believe is your major fighter vehicle?

Well, interesting you should mention Food 4 Less, because we have a plan to enter Chicago with Food 4 Less this coming year, and that's under way. And we're excited about it. It's a great format and it is -- we have a careful plan, Dave Herz and his team, put a lot of time and careful study and they're great, they know how to do this. That's the answer to the second question. Spiral down? My own guess is no. The answer is no. First of all because, you know, because it's going to take a while for people to figure out what we're doing, we have a very careful plan on this. And it's -- it's a sort of industry where, you know, all things are not immediately apparent. But in addition to that, the facts are, we have a number of competitors whose top line growth is not very good, whose EPS growth is far below ours, and does not have the financial capacity to get the economies to scale, or to sustain them, and we believe we have all of those characteristics. So, it's a different -- it's a different picture for us.

Okay. Do you feel a need to be more EDLP, which is my Food 4 Less question? It seems to me, the cost structure in the industry as long as it is high-low and double coupons and even quads out there now, isn't the way to go against Walmart with a lower cost structure because of their EDLP.

I would disagree with that. We're a feature merchant and we'll be an even better feature merchant and more competitive on everyday prices and more competitive on promotions.

Okay, do you have more square footage reductions at this point in time, you talked a little bit about that. And can you elaborate on what you're seeing in the consolidation game?

You mean square footage reductions in--

Do you see any -- I mean we talked about, I mean we know there have been reductions in square footage, for example, with Avco and Southwest supermarkets and that type of thing, but are you seeing any kinds of trends in more of that happening in freeing up space. We're just seeing supercenters opening up space?

That's a great question. Ronny and I sat down late last week, and we've both done quite a bit of research. We came up with 600 supermarkets that have come on the market within the past 18 months. That's a tremendous number! We bought about 75 of them. A fair number of those have gone away. And, you know, we don't bother to do this every quarter, but the thought occurred to us, there is a lot of activity out there and you can name the names as well as I can, you know, people who have announced closings of several hundred stores, it's also happening in drugstores, CVS announced 200 stores are going to close. Yeah, it's happening. That's part of the reason we believe the timing is exactly right for us to initiate this set of actions.

Okay, and then consolidation, is there anything going on out there that you think we can see positive spillout from the supercenter pressure in terms of new opportunities for you to go into either new markets or be able to flush out an existing?

Well, I've already talked about Chicago.

You did talk about that.

Of course. And we have market areas and I don't want to get too specific here, we will have competitors on the line, but we have a number of market areas that I can think of and that we have reviewed in our capital committee, we go through MSA by MSA, and look at our density at competitive density at our performance and we run out of money before we run out of opportunities.

Okay. Good. Thanks.

Very good, thank you, John

Your next question is from Jack Murphy.

Good morning, a few quick questions. I have a similar question that was asked earlier, just a bit different way. Your 10 to 12% earnings growth -- does that assume stable Walmart pricing from here or does it assume that if you were to cut prices, or when you cut prices, that they will cut prices further?

Well, I think the -- the way to answer that question is, you know, first of all we have performed very well against Walmart Supercenters, as you know from earlier -- earlier conference calls and press releases and analyst conferences and we've given the numbers on that. We know how to do this. And there are a variety of approaches, some things Walmart won't do and so on. Secondly, the key thing is that there are only a handful of markets where Walmart Supercenters have gotten to the No. 2 share of market. And most of our cases, you know, the major share of our markets, by far, are in traditional supermarket operators, not to mention the nontraditional folks such as drugstores, which are using food to drive their GM pharmacy sales, or the discount operators using it and we've gone after that. So, the issue is not, you know, it would be wrong to position this thing and we would make a foolish mistake if we said the backboard here we're banging off of is Walmart. There is an immense market out there, that is far different from Walmart.

So I guess, when you look--

--and against whom we have significant economy of scale opportunities.

Okay, but I guess if you look at, then, the setting Walmart aside for a moment, the rest of the competitive pool, you know, does your 10 or 12% assume that competitors cut prices as well, or they have stable prices from here?

It could go either way. And we will be just fine.

Okay. Last question is, I wonder if you could give us a sense of how the quarter progressed from the sales standpoint and then, you know, what you've seen so far in this quarter in terms of sort of, you know, I.D.s and how that progressed, you know, over the last say four months or so?

