克羅格 (KR) 2003 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kroger Company conference call for their fourth quarter earnings.

My name is Carol, and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will be facilitating a question and answer session toward the end of today's conference.

If at any time during the call you should require assistance, please press star followed by a 0 and coordinator will be happy to assist you.

As a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to turn the presentation over to Ms. Karen Shibu (ph).

Ma'am, please go ahead.

Thank you.

Good morning and thank you for joining us.

Before we begin, 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 ongoing basis, is contained in our S.E.C. filings, but Kroger assumes no obligation to update that information.

Both our fourth quarter press release, which includes additional details on many of the items you will hear about on today's call, and our prepared remarks from this conference call, will be available on our website at www.Kroger.com.

One other note before we get started.

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

Thank you.

Thanks, Karen, and good morning, everyone.

We appreciate you joining us today to review Kroger's fourth quarter earnings.

With me today are Rodney McMullen, Kroger's Vice Chairman, Don McGeorge, Kroger's President and Chief Financial Officer and Mike Schlotman, Senior Vice President and Chief Financial Officer.

This was a complicated quarter, and we will explain each of the unusual items.

Then I will comment on the new contract in southern California.

We will also provide year-end information about our market share and then some perspective about 2004.

Total sales for the 12 week fourth quarter of fiscal 2003 increased 4.5% to $13.0 billion, including stores affected by the labor disputes.

On this basis, identical food store sales, including fuel, increased 1.8% and excluding fuel, increased 1.2%.

Comparable food store sales, which include relocations and expansions increased 2.3% with fuel and 1.7% without fuel.

Excluding stores affected by labor disputes, identical food store sales including fuel increased 2.0%.

On this this basis, identical food store sales excluding fuel increased 1.3% and comparable food store sales increased 2.5% with fuel and increased 1.7% without fuel.

We estimate that product cost inflation, including fuel, was 2.3% and excluding fuel 2.1%.

We are pleased with Kroger's fourth quarter sales.

This represents a continued sequential improvement in both total sales and identical food store sales.

Turning to southern California, we are pleased to have a new contract in place.

Most of the key provisions of the agreement have already been widely reported.

But I would like to offer a few brief comments so that you can better understand how this agreement affects our business.

In southern California, we expect our fully-loaded costs per labor hour over the term of this new contract will be lower than the previous contract.

As was the case in West Virginia, the final contract in southern California is less costly to Kroger than the offer that was on the table when the strike and lockout began last October.

These contract changes were essential to improve the competitiveness of our cost structure in this market, and they continue to provide our employees with excellent wages and benefits.

Kroger is committed to achieving a competitive cost structure that enables us to grow our business while providing our associates with competitive wages and benefits, market by market.

We are truly delighted to have Ralph's team members back at work serving our customers.

They are the best at what they do and we know they are essential to Ralph's continued success.

Ralph's has a comprehensive plan in place to build its business in southern California, and will receive our full support.

Now, I want to update you on Kroger's market share based on our internal estimates at year-end.

These market-share data were not adjusted for the strikes because their effect on results would have been minimal.

Kroger competes in 52 major markets.

A major market is defined as one in which we operate nine or more stores.

The number of major markets grew by four from a year ago as a result of our capital investment and storing program.

For 2003, Kroger held the number one or number two share in 43 of our 52 major markets.

Kroger's share increased in 28 of these 52 markets in 2003.

On a volume weighted basis, Kroger's market share was unchanged.

Kroger competes against 918 super centers.

There are 31 major Kroger markets where super centers have achieved at least a number three market share position.

In 2003, Kroger's market share increased in 21 of those 31 markets and declined in 10.

On a volume-weighted basis, Kroger's market share remained unchanged in those 31 markets in 2003.

Kroger competes against 678 Wal-Mart super centers.

Wal-Mart super centers have achieved at least a number three share in 22 of the 31 major markets where we have significant super center competition.

Kroger's market share increased in 12 of those markets, declined in nine and remained unchanged in one.

On a volume weighted basis, our market share declined by 30 basis points in those 22 markets.

Now, turning to 2004.

We expect identical food store sales for 2004, excluding fuel, to be stronger than the fourth quarter of 2003.

Strong sales related to inclement weather in many parts of the country during early 2003, though, will make comparisons difficult in the first quarter of this year.

We expect earnings in 2004 to be lower than in 2003, excluding the effects of labor disputes and unusual items.

It is not possible for Kroger to provide a more precise earnings estimate for 2004 because of the inherent uncertainties and the cost of the labor dispute in southern California, the time and investment needed to rebuild Ralph's business and the investment necessary to meet Kroger's plan to drive profitable sales growth.

We have achieved significant cost savings over the past two years.

We believe that in 2004 there will be additional opportunities to reduce our costs in areas such as administration, labor, strength, warehousing and transportation.

These savings will be invested in our core business to drive profitable sales growth and offer improved value and shopping experiences to our customers.

Now I will ask Rodney to provide some additional perspective on Kroger's fourth quarter financial results and the outlook for 2004.

Rodney?

Thank you, Dave, and good morning, everyone.

Kroger's net loss in the fourth quarter was $337.4 million or 45 cents per diluted share.

These results include several items that collectively reduced after-tax earnings by $663.1 million or 89 cents per diluted share.

We estimate the labor disputes affecting stores in southern California and the West Virginia area reduced earnings $156.4 million after-tax or 21 cents per diluted share.

Approximately 95% of that cost related to southern California.

The labor disputes in West Virginia lasted for 26 days for the fourth quarter, while the dispute sin southern California continued throughout the quarter, fourth quarter.

In order to estimate the cost of the strike, we assumed that the Ralph's and Food For Less stores in southern California and the Kroger stores primarily in West Virginia that were adversely affected by the labor dispute would have maintained their pre-strike operating trends during the quarter.

This resulted in an estimate of the effect on gross profit and OG&A.

