克羅格 (KR) 2004 Q1 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to The Kroger Company first quarter investor conference call.

My name is Carlo, 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 this presentation.

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

I would now like to turn the presentation over to your host for today call -- for today's call, Ms. Carin Chabut.

Please proceed, ma'am.

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 affect on our business on an ongoing basis is contained in our SEC filings.

But Kroger assumes no obligation to update that information.

Both our first quarter press release and our prepared remarks from this conference call will be available on our website at www.kroger.com.

Now, I will turn it over to Mr. Dillon.

Thanks Carin and good morning, everyone.

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

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

I would like to begin this morning by briefly reviewing our first quarter results and our sales and earnings expectations for 2004.

And Rodney will provide some additional details on the quarter and update you on our progress in contract negotiations.

Then we'll be happy to take your questions.

Total sales for the 16 week first quarter increased 3.9% to $16.9 billion.

Identical food store sales including fuel increased 1.3% and excluding fuel increased .3%.

Excluding for the entire quarter the Ralphs and Food 4 Less stores affected by the labor dispute, identical food store sales including fuel increased 1.6% and excluding fuel increased .5%.

We estimate that product cost inflation including fuel was 2.3% and excluding fuel 1.6%.

We're pleased that Kroger continues to grow our identical food store sales in a challenging operating environment but there is clearly more to be done.

Our investment in gross margin has one been slower than originally planned as our divisions implement their sales plans.

We are implementing these plans in a careful manner.

We plan to continue making investments in pricing, customer service and product variety to deliver strong, sustainable sales growth.

Our target for identical food store sales in 2004 excluding fuel continues to be higher than what we achieved in the fourth quarter of 2003.

We are also pleased with Ralphs sales and earnings following the end of the southern California labor dispute in late February.

Our associates in southern California did a great job of quickly getting our stores back in shape and providing our customers with outstanding service.

And that is true for both Ralphs and Food 4 Less.

Ralphs, as you know, was involved in the labor dispute and Food 4 Less had a corresponding increase in sales.

Based on our independent shopper surveys, our service ratings have returned to pre-strike levels.

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

We are off to a good start in four and we expect earnings for the year including the effect of the southern, California labor dispute to be sufficient to generate positive free cash flow.

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

Rodney?

Thank you, Dave and good morning everyone.

Kroger's net income for the first quarter was $262.8 million or 35 cents per diluted share.

We estimate the labor dispute reduced net earnings by $71.6 million or 10 cents per diluted share.

Approximately 30% of the expenses related to the labor dispute is attributable to the recovery after the strike ended.

The weekly costs associated with the post-strike recovery continues to moderate.

At this point because of the competitive activity in southern California, we cannot estimate how long this will continue or the amount.

FIFO gross margin was 26.01%, a decrease of 72 basis points from the first quarter of 2003.

FIFO gross margin at the supermarket divisions not affected by the labor dispute and excluding the effect of fuel declined by 17 basis points.

We have seen some improvement in shrink as a result of the use of technology and increased attention that we have devoted to this area.

As we have discussed in the past, our divisions have been working hard to target various opportunities for shrink reduction.

Part of that is helping our associates better understand what shrink is and how we can tackle the problem.

We are pleased with the progress Kroger is beginning to make.

This will continue to be a focus for the entire organization in 2004.

OG&A increased 41 basis points to 19.04%.

OG&A at the supermarket divisions not affected by the labor dispute and excluding the effect of fuel increased approximately 23 basis points.

The cost of providing healthcare and pension benefits to our associates and their families increased OG&A by 24 basis points.

Our effective tax rate is 36.9% versus 37.5% a year ago.

The effective tax rate is expected to vary between quarters based on the status of open items with various taxing authorities and law changes.

Assuming the work opportunity tax credit is not re-established, we expect the tax rate for 2004 to be in the range of 38%.

Total debt was $8 billion, a decrease of $258.3 million as compared to the first quarter of 2003.

A lower market value adjustment for interest rate swaps and the implementation of FASB interpretation number 46 accounted for $139.8 million of this decline.

We were delighted by Moody's decision in April to raise Kroger's debt ratings from BAA3 to BAA2.

The upgrade was spurred in part by our strong market share, geographically diverse store base and a continued deleveraging of our balance sheets.

One other note about debt.

We recently called our 7 3/8% debt due in March of 2005.

The call will be funded on July 7.

Based on current interest rates, we expect to incur a premium of approximately $33 million and anticipate a reduction in interest expense of $26 million for the balance of the year.

Also during the quarter, Kroger executed a new revolving credit facility totaling $1.8 billion in May.

The new five-year facility replaces a 364 day facility in the amount of $1 billion and a 5-year credit facility in the amount of $812.5 million.

The new credit facility provides Kroger with improved flexibility and lower interest rate spreads.

Kroger also resumed its stock buyback program in the first quarter, repurchasing 9 million shares of common stock at an average price of $16.62 per share for a total investment of $149.3 million.

Last March we pointed out that consistent with our strategy of using one third of cash flow for debt reduction and two thirds for stock repurchase for the payment of a cash dividend we have not repurchased any stock in the fourth quarter of 2003.

Since January 2000 Kroger has invested nearly $2.6 billion to repurchase 130.1 million shares or approximately 15% of the company.

Kroger opened, expanded, relocated or acquired 32 food stores and closed 22 food stores in the quarter.