Well, the last four months, you know, we've been in the 8/10, p ositive 8/10 same-store sales, the number we just reported for the third quarter was the same as for the second quarter. Now trends will stay about the same, to be honest with you. Fourth quarter, it is too early to tell. The quarter is only four-weeks-old and it is an unusual quarter in that there is another week between Thanksgiving and Christmas. So, we're not prepared to talk about any trend at this point.

Okay, thanks.

Your next question is from Charles Cerankosky.

Hi, Chuck.

Good morning. Joe, looking at working capitals since you acquired Fred Meyer, it just seemed to be a very tough number to bring down, whereas before Fred Meyer you had better control of it. Can you get into why that has been kind of an erratic path to getting to the $500 million in reduction.

As I mentioned, you know, we improved the trend over second quarter.

We got the $44 million, we're $44 million up on the $500 million. There are a couple of things that are significant. First of all, we have rerationalized our logistics system. And that is involved, you know, some warehouse openings, closures, and shifting of divisions into different warehouses, so, for example, in our Peyton division, we have reallocated the division that's Peyton -- that each individual Peyton warehouses serves. And as you know, we have what? Four Peyton warehouses spread across the business. As you reallocate and we did some of it this quarter, that just completed and is still under way. You have to double up on the inventory in the warehouse to be sure you don't have a significant reduction in -- in service level. And so, we know you're going to get duplicate inventory under those circumstances. Secondly, a challenge has been to -- to monitor and respond on working capital until we have gotten the enterprise accounting system spread across the company because working capital, as you know, has got, you know, multiple components to it, under Kroger accounting systems, our own divisions that we had before the merger, we can see what those lines are and break it out in detail. We were not able to do that under the accounting systems that were being utilized in the central and western divisions. Now that most of them are on KAS, that is Kroger Accounting System, the enterprise system, we can see the components. And the way to go after working capital is, you know, component by component. Third, having said all of that,

I'm not satisfied that we, by any means, utilize what was already available. And we're going after it with our divisions. This is -- this is -- it's a challenge I would point out, of course, that we have also, you know, increased our store numbers in that period, but that's not an excuse. There is a lot that we should be getting and we're not getting it and we're going to get it. And it's going to be more functionally capable of doing it now that we've moved our systems across most of our divisions. We know where the fat is. And that's -- that's the advantage we need. Again, it's not an excuse, we should have done better than we've done thus far, but we now have a capability we didn't have. And -- the rerouting of our distribution systems should be rolling through to completion during the first quarter.

Chuck, a great example of what Joe just said, in the accounts receivable area, in the process of bringing them to enterprise our payroll and accounts receivable system, but during that transition, we always have the receivables go up, but once we get through the transition, we can deduct across the whole company then any receivables. Like Ralph's, if we make a payment to any vendor they do business with, we can deduct that across the company. During the transition, we always have a receivable balance going up, and right now we're in the middle of that transition. We're just completing it.

So, we have receivables from a vendor, anywhere in the company, and we've -- and, you know, in division "A," division "B" buys stuff from the company, gets the invoice, our system has the capability to deduct that receivable from another division, against the invoice that the second division has. We have not be able to do that in the western divisions until we get the enterprise system moved through. We're talking about millions of dollars here. That's just one example.

So, some of it is structural?

Some of it is structural.

Turning to Chicago quickly. Can you give us an idea of how the entry will ramp there, how many Food 4 Less units you're looking at and what kind of union contract will be in the Food 4 Less stores relative to what the other operators have in the Chicago market?

In terms of the first question on the numbers, we would expect next year to get between three and five stores open, those sites have been identified and we're actively working on those locations. Some are existing facilities or existing buildings. In terms of the labor side, it's really too early to make any comments relative to that at this point. It's an exciting opportunity, Chuck. As Rodney has said on a number of occasions, in response to the questions, you know, we started with something like 100 MSAs that were potential targets and we worked those down in an analysis during the past year, 14 months, got it down to four finalists and Chicago, we believe, is the best, first alternative among those four.

Thank you.

Your next question is from Steve Chick.

Okay, thanks. Just a couple of things, I wanted to circle back to the $500 million in savings. Just to clarify, you had said the 1500-person head count reduction, that's contributed about 75% of those savings, is that right?

No, the -- the 1500 would be well less than that percentage. The 75% is in terms of the positions and the restructuring of those positions. We're estimating 75% of that restructuring would be completed by mid-year 2002.