This estimate is based on the assumptions that were outlined in Table 3 of our earnings release and are the same as used during the third quarter.

The strike estimate also includes the expected health and welfare payment required from our previous labor contract.

The southern California estimate also includes costs such as incremental strength, costs associated with hiring and training replacement workers, costs associated with bringing in employees from other Kroger divisions to serve Ralph's customers and expenses associated with the mututal strike assistance agreement among the three employers.

Now, I would like to take a few minutes to explain the other items in the quarter.

Kroger incurred a goodwill impairment charge of $444.2 million after-tax or 60 cents per diluted share related to Smiths.

This charge is not tax deductible and this is the reason why the pretax and after-tax amounts are the same.

Under Generally Accepted Accounting Principles, Kroger is required to conduct an annual evaluation of goodwill.

In this case, the current fair market value of the assets is less than the value reported on the balance sheet.

Kroger also incurred a charge of $75 million or 10 cents per diluted share for an asset write down related to 74 underperforming stores.

Some of these stores are likely to close in 2004.

For any leased stores that closed, Kroger may incur additional charge for the remaining lease liability in 2004.

This is part of our ongoing continuing effort to achieve the most efficient use of our assets.

For example, we recently announced plans to convert five Fred Myer stores in Utah to the Smith Marketplace banner.

This is an exciting new store format that offers full service grocery, pharmacy and a full selection of general merchandise.

The conversion builds on our success with the Fryes Marketplace stores in Arizona.

You will recall that we converted 17 former Fred Myer Marketplace stores to the Fryes banner in 2003 and opened one ground up in 2003.

I'm sorry, we did the conversion in 2000.

The significant expertise of the Fred Myer team, particularly in nonfoods, makes this format possible.

It is also something that is playing out across the entire company as Kroger features a broader selection of seasonal and general merchandise in all of our combination stores.

Now back to the fourth quarter.

Kroger also had income of $12.5 million after-tax or 2 cents per diluted share related to the adjustment of a property tax allowance.

FIFO gross margin was 26.44%, a decrease of 43 basis points from the fourth quarter of 2002.

Gross margin at the supermarket division not affected by the labor dispute and excluding fuel sells declined slightly.

Operating, general and administrative costs increased 167 basis points to 19.7%.

OG&A at the supermarket divisions not affected by labor disputes and excluding fuel sells increased approximately 40 basis points.

Higher health care costs represented nearly half of that increase.

As you know, normally we do not provide supermarket-only data, but felt it would be helpful in order to understand the trends outside of the strike-affected divisions this quarter.

For the full 52 week fiscal year of 2003, sells increased 3.9% to $53.8 billion.

Net earnings were $314.6 million or 42 cents per diluted share.

These results include total charges of $801.3 million or $1.06 per diluted share from the labor disputes, asset writedowns, goodwill impairment charge and a charge for resolving disputes related to energy supply agreements and other items.

Net earnings for fiscal 2002 were $1.2 billion or $1.52 per diluted share.

For the year, Kroger reported a LIFO charge of $34.2 million versus a credit of $49.9 million a year ago.

This is an $84 million a year-over-year swing, most of which was driven by product cost inflation in groceries and meat, and the $28 million credit resulting from the adoption of a merging issue task force issued 02/16 in 2002.

In 2003, Kroger's cash flow enabled the company to reduce total debt by $211 million, repurchase $301 million in stock and invest $2.1 billion in capital projects.

This capital investment figure includes $202 million for the buyout of a synthetics lease and $78 million for acquisitions.

I want to point out consistent with our strategy of using 1/3 of cash flow for debt reduction and 2/3 for stock repurchase or payment of cash dividends, we did not repurchase any stock during the fourth quarter.

For the year, Kroger opened, expanded, relocated or acquired 116 food stores and closed 44 stores.

Total food store square footage increased 2.7% over the prior year.

Now, a few comments on labor.

We currently had indefinite contract decisions in Arizona and a portion of Indiana.

Those contracts are subject to termination by either party following the notice.

In addition, the contract with Food For Less employees in southern California has been extended through April 4.

We are actively pursuing new agreements in those markets and remain hopeful that we can reach satisfactory agreement without work stoppages.

In addition, employees in Memphis recently ratified a new contract and teamster contracts in Portland, Oregon, that were set to expire in April have been renegotiated and a new long-term agreement have been ratified.

In 2004, Kroger has major USCW contracts expiring in Houston, Seattle, Louisville, Nashville, Detroit, Denver, Las Vegas and Cincinnati.

As Dave said, Kroger is committed to achieving a cost structure that enables us to grow our business while providing competitive wages and benefits to our associates, market by market.

We hope to do so without further work stoppages, but it will require creativity and tough choices from everyone involved.

Now, turning back to 2004, or turning to 2004.

Kroger's storing plan called for 100 to 110 new, relocated or expanding stores excluding acquisition.

The company also plans to complete 150 to 180 within the wall remodel and 70 to 80 supermarket fuel centers.

Total food store square footage is expected to grow 2 to 3% before acquisition and operation, operational closing.

Kroger expects capital investments for 2004 to be in the range of 1.8 to $2 billion excluding acquisition.

This represents a reduction of approximately $200 million from the amount that Kroger originally allocated for the year.

Kroger takes a disciplined approach to capital investment and we continue to tighten capital.

In our core markets, excluding strike-affected markets, we're satisfied with the performance we are achieving from our prior capital investment.

The company plans to continue using 1/3 of free cash flow for debt reduction and 2/3 for stock repurchase for the payment of a cash dividend.

More than ever, Kroger's financial strength is an important competitive advantage.

We have the financial resources and the right team in place to continue to build Kroger's business for the future.

Now, I will turn it back to Dave.

Thanks, Rodney.

In closing, it's obvious that the labor disputes were constantly both for our company and our associates, and in addition the forecasted lower earnings for 2004 is not what we would prefer.