Total food store square footage increased 2.4% over the prior year.

The 26 store closings during the quarter included 16 operational closings.

The company continues to evaluate underperforming stores and additional closings are expected during the balance of the year.

The previously announced closing of 14 Ralphs stores took place early in the second quarter and are not included in the 16 operational closings.

Capital expenditures for the first quarter total $456.3 million.

For 2004, we expect capital investments excluding acquisitions to total 1.8 to $2 billion.

We continue to emphasize a tightening of capital.

Some of the capital will go toward expanding our marketplace format which has proved so successful at Fry's in Arizona.

We recently announced plans to open for the first time in anywhere in the country four marketplace stores under the Kroger banner.

The stores will be in Columbus, Ohio, and offer our customers the opportunity to shop for groceries, specialty foods, linens, gourmet kitchen items and other merchandise in a convenient neighborhood store from a retailer they know and trust.

The first Kroger marketplace store in Columbus will open later this year with the other three opening in 2005.

This was made possible by identifying several attractive real estate sites and negotiating a new labor agreement in Columbus with a competitive cost structure especially for these stores.

Also earlier this week we converted five former Fred Myers stores in Utah to the new Smith's Marketplace banner.

All of those stores will undergo extensive remodeling during the summer.

These changes, along with Fry's Marketplace stores would not have been possible without the Fred Meyer merger and the great team we have at Fred Meyer to know what categories and products to sell.

Turning now to the labor front.

We continue to make progress in negotiations with the UFCW around the country.

Since our last conference call in March, Kroger reached new agreements in central Indiana, Houston and Detroit.

We also have tentative agreements in Nashville and Arizona fully recommended by the union that will be voted on by our associates over the next couple of weeks.

Each of these new contracts and tentative agreements was reached without a work stoppage and all have limits in place to control our healthcare costs.

But there is still a lot of work ahead of us.

With major contracts expiring later this year in Denver, Las Vegas and Cincinnati, we also have contracts extensions in Seattle, Louisville and Food 4 Less in southern California.

We continue to pursue new agreements that meet our objectives in those markets and we remain hopeful that we can do so without work stoppages.

Our goal in every negotiation is to achieve a balanced solution that provides our associates with the quality healthcare and fair wages they need at a cost that is fair to everyone involved, including Kroger customers.

Our associates have played a key role in our growth and we understand the importance of good wages, quality healthcare and a secure retirement.

We're determined to continue providing excellent wages and benefits in a way that allows us to be competitive in the interest of every Kroger associate and customer.

Now, I will turn it back to Dave.

Thanks, Rodney.

Kroger is off to a good start with improvement in sales and in identical sales in 2004.

Our earnings per share were slightly better than expected.

Kroger continues to reduce debt and buy back stock.

We are squarely focused on providing customers with better service, selection and value each time they shop in one of our stores.

We have a clear strategy in place to build our business and the financial resources in place to execute the plan.

We are reducing costs and we will continue to reinvest the savings in Kroger's core business to improve our customer shopping experience and consistently deliver better value.

We will now be happy to take your questions.

Thank you, sir.

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

If your question has been answered or you with wish with withdraw press star 2.

Questions will be taken in the order they are received.

Once again, star one to submit a question at this time.

One moment, please.

Our first question is from John Heinbockel with Goldman Sachs.

Two questions.

One on labor and one on sales.

I want to hit labor first.

The Detroit contract.

Can you give color as to how concessionary that might have been in light of the A&P contract that they signed a year ago?

And then generally, on the contracts you are signing, what are the provisions with respect to bringing Food 4 Less into some of these markets, particularly Detroit, is that being built into the contracts?

Okay, let's start with that one and I will have Don McGeorge comment on the Detroit labor contract.

Don?

Yea, John.

The previous Detroit agreement had uncapped healthcare.

The new agreement does have limitations placed in the agreement on healthcare.

We expect that the healthcare costs in Detroit to increase no more than 6% cumulative over the three years of that agreement.

And on the second part of your question on Food 4 Less, generally I think as a general rule it has not been addressed in the contracts.

No.

And I think that is probably the answer you're looking for.

John, you had a second question on sales?

Yeah.

If I look at your guidance for the full year, your .5% through the first 16 weeks or thereabouts, that sort of implies a pretty steep acceleration through the end of the year, you know, somewhere between 1.5 and 2% in the latter 36 weeks.

Can you kind of speak to how you see that playing out?

You know, what sort of clarity do you have on that and, you know, are we seeing that acceleration already or that's really a second half phenomena?

Well, John, we don't plan to give any sales current for this current quarter now to give any trends there.

However, I will tell you that as you look at the first quarter sales you do need to recall that Memorial day selling week, that is the week preceding Memorial day actually is in the second quarter this year where last year it was in the first quarter.

So that affected things in the range of 20-30 basis points for the quarter.

So that is one shift that you should take into account when you look at that.

Second is while I would admit that sales growth is hard to predict, it is the central focus of our strategy and that is the primary reason we have not given guidance but we are squarely focused on improving our sales trend and are very focused on getting the target that we have described but we do realize it as steep curve.

Not as steep at what it looks like once your add the Memorial day shift in but still it is a growing trend for the year for that statement to be true.

Okay.

Thanks.

Sir, our next question is from Phillipe Guissant [ph] with Credit Suisse First Boston.

Yes, good morning.

I have actually three questions this morning.

