克羅格 (KR) 2005 Q4 法說會逐字稿

Good day, ladies and gentlemen. and welcome to the Kroger Company Fourth Quarter 2005 Earnings Conference Call.

My name is Cindy, and I will be your coordinator for today. [OPERATOR INSTRUCTIONS] I would now like the turn the call over to Carin Fike.

Please proceed.

Thank you for joining us.

Before we begin I want to remind you that today's discussion 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 SEC filing.

But Kroger assumes no obligation to update that information.

Our fourth quarter press release, as well as this morning's press release about Kroger's dividend announcement and our prepared remarks from this conference call, will be available on our website at www.kroger.com.

Now I will turn the call over to Mr. Dillon.

Thanks, Carin, and good morning, everyone.

We're pleased you could join us to review Kroger's fourth quarter and fiscal year 2005 financial results.

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'd like to begin by recapping some highlights of Kroger's fourth quarter sales results and then I'll provide market share information along with sales and earnings guidance for 2006.

Rodney will discuss Kroger's fourth quarter and fiscal year 2005 results.

He will provide additional detail on our 2006 guidance, and then we'll be happy to take your questions.

The continued focus of Kroger's associates on delivering improved service, product selection, and value to our customers has generated another quarter of impressive sales growth.

Total sales for the fourth quarter increased 7.5% to $14.7 billion.

This growth was broad based across all divisions and store departments.

Grocery, produce, bakery and fuel sales were particularly strong.

In addition, our holiday sales were well planned and well executed by our associates.

The convenience stores turned in another solid quarter of sales growth, not only in fuel sales, but in non-fuel merchandise too.

Fourth quarter identical supermarket sales increased 6.2% with fuel and 4.7% without fuel.

This represents Kroger's tenth consecutive quarter of positive identical supermarket sales, excluding fuel.

Fourth quarter comparable supermarket sales, which include expansions and relocations, increased 6.7% with fuel and 5.1% without fuel.

Our fourth quarter identical supermarket sales results reflect Kroger's highest identical supermarket sales since the merger with Fred Meyer in 1999.

All 17 of our supermarket divisions had positive identical sales growth.

We are extremely pleased by this performance.

As we discussed before, sustainable identical sales growth is a key driver of Kroger's financial objective to increase earnings and generate value for our shareholders.

Each year at this time, we provide you with statistics that describe Kroger's market share.

The market share figures that we report are based on internal estimates.

We include all retail outlets that sell merchandise comparable to our own, including super centers and other non-traditional retail formats, such as dollar stores, drug stores, and warehouse clubs.

Although we look at market share statistics provided by a variety of third party resources throughout the year, we believe it is important to take a broader view of the market to understand any shifts in this area and respond to them appropriately.

When you're doing your own analysis in this area, please keep in mind that many third party market share data providers do not include these alternative formats.

Kroger defines a major market as one in which we operate nine or more stores.

By this definition, Kroger serves customers in 44 major markets.

Last year that figure was 52.

The decrease is primarily due to a realignment of metropolitan statistical areas, or MSA's by the U.S.

Census Bureau.

We rely on the Census Bureau reports to obtain the total sales potential for a particular market in order to calculate our market share.

Under this MSA realignment, certain markets were combined with other markets, and other markets were separated into two or more markets each containing less than 9 of our stores.

In our count of 44 major markets, we also excluded the San Francisco and Sacramento MSA's due to the market exits we've announced for 2006 under our Cala Foods, Bell Markets and Ralph's banners.

We'll continue to operate price impact warehouse stores under the FoodsCo banner in these markets, but neither MSA contains sufficient FoodsCo locations to meet our definition of a major market.

Now for the market share detail.

For 2005 Kroger held a number one or number two share position in 35 of our 44 major markets.

Kroger's overall market share in these 44 markets rose more than 35 basis points during 2005 on a volume weighted basis.

Our share increased in 29 of those 44 markets, declined in 12, and remained unchanged in three.

Kroger competes against 1,129 super centers, an increase of 109 over last year.

There are 32 major markets in which super centers have achieved at least a number three market share position.

Kroger's overall market share in these 32 markets rose more than 50 basis points during 2005 on a volume weighted basis.

Our share increased in 24 of those 32 major markets, declined in seven, and remained unchanged in one.