However, these events are signs of a rapidly-changing industry.

At Kroger, we identified these industry trends more than two years ago.

At that time, Kroger announced a plan to reduce costs and use the savings to offer lower prices and better value to our customers.

We have made considerable progress since then and our 2004 forecast is a sign that we intend to be prudent and deliberate about improving our future.

Our sales are good, our sales trend is good.

Our expenses have been well contained, given the current healthcare and pension cost environment.

Our cash flow is strong.

We reduced our debt.

We have identified additional opportunities to increase sales and reduce costs.

As Kroger enters 2004, I believe we are a stronger, smarter company that better understands the needs of our customers and employees.

We also have key strengths that no other U.S. food retailer can match, including a high quality asset base with leading market share and many of the nation's largest and fastest growing markets.

Broad geographic diversity and multiple store retail formats.

A successful track record of competing against super centers and industry-leading corporate brand products.

We remain very optimistic about the years ahead.

We will now be happy to take your questions.

Thank you, sir.

Ladies and gentlemen, if you wish to ask a question, please press star followed by 1 on your touchtone telephone.

If your question has been answered, or you wish to withdraw your question, press star followed by 2.

Your first question comes to you from the line of John Heinbockel of Goldman Sachs.

Your question, please.

Yes.

Two things, interrelated.

Number 1, when you look at the '04 earnings guidance, how much of that is, maybe, you can give us a relationship.

How much of that is the recovery at Ralph's and how much is investments outside of California?

And then two, have you changed your philosophy at all?

You know, it sounds like you might want -- you know, you may be a little more inclined to push hard on the Cap Ex and promotional side to drive sales now and you know, take the trade-off of lower earnings than maybe you might have been, you know, a year ago or 18 months ago.

Has that, has that balance changed at all?

John, let me answer the first one, that is on the 2004 guidance.

As I understood your question, how much of that lower guidance in terms of earnings from the previous year was was because of the recovery in southern California and how much of that was outside of that question.

And as we said in the prepared remarks, we compared our earnings for 2003 as we saw them without the strike effect and the other costs, and we looked at our own forecasts for earnings this year also without being impacted by the strike costs or the recovery costs, and that's what we said we believed would be down.

And so that's probably as far as we are going to say on that.

Certainly the recovery in southern California and whatever lingering strike costs may remain, those costs will impact our earnings for this year, and we also are not attempting to quantify that at this time.

In terms of the second part of your question, the philosophy of driving sales versus trading off on earnings, we have been pushing, as you know, for two years to improve our sales performance and believe that our long-term success is, is really tied closely to our ability to grow sales.

And so to that extent, I think it would be true, because that is what is driving the lower guidance for 2004.

It reflects our decision, really, to do what we believe is necessary to build profitable, sustainable sales.

We have said before and continue to say that directionally, we see our gross profit going a little lower.

Our pricing today is not where we would like it to be, although I don't want you to overreact to that, because we are being -- being very particular, very selective as we look at pricing.

But -- but it will cause our gross to be directionally lower, and our cost of doing business will also be directionally lower.

Now, when I use cost of business, I am really talking more broadly than OG&A.

I am talking about costs that are embedded in gross, for instance, which include advertising and shrink, and warehousing and distribution, and so we believe that will also be lower.

In 2004, we will have one other pressure on those costs, is that the health and welfare costs and pension costs will be a little slower to contain than we might like them to be, and so I expect that we may have a little bit of cost pressure in 2004 just as we had or similar to what we had in 2003.

Rodney, do you want to add anything to that?

No.

Thank you, John.

Your next question comes to you from the line of Mark Hudson of Merrill Lynch.

Your question, please.

Yes, just to follow on from that.

Just to follow on from that.

So, your 2004 number.

If we take $1.49 ex-strike number, your guidance says that it is going to be less than the $1.49 ex-strike for 2003.

But there are some other things that could reduce that number further.

For instance, the strike termination benefits and the contribution towards the healthcare pool in southern California.

Those things are contemplated within our guidance, but does that mean that that, you know, you could be very significantly below 2003?

Well, first, your first part of the question, as you calculated, a number for last year, we are saying that we would be below that.

That was the way in which we looked at it this same way.

As to the other things that would be included, I think Rodney already described one of those that you asked about.

You want to comment?

The contribution to the healthcare plan, we included an estimate of that in our 2003 results.

Now obviously, until we get a final number, we don't know for sure what the number is going to be, but that was included in our results for 2003.

That's the one-time payment that results, goes into the health and welfare trust that results from the last contract, the past contract that we had in southern California.

Okay, so there's no incremental payment then, in '04, then, that's already been in the '03 number?

That's correct, unless there is some difference in the actual number, than the estimate.

Now there are some other costs.

Comparing costs.

Comparing costs.

It wouldn't be much, if anything, and then there are some costs like the ratification bonus that will be paid soon, but it will be paid this year, so that's included in there.

Excluding southern California and the recovery costs and everything to do with that, that whole situation, is Kroger's earnings stable or improving or getting worse in 2004?

I am not sure how to answer that.

What we have said is that if you take the effects of the strike out of both years, that our earnings will be below, this year, in 2004, will be below what they were in 2003.

When you take out the unusual items that were described.

But the strike recovery or the market share recovery in the marketplace is kind of unusual, but it's not a quantified effect in '03, clearly?

That's correct.

But the one, the difference between how I am answering your question and how you're asking it is that I'm including in my answer how we view the ongoing business in California to the extent that you can actually dissect the ongoing business in California and the profit from that and the recovery.

So I am looking really at the total company.

I am not excluding California from my comment on where I am see our earnings for 2004 but I am taking out what I believe to be the strike effect.

Okay.

Under what circumstances would earnings improve at Kroger?

Well, strong sales.

We think strong sales is ultimately the long-term key to our health, and, we want, and I chose those words, in particular, to this call.