The first one with regard to product price inflation, can you share with us perhaps how much of the higher costs for dairy products, meat, chicken you have been able to pass on to customers?

The ability to pass on product cost inflation as we have discussed before is -- widely varies by item and market and is very dependent upon the market circumstances.

It also isn't always directly item for item.

For instance, you might have increased inflation in beef but you might see us be able to make up some margins say in chicken because of the ability to sell it in that environment.

So you have to take into account the product mix change and other things as well.

We certainly are seeing the ability to pass through some but by the same token we also realize in a competitive environment it is not going to be possible to pass through everything, at least not immediately.

Okay.

Second question with regard to southern California if you look at some of your competitors for example, including Stater Brothers, it seems they are still trending positive over last year before the strike.

Is it your perception at the end of the day that perhaps they may still retain some of that extra market share they picked up during the strike, these alternative formats of some of those competitors, or do you think you're going to gain back most of what you lost during the strike?

Phillipe, it is hard for us to estimate that.

You really have to look at a very long period of time.

You're right, during the strike which was 141 days long, a number of competitors picked up additional sales.

It is too early to say where that is going to settle in.

We are quite happy as we said, though, in terms of our store conditions.

The way the associates, the members as we call them at both Ralphs and Food 4 Less have responded to this challenge and actually are pretty pleased where our sales have trended in that market.

I think that is really all I can say on that.

Okay.

And then my final question, if you look at the two new store formats that have been rolled out by both Food Lion and I'm referring now to the bloom concept as well as March, it seems like the industry is migrating towards two business models, at least in my opinion.

One which is focusing more on efficiency and on price of the customer and the other one is focusing more on the shopping experience.

Can you perhaps elaborate a little bit in terms of where you see Kroger migrate towards within that kind of framework?

Within the framework that you described we have long talked about the fact that we have multiple formats and in the specific areas that you described we have formats that fit those each quite well.

I do think it's a little bit more complex than the description you gave.

For instance, Food 4 Less for us is more than just an efficient and price format.

It has some service element and some ethnic elements that they deliver on extremely well.

But essentially, it is, as you described, it goes after the market where price is more important than the shopping experience might be.

And then the other side of that is we have individual stores within several of our divisions that squarely addresses the topside of the market as you might describe where the shopping experience becomes even more important.

It is one of the advantages we think Kroger has because we have now quite a long time, quite a long history now in operating these formats and the ability to understand how best to use them so we see that as something of an advantage that the market might be shifting in that direction.

Wonderful.

Thanks very much.

Sir, our next question is from Mark Hossens [ph] with Merrill Lynch.

Good morning.

You talked in your comments about the gross margin investment being somewhat slower than you thought.

Is that because sales have been somewhat better than you thought in response to that gross margin investment initially or because there is a whole wall of gross margin dollars about to fall on the market? [ LAUGHTER ]

Mark, I don't think I'm going to take either of those choices.

Is there a C?

The reason really is pretty simple is that we have been slower in implementing some of our plans.

Slower than what we originally planned and it is more because we are wanting to move carefully and in my mind it's because I want to reduce the likelihood of over investing.

That is spending promotional money that doesn't really produce a long-term benefit.

Because remember, we are after profitable sustainable sales growth and so we wanted to come on gently and not suddenly.

I could go out and get these kind of sales we want tomorrow if I did not have any requirements in terms of free cash flow or gross profit, but we do and we're trying to do this in a measured, balanced way.

And so the slowness that you saw and that we described really was our effort to be more careful.

A year ago you were a little bit more rash in the way that you went market to drum up some sales and perhaps you could talk a little bit about the quality of the comparable sales number here.

It seems to me that you are obviously focused more on core customers and last year you weren't.

So I wonder if you could sort of talk about comp store sales per core customer.

I know you won't give me the number but can you sort of talk about that as a trend in the business?

Actually I cannot right now.

But I will tell you that while what you said is directionally true last year we weren't after sales at any costs nor were we disregarding our core customer but it is true this year we are more focused on each of those than we would have been a year ago.

So I certainly agree directionally with what you're saying, I just am not sure I would accept the radical departure from the position last year that you describe.

Okay.

We always just paint things black and white as you know.

That's true.

I understand it.

It does help show contrast better but I want to make sure that you see that this is directionally changed and more gradual than an abrupt change.

That's, I guess, my main message.

And the final thing is just on shrinkage.

One of your concerns in giving guidance for the full year is you weren't sure what the shrinkage results were going to be out of California or the end of it and I wonder given that the shrinkage numbers in general have come in better than perhaps expected if you can talk about if you have done those counts yet and do you find anything funny?

We won't, well, you know for sure where you are in shrink in my opinion as an operating after you have gone through a couple of cycles on inventory in the stores.

We have now, of course, gone through some inventories in many of the stores and are getting a better handle on where we are and there has been no big surprises really from where we had thought we were and I'm feeling pretty good about that.

Now the shrink, generally.

We have improved our shrink in the second quarter as a company.

We have targeted that as you know for the last several years and not made much progress.

We are, though, applying some different sorts of resource this time around and we think we are showing better results.

It's too early in the year to decide that.

Mike, do you want to add anything else?

No, other than the comment you said we improved in the second quarter and actually it is the first quarter.

You wouldn't be accruing an improvement in the first quarter if you didn't expect to see it -- a similar improvement in the second quarter, now would you?

