克羅格 (KR) 2003 Q1 法說會逐字稿

Good morning.

My name is Terry, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Kroger first 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 star and the number one on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you.

Miss Kelly you may begin your conference.

Thank you.

Good morning.

I'm Kathy Kelly, Director of Investor Relations.

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.

A detailed discussion of the many factors that we believe may have a material effect on our business on an on-going basis is contained in our SEC filing.

One other note before we get started.

When Joe and Rodney have finished their remarks and we open it up for questions, we ask that you limit your questions to one per person with only one part, so that we can accommodate as many of you as possible in the allotted time.

If you have follow-up questions after the call, please call me, my direct phone number is 513-762-4969.

Thank you.

And with that I'd like to introduce Joe Pichler, Kroger's Chairman & CEO.

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, Group Vice President and Chief Financial Officer.

I will begin with a few highlights of Kroger's first quarter results and some perspective on the current economic and competitive environment.

Rodney will provide additional detail about our quarterly results, and then we will be happy to answer your questions.

For the first quarter ended May 24th, Kroger reported net earnings of $351.5m or $0.46 per diluted share.

Earnings in the year ago period before the cumulative effect of an accounting change were $321.7m or $0.40 per diluted share.

Our results for both years include several items that Rodney will discuss in a few minutes.

Total sales for the first quarter of fiscal 2003 increased 3.8% to $16.3b.

Total food store sales rose 3.5%.

Identical food store sales including fuel declined 0.1%.

Identical food store sales excluding fuel decreased 1.1%.

Comparable food store sales, which include relocations and expansions, increased 0.7% for the quarter.

Comparable food store sales excluding fuel declined 0.5%.

We estimate that our product costs including fuel were flat during the quarter.

Excluding fuel, product costs deflation was negative 0.5% in the quarter.

Overall, we are pleased with our sales and earnings performance in the first quarter, especially in the light of continued economic uncertainty, high unemployment and intense competition.

Kroger's strategic growth plan is the appropriate response to this economic and competitive environment.

We expect to exceed the plans original goal of $500m in cost savings by the end of 2003.

During the end of the first quarter, Kroger had achieved savings of $377m.

These savings have been generated in several areas including labor productivity, administrative efficiencies and better purchasing.

We believe that the continued enhancement of Kroger's strategic growth plan will improve our competitive price position in selected categories and markets.

Our corporate brand had another solid quarter.

The market share of Kroger's private label grocery items, in terms of units, increased to approximately 31.4%.

Private label grocery share in terms of dollars grew 23.6%.

Private Selection, our premium label corporate brand, continues to post impressive growth.

In addition, we have recently announced the national launch of Naturally Preferred, our own brand of premium quality natural and organic products.

We currently offer approximately 140 items under the Naturally Preferred label, including baby food, pastas, cereal, snacks, milk, and soy items.

Natural foods comprise one of the fastest growing segments of our business and 1,145 Kroger stores now feature natural food departments.

Looking ahead, we expect identical food store sales including fuel to be positive for the full-year.

Our strategic growth plan is targeted toward markets and categories to produce those results.

In the second quarter of 2003 however, year-over-year identical food store sales comparisons will be challenging because of Kroger's over investment in gross margin during the second quarter of 2002, which you will recall.

Last March, the company estimated that earnings for 2003 would be $1.63 per diluted share, assuming that the economic and competitive climate remained unchanged.

The economic environment became more challenging in the first quarter.

Consumer confidence appeared to wean in April as wages and salaries declined and unemployment levels rose.

Like many retailers, Kroger experienced soft sales after Easter.

At the same time, increases in health-care, pension and energy costs are exerting pressure on operating expenses for Kroger and for most food retailers.

Our earnings guidance for 2003 had included a projected gross profit margin increase of 20 to 30 basis points to cover a portion of cost increases including healthcare, pension, and energy.

Improvements in shrink continue to be difficult to achieve.

Competitive conditions thus far have prevented us from increasing the gross profit margin as anticipated.

We are taking the actions necessary to protect our market share.

As a result, Kroger estimates its earnings for 2003 will be in the range of $1.55 to $1.63 per diluted share, on the same basis as our previous estimate.

Now, I will ask Rodney to provide some additional perspective on Kroger's first quarter financial results.

Rodney.

Thank you Joe and good morning every one.

As Joe said, net earnings in the first quarter were $351.5m or $0.46 per diluted share.

These results include income of $200,000 after tax from items listed in Table 2 of the earnings release.

The net effect of these items did not change our earnings per share for the quarter.