Of the 1,129 super centers that I mentioned, 875 are operated by Wal-Mart.

This is an increase of 94 over last year.

Wal-Mart Super Centers have achieved at least a number three share position in 28 of the major markets where Kroger faces significant super center competition.

Kroger's overall market share in these 28 markets rose nearly 40 basis points during 2005 on a volume weighted basis.

Our share increased in 20 of these major markets, declined in seven, and remained unchanged in one.

I realize that all those market share data could be overwhelming, so let me recap the most important points.

First, Kroger's overall market share in our 44 major markets rose more than 35 basis points during 2005.

Second, our share gains in the markets where we face significant Wal-Mart Super Center competition were even stronger.

In those markets our overall market share rose nearly 40 basis points, and third, we fared even better if you include all the major markets where we face super center competition.

This is Kroger's best performance since we began tracking this type of information.

A popular theme among some investors in the media these days is that traditional supermarket operators, like Kroger, are being squeezed out of business by price focused discounters at one end and high-end specialty retailers at the other.

To the contrary, the market share statistics that I just shared with you show that Kroger continues to grow in this highly competitive industry environment.

We believe these statistics clearly demonstrate that our strategy to connect better with our customers is succeeding.

Our retail price investments, combined with our service and selling initiatives, led to excellent market share gains in 2005.

Kroger's significant market share continues to be one of our key competitive strengths and we believe that it is critical to further improve our market share in 2006 and beyond.

There's plenty of room for further growth, even with Kroger's strong share in our 44 major markets, almost 50% of the share in those same markets is held by competitors without our economies of scale.

Well, turning now to Kroger's expectations for fiscal 2006.

Over the past several years, Kroger has been transitioning its business model to meet the changing needs and expectations of our customers.

This strategic plan requires a balance among several elements including sales, earnings, and capital investment and is driven by strong sustainable identical sales growth.

Kroger plans to grow identical sales through merchandising and operating initiatives that improve the shopping experience and build customer loyalty.

These initiatives will be funded by operating cost reductions and productivity improvements.

As a result of this strategy, Kroger expects to deliver earnings per share growth in 2006 and 2007 of 6 to 8% per year.

In addition, shareholder value will be enhanced by the yield associated with the cash dividend we announced earlier today.

The estimated range for earnings per share growth in fiscal 2006 includes the effect of beginning to recognize stock option expense, which is largely offset by the benefit of a 53rd week in fiscal 2006.

Kroger's earnings per share growth will be driven by three factors.

First, strong identical sales.

We expect to achieve identical supermarket sales growth in excess of 3.5%, excluding fuel sales.

Second, slightly improving operating margins, primarily resulting from continued improvement in southern California.

And three, fewer shares outstanding due to continued share re-purchase activity.

Now Rodney will review Kroger's fourth quarter and fiscal 2005 results, as well as some additional guidance for 2006.

Rodney.

Thank you, Dave, and good morning, everyone.

Kroger reported net earnings of 282.1 million or $0.39 per diluted share for the fourth quarter.

In the year ago period Kroger reported a net loss of 652.1 million or $0.89 per diluted share.

The year ago results include a goodwill impairment charge of $903.8 million pre-tax that affected net earnings by 860.8 million or $1.17 per diluted share.

Some of you may have noticed back in December, Kroger sold nine shopping centers anchored by Kroger stores for approximately $80 million.

Following this sale, we assigned a long-term lease agreements with the buyer to continue our operations in each of the nine Kroger stores.

In accordance with Generally Accepted Accounting Principles, the gain associated with the sale of these shopping center properties will be recognized over the term of the lease agreements.

Thus the sale had no effect on our fourth quarter earnings per share.

Now turning to gross margin and OG&A.

FIFO gross margin was 24.85% of sales, a decrease of 22 basis points compared to the fourth quarter of 2004.

Excluding the effect of retail fuel operations, FIFO gross margin rose 32 basis points from the prior year.

When we analyze gross margin internally, we use a term that we call 'selling gross margin' to describe Kroger's gross margin before incurring expenses directly related to distributing and merchandising the products on our store shelves.

These expenses include advertising, warehousing, transportation, and shrink.

Selling gross margin is a measure on - - of how competitively we are pricing the products we sell.