We want profitable, sustainable sales growth, and so, we are not going to buy business that will cause us not to end up ultimately with a better-run business.

But as I tried to close with, the industry is rapidly changing and going through a number of changes that are causing us and everybody else, I think, to react to that, and our plan is, accordingly, to try to build the sales and to grow our business in that climate.

One final bit.

The difference between your comp store sales with and without California was tiny.

Does this suggest that your sales in California were actually pretty robust in this period?

As you will recall, we had the pickets in our stores came off on Halloween and remained off for the most part until close to the end of the strike.

Mark, our estimate on the impact from the strike during the fourth quarter was about 40 to $45 million, so obviously it's pretty modest.

That's total, not just identical, but I wouldn't expect that number to be too much different.

Great.

Thank you.

Yes.

Thanks, Mark.

Your next question comes to you from the line of Meredith Adler of Lehman Brothers.

Your question, please.

Meredith, could you check your phone?

Sorry.

Yes.

Start by talking about, again about southern California, because you weren't as impacted in sales.

Do you see that most of what you spend in terms of winning back customers and really responding to what your competitors do, do you feel like you have won some customers and that's going to help you make it less costly for you to operate that business going forward?

And then I have a couple more questions.

Meredith, that is going to be really hard to say.

During unusual times, like a labor dispute, it's real hard to say what your customer flow looks like and what it means and what customers will do afterwards.

I would say that there's really two parts to how I see southern California.

One is that we will have to do some things to get our business back on a good even keel, and I think that's normal at a time when you have gone through this kind of disruption.

It includes operating things like getting our warehouses running properly with a smooth flow of product, getting some of the departments up and running that were not previously running, it means welcoming our associates back.

The Ralph's team members have been back to work since this past Wednesday and we are very glad to have them back but it takes a little while to get the stores back into their usual strong conditions.

All of those will require some investment in that recovery.

In addition to that, we have the normal competitive pressures of that market.

To the extent you can dissect what is related to the strike and not, we do expect the southern California market to have a number of competitive issues, and so we plan to address those as well.

I think there are there likely to be any store closings in southern California as a result of this?

As you know, we announced some stores that were being written down, some of which would obviously be evaluated for closing and some of those obviously would be, there are many of them scattered across the country, but some would be in southern California as well, but I would not characterize the strike as having caused any stores to close.

And in fact, we did have some stores close in the West Virginia market following that strike, but I wouldn't characterize those store closures as being because of the strike either.

They really were an opportunity to evaluate assets and say what should we do going forward, looking at what we believe the future to be, not what we believe the past two have been.

And so we evaluated the ones in West Virginia and really all of the 75 stores that we had or 74 stores that we had here on our list.

We evaluated them from the point of view of going forward, rather than just looking back.

And those 74 stores were spread throughout your geography?

Yes.

There were stores scattered in a number of markets.

My final question is, you took a large goodwill impairment on Smith.

Could you just talk a little bit, I know you don't usually like to talk about individual divisions, but that was a big charge.

Could you talk a little bit, maybe first, how much was goodwill originally associated with Smith's and maybe what caused the impairment other than the market value is lower?

Sure, Meredith.

I will be happy to comment on that.

And as to the goodwill amounts, I will let Mike add if he wants to add to that.

The markets that Smith's operates in are very competitive, made even more competitive by super centers as they have grown.

We are very bullish on the markets that Smith's is in and very excited about the future of those markets.

We have made a deliberate decision to build our sales and grow in those markets over the next few years.

Because of the competitive climate though, in those markets in the short run, that is the next two or three years, as we looked at our 2003 performance and then as a result forecasted our performance over the next few years, we believed under FASB 142 that we were required to take a writedown, but I don't want to create an impression about the Smith's markets, anything except that we are bullish on those markets, we believe that the decision of how we are pursuing those markets is the best one for our shareholders and in the long run, we think our shareholders will be very happy to be represented in those markets.

And, Mike, I don't know if you want to add anything, or Rodney?

Just rough numbers.

Goodwill was about $600 million beforehand.

This is writing off $444 million of that so there is about $150 million still left.

Great.

Thank you very much.

Meredith, thank you.

Thanks, ma'am.

Your next question comes to you from the line of Steve Chick of J.P. Morgan.

Your question, please.

Hi.

Thanks.

I guess, first, I was wondering, you know, the agreement that you established in southern California and the differing tiers, how, as you look at it, you know, to the other contracts under negotiation, is this -- can this be viewed as somewhat of a blueprint and is tiering something that you would be interested in and is it possible to get some of those contracts in the same type of form?

Steve, it is hard to predict where each market will go.

We evaluate each market individually.

We think in most markets, issues of healthcare and pension will obviously arise.

But each market we evaluate differently and we address each of those differently.

I do have a comment about two tiers, is they are only one of many ways that we can address contracts.

And they happen to be one way that I think is a good way to do it, and here is why.

In some markets, when you need to reform a contract, that is to cause major change in the contract in future years, you can either choose to do it by radical change of the existing contract which directly affects the current employees, which then, I think, shakes up markets and individuals and our performance in those markets tremendously, or you can choose to try to reform it over time by asking the new employees hired closer to market rates and closer to market benefits, they end up coming on board with very competitive wages and very competitive benefits, but you in effect reform the contract over time in that situation and you haven't been as impactful on existing employees.

That makes it a little less disruptive to the business.

Sometimes that works in markets and sometimes it doesn't.

We have, actually, many occasions and have had many occasions over the years where we've used second tiers before.

This is not the first, this is not some new concept or new ground that we are trying to, trying to plow.

So we believe in southern California we'll be successful.

We think that there may be other markets where it will be successful as well, but there will be other markets where it won't be necessary or the unions and we in our negotiations will choose a difference approach to solving those same kinds of problems.