They included income of $6.3m after tax from the reversal of lease liabilities related to store closing that did not take place or were less costly than anticipated.

As a result of merchandizing and operation changes, the financial performance has improved at several stores and we no longer plan to close them.

Earnings for the first quarter of 2002 before the cumulative effect of an accounting change were $321.7m or $0.40 per diluted share.

These results include an after tax charge of $66.4m or $0.08 per diluted share from the items listed on Table 2 of the earnings release.

These include an expense of $56.7m after tax from the adoption of the item-cost method of accounting at the former Fred Meyer division.

FIFO gross profit margin was 26.73%, an increase of 24 basis points from 26.49% in 2002.

Excluding fuel sales as the company's convenient stores and supermarkets in both years, FIFO gross profit margin for 2003 increased 53 basis points to 27.6%.

Excluding fuel and the effect of the adoption of the item-cost method of accounting at the former Fred Meyer divisions, gross profit margin for 2002 was 27.67%.

On this basis, comparable gross profit margin declined 7 basis points in the first quarter of 2003.

Operating, general, and administrative costs increased 20 basis points to 18.63% in the first quarter.

Excluding fuel sales in both years, OG&A increased 49 basis points.

Higher healthcare, pension and energy costs accounted for 41 of the 49 basis point increase.

Net operating working capital totaled $364.4m, a reduction of $47.1m from a year ago.

Our calculation of net operating working capital is detailed in Table 6 of the press release.

The company expects to reduce net operating working capital by $100m this year.

Net total debt was $7.96b, a decrease of $325m as compared to the first quarter of 2002.

Details for this is also included in the earnings release on Table 7.

We continue to make progress in deleveraging our balance sheet.

Going forward, we expect to use one-third of our free cash flow to reduce debt and two-thirds to repurchase stock or pay a cash dividend.

Kroger's investment grade debt rating is very important to us.

We will continue to execute a financial strategy designed to achieve a mid BBB rating.

During the first quarter, Kroger repurchased 9.6m shares of common stock at an average price of $13.98 per share, for a total investment of $134.3m.

Since January of 2000, Kroger has invested $2.2b to repurchase a 111.3m shares, equal to approximately 13% of the shares outstanding.

At the end of the first quarter, Kroger had $313m remaining under the $500m repurchase program authorized in the fourth quarter of 2002.

At current prices, Kroger continues to repurchase shares.

A comment on dividend.

The Board evaluates dividend policy on a regular basis.

Our goal is to maximize shareholder value.

At recent prices, we believe that goal can best be achieved by repurchasing stock.

We are very pleased with our strong free cash flow.

Over the past four quarters, Kroger's has repurchased $761m in stock, reduced debt by $325m, and invested $2b in capital projects, including the buyout of a synthetic lease for $198m.

We continue to achieve our financial triple play.

During the first quarter of 2003, Kroger opened, expanded, relocated, or acquired 23 food stores.

Total food store square footage increased 4.1% over the prior year.

Capital expenditures for the quarter totaled $671m, including the synthetic lease buyout for $198m.

For the year we forecast capital expenditures of about $2b excluding acquisition in the balance of our synthetic lease buyout.

Kroger takes a disciplined approach to capital investments.

We continue diligent review of capital projects in our increasingly demanding on approving project proposals.

We are exceeding our hurdle rates for the stores that have been opened at least two years and we are generally pleased with the performance of stores that have been opened for less than that.

On the labor front, Kroger has a number of UFCW contracts expiring this year.

Toledo was recently settled.

We have other major contracts coming up in Peoria;

Portland, Oregon;

Memphis, Tennessee;

Ralphs in Southern California;

Charleston, West Virginia;

Arizona and Indianapolis.

As usual we also have dozens of other smaller contracts expiring.

Rising healthcare and pension costs will be an important issue in all these negotiations.

We have been communicating these challenges to our employees and to the union leadership.

Now let’s turn to some guidance for 2003.

As Joe said our earnings estimate for 2003 is now $1.55-$1.63 per diluted share.

As before this estimate includes $0.02 of expense for systems conversions and the consolidation of Kroger’s Michigan and Columbus division offices.

This estimate also excludes the effect of any gain or expense from the mark-to-market of excess energy contracts in California because it is not possible to estimate the effects at this time.

Joe has already talked about the background for guidance on gross profit margin.

We now expect gross profit margin to decline 10-25 basis points for the year including the first quarter.

This excludes the effect of the conversion to the item cost method of accounting at the former Fred Myer divisions last year.