Kroger's fourth quarter selling gross margin on non-fuel sales declined approximately 23 basis points.

In other words, we were able to use improvements in shrink and warehousing expense to fund additional targeted investments in competitive prices for our customers.

This remains an important part of Kroger's strategy.

OG&A declined 38 basis points to 17.98% of sales.

Excluding the effect of retail fuel operations, OG&A declined 6 basis points.

Leverage from strong identical sales, plus cost control in areas such as health care and workers' compensation, helped offset increases in credit card fees, pension, and energy related costs.

Improvements in OG&A expense at Ralphs also contributed to this decline.

Excluding our retail fuel operations, we estimate that higher energy prices negatively affected gross margin by 5 basis points and OG&A by 8 basis points for a total negative effect of 13 basis points or approximately $17 million pre-tax.

In 2005 strong cash flow enabled Kroger to carry on its financial triple play strategy.

And that is to deploy cash to grow the business and maintain our high quality asset base, reduce debt, and return value to shareholders through share buybacks.

We believe achieving the financial triple play is important for our future success.

Capital investment totaled $1.3 billion for the year compared to 1.6 billion in 2004.

During 2005 Kroger opened, expanded, relocated, or acquired 52 supermarkets.

We continued the expansion of our multiple format strategy.

Our store portfolio now consists of 2,214 combo stores, 143 price impact warehouse stores, 123 multi-department stores, and 27 marketplace stores.

The roll out of the marketplace concept has followed our general strategy for format expansion.

You might recall that in Phoenix we converted some of our existing stores to the marketplace format back in 1999.

When we were comfortable with the economics of the business model for our new store, we built a concept store from the ground up.

This store is located in Chandler, Arizona.

The next step is learning how to operate the concept in other markets, which we did first in Salt Lake City and then in Columbus, Ohio.

Now we're ready to expand the format to another market.

In 2006 we plan to open two marketplace stores right here in our home town of Cincinnati, Ohio.

We are very excited about these plans and our ability to further segment our diverse customer base with our multi-format strategy to meet our customer needs.

Also during 2005, we remodeled 147 stores and closed 66 locations, including 54 operational closings.

Net total debt at the end of the fourth quarter totaled $6.9 billion.

That's $800.7 million less than a year ago.

Net interest expense for the full year totaled $510.4 million, a decrease of 46.6 million versus a year ago.

We have reduced net total debt by $1.9 billion since January 2000.

Our investment grade rating is very important to us.

We are focused on improving our coverage ratios.

Our net total debt to EBITDA ratio in the fourth quarter was 2.06.

This is our best performance on this measure since Kroger's leveraged recapitalization in 1988.

During the fourth quarter Kroger re-purchased approximately 2.6 million shares of stock at an average price of $18.93 for a total investment of 49.4 million.

At the end of the fourth quarter, there was approximately $114.3 million remaining under the $500 million stock buyback announced in September 2004.

Since January 2000, Kroger has invested $3 billion to re-purchase 155.7 million shares of stock at an average price of $19.13.

Kroger continues to buy back stock.

Our customers response to Kroger's strategic plan has now made it appropriate to return value to our shareholders, both through our current stock re-purchase plan and additionally through the payment of a dividend.

Earlier today Kroger announced that its Board of Directors has adopted a dividend policy and declared the payment of a quarterly dividend of $0.065 per share.

The board's approval of the dividend and the continuation of the share re-purchase program underscores its confidence in Kroger's strategic plan.

Needless to say, this is a monumental event for the company.

As Kroger has not paid a cash dividend since our leveraged recapitalization in 1988, some eighteen years ago.

Kroger's board will review the dividend annually with the objective of increasing the amount of the dividend.

Any changes in the dividend amount will be made after consideration of the needs of the business, the interests of shareholders, cash flow trends, and other factors.

We continue to be guided by our long-term financial strategy of using one third of free cash flow for debt reduction and two-thirds for share re-purchases and the payment of a cash dividend.

Before sharing some additional guidance for 2006, I would like to briefly review some of the objectives for 2005 that we outlined for investors a year ago.

Thanks to the hard work and dedication of our associates, Kroger delivered a strong performance in 2005 that exceeded our original expectations.