The first two tier contracts were in place in 1978, just to give you a feel for how long they have been in place.

Yes, a lot has been written about two tier contracts as though this is something new to our industry and that it was borrowed from other industries.

Well, it's been in this industry a very long time and we have used it and UFCW has used a number of time to address just the kind of questions that I am describing.

What percentage of your markets right now are under a two tier structure?

I am under the impression it's not many.

Is that wrong?

I don't know a percentage.

In fact, I haven't gone to calculate it.

I don't know that I would even have a guess.

Every market you have to look at it market by market, what the economics of that marketplace and where are we?

So, in some places it may not even be called a two tier agreement.

It may be a base agreement may be competitive towards the marketplace.

That's very true.

We have a number of markets where our labor contracts are pretty competitive with -- we are very competitive with the existing labor market.

So that just by calling something a two tier or three-tier agreement doesn't mean anything other than you have to look at it market by market.

Okay, and a followup to that.

Have you thought about or can you execute with this agreement, a buyout and then, you know, secondly to that, it seems like there are a lot of buyouts in situations where you have like split tiers could be pretty favorable.

I guess I am wondering because your Cap Ex level will still look pretty high and Albertson's had said specifically that their ROI on this agreements specifically was better than any internal project that they had, I think.

You know, why wouldn't you kind of trim your Cap Ex and allocate cash to more buyouts?

You know, it seems like there could be a lot of labor costs and value unleashing just by that process.

Have you guys thought about that?

We obviously always think about ways in which we approach the structures in markets, but this contract was just completed last week and our employees have not been back to work a full week yet, will be, I guess, as of today.

And I think it's way too soon to discuss that kind of issue.

The contract does provide for discussions between the companies, individually, and the union if a company chooses to pursue a buyout arrangement.

But there are a lot of things to consider in those kinds of situations, one of which is we have some very strong, talented associates in our operation right now today, and they offer a great deal to our customers, so we are grateful to have them back to work.

And I don't see any reason that we need to address this particular issue at the present time.

Okay, and one last thing.

Do you have an approximation of what your level of attrition, you know, might be, you know, I guess in your unionized areas?

I am not sure I'm following your question.

Are you talking about the percentage of people that leave in a given year or normal year or are you talking about the people who return to work in southern California?

Well, actually I guess both would be interesting but your level of turnover, you know, average, if you can, some sort of normalized level and then if you know the percentage of who returned in southern California already, that might be interesting as well.

Well, on the southern California question we do not have that question and won't have, and I am not sure we would make it public even if we had it.

And in terms of our normal turnover in other markets, we do not specifically release that information but I will tell you one thing about turnover that probably would be helpful as you think about this.

While there is a certain amount of turnover at all levels within a store, the turnover is a higher rate at the entry level, that is the carriouts, the baggers level, than it would be at any other level in the store.

And so you shouldn't make any too abrupt decisions or choice about how quickly would the higher end level of our employees, how quickly that would turn over, because that number is dramatically different than what would be true for carrie-outs.

Okay.

Thank you.

Your next question comes to you from the line from Chuck Cerankosky, McDonald Investments.

Your question, please.

Good morning, everybody.

Looking at the general merchandise effort you are making in some of your stores, you are talking about using seasonal, general merchandise, Dave, and I see a lot of competitors doing that.

How are you trying to differentiate your general merchandise offerings in the store and perhaps compare it to what Albertson's is doing by making a big statement in toys?

Well, I would just tell you we have a secret weapon that's not particularly secret.

Fred Myer has been a huge help in this regard, and I am not trying to diminish the staff we have here at general office.

We have a pretty good staff here of general merchandise merchants here that have been seasoned for a lot of years and know really what they are doing.

But with the addition of Fred Myer to our organization, it not only helps us in ways like the Fryes Marketplace, the Smith's Marketplace.

We have described it helps us in some of the product mix that we have in some of our stores throughout the country, and I have, in answer to a question that many of have asked before about expanding the Fred Myer franchise elsewhere, I have commented that remember there are lots of ways to spread that franchise and one of them is using their expertise and the ability of the fine folks out in Portland, Oregon, to help us figure out the products and the product mix and distributing that throughout the company.

Seasonal general merchandise is probably the single best example of that, but there are many others.

Not necessarily to a specific competitor but if you just look at the products we are offering, it is always the highest quality and it will be department store quality.

Yes.

I can't recall, Chuck, whether you have been out to any of the Fred Myer stores, but they are a cut above.

They are really first class stores.

And so Rodney is right.

The blend of the merchandise is, I think, exceptional.

Thank you, Chuck.

Thank you.

Your next question comes to you from the line of Edward Aben of Deutsche Banc.

Your question, please.

Yes, good morning.

You mentioned during the call that you intended to reduce costs in '04, warehousing and transportation costs so could you quantify and expand on that?

No, we don't plan to quantify those.

I think the only things that I have said that I may call your attention to, first is we do believe our costs, and by costs in this case, I'm defining costs as being what we usually talk about with OG&A, including though, in addition to some costs that are in our gross which would be advertising, transportation, warehousing and shrink.

We do believe the collection of those costs will be down, directionally.

And we expect them to be in '04.

We are not quantifying any of the individual items.

And I also identified that there will be some cost pressure on what we traditionally look at as OG&A and I think costs - that cost pressure mostly will bear itself out with health and welfare and pension costs as we work to contain that growth over time.

Rodney, do you want to add anything to that?

Okay.

Good, thank you.

Right, and sorry.

Related to that, could you comment on the impact of the trucking regulation and higher gas prices related to that?

Well, I don't think we -- well, we have an internal estimate on the trucking regulation change on the driver time, but I don't think we have released anything on that, and I don't think we plan to.

Obviously, it will have some impact.

But an impact like that has the same impact on all of our competitors.

Yea, anyone who has a truck.

It may change some, some various costs between shipping modes, transportation by railroad may become, for instance, more cost-effective, as an example, but that's the trucking regulation.