Mark, our accruals are based on historical averages and actually as we go into the second quarter we don't make big right turns or left turns in our accrual rate during the second quarter based on what we saw in the first quarter.

We like to see that trend sustain itself for awhile and we take a fair number of inventories in every quarter and construe that up at the end of the quarter as we see what the actual results are.

We don't look at a one quarter improvement in shrink and say gee, I am going to reduce my accrual by a whole bunch of basis points.

I want to see that trend continue for awhile before we do that.

Sure.

But the first quarter trends for exactly that reason can't be very different than the second quarter, it'sunlikely to be different in terms of the impact on your P&L account.

We would expect continued improvement in shrink when you look at it over time, Mark.

Thanks, Rodney.

Sir, our next question comes from Meredith Adler with Lehman Brothers.

Hi, guys.

A couple of questions.

I would like to talk a little bit about sales again.

I mean I hear that you're trying to be thoughtful about how you invest your gross profit dollars but I was wondering if you could just talk about what you are seeing more generally in the environment?

Are you seeing a consumer that is spending more?

Are you seeing any changes in the competitive environment?

And then I also have a question about inflation.

As -- Meredith, as I look across all the markets, it is real clear to me that the overall economic environment, that is the environment for our customers, has improved.

That is evident and I think you have seen that actually with lots of other companies, too.

But it does remain very competitive.

And it would would vary by market.

We have several markets where it is still pretty hotly contested.

And as a result there are some markets we are quite pleased in and some other markets where we are behind where we would like to be presently.

So it is a tough uphill battle.

But one that you can see already that we have made some progress on.

Great.

And I guess just a related to that is would you say that in the markets where you have made some price investments or promotional investments in the past that you have gotten, you know, some kind of a response or reaction that you're pleased with?

That would be true.

That is absolutely true.

There are several markets I can think of just off the top of my head over the last year, even two years where we made a deliberate investment and where we can see direct results.

Sometimes the results take a little while to develop and sometimes they are quick.

Now, quick in this case is maybe, you know, a quarter or two.

Long-term is maybe a year or so.

But we are clearly seeing response in those areas.

Now it is important also to recognize that our investments aren't just in price and gross profit investment.

As we pointed out it is in product variety, it's in the services we offer, it's in the shopping experience.

Those are all areas that are important to producing improved sales and we are addressing each of those.

Good.

Another question I would have would be about product cost inflation.

I mean so far I think what we have seen is simply commodities and a lot of volatility in those commodities.

General Mills made an announcement yesterday that they were going to be raising prices on some packaged goods and that may be the first of a number of increases.

What is your outlook in terms of the ability to pass along higher costs for packaged branded goods some of which may not be high profile to the customer.

Do you think it gets easier?

Well, I don't know that it is easier or harder.

I would say the same thing that I commented on earlier with Phillipe on inflation, is that it varies by the item and market circumstance.

Our pricing reflects the competitive environment in a particular market.

And so I don't think there is -- there is no way I could globally answer that for instance if General Mills raised the cost to us what we would be able to do because we would probably do something different in each market depending on the situation.

So I don't really see it as a standard rule or anything along those lines.

It is an environment, at least these last several years has been an environment where it has been difficult not just for us to pass along increases but also for the packaged good manufacturers to pass along increases to us.

And the reason it has been hard is when they did it they found that it hurt their sales and that they found that the folks with whom they compete got a stronger position and so they had to reconsider.

So I think that factor and that governor, so to speak, is still clearly in effect.

Another advantage that Kroger has is obviously our strong corporate brand, private label, whatever term you want to use but to any degree that a national brand person would try to have a cost increase that is not consistent with what their actual costs are going up, that just creates another competitive advantage for our private label products and as you know, we have an incredibly strong private label.

And we have found time and time again we when the national brand focus tries to increase prices more than what is economically the right thing to do we gain tremendous share in those categories.

Got it.

Thanks.

One other question?

Yes.

When you talk about the concessions you're getting on the labor front it sounds like you are being successful in capping your healthcare costs.

Is it fair to say that you can envision costs actually going down year-over-year at some time in the future or just to slow the pace of increase?

We have a couple of contracts where it will clearly go down in actual dollar costs.

I suppose I could be wrong on that if the sales went up high enough that the amount of labor used those costs might go up a little but on an apples to apples basis the cost would actually go down when you combine labor and the benefit costs but that is not the general position.

There is a few cases where that is true.

In the other cases it is a very strong moderation or even a flattening of cost growth going forward.

And each contract will be different as we have said before we have to consider the competitive situation in every market as we decide on marketing or as -- on negotiation objectives in a contract.

And in some markets it is important for us to reduce our actual costs.

In other markets we are in pretty good shape and are perfectly fine with moderating those cost increases.

Okay, great.

Thank you very much.

Thanks, Meredith.

The other piece on labor is always focused on improving productivity in terms of the operation of the store, too, and you can't just look at labor costs by itself you have to look at the total operation of the store.

Yea, that is a really good point that Rodney is making.

Because the way we look at the overall costs, they're made up of those two components and probably a few other corrolators.

One is the actual cost of the labor hours and the other is how many hours you have to use to do the same kind of work.

Okay.

Next question?

Sir, our next question is from Edouard Auben with Deutsche Bank.

Yea, good morning.

To come back on shrink.

Could you talk a little bit about the initiatives you have taken and are taking right now and could you quantify a little bit also?