We expect the OG&A rate to increase 15-25 basis points for the year including the first quarter.

Fuel sales continued to help the overall rate and we continued to happy with our expense control as it is demonstrated by the $377m we have taken out of the business so far.

For LIFO, we are expecting a charge of $15-20m because inflation on some commodity is trending lower than what we had expected.

We expect to have an average of about a 750-755m shares outstanding for the year and 740-745m shares outstanding at the end of the year.

With that I would like to turn it over to Joe for some few final comments.

Joe?

Thank you Rodney.

Continued consolidation among food retailers has provided Kroger attractive acquisition opportunities.

We recently purchased three Food For Less stores in Northern California from Fleming and three Food Town stores in Toledo.

These acquisitions support our strategic growth plan by increasing our market share at capital investment levels below the cost of new construction.

We believe that the strategic growth plan will provide Kroger with opportunities to increase market share by using our economies of scale effectively.

In summary, on the quarter Kroger produced strong results in the first quarter.

We were able to reduce debt, repurchase stock and maintain a solid capital investment program while generating sales and earnings results ahead of our traditional competitors.

We are pleased with the implementation of our strategy.

Kroger has the financial resources to continue making the price investments necessary to build our business, remodel and expand our store base, protect our market share, and repurchase stock.

As a result, Kroger is well positioned to continue generating strong free cash flow and building shareholder value.

We will now be happy to take your questions.

As Kathy indicated we ask that you limit your questions to one per person so that we can accommodate as many of our listeners as possible in the allotted time.

At this time I would like to remind everyone in order to ask a question please press star then the number one on your telephone keypad.

We will pause for just a moment to compile the Q&A rooster.

Your first question comes from John Heinbockel of Goldman Sachs.

Joe, how are you guys at this point looking at in measuring you know the ROI on your gross margin investments?

Obviously your sales are better, had been better sequentially than your peers and are better in absolute terms.

But how do you sort of measure whether you are getting what you want out of gross margin dollar spent and are you getting what you want out of that investment?

Return on investment, John, takes several different forms, depending on the market.

In some markets, the investment my belief has definitely improved our sales and is improving our market share.

Other markets the investment is the one that is necessary, particularly in areas where they have had substantial energy increases, as well as health and pension.

For us to maintain our share and to prevent a situation where someone by investing their own gross begins to take our share.

Our belief is that by following this program and by consistently pricing below our traditional competitors, as many of your own price checks are found, and lowering the gap with discount operators and making sure in markets where costs are not being passed through, that we don't pass them through either.

So, we protect market share.

And our belief is, given our financial strength and the strategic growth plan, that this will lead both to an increase in sales and market share and to an increase in shareholder value.

So the big payoff then is when the economy turns, that is when you get up to a real big payoff on this, probably not until then?

You get a big payoff.

I think when the economy turns and as, you know, consolidation has occurred for example with the acquisitions that we have made, I believe that also will lead to a financial return.

Your next question comes from Meredith Adler of Lehman Brothers.

Hi guys, it was a much better quarter than I expected, congratulations.

Thank you Meredith.

I would like to just talk a little bit about the change in your guidance and gross margin.

I believe that when you first gave out the guidance you said that you had never anticipated that the gross margin would be up in every division.

But I am wondering whether the divisions that you did think were going to be up or not going to be up or are you seeing gross margin weaker in markets where you would always thought the gross margin would be down.

And I guess that is actually a way of getting out how varied is performance regionally?

But they are two different questions?

There is variations regionally and that is apparent in, Dave and Rodney and team here goes through, Don goes through, you know, every division at the end of each quarter as well as projecting forward.

You see, because the competitive structure is so different in different markets you see different outcomes with respect to gross profit line.

What is clear is, we indicated when we initially projected our increase in gross profit margin corporate wide, we expected that the market would react pretty swiftly to increases in healthcare, pension, and energy costs that we knew were going to effect all of us.

In some cases the market hasn't reacted and that is part of competition.

That's fine.

In that what we will do is make the investment necessary to keep our pricing competitive and not let somebody take some share simply because they are not passing through cost increases.

When you balance all of that out, we come up with the guidance that Rodney talked about.

Dave or Rodney, would you add anything to it?

Rodney?

Also, in shrink so far, as we talked about several previous times, continues to be more difficult than what we have historically expected or anticipated, a small part of it is shrink, obviously the biggest piece is what Joe mentioned.

So just to understand, the markets that were negative aren't necessarily getting more negative?

It’s just the market that you thought would get better aren't getting better?

That is probably a safe statement.