On the gas price, obviously the gasoline prices will affect anyone who ships by truck, anyone who actually uses fuel, and we can't really predict where that's going to go, but certainly as you can see at pumps today, it is higher than it has been, and so that will have some impact as well.

We think we have a pretty good process to minimize the number of truck runs required for the actual work achieved throughout Kroger.

We have been working on that for a number of years and have had good success with that.

As a result, we think we can minimize the impact on us but it still will have an impact.

Okay.

Great.

Thank you.

Thank you, sir.

Your next question comes to you from the line of Jack Murphy of Credit Suisse First Boston.

Your question, please.

Good morning.

Good morning, Jack.

First, just quickly on the $156 million related to labor disputes.

Could you give us a sense of how much of that is related to payments out, related to the joint agreement to share losses?

Actually, we don't plan to release that at the present time.

Obviously, though, that's embedded in the cost of the strike for us.

Okay.

And that did increase, that payment did or will increase once we make it, will increase, in part, due to the strong sales we had at Ralph's and Food For Less during the quarter as was illustrated by our identical sales.

And does the agreement extend beyond the conclusion, the labor dispute, does it just kind of, you know, in March 1, you are not responsible for any more sort of joint sharing or, I mean, sharing of losses and profits, or is there some amount of time following that that you are responsible for?

There is a specific amount of time but I don't think we will comment on that publicly, and it's fairly short, and it is specific.

Okay.

Fair enough.

On the strike benefit, longer term meaning the reason you took the strike.

Could you just give us a sort of you know, broad sense, when you look out three to five years or some amount of time, what you think, as it sort of matured, what type of benefit in that region, that you get to SG&A, you know, on a basis points type of estimate?

We have not, well, we have done some work on that ourselves internally, but we have not given that number out publicly.

And I don't think we plan to do so.

I will just remind you have what I had said earlier is that the fully-loaded labor costs, throughout the duration of the new contract, we believe, will, as a result of this new contract, be lower than what we had run in the previous contract on a fully-loaded basis.

Okay, last question.

We certainly expect to have a stronger business, because from a cost standpoint, we have a cost structure more similar to what is in the marketplace and our customers will be able to enjoy that benefit.

Yes, if you put that in perspective as to why the strike occured or really why we are having good, strong negotiations on any labor contract at the present time is the change that has occured in the marketplace and with those trend changes, we are seeking to have better pricing and some other attributes of our stores that may cost us a little bit of money to provide for our customers, and to do that, we have to have some of our other costs in the competitive zone, and labor, over time has grown to where it is not in many markets, or some markets, anyway, has been as competitive as it needs to be.

It is our intention to plow this back into rewarding our customer for shopping with us.

And Rodney is is exactly right that this should produce a stronger, more vibrant sales environment for us.

Okay, last question just quickly on free cash flow.

For this year, I think if you add back the sale lease back, and you are a little over $400 million.

What items that were in the 2003 cash flow that might not be in 2004, I know you don't want to give us, you know, bottom line number on free cash flow guidance, but what might have been a drag or benefit in '04 of any kind of size that we should adjust on a model cash flow for next year?

We had a pension contribution in 2003 that we would expect to have additional pension contribution in '04.

The same magnitude?

We -- I mean, our expectation is that our contribution in '04 into the company plan will be higher than what we made in '03.

It's that $100 million item?

That's correct.

Okay.

We would expect working capital overall, when you look at base business, would improve in '04 versus where we finished in '03.

We are not giving any, you know, detail on how much, but we do expect it to continue to improve.

Those would probably be the two biggest things.

Our tax payments are lower than what you normally would expect, because of some of the tax law changes, I guess it was last year.

We would expect that to continue to '04 than if it were also to be there, but in '05 we would expect that to start changing.

Unless Congress extends it.

The other thing, Steve, we do not talk about free cash flow anymore because of Reg G, and it's a non-GAAP term.

You did the math on what debt would have gone down by adding the $200 million lease buyout back and the $200 million we reported as a reduction.

Don't forget we also used $300 million of cash to buy in stock.

Okay.

Thanks.

Thank you.

Your next question comes to you from the line of Jason Whitmer of FTN Midwest Research.

Your question, please.

Good morning.

Good morning, Jason.

Could we talk a little philosophically about maybe some paradigm shifts in grocery?

You mentioned a couple -- in particular, price.

What has been the biggest difference on the importance of price over the past couple years?

Where is that going and more specifically maybe on margins and the timing and magnitude on that directional decrease?

As I think about pricing, looking back over the last several years and looking forward, I think about the -- what a customer looks at is where they buy products, and the two or three things that have really changed in recent times, first, as we have, of course, talked about, the growth of super centers, generally, particularly the cost format site of that as represented at Wal-Mart, related, closely related to that are the club stores and the dollar stores who have emphasized price, and then not so much a price equation, but certainly happening in the lives of customers is the fragmentation of where they can buy these products that we sell which now include places like drugstores too and lots of other formats.

So, you have a lot of things going on in the customer's mind, but a part of what is going on in their mind, a part of what is driving them to some of the lower, lower costs of doing business formats is the lower prices that they may offer, and in trying to address that, we believe that the gap between our pricing and theirs is too large, and we believe that it needs to narrow.

That's not to say that it needs to be the same.

That's not -- we are not trying to change our kind of format.

We believe that we have lots of reasons customers prefer to shop with our kind of a format, and we believe that as we add improvements to our format, customers will even, much more, rather, shop in those stores, and all that is required is for that pricing difference to be narrower than it is represented today.

So the paradigm shift for us really is to recognize that we want to satisfy customers, we want to push for sales improvements, we think that some pricing is required for that and that's why we set our gross profit directionally over time.

We think it will be down and we think it's because as we try to address those issues, that that's what will happen.