I mean are you above or below industry average today and where you want to be in the future and so on and so forth?

I'll talk a little bit about the methods.

I won't be able to comment in terms of quantifying it for you compared to industry numbers particularly because we don't know, first of all, if others would compute shrink the same way that we would.

The best way for us to benchmark really is our historical trends compared to where we have been and on that measure we have made some improvements.

But the efforts that we have made have focused on two areas that I would describe.

One is procedural or process.

The methods by which we do certain activities helps us solve problems that have been inherent in the retailing food business for years.

And secondly, I would talk about use of technology where we have applied solutions of additional data and using data in ways that is helpful for us to evaluate our business and to change the way we physically present our business that can improve on shrink.

One of the areas that is important to think about shrink, most of us think about shrink at first as loss of product.

Things that have been wasted.

But we also think about shrink from a different point of view is you can actually improve your shrink position by improving your sales.

If you have some products that aren't selling well and you have losses in them, if you can improve the sales in them in that same product, you end up with fewer losses and you end up with less shrink, too.

That is one of the angles that is important to us in future shrink for us.

Do you want to add anything, Rodney?

Good, thank you.

Is there an additional question you had.

Yea, actually, you mentioned in the past that improving warehousing and transportation would be one of your main initiatives in 2004 but without giving a lot of details.

Can you explain maybe to us what exactly you are trying to improve and how different you see the logistics in the next few years?

We see some real opportunity in logistics and I would include both the process of warehousing or picking and selecting of products as it goes through our distribution center and also the cost to transport the product to our stores.

I don't think we will describe the specific initiatives that are leading us to that conclusion, but I am very pleased with our progress to date and believe that over the next several years we will be even more pleased with the results that we are able to achieve.

Great, thanks.

Sir, our next question comes from Steve Chick with J.P. Morgan.

It's actually Alannah calling for Steve.

A couple of questions.

You said in the press release this morning in Table 2, Footnote B that included in the southern California strike impact amounts were reversal of the prior year liabilities of about $4.8 million and what does the reversal relates to and is it store closings?

And also where is it included?

In 31.9 million or 4.5 million is the first question and then second I'll ask later.

I'll have Mike Schlotman answer that question.

The reversal relates to an accrual for some vacation obligation to people who were replacement workers in the stores from across the country who had the option to take their vacation in cash or in days off and fewer people chose cash than we originally expected, so we reversed that accrual in this quarter.

Where that would be is in -- it is not in the 31.9.

It is part of the 4.5.

The 31.9 is only the strike assistance payment expense in the quarter.

So you're saying it's in 4.5.

Yeah, the 4.5 would have been 9.3 if not for the reversal.

I see.

Okay.

Great.

And then the second question.

Can you quantify the contribution to health and welfare fund and and the contract ratifications.

I think that both Safeway and Albertson's gave us those numbers.

The contract ratification, I don't know what the cost of that was off the top my head.

I mean we could get that for you.

The contribution to the health and welfare fund is -- we actually expensed that last year.

And we announced that last quarter.

We expensed that in the fourth quarter of last year because that payment was actually due as a result of the old contract that expired last year.

That expiring contract said that if we entered into a new agreement without uncapped healthcare which is what we entered into because we have capped healthcare that we had to increase the reserves in the health and welfare fund so in our mind that was a subsequent event.

A type of subsequent event that required us to expense that in the year that the contract expired and it was, you know, in the mid $30 million range of what we actually expensed in the fourth quarter of 2003.

Okay.

Great.

Thank you very much.

You're welcome.

Sir, our next question is from Mark Willamuth with Morgan Stanley.

Good morning.

Good morning.

If you could talk about the sequential trends and the identical store sales.

Looks like you had a setback from the fourth quarter levels and we also saw some sequential setbacks for the fourth quarter out of Safeway and Albertson's.

I'm just curious if you could comment what is behind that?

Well, Mark, one thing we said last quarter when we were talking about expectations for the first quarter was to remind everybody that in the preceding year, that would have been in the first quarter of 2003, because of weather-related opportunities that improved our sales in 2003 that our early sales in the first quarter of 2004 or at that point we already knew that in the first period or so were not as high as what we expected later in the quarter.

That ended up obviously being true for us.

And I don't know that we specifically talked about it but we have now talked about the fact that Memorial day for us was a swing of 20 or 30 basis points from being last year in the first quarter and this year being in the second quarter.

And so those are two reasons that you saw some decline from the fourth quarter.

Now, in addition to that, fourth quarter was strong.

As we have said, we were very pleased where those were and that became our target objective then for where we wanted to be this year when we saw what that could represent.

So you're right.

Generally, it is a little lower than the fourth quarter but it is certainly sequentially if you go back now for the last two years, I don't have them in front of me, I think other than the fourth quarter it is consistent with improvements and probably about equal with the third quarter last year.

I think it was.

Mike is looking at the chart.

Third quarter last year was 40 basis points.

Yeah, so we were depending on whether you want to take the without fuel number, the without the strike affected stores or whether you want to take the without fuel number with the strike affected stores we would have split the third quarter number on both sides of that, right?

Right.

The other thing, Mark, to keep in mind to the extent there is any length between inflation and sales inflation without fuel was 50 basis point lower in the first quarter than the third quarter.

Right.

Historically the relationship between those two wouldn't you expect the identical store sales number to be higher than the inflation number?

Typically we like to see that.