At the beginning of fiscal 2005, we expected to achieve identical supermarket sales growth in excess of 2% for the full year, including southern California and excluding fuel sales.

When we reported our second quarter results, we raised that bar to exceed 3% for the balance of the year.

Our identical supermarket sales growth, excluding fuel for fiscal 2005, was 3.5%, well in excess of our original goal.

We expected fiscal 2005 net earnings to increase compared to 2004, excluding the effect of the goodwill impairment charge.

On a per share basis we originally expected fiscal 2005 net earnings per share to exceed $1.21 as a result of four factors.

First, improved results in southern California.

Second, growth in the balance of the company.

Third, lower interest expense and finally, fourth, fewer shares outstanding as a result of stock buybacks.

When we reported our first quarter results, we raised that target to exceed $1.24 per diluted share.

Today we reported fiscal 2005 net earnings of $1.31 per diluted share.

Each of the four factors I mentioned contributed to our 2005 earnings per share growth.

We believe that this is a very strong performance in a challenging operating environment.

In 2005, Kroger invested cost savings and productivity improvements to improve our customer's shopping experience through enhanced service, product selection, and value.

Successful execution of this strategy resulted in a better balance between margin and sales growth.

The structure of our incentive plan for 2006 will further encourage this balance to deliver sustainable sales growth, earnings growth, and an improved shopping experience for our customers.

We would now like to provide some additional guidance for 2006.

Dave already outlined our identical sales and earnings guidance for 2006.

I would like to add that this guidance assumes that the same highly competitive environment we see today stays the same.

It also assumes that energy prices remain at the level where they are today.

Here are some other expectations that are incorporated into our guidance for the year.

We plan to invest approximately 1.7 to 1.9 billion in capital projects, excluding acquisitions.

These capital projects include 30 to 40 new stores, 150 to 175 remodels, and other investments to support our customer-first business strategy.

We anticipate supermarket square footage growth of 1.5 to 2% before acquisitions and operational closings, with an emphasis on large, fast growing markets.

We expect to make a cash contribution of 100 to $150 million to the company sponsored pension plans.

This is a reduction of 150 to 200 million from 2005.

We plan to adopt the expensing of stock options in the first quarter of 2006.

Our estimate for this action will reduce fiscal 2006 net earnings by 0.05 to $0.06 per diluted share.

We estimate that our effective tax rate will be approximately 37.5% and cash taxes will be approximately $160 million higher than last year, primarily due to higher net earnings.

Recall that we also enjoyed a cumulative reduction of approximately $340 million during fiscal 2002, 2003, and 2004 in our cash tax payments due to federal bonus depreciation legislation passed by Congress in 2001.

That provision expired in December 2004.

And the related cash benefit now started to reverse in 2005.

Labor negotiations will continue to be a challenge in the face of competitive pressures and rising pension and healthcare costs.

We'll be back at the bargaining table in 2006 with a number of contracts covering smaller groups of associates, but nothing of the magnitude we faced in 2005.

While we do not give specific quarterly guidance, I do want to point out the timing of certain items that will affect our quarterly results during 2006.

The estimated stock option expense of 0.05 to $0.06 per diluted share will after affect each quarter of the fiscal year.

Expenses with the San Francisco and Sacramento market exits, that Dave mentioned earlier, will occur in the first half of 2006.

This has been reflected in our guidance for the year.

The sales and earnings benefit of the 53rd week, that Dave mentioned, will occur in the fourth quarter as it contains the one additional week for the year.

We believe that Kroger's 2006 strategic plan is the balanced approach that will allow Kroger to meet the wide ranging needs and expectations of our customers.

This in turn will position the company to deliver value to our shareholders in the form of a strong business model that produces solid, sustainable growth in both earnings and the dividends that we announced earlier today.

Now I'll turn it back over to Dave for some closing remarks.

Thanks, Rodney.

We're very pleased with our results for the fourth quarter and fiscal 2005.

As Rodney discussed, our fiscal 2005 results compared very favorably to each of the objectives we outlined for you at the beginning of 2005.

During 2005, we made progress on many fronts.

We grew our average market share by more than 35 basis points in a highly competitive environment.

We showed even stronger growth in the super center markets.

We continued it improve our pricing position with an increased focus on non-price initiatives, such as improved customer service and product selection tailored to match the broad mix of customers who shop in our stores.