We are also trying to save money wherever we can to reinvest that in that process of those lower grosses.

Rodney, do you want to add anything to that?

And there's a lot more, as Dave mentioned, than just price, and, if you look at going to market, you know, our employees are just as important or more important and the quality of perishable products we have and everything else is part of that total shopping experience and price is just one piece of that.

Yes.

Are you frustrated that over the last couple of years since you launched this program that your margins have been hit, gross margin have been hit by 100 basis points but your sales have been essentially flat.

Does that that frustrate you and what really changes in that?

Well, on one hand, I can see where you or we might be disappointed that we haven't had stronger sales growth, because the numbers aren't hugely positive.

On the other hand, when you look at what we have been through in terms of the economy and in terms of what has happened with the customer, in terms of how they see the world, the uncertainties in the world, not just the economic uncertainties but the war and so forth.

When you look at the fragmentation of where people can buy products, if I were forecasting, I believe had we not taken the steps we took, our sales would be down rather noticeably as opposed to where they are today.

And you haven't heard me -- you have heard me talk about sales a lot on calls for actually several years whenever I've commented on them, and it is rare that I say sales are good and that I am pleased with them.

But I believe that sales are good and I am pleased with them.

And if you look -- particularly, if you look over the last three or four quarters, we have had a clear trend sales in where our sales are headed and good improvement there.

So we have been very pleased about that, and if you compare them to other retail formats, some are doing better than us, but many are not, and so we are quite pleased with that trend.

Okay.

Last question.

In terms of warehousing or supply chain management, are you interested in doing any kind of outsourcing?

You know, it looks like you have been working a little bit more closely with Super Value.

Is there any thoughts of doing any more deals there?

We have a lot of our warehousing and distribution where it is set up through outside companies that we have worked with over the years, and we are quite satisfied with that business.

We have several cases where we do it ourselves, we are also quite satisfied with that business.

We constantly reevaluate which format for a particular warehouse or particular distribution is appropriate from a cost structure, from an effective performance structure really from a total business point of view, and that's what led us in the past to electing to go to some of the outside companies like Super Value and others, and we have been quite pleased with that but it also led us some some cases to remain where we are.

So I won't predict whether we will go either direction on any additional distribution centers.

What I will predict is that directionally, our distribution and warehousing costs will go down in that we are working hard to find ways to reduce it further.

Great.

Much thanks.

Thank you.

Thank you.

Your next question comes to you from the line of Bob Summers of Banc of America Securities.

Your question, please.

Hey, good morning.

Two questions, here.

Just regarding pension expense.

When you look at the new Medicare bill and the provisions for rebates and extending or maintaining healthcare coverage, you know, effectively lowering the present value of the obligation.

Have you looked at that?

Is that going to impact your costs at all?

Yes.

We have looked at it.

There will be some benefit on it.

It won't really affect pension, it will affect our retiree healthcare amount.

And the amount we have not calculated primarily because we don't have what the final rules are on how to do the calculations so it is kind of difficult to project at this point.

You know, the governing bodies these days are great at putting out ideas and doing things and then they wait forever to do the rules.

It's kind of like section 404 of Sarbanes Oxley.

We have to have it implemented by the end of the year but we don't have what the rules are yet.

Right.

Very true.

Okay, and then in the past, you have given us an annualized cost savings amount that's been driven by the strategic plan.

I think we were at 490 in the third quarter.

Can you tell us where that number totaled out in the fourth quarter and then again, just trying to drill down a little bit, four, without getting specific though, I mean is the cost opportunity savings accelerating, is it decelerating?

And if it's decelerating, you know, why, because I would think that you have, you know, between, you know a lot of room in your cost curve as you try and you know, get closer to, say, Wal-Mart.

Let me talk first answer the question about the $500 million target.

You're correct.

Last time we talked, we we told you where we were at that point.

In evaluating where we are at this point, while I am quite comfortable in the progress that we have made with the company, I was not so comfortable in our ability to actually estimate a precise number that would be a useful number, and that's because of the impact that the labor disputes had throughout the company, because it impacted lots of different places of the organization and made it hard to determine what's a cost savings and what isn't.

And because of that, we just simply elected not to address a specific number going, looking back, and, to answer that question, but, I have said, and I continue to believe that I am very pleased with the progress that we have made on the cost savings that we have achieved, and many of those will go forward, of course, in the way in which we operate.

We have also said but have not given an indication of quantity and don't plan to here but we have also said we have lots of opportunities going forward.

One of the big opportunities, and frankly, one of our disappointments last year was shrink management.

We did make some headway but not as much as what we had hoped to achieve.

We do have more specific plans this year, in 2004, to make better headway there than what we have made in the past, and we see these cost saving opportunities as being significant.

We also see them contributing strongly to our ability to lower some of our prices or to spend money in other ways that directly affects our customer, and so that's actually part of our plan.

And then, finally, I have indicated that the health and welfare and pension costs in 2004 will make the typical measurement of OG&A a difficult one for this year because those cost pressures, as in the past couple of years, really, are hard to overcome because they are fairly large.

Okay.

Thanks.

Thank you.

Your next question comes to you from the line of Mark Willamuth of Morgan Stanley.

Your question, please.

I would like to dig in a bit on the commodity inflation that was reported in the quarter.

Could you give us an indication of how broad-based that was and largely coming from commodity categories and then talk to us a little bit about how you have done on passing on pricing in those areas?

I'll have Mike comment on the inflation and then I'll comment on the pricing.

The inflation in the quarter, it's kind of an interesting analysis when you start digging into the numbers, becuase when you look at the inflation number that were reported, there were several categories that actually had inflation, but when you look at what categories wound up driving our LIFO charge for the year, they may have been different categories.

A couple of the big categories during the quarter that drove the inflation number, we have, we have over 90% of our sales on LIFO.

In fact, it's probably closer to 95% of our sales are on LIFO.