Some of the questions earlier were a lot of the inflation that we've seen has been in commodities and typically you see inflation in commodities lag being passed on because many of the commodity items are front page feature kind of items and you always want to stay competitive on the front page.

So as well as commodities go up and go down down quite regularly and there is always the sense of let's hope this increase in meat is only temporary before we adjust our retail pricing to reflect that.

So when you see a lot of inflation in commodity based products you don't always see a direct correlation and generally speaking you see a lag because people wait to see that the higher costs are there for awhile.

Is that translating to better penny profits for you right now or is that there a lag in that as well?

Depends on the items.

When you have a higher price if you don't make up the margin percents it will be difficult, of course, I suppose you get the price high enough you could make up in terms of pennies.

But I would say it has gone both ways.

Milk is a good example because milk increases in the last couple of months have been the highest increases month to month that I think I have ever seen in my career.

Milk is extremely difficult to understand because we also happen to operate in 11 states that have minimum milk pricing laws and I won't get into how every state calculates the minimum milk pricing but you don't always wind up with the minimum milk price that represents that actual increase in the cost of the underlying milk.

While there could be a minimum out there that you can sell milk for it may not accurately reflect the total increase in the cost of the milk.

So you know, people wind up gravitating to the minimum price because they want to stay competitive and that may or may not reflect all the inflation that's occurred.

Okay.

So you're saying when it goes both ways, you are saying there are times when the penny profits contract and there are times with they expand but you don't have a general comment for us?

I don't think we would have one.

Rodney?

The only thing that makes things a little more complicated on certain items the volume changes, too.

When you look at milk, and if you look at milk prices when it goes up to 50 cents to a dollar a gallon that affects tonnage.

So you actually may be making equal or more cents per gallon on the ones you sell, but the customer will not buy as many gallons as what they have in the past.

Now that is obviously different.

I mean gasoline you have a completely different set of dynamics but each item actually has different set of dynamics relative to that.

We look at the collage of items that we sell.

While we of course look at each individual one and look at it, but each market as we have described is going to be difficult to predict and will be different than the last market.

What is important is looking at the total mix of what we sell and what we end up with at the end of the day and that's how we are trying to approach our business is what kind of gross profit dollars can we generate off of the sales that we are generating.

Okay.

Thank you.

Mark, just one other comment relative to the sequential change on identicals if you look at since the second quarter of 2002 this quarter was the best identicals to the food stores without fuel except for the fourth quarter of any quarter during that period of time.

Okay.

Thank you.

Thank you.

Sir, our next question comes from Jason Whitmer with FTN Midwest Research.

Good morning.

Hoping you could put a little color around your balance sheet.

The a store deposits and transit.

Mike Schlotman will be happy to.

Mike?

I will try to do this in a manner that I won't confuse the other people in the room that are accountants because I tried this yesterday when we went through the earnings release with our audit committee and I got some stares from other people in the room that are also accountants.

We have two things that go on in our business.

One is as we write checks to pay for product we write those checks on accounts that don't get funded until the checks clear.

So when I owe G&G money and I write them a check, I still have an accounts payable for that even though I have written them a check because I don't haven't to fund that check until it clears.

That results in the technical book overdraft in my checking account just like if you wrote a check and didn't have any money in there yet you're technically overdrawn on your books but not the bank because the check hasn't cleared.

On the other side of the ledger we have cash and checks and credit card receipts from our stores that have been deposited to the bank that they have not given us credit for.

Typically those wind up being the same bank that I have to fund checks that haven't cleared and they owe me money for checks and credit card receipts I have deposited that haven't gone through the fed yet.

Historically the checks we've written exceeded the deposits we made so we were still in a net obligation status to the banks.

That has turned where now the checks we have written are less than the deposits we have made so actually results in net positive cash when you look at that.

Because of that, we have decided to gross those two numbers up on each side of our balance sheet.

So now we're showing everybody the cash that is in transit from our stores to the banks and in payables we are showing the full amount of payables including checks we have writ than just haven't cleared the bank yet.

In the past that would have been netted all in payables.

It would have been netted all in payables historically.

We made the change for both years so that the numbers are comparable.

Alrighty.

Fair enough.

That wasn't a very confident alrighty.

How about on the operational side.

It's been a little while since we heard anything on centralization and divisional consolidation.

Can you give us an update there, the timeline where we've been and where we are going and the some of the focus on those kind of things?

Well, the two questions you asked, one is on centralization, which is I presume you're talking about the role here at our general office that we play in terms of merchandising and buying and some other services that are provided for our divisions and then the second part was on division consolidation which I presume you're referring to the last time we did that which was a year-ago where we combined our Michigan division and our Columbus division to create the Great Lakes division.

First let me start with that.

The Great Lakes division is doing very well.

So well that we promoted the President of that division to come in here and work with other divisions and we are quite pleased at how that has gone.

The folks in Michigan have done a fabulous job of making this all work and, of course, the folks in Columbus have had to do the same.

We have -- we have used much of the talent in fact I would say about all of the talent through the organization in different jobs and different places but I think that has worked out extremely well as have some of the other division consolidations that we had in preceding years.

So that part we're pleased with, happy with, don't have any current new announcements to be making on that front and so I view that basically as old news but good news.

The second area is the centralization.

The things that we have brought in to general office as service to the entire company.

And that has gone pretty well.