Already 2006 is proving to be a year of continued consolidation in our industry.

This process began several years ago and will continue for several years ahead.

Kroger's financial strength positions us to take advantage of the many opportunities that consolidation provides.

In this environment we will continue our focused efforts to connect directly with customers in 2006.

We believe that our multi-format approach and our ability to segment our customer base uniquely positions Kroger to serve the very diverse needs of today's grocery shoppers.

We're working harder every day to become increasingly relevant to each and every customer who shops our stores.

And we have the expertise and technology to do so.

We'll now be happy to take your questions.

[OPERATOR INSTRUCTIONS] Your first question is from the line of Steve Chick from J.P. Morgan.

Please proceed.

Hi.

Thanks.

Good quarter.

Thank you, Steve.

Some exciting news.

Just a question maybe for Mike or Rodney.

With your capital spending level that you're increasing for next year, your CapEx D&A ratio this year looks like it hovers around one.

That's usually pretty low.

Is it a function of getting back to a normalized rate of spending or do you think maybe there is room to bring that down as you head into next year as well?

As you know, we always continue to focus on making sure we use our capital wisely.

We do feel to have some additional opportunities with remodels in our plan will be to get additional remodels done in '06 versus what we did in '05.

Part of it will be that.

With that said, we will continue to focus on being tighter with capital rather than looser with capital.

The other piece, we are start to go see some improvement in our performance to budget on the capital that we have spent over the last couple years, and as we see that continued improvement, that will also give us more comfort in spending a little bit additional capital.

Mike, anything you want to add?

The other thing is we're spending a lot of time and energy to make sure we get fiscal 2007 storing program off the right food and built into our plan to some expectation that we'll be spending some dollars in the second half of '06 on '07 openings to we hit the ground running in '07.

I guess it has been amazing this year would you have been able to achieve the sales you've gotten with a pretty low level of capital spending, and doesn't sound like to me -- I guess what I am trying to look at is if you under spent and it was a pretty good year and doesn't sound like you think of it as having to catch up as you head into sixth sike at this point?

Certainly not.

It would certainly be early as Mike said for 2007 and certainly several good opportunities we see for '06.

Okay.

And second question related to cash flow, I guess, with the new dividend and the two-thirds, one third allocation, you're operating cash flow has actually been flat to down for two years.

If you spend a little more in capital spending, it sounds like that remaining piece after the dividend is a lot lower, that you can allocate between share repurchases and debt pay down.

Are we -- how at risk is it that you might end up buying back a little less stock as you look -- as you go through '06?

I think if you look at our cash flow levels, we're comfortable that we're going to be able to maintain and do all three of those.

Obviously any time you decide to have a fixed use of cash like a dividend that is less dollars I have to supply to stock buyback, but when you look at two-thirds of what a reasonable amount of cash flow would be and if you actually looked at operating cash flow minus investing cash flow,s quite a strong number this year, and that's actually a lot better number than the prior year, and I think we have plenty of room to continue to do all three of those, and, as we like to call the financial triple play and execute on all three of those strategies.

It is readily apparent if I pay this kind of dividend, that's less we have to buy in stock.

We factor that into our plans going forward.

Right.

Your cash was clearly supportive.

It is just as I recall I think you have 500 million maturing in '06 and if I take the numbers as you reported it and factor in higher capital spending, it seems like we might lean towards debt pay downs forecasted in the next year but wanted to get a sense how you thought about that.

Good quarter in any event, and I appreciate it.

Thanks.

Steve, I'd continue using the two-thirds for stock buyback and dividend and one third for debt.

If you look at 2005 we ended up reducing our net debt by a little over 800 million.

If we realized cash flow was going to be that good, we would probably have been more aggressive on buying back stock during the year.

If you look at the end of the day, we're very pleased with our free cash flow in 2005.

Thanks.

Steve, thank you.

Your next question comes from the line of John Heinbockel of Goldman Sachs.

Please proceed.

Good morning, guys.

This is Eric Weissman from Goldman Sachs.

First, I wanted to ask you about the competitive environment with Wal-Mart.

In terms of what you're observing in their stores and execution wise over the past six months or a year, what are you seeing most pock used on what are they getting better at or where might they be falling behind, and also on the margin, are they now delivering a better perishables offering?