Generally, that's correct.

That's generally accurate statement.

Okay great thank you.

Your next question comes from Phillipe Gusen (ph) of CSFB

Yes, good morning and congratulations on a good quarter here.

You have first stated for some time now that you would like to achieve mid-BBB credit rating.

Now based on my conversations with the rating agencies, they have indicated to me that you would already have been upgraded to mid-BBB, if you would have brought back less shares of the last couple of years.

So based on where your bumps are trading today, and they are right now trading well ahead of Albertson's as well as Safeway, could you comment perhaps on the timing when you would like to achieve that mid-BBB something you really would like or if by the passage of time you get it that is okay as well?

Well, that is definitely a goal of the company, one that's been a consistent goal.

I would ask Rodney to comment on the in play here between share repurchases and debt reduction.

It continues and has always been very important to us.

Relative to the timing obviously that is left up to the rating agencies rather than us.

One of the things that we mentioned on free cash flow and this is something that we started last year, is taking approximately one-third of free cash flow and paying down debt and two-thirds to buy that stock.

You go back longer than that we were skewing more to buying that stock so we actually have changed that balance a little bit to delever, and hopefully that would be something that the rating agencies would view positively.

Now with regards to the one-third going towards debt reduction and I do appreciate because that is very helpful for us on the fixed income side, good to see that commitment.

Will that be offset or in other words the actual amount of debt that you would pay down will that be offset by any gains that you make on your interest rate hedging portfolio?

Or will you still actually pay down one-third extra amount of dollars regardless of how well you do with your hedging strategies?

I am not sure of it completely, Mike would you take it?

I will take a shot at that, what you are asking is the bookkeeping entry we have to make to reflect the fair value of the hedges in our debt section.

When we give the guidance of one-third of our free cash flow to pay down debt, it's without regard to that book keeping entry.

It's really relative to the net total debt number that we talked about in our press release and we have on one of these cash tables showing that reconciliation.

So, we don't take into account where we are with those hedges because it is a book keeping entry and over time that just goes away as it hedges as their life expires.

Okay thank you so much.

Thank you.

Your next question comes from Jack Murphy of CSFB

Good morning Jack.

Good morning.

You've spent a lot of time highlighting the importance of free cash flow.

I wonder if you could give us a free cash flow target for this year with components, I guess net income just, obviously is flat to down somewhat, D&A working capital changes in CAPEX, which I guess you've already given.

Jack, the way we interpret regulation G, we can't get give the specific number, but we have on the 8-K that we've filed tried to give enough of the detail that you can get pretty close.

I mean those were the same numbers that we are using to calculate the numbers.

So hopefully with that you can pretty close to where we would expect it to be.

And sorry but we just can't.

Okay.

And just to make one quick clarification.

On the CAPEX, the $2b you are talking about that includes the synthetic lease buyout that you -- within the first quarter?

That excludes it.

Excludes.

Thank you.

The next question comes from Lisa Cartwright of Smith Barney.

Good morning.

Good morning.

Are you guys going to be lapping in the back half of the year the most significant price reductions that you began with your strategic plan with the introduction of that plan at the end of '01 or would this new level of gross margin investments would you say you're going to be making more significant price reductions?

Because we've been hearing that you are lowering prices in -- or that you have recently lower prices in your Delta and central KMAs.

I am just wondering if this is sort of a, just kind of another round that's not a significant as it has been in '01 and '02 or if it is of the same magnitude?

Well you recall, in the first year of the plan, which was announced 19 months ago, we phased in the first year of the plan quarter-by-quarter, period-by-period with some very careful projections by Dave and Don in the merchandising team.

So you know the first answer is yes there will be some overlap.

But secondly we continue to plan and have as we talked about in the materials enhanced the plan with targeted categories and markets.

That we believe we can make some real gains in share.

So there's more coming, I guess is the best way to put it.

Dave would you add anything to that?

I think that's a fair assessment.

And would say Joe that you are maintaining or gaining share in a majority of your market?

Well we don't do a quarter-by-quarter analysis.

We watch our pricing comparatives.

We watch our sales.

And it would be, I couldn't give you an accurate answer on share.

I just can't calculate that frequently.

Okay, thank you.

But we are pleased with our sales in many, many markets.

Okay, thanks.

Your next question comes from Steve Chick of JP Morgan.

Joe, I was wondering if you would you be willing to maybe reinstate or talk about EPS guidance at least for the up coming second quarter, the range looks a little wide.

Can you give us a sense what, should we expect something that might be flat year-over-year for that quarter as well in terms of EPS?