We do have a few smaller areas that probably need to be addressed still in terms of broadening the degree to which we serve the entire organization.

Because of systems, generally because of systems, we have not always been able to address the entire company from one location.

The more we move to those common systems the more we are able to move information to one common source.

Then we are more able to address with one common work group the entire company.

And that is -- those are more subtle differences.

And as a result I would say that is really what our plan is for this year.

Now, Don, do you want to add anything more that?

I think characterizing it Dave with the simpilization efforts we made thus far.

We've had a lot of learnings and in many ways a lot of benefits.

We continue to look for opportunities like that.

Today is platforms and systems that we continue to work with and as we work through those we will continue to look for more opportunities.

One of the real big helps to us was when we got to what we referred to as enterprise systems which is a common set of systems throughout our company for certain purposes.

There are still and we are looking at the next range of enterprise systems that need to be addressed because we have some systems that are a little out of sync and it increases our cost to operate and it increases the cost to maintain the systems and increases our costs because we are not able to collectively bring in information in one flow of one system so to that extent we are working that area.

But I see this as an area that we learned a lot and improved a lot and are quite pleased with the results currently.

Good.

And last thought here on the sales front.

Could you provide some more inflections on volume and traffic and just general market share to give us a sense of, you know, more the baseline improvements or momentum within the food side of things?

I think the only market share information we release is what we released in the first quarter and I'm not sure I want to repeat it by memory.

I can tell you part of it by memory.

We had 52 major markets and those are major market for us has nine or more stores in it.

I'm looking around to get corrected if we need to be.

Of those we were number one or number two in 43 of those markets and I believe it was 28 markets had increases in market share.

Yes.

Isn't that correct?

Yep.

Of the 52.

And then we had a weighted average on the market share for that group.

What was it, flat?

It was unchanged for that period and that represented -- that was the numbers we gave in February or March I guess is when we released those and that is probably all we would give on market share.

Although we see in the current environment that that is a pretty positive picture, really.

And we need to improve on that.

We want to see those market share numbers go up, even given because we look at market share as the whole range of places that these products are sold and that is actually the story of what happened and what has changed in our industry is the fragmenting of where people buy the products that we sell and so that's a pretty good position to be stabilizing that number in the way in which we measured it.

And that is looking at market share on everybody that sells the items we sell.

Right.

If you look relative to traditional competitors we continue to gain share and we have for a long period of time.

Yea, that's a good point, Rodney.

If you look at the way A.C.

Nielsen would measure market share, for instance, and we do track that they show remaining foods for instance and they would exclude for the moment what Wal-Mart does in their supercenters and the remaining food with our existing competitors we consistently and for some period of time have shown market improvements.

Market share improvements but we think that is not a broad enough market share.

We need to look at all the places our products are purchased by our customers because that is really what our competitor has become in the last several years.

Thank you very much.

Sir, our next question comes from Bob Summers with Banc of America Securities.

Good morning.

Can you just talk about how IDs trended during the quarter.

Also, where are we on the stock buyback program?

And do you look to increase that authorization?

And then finally you talked about tightening capital but you reiterated Cap Ex of 18 to 2.0.

But when you look at the run rate in the first quarter, it suggests that you know, full year spend is a little lighter than that.

I will answers the IDs and then I'll have Mike Schlotman comment on stock buy backs and Cap Ex.

But before let me just talk about the IDs for a second.

We don't release the trends through the quarter except that what we have said already are two things.

First is that the first period of the quarter we said this actually when we reported fourth quarter the first period of the quarter was not as strong as what we would have wanted or expected.

And it was because the year before was the strongest it was due to weather fluctuations in various markets.

And so you can see from that that we started off slow and grew.

That part would be true and that is obvious I think from what we said.

The second is Memorial day shift.

When it shifts that then, of course, meant that the last week or two of the quarter was weaker than the preceding year because of the rise that you would ordinarily get with Memorial day selling coming about.

So at the very end of the quarter it would have trended off because of that but then obviously because Memorial day is now in this quarter we saw an immediate jump there to begin with in the quarter because of the swing in that Memorial day holiday.

Okay.

So then putting words in your mouth adjusting for Memorial day you had a, you know, sequential improvement throughout the quarter?

I don't think I'm saying that.

I'm saying the first period was lower around the rest of the quarter was better.

Okay.

That part I would say.

I don't have it in front of me periods two, three and four and your comment implies that each one went up sequentially and I can't verify that because I don't have it in front of me nor do we release the period numbers anyway.

Mike, do you want to comment on the stock buyback and Cap Ex?

Yea, relative to Cap Ex, I agree if you just simply annualize what we spent in the first quarter, you would get a number well below the range that we talked about today.

However, I would point out that with what we spent in this year's first quarter is very comparable to what we spent in last year's first quarter and our spend for last year wound up within -- if not within, right around the range that we are talking about for the year and that is not an unusual phenomena.

You know, we did say in the prepared remarks that we continue to have a focus on tightening capital and I would say that is true.

We just aren't at the point -- at this point it doesn't make any sense to change, you know, we have nine periods to go even know it seems like the year is half over we are only one quarter of the way into it ourselves.

So we have got a long way to go for the year and it just doesn't seem to gain us anything by changing what we expect to spend at this point.

The other thing is to remind everyone last year in the first quarter we had about $200 million of capital for the repurchase of some real estate that had previously been off balance sheet.

Right.

When you adjust that $200 million out that gets you back to an apple to apples number.