Okay, what percentage of that -- that 1500, what percentage of the work force is it? And if you say well less, what percentage of the savings is it going to be? Can you quantify that?

Well, if you look at the total work force, we have 312,000 people, so it is a small percentage. But, again, these are primarily management positions, and so it is a much larger percentage of our management staff. I don't know if we calculated the figure or not, but it is a significant number.

Okay. The [INAUDIBLE] charge, how many stores did that relate to and is that included in the 15 or so that were closed this quarter or will close over the next year.

Rodney is scratching his head here for a minute.

Well, we can--

25 to 30--

It's about -- Steve, Mike just counted, it is about 25 stores. And probably less than a third of those would be stores that would be closed and half of those have already been closed.

Gotcha, okay. One last thing, the -- just to get clarification on the goodwill comment you made on the press release that will be additive by 7% per share, through EPS. Can you -- what is the [FAZ] related goodwill per share piece that you would add back? And I guess I'm kind of surprised with the loss financial leverage with goodwill add back that would be additive. Can you just walk me through that a little bit?

In terms of the goodwill benefit, will be about 11 cents per share. Where this year, goodwill is being deducted, obviously, from earnings starting in 2002 it no long will be deducted. The absolute number on an earnings per share basis is 11 cents per share.

Okay.

The 7% that's in the press release in the comment. It's just the 11 cents divided by estimated earnings per share.

Right. Okay, alright, thanks.

Your next question is from Neil Currie.

Hi, Neil.

Hi, good morning to you. I just want to ask Jack Murphy's question in a different form. You've obviously raised the bar in terms of your sales expectations, you're cutting your costs accordingly, and you obviously have your own estimate of what reinvestment you need to put in place in order to get to that 2 to 3% above the rate of inflation. My question is more about what happens if you make the reinvestment and the sales don't come according to plan? Or your competitors don't just stand back and watch it happen? And if you fall short of your sales target, will you eat further into the earnings growth expectations? Or, basically, which the more important target going forward, the top line growth or the 10 to 12% growth in earnings?

Well, both. I guess the short answer is both of those are important. We believe that we have built enough of a fund here to drive that 2 to 3% top line growth. And again, we were at that level, you know, the first quarter of last year. First quarter of this year, I'm sorry. You know, it -- if it -- if we step on the gas and the car doesn't move, as always, we will step back and do something different. We've got great bench strengths, marks, expertise here, and we think we've got the right plan and expect the car to accelerate.

Okay. Thank you.

We know this business a lot. We know, you know, and we know what targeted investments can do.

Joe, thanks.

You bet, thank you.

Your next question is from Steve [Denall].

Hi, Steve. STEVE [DENALL]: Good morning, everybody. You know, if you had to rank sort of the three challenges that you talked about, you know, one being the supercenter encroachment, two: sort of the conventional pricing aggressiveness from your conventional com petitors, and maybe three: the economy. You know, which one would be sort of the most severe? And, in addition to that, is there any one in particular that your pricing strategy targets?

The answer to the third question is no.

The economy is pervasive. There is no question about it. You know it takes the form of, as we talked about before, customers being cautious about -- about general merchandise and other non-necessities. Probably also takes -- we also see positive from that, from our -- some pick up in the private label, but our corporate brands have been on such a strong growth, it's hard to separate the secular growth, you know, from the cyclical effects. You know, the third, the third point, I think, is on pricing in general, competitive pricing in general, several of our traditional competitors have announced within the past year, as well as some non-traditional folks that they need to get their top line sales up and they've made really significant investments in EPS, if you go back and read the releases, to drive those sales. Some have had a bit of a lift, some not at all. And we look at this environment and say, you know, we go in -- we are in a period of consolidation in which we lead from strength. We are the number 1 or number 2 share in 41 of those 48 major markets where we operate. We have a very powerful, you know, balance sheet and a strong stock repurchase program, and most importantly, tremendous economies of scale. Some of which we have achieved since the merger, as expected, to get the $380 million. But what's wonderful is that through the analysis, once the merger was over, people just didn't say "well, that was fun, let's put it on cruise control," but started looking again and in the past five months, have identified through taking best practices across the company

as well as looking at the performance of categories that we've centralized, and said, gee, we can do better on the top line if we make investments here. So, that's what we're in the process of doing. I have a note from Kathy inviting you to follow up with her if you have questions beyond today's session. We thank you very much for participating and we look forward to visiting with you. Have a great holiday! Bye.