Steve we decided over a year ago we just don't give quarterly guidance.

We give annual guidance, and try to provide information that enables investors and commentators to make their own assessments.

But we just are not going to give quarterly guidance.

Okay.

That's fair.

Mike separating the $10m lease reversal, lease liability reversal that you referred to, was that -- that's in your schedule, is that included as a one-time charge in past quarters I guess for the impairment of Fred Meyer stores?

It was set up back at the time of the merger.

Yes and that's one of the reasons we highlighted it separately.

We would have treated it exactly the same way today, but reg G won't allow us to report numbers that way.

So we disclose the information in the attached table, so everybody can see with good transparency exactly what made up the quarter.

Also don't lose sight of the fact that in the quarter there was the energy contract expense from the mark-to-market that was not included our guidance either.

That went the other way.

And when you look at the two nets together, it had no effect on the quarter from an earnings per share [Inaudible] .

Right okay.

Thank you.

You are welcome.

The next question comes from Mark Husson of Merrill Lynch.

Yeah hi.

I am going to try and string two questions together.

So, it sounds like one.

If you look at the return on its operating assets, which is something that you do measure, I just wondered if you can just share, because we don't have all the component parts, so, if you could just sort of, I think just share with us what return on its operating asset is and then think about the capital expenditure that you have recently made and you made in the last little while, I think you said that the reason your still spending Capex and other people may have cut it back, but you are still spending it because you can still make a return.

Could you sort of comment on the outlook, the way you see your business over the next two or three years, how much of a capital expenditure number do you think is still appropriate to keep in your budgets and how much free cash might be available to pay dividend at some stage and then given that free cash, when will you judge it or when will you be able to judge whether or not it's prudent to stop paying that dividend?

Hey Mark, that sounds like about six questions.

First of all, on the dividend issue and on the repurchase, we calculate the return on our investment on share repurchases as we do on all investments.

And at the recent prices, it's been a good return to our shareholders.

As Rodney pointed out, we've taken out about 13% of our currently outstanding shares since we started this program, and it's provided each remaining shareholder with a very fine improvement in those proportionate share of the cash and the earnings that we generate.

Secondly, we are committed to getting the BBB rating and to continue to pay down debt in order to achieve that.

And with recent prices, our judgment was, it was a better investment for our shareholders to buy in stock.

The Board continually evaluates dividend policy and the return from the repurchase of stock, our goal of paying down debt.

The returns available as we present them on our capital investment program and as Rodney indicated, we are blessed to have highly attractive capital investments available, and that's what builds long-term shareholder value because return on that is higher than any other use risk adjusted.

So as far as timing on that, it's a question of a number of factors including the price of the shares.

There's a point at which repurchases are no longer attractive.

Now on the question of return on net operating assets, Rodney, do you have to need to comment on that?

Well, if you look at the Aronova (ph) at the end of the first quarter of '03, I can't give it.

Okay, sorry, Mark.

How about ROIC, save me calculating it?

If you look at the returns in the first quarter versus last year, they were down and they were down consistently with where we would expect them to do, given the investments in the strategic growth plan.

Okay.

I guess the question is, do you think risk-adjusted, given that your earnings keep going down, and add them for a while, risk-adjusted, is it still worth the $2b Capex and won't there be a big [wedge] of money being available to liberate a dividend if you like and still pay down debt?

Well, as Rodney indicated, the returns that we've achieved on investments made two years ago and more have exceeded our hurdle rate.

We are very happy with those.

We are also generally happy with the ones we have made in the last two years and the markets will recognized that.

We see certain areas in which, we may gain a real edge in some markets because competitors of the wide (ph) stripe are cutting back.

Okay.

There is also some profitable growth left in this industry.

You are not just a cash cow.

No.

There is no profitable growth.

Again, recall as we talked earlier and as mentioned in the comments, this industry is consolidating rapidly.

And we believe that consolidation represents opportunity for us by making through the strategic growth plan to enhance our market share and in the long run, we know that from our own calculations market share is highly related to return on assets.

And the share that we are after, as you recall, in our 48 major markets, we estimate that there is 50% of the share in those markets is held by competitors who do not have economies of scale.

That's if you take those markets and you strip out the big three, you strip out the big Supercenter operator, you strip out the good regionals, you still have 50% of the market level and that's what we are going after and that's a growth opportunity as we see it.

Great.

Thank you very much.

Your next question comes from Mark Wiltamuth of Morgan Stanley.

Hi, good morning.