Good point Rodney.

Relative to the buyback.

We are right around $40 million left in our existing authorization and, you know, I'm not going to sit here and announce a reload of that authorization this morning, that's for sure.

But I will tell you we are not changing our expectations of how we plan to use free cash flow going forward and that is one third on debt reduction and two thirds on stock buyback.

Ultimately the decision to reload that buyback ability would be up to our board.

But it is something you would expect?

I will not go there.

Okay.

Thank you.

Okay, thank you.

Sir, our next question is from Jack Murphy with Credit Suisse First Boston.

Good morning.

Hi, Jack.

A couple of questions.

When you answered Meredith's question regarding some of the year-over-year labor and costs actually being done in some markets I was wondering if you could tell us, you know, the characteristics of those markets in particular?

You have higher than usual turnover in those markets.

And then a related question.

When you look at southern California, how much of the -- how much of that work force do you think will be in the second tier within a year or two?

Well, first on the labor costs, one of the characteristics of those markets, probably the only characteristic we can describe is that our costs were less competitive than they needed to be and so it required more adjustment there than other markets require.

Some markets we were in fine shape on labor costs and as a result those wouldn't typically follow that kind of a pattern.

The turnovers in those markets I don't think that there is a material difference in those markets versus other markets.

I don't believe.

One of them actually would have a little lower turnover now that I think about it.

But at least on a historical basis.

Now, turning to southern California, you asked there about the workforce.

And you're asking to us predict when would we be in to lower costs and I'll have Don maybe comment on the return of the workforce but we really don't have any predictions as to when we will be back or when we will be in a position where we would say, you know, 50% of the work force is new hires.

I don't think we have any targeted numbers like that.

Don, do you want to comment on the returning workers?

In southern California, in terms of the associates not returning to work we actually had more not return to work than we expected.

That does present some operational issues.

Largely, training.

But on the other side, it also gives us an opportunity to benefit sooner than we expected in terms of the ability to hire under the new agreement.

So it is a little bit of a positive and a negative.

Negative in the sense that we are today spending more money in terms of training and development but over the long haul actually will get into the contract benefit sooner.

On average the employees that did not come back, were they cheaper, less experienced on average?

We actually had some of both.

We had some people who were experienced, that is the need for the training.

And we had some who you would expect.

That part we expected which would have been the lower level entry rate type employees.

But we did have quite a number of experienced people who also chose not to return.

And then just one quick question.

On the presentation of the numbers going forward, you talked about 30% of the expenses and I guess that would translate into 3 of the 10 cents for the strike that were post-strike impacts.

Will you be breaking that out in future periods or is this kind of the last time we will see, you know, a carveout for strike impact?

As long as it is a meaningful number we will continue to break it out.

Because we just think it will be helpful for you to see and know what that number is.

So we would plan to do that assuming that it is meaningful enough to do that.

Okay.

Thank you.

Thank you, Jay.

We have time for one more question.

We will take one more question now.

Our next question is from Chuck Cerankosky with KeyBank Capital Markets.

Good morning everyone.

Hi, Chuck.

Just a quick strike question.

Can you break out in the strike impact costs what is directly due to the strike and what is, call it, recovery portion?

If you look at the recovery portion, the 10 cents, about 30% of that or 3 cents would be recovery portion, Chuck.

Most of that would be in gross margin is where those dollars are showing up if you look at it between gross and OG&A.

So large, the bulk of it then seems to be behind us.

Looking at your --

I think it's really too early to make that decision one way or the other.

Because really the competitive marketplace will determine whether that is true or not.

I did say it was continuing to moderate as we go through the quarter but we don't know what our competitors are going to do so to specifically say yes, it is going to be X, it is too early to make that comment.

If you hit your same store sales target for this year will you be able to leverage your OG&A line?

That is a great question, Chuck, one we asked ourselves quite often.

You can see in the OG&A area that for the year, for this quarter so far, the health and welfare certainly was the issue.

And we said that actually before the year started that that was the issue.

We have pushed ourselves on that area to try to see if we can't get those costs to moderate as they are in the number of labor contracts and we do expect further progress on our OG&A in each quarter that goes through the rest of this year.

Whether or not the sales increase can offset what is happening in health and welfare I'm not sure I can predict.

I can certainly predict where we are headed is a declining rate and we see it as important because as sales grow we think that it makes the job on OG&A that much easier.

One other comment on costs is to remind you that we are looking at costs, too, really beyond just OG&A.

We look at costs in total of operating our business which include those costs that are embedded in gross which is shrink and advertising, warehousing and distribution costs two of the three.

Transportation.

Rent and depreciation.

Right.

We look at all of those as costs we have to look at trending down.

Internally our own objective relates to those numbers combined, not just to the OG&A.

Although the way it's current publicly reported would relate to the OG&A.

About all I think we can forecast at the moment is that we do expect the trend to improve through the rest of this year on OG&A.

We do think that improved sales will help that trend.

We also think some of the steps we are taking to control our costs and the labor negotiations that we have gone through will help in that regard as well.

Rodney, do you want to add anything to that?

No.

Anything else, Chuck?

Thank you.

Thank you, Chuck and we want to thank everyone for joining us today.

We appreciate all your questions and for following up, call Carin.

Great.

Thank you.

Ladies and gentlemen, we thank you for your participation in today's conference and this concludes your presentation.

You may now disconnect.