Just about all of our grocery stores are on LIFO, and that affects us, our LIFO calculation.

The -- when you start to look at the categories that did have the inflation, you have produce certainly contributed to it, meat contributed to it in the fourth quarter, grocery was up, some of the hard good sides, I call them hard goods, the folks down in Portland all probably mess it up, some of them are soft goods, but the apparel, the hard lines, the home fashion, a lot of those categories actually had some deflation and of course, pharmacy had continued its rather significant inflationary trend.

So, it's kind of a mixed bag, and I would say the one that had the biggest trend change during the year from deflation to inflation was the grocery category.

And has meat reversed back now that the mad cow situation has appeared?

If I look at the trend of meat throughout the year, it, it actually did not, it continued to increase throughout the year, the inflation in the meat category.

Okay.

And then how, how did you do at passing on pricing and did you see a margin drag in these commodities?

Well, it's very difficult to try to split out what got passed on, what didn't get passed on, how much inflation affected sales, how much good promotions benefitted sales and it's virtually impossible to sit down with the number of items we sell and decisions we make every day on what retail pricing was, be it a competitive decision or our own decision about a promotion, how much inflation helped or hurt or was a drag on growth.

So if you try to quantify, it's virtually impossible when you look at all of the items we sell.

Okay.

Maybe to get at it a different way, how much of the identical store increase do you think was traffic and how much was price?

Well, we know that -- we know that some of our sales improvement is the result of higher inflation in some of those areas, but we, we also know that some of our sales improvement is because we have been doing a better job in merchandising and in pricing, and we haven't attempted on this call to quantify what that is, now we have our own gut feels, but I don't I don't plan to offer that here and we have some data that I think supports our view that it's a little bit of each.

Mike, do you want to add anything more to that?

I don't think we want to add anything more to that.

Thank you.

Thank you.

Your next question comes to you from the line of Margaret Canella of J.P. Morgan.

Your question, please.

Thank you.

I wonder if you could talk a little bit about your plans for RFID and what they might be in the upcoming year and then also if you have a specific plans with regard to debt maturity this year and whether you would be paying them down or refinancing them?

Thank you.

Let me comment on RFID first and then I will let Mike comment on the debt maturities, if he has that information.

RFID is an improvement in technology that is advancing in the papers, in the articles, more rapidly than in practice.

We are very close to the subject, and Mike Heschel, actually, who is sitting in the room with me, is very involved.

He is our Chief Information Officer and a few other things too, but he has stayed very close to this whole process, and we tend to look at technology to say when is it of value of us to push hard on it and when it is, when it's effective for us to do that, we plan to push.

But you won't hear much in the way of press coverage of what we are doing there because we actually prefer to be a little quiet in that arena.

Do you want to comment on the debt maturities?

Yes.

We have got less than $250 million of debt due on a current basis in 2004.

So the opportunities to reduce debt just based on what we have current obligation at the end of the year is relatively minor.

We do have in March of '05, $750 million lug of debt that came with the merger with Fred Myer that becomes due and we always look at opportunities to refinance debt when it makes sense on a net present value basis and so we are always looking for opportunities to get the best capital structure we have, and, you know will I pay cash to pay off all $247.8?

We do expect to generate positive cash flow for the year and we do expect to use a third of it to reduce debt and two-thirds of it to pay a dividend or buy in stock, so our goal is just to have lower debt next year than we've had this past year, so to quantify that at this point would be very difficult.

Okay, thanks very much.

At this point we have time for one more question.

Thank you, sir.

Your final question comes to you from the line of Felipe Gussins (ph) of Credit Suisse First Boston.

Your question, please.

Yes, good morning, Actually, if I may, I would like to ask two questions.

The first one is, this morning, Albertson's indicated that they had gotten some positive responses to the rollout of their loyalty card in southern California.

Can you perhaps share with us what you have in terms of loyalty programs in that market and my second question, given that you have basically fared better than your peers in southern California during the strike, any update in terms of what Moody's current thinking is with regard to the pending review for potential upgrade?

Okay.

On the loyalty card question, Felipe, we have had a card program in that market for some time.

In fact, we are very proud of that program, it has worked well, that division for us has actually developed lots of approaches to using a card effectively, and so we have been in there a long time and understand that business quite well, and the fact that Albertson's introduced one or commented on it, that is fine, that's whatever they choose to do.

I don't think I have any other comment on that.

As to Moody's, do you want to comment on that, Mike?

Relative to Moody's, obviously I can't predict what any one of the rating agencies are going to do with our actual rating.

I do feel very good about about our ability to reduce debt during the year.

If you make it upon an apples to apples basis, there was a new accounting pronouncement about consolidation of equity entities that also helped with the debt comparisons on a total debt basis, but a reduction in face of the work stoppages that we had during the year of apples to apples of $350 million, I think the rating agencies will look favorably on that.

I believe it will look favorably on our prudent use of cash once the strike started and that reduced our stock buyback program to balance the use of the cash that we had available, and if you look at what we actually did, it came very, very close to 1/3, 2/3, which is our goal to get it to basically 60/40 is a pretty good performance for our treasury group given all the uncertainties of what the cash flow streams would wind up being the last part of the year.

If I can just ask a followup of my first question.

Given that everybody is going to develop or basically rollout initiatives to regain customers lost during the strike, do you have a sense from where you sitting that at the end of the day it's going to be a balanced approach in terms of promotional activities or is there a some risk that you might see kind of a small price war here, initially?

I can only tell you that we look at our own behaviors, our own practices, and what we attempt to do.

And we look for ways to build long-term sustainable profitable sales growth, which tends to suggest something a little less promotional.

We are very rational about, very deliberate about, very prudent about the choices we make in terms of our pricing and our plans, and that's true in every market, including southern California, and that's probably all I would be able to comment on.

Thanks very much.

Thank you, Felipe.

And thank you all for joining us today.