Just wanted to ask if you are seeing any categories where you are getting some price improvements and just in general what would the deflation number look like if you took out the pharmacy out of those numbers?

I would really estimate, Mike, on the deflation number if you took pharmacy out, it [Inaudible] ?

What is your read, Dave, on different categories?

The categories vary widely Mark.

There are some certainly that are deflationary and those are some of the bigger ones, probably well known because they are impacted by the economy.

But others are inflationary and you are starting to see some rebounds.

You see it in the perishable categories, particularly, you see a lot of jumping around over time in inflation and deflation.

Meat as an example, would be a real good example of that.

Gas wage you saw that in there, you didn’t ask about gas, as we separate that, but you saw a real significant change in that in the quarter.

And, some of the other categories are really too small to be significant and I would suggest the ups and downs to kind of evened out.

How about some of the major ones, some highlights of some of the major ones?

Well, Dave commented on the perishables.

You know, we are seeing meat comeback, you will find eating our way out of the oversupply and that's just recently.

That's just recently.

That’s just very recently.

I can't think of anything that jumps out, Mark, that would be over the account Dave has done.

And George, anything that you see?

No.

We are getting a lot of head-shaking no.

In terms of your comment or question on pharmacy inflation, we estimate pharmacy inflation to be about 4%.

If you look at the effect on the overall numbers, that is about 50 basis points.

So, deflation would have been about 1% without fuel and without pharmacy, approximately.

Okay.

Thank you.

That's cost deflationary.

Thank you.

Welcome.

Your next question comes from Chuck Cerankosky of McDonald Investments.

Good morning everyone.

Good morning Chuck.

If you take a look at what the consumer is buy in right now, that is, the product mix, and Joe I have talked to you about this before.

What's it telling about the willingness to make discretionary purchases and what's that saying about industry consolidation over the next several quarters?

Well, we have talked about mix changes.

We have talked about the floral business continues to be very slow.

The discretionary parts of the business are showing that.

On the other hand, what were once discretionaries appear to be coming mainstream.

For example, natural foods, organics are growing at a tremendous rate.

We are seeing shifts in customer patterns, at the same time that some of the more judgmental categories have been affected such as floral, you see it as boom as natural foods is, as people become more interested in it.

My belief is that more of that pattern is related to business cycle rather than to consolidation.

Dave, would you?

Chuck, I would add, I once worked with a fellow who said that customers tend to save where they can so they can spend where they want to.

What that really means is it's really more unpredictable than you would imagine.

Just as off the cuff example, the new Harry Potter book is selling very well.

Yet, I think you could argue that some books could be and should be discretionary kinds of items and so you might expect that not to do so well.

Well, I believe customers are saving in areas, that are personals to them and specific choices for them and as a result it's hard to get some sort of an overall view of what's happening because everybody is a little bit different.

It's a fragment.

And then they spend where they want to spend.

That's why natural food is doing so well.

That's an area that you might think because it is a little higher cost that the customer might elect in this economy not to go down that path.

And yet they have chosen to do so.

Thanks.

The implication that I was trying to get to is if the customer is still being cautious, that would mean your weaker competitors are going to see the same pattern and consolidation is going to continue at a pretty rapid pace, that is rising economy, consumer willing to spend more is going to save some stores out there that otherwise go dark.

We do believe that the customer continues to be cautious as you described.

The remaining conclusions you draw are your conclusions and I think I am not going to comment on that.

But the strategic growth plan is one that is not cyclically determined.

This is our fundamental strategy and it will have the same effects on, I believe, in increasing our share and the upswing as it should have in the current really difficult part of the cycle.

Thank you.

Welcome.

Your next question comes from Edouard Aubin of Deutsche Bank.

Hello.

Good morning.

I have got a question on your cost stucturing, your supply chain and I believe few weeks ago, Wal-Mart has announced that it would make it mandatory for its suppliers to start using RSID tags on pallets within the next few months.

And my question is first, are you currently testing the technology yourself?

And second, what are your current major initiatives in terms of supply chain and IT, if you have any?

Well, I believe that the announcement from our competitor was not the next few months, it was the next two years or so, that they would require that, because technology is still ill formed and very expensive.

So, we watch that very closely through our activities industry wide on things like UCC.

We are kept up-to-date and follow the technology as it unfolds.

My [Inaudible] and at this point, it would be far too early to make the call.

We will follow the economics.

There's a parallel here with electronic shelf tags.

If you look at those, it's pretty slick and interesting type of technology.

It just doesn't generate a return for us in most areas.

Some areas that require item pricing, it might.

But for most of our areas it doesn't.

And so we let the market determine when we would begin to make an investment and require it.

There is a lot of chapters left in that book before it becomes a reality, I believe.

As far as supply chain, as we've commented in earlier times, we have quietly revolutionized our supply chain over the last six or seven years.

My recollection is we've closed 44 distribution centers and opened 24 for a net decline of some 20-distribution centers.

We've invested heavily in the distribution technology that's become available both in terms of scheduling, the picking product scheduling and loading (ph) the trucks and on site i.e. on forklift technology, the speed, the pick and the accuracy.

We've devoted a great deal of attention to this area, and I'm very pleased by the results that we've achieved. [Inaudible] is well ahead, most of our competitors, you will recall, because we have a three-tier distribution system with fast turn at our divisional, supermarket divisional sites with slower turn, health and beauty care items, general merchandise and pharmacy at our patent sites and with seasonal items and heavy bulk items coming through a couple of patents facilities.

All of that works to reduce our working capital and to yield cost efficiencies and the operation of the warehouse.

And we continue to invest a portion of that $2b in capital we talked about in distribution and logistics.

It is an exciting area because there is so much happening; my judgment is we have a strategic advantage in that area.

All right.

Thank you very much.

Okay.

Your next question comes from Jason Whitmer of FTN Midwest Research.

Good morning.

Hi, Jason.

My question for you is on consolidation.

Again, the presence of the independents maybe in your markets, those without the economies of scale.

What has been the direction for some of those periods and maybe more specifically some of the implications from various bankruptcies.

Fleming really top on line on that and some of the repercussions from that through the system as well as even Penn Traffic and Eagle in Illinois?

Well yes.

Our recollection is, since the Fred Meyer merger.

Since we have acquired Fred Meyer, we have purchased over 200 additional stores in the period since May of 1999.

That's the equivalent of a very large Kroger division being grafted on to us.

And it's difficult to overstate speed of consolidation and it takes place in a variety of forms.

People simply go out of business, they sell out, they close some stores in some of the areas.

Even our competitors who have had the economies of scale as a general principle do not have them in certain markets.

So we have been able to acquire stores for example in Dallas, in Houston, in Nashville, Memphis, Las Vegas, Maurice League.

We just talked about two recent acquisitions, one Toledo, and one in Northern California.

To me that's a signal that the plan we are on is working and that with our financial strength we will win this game.

Okay.

Have you seen any your peers have a more material downward shift in the past six to 12 months that has been able to at least offset some of the other competitive factors to your benefit?

Yes.

It is hard to come, markets vary substantially.

I have just listed some of the markets where we have picked up share by acquisitions and maybe that addresses your question in part.

Okay.

Fair enough.

And just a last part here is on your expansion of your formats.

Have you made any progress in which you would like to do with Fred Meyer or Fry's or Food 4 Less?

Well, as you know we have expanded the Food 4 Less format.

Taken it in to Chicago.

Beginning of the year we had three open.

I think we have got another three coming this year, Rodney.

Right.

In Chicago we are very pleased by the result, first three.

They are on target.

We have expanded the - might ask Dave has commented about Fry's and what we have down there with the marketplace.

We have done a number of things.

Fry's, you may recall, picked up the former Fred Meyer stores that used to be the [Smithy] stores that were larger stores than what we had previously operated in this market.

We converted those to priced (ph) marketplace and had some pretty good success and we are pretty pleased with the results there.

And we are trying to consolidate what are learnings are from those and see what among those may be transferable to other places.

One of the things though that - and it is a settled expansion of formats.

You may see in fact you have already seen is where we take ideas from a format and share that in other formats.

And so rather than actually take the format and move it we take some of the ideas that we picked up at one place and transferred it to another.

And we have picked up some of Fry's marketplaces that we have moved to other divisions and we have picked up a plenty at Fred Meyer that we have moved to other divisions.

Great thanks.

Thank you.

Your next question comes from Chris O'Donnell of Caxton Associates (ph) .

Good morning and congratulations.

Thank you Chris.

Could you please give us a sense of price gaps on the standard basket between yourselves and your major supermarket and super center competitors please?

We have a pretty good idea of what that is market by market.

We don't divulge that.

There have been certainly a number of studies done by independent analysts and probably, the safest thing will be to refer you to those.

Which one do you think is the best?

No comment.

Thank you.

I’ll make one friend and several enemies if I respond to that.

Thanks.

Our next question comes from Stuart Fru (ph) of Hunter Global (ph).

Joe, you consistently talked about protecting market share.

Just, is there a point at which, are you ready to protect market share at all cost regardless of the impact on margins or is there a point where we are just going to take margin and maybe give out some share, because you have high market shares in lot of places?

Well, as with any process, there are diminishing returns and one of the things that we've tried to do carefully with the strategic growth plan, you can't do everything everywhere at once with a company of our size is to target those markets where we believe we have the best opportunity to increase share.

Obviously those would include some very substantial markets.

And to target those categories that we think will move the business, generally but particularly in those targeted areas.

So, this is a, there's some careful selectivity here in the way that the program goes.

The game isn't to win market share at any cost.

The game is not to give up what we have because we're the number one or number two shares in the 41 of our 48 major markets and we're not going to give that up.

And our belief that somebody who would come after that at all costs isn't going to last because we have the financial strength to outlast them.

Most people won't play that game for long.

We are about 18 months into this strategy of lowering prices to drive sales and to take market share and we still have not really seen any kind of lift to ID sales excluding the benefit from fuel.

I think what you're seeing is that our ID (ph) sales have performed better than our peers, and that is a result of the strategic growth.

Okay that you comfortable that you are not -- I guess my concern is that the traditional players are losing to other channels and so, while you are better relative than your traditional competitors, maybe the other channels are comping better than you?

Some of losing, that's true.

We've commented on our last call, I want you go through it again on our market share performance in areas where we compete against supercenters where supercenters have at least the number three share and in particular, against those at which Wal-Mart has reached the number three share and are satisfied with our performance in those markets.

One of the things to recall, of course, all of this taking place in the context of a market, of an economy that's been miserable.

If you look for example at commerce department figures in May, April numbers on salaries and wages declined, personal consumption expenditures declined, and then unemployment hit 6.1%.

That's a terrible scenario.

If you also look at the sales of many of the significant discount operators, their [idents] aren't looking as healthy as they once looked either.

So, all of this takes place in an unusual context of a tough economy.

Our belief as we said before is economy turns around, our life gets better.

So, we keep the pressure on.

Thank you.

You are welcome.

Your next question comes from Rodman Warhead (ph) of Bogee Capital (ph) .

Hi, I was wondering if you could elaborate on your plans organic, the rolling out organics?

Are you - how many SKU's, what areas are you doing it and are you growing it in the stores or you have it or leaving it there?

Is it just Soy milk and snacks etc?

No, it is not just Soya milk and snacks.

We have organic produce in many, many markets.

We talked about the rollout of our Naturally Preferred item, 140 items.

I'd let that Don (ph) or George would you comment on it?

The total SKU count, if you take all of the products that would fall within that range of natural or organic, we are approaching about 3000 SKU's.

That is a substantial number.

What percent of the stores, space wise, or its square footage wise is dedicated?

We have 1145 of our stores have departments.

In addition to that, the other stores carry in line selective organics and natural foods.

It has become a standard part of the business.

I am just trying to get a percent of your sales percent of square feet of these; the ones that had, the 1145 how much, what percent sales or square footage of the source that you have departments are organic?

First, we don't give out that statistic, but second is, I am not sure it would be easily calculatable because the SKU's even where we have departments aren't always consolidated into that one department.

In many cases, they are spread throughout the store and it would be, I think, impossible to run a meaningful calculation.

And do you go after categories such as organic meat and in terms of going forward your aggressiveness, is there some sort of - can you give some color on how your managing price there versus some of the competitors and how do you, in relation to specifically maybe a WholeFoods or a more specialized retailer such as that?

Well, we are a competitor and we have strategies for each of our categories including that one, it certainly takes into account where our competitors are, and also our own economies of scale in distribution and purchasing in those areas.

And we are very competitive and the number of SKU's is growing rapidly as customers move through that area.

So, I expect that to see continue to grow at a healthy rate and profit incidentally.

We now have time for one more question.

Your next question and final question comes from Karen Young (ph) of AllState (ph) .

Hi, thanks.

Can you give some data on the trends and traffic, average ticket, and shopper frequency?

Hello?

[Laughter] We are all looking.

My recollection, I believe is that the customer count has declined.

Per identicals, total increasing.

Yeah and that the size of the basket has increased.

Dave has commented on earlier calls about the complexity of using transactions data and it is affected by changes in the way we rent our products at the store.

But I think that is probably the safest general answer.

Okay, we thank you very much for joining us and I appreciate your good questions and look forward to our continued discussion.

Thank you.

This concludes today's Kroger first quarter earnings conference call.