Well, Eric, I don't plan to make this call about analyzing Wal-Mart's competitive strategy, but I will maybe say to you Wal-Mart is a very strong competitor.

We admire what they do, hold them in very high regard, watch closely the steps they take.

I see the competitive environment overall including the part that Wal-Mart plays to be a very strongly highly competitive as we've said before, and it continues to be that way, and we expect it to continue to be that way.

I think that's a function really of the overall retailing environment we find ourselves in.

We all have to find a way to fight for the sales and become relevant to the customer, and so that's what we're doing.

That is what we're doing.

You can see the results of ours in our quarter release.

Rodney, do you want to add anything?

As we develop our plan and where we're trying to go, we certainly assume Wal-Mart will continue to get better on perishables like Safeway and Albertsons and Whole Foods and Auldis, and everybody else.

Our assumption is that every competitor will continue to get better and every day when you get in their stores you can see a Wal-Mart perishable department produce is better today than it was two or three years ago.

We would hope you would go into one of our stores and you would say the same about us.

Okay.

Thanks.

Secondly, can you guys talk a little bit about your business in California, first in terms of the pace of the ongoing recovery at Ralphs and how much room or where you see the opportunity there and then secondly, when you think longer term about our position in northern California, are you guys planning to stay from in a more limited way or due for see opportunities now that Albertsons is exiting that would allow to you increase your presence there over the long-term?

The first let me talk about southern California.

We were pleased with the progress really in 2005.

But we're not yet satisfied with where we are.

On the sales front if you take Ralphs and Food 4 Less together for the southern California market, our identical sales, I believe it was identical, was up 3.3%.

That would be the highest of that same metric through all four quarters last year, so that's improvement.

We expect to see further improvement in 2006 in their overall financial performance.

We're bullish on the market.

We're bullish on our associates.

I have been out there a number of times and am very impressed with what they're attempting to do.

And as you probably could see in our numbers, OG&A improvement some of the OG&A improvement reported by Kroger was helped by what happened out at Ralphs in southern California, so we're quite optimistic, but we're quick to recognize that we're not yet satisfied with what where we are, and really shouldn't be.

Turning to northern California, as you know we're exiting for the Ralphs and the Cala and Bell formats but Foodsco format, we're pleased with and continue to let it evolve further.

Our presence in the short-term future at least will be based on that strategy and the success of that format.

I was going to say we have several Foodsco locations that we're working on developing in northern California, and we feel very positive about that format in the market.

It is really not just maintenance.

It is a growth opportunity.

Okay.

Thank you very much.

Thanks, Eric.

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

Please proceed.

Hey, guys.

Hi.

I want to start by I have to admit I am a little confused about the guidance, so I just have some questions understanding the extra week and first you get extra sales, you obviously have extra operating expenses.

The rent and D&A go up for the extra week?

Mike, do you want to highlight that on the extra week.

We pay rent every day we have the store opened.

Basically every operating expense we have, virtually every operating expense we have, we expense on a daily basis on the calendar year, so virtually every expense we have continues whether it is a 52 week year or 53-week year.

Our wage expense, our interest expense, utilities, all of that is based on an annual year.

D&A as well would have a 53rd week?

That would not.

Okay.

One other thing, identical sales, that will be 53 weeks to 53 weeks on a 3.5% guidance we provided.

Right.

And the guidance of 6 to 8%, is there any impact from the 53-week year in positive in this come in '06 and negative in '07 and your average 6 to 8, is that an average between the two or does the stock option expense complete apply wipe out any of the benefits on the extra week?

Basically when you look at 2006 the stock option expense eliminates the benefit of the extra 53rd week in 2006.

Then expectation for 2007 would be on top of that 2006 results.

Right.

Okay.

You won't have a stock option expense incremental in '07?

You would have it but not incrementally obviously.

Right.

And then my other question is just I think it is useful to clarify what you did in northern California.

There is nothing left once these closures are completed other than Foodsco-so all the Ralphs, all the Cala, all the Bell's will be closed?

When you look at Sacramento and San Francisco north, that would be correct.

Okay.

I guess I have to say I am going to go back to the guidance.

We had somehow, I think the Street had expected the numbers would be stronger.

You talked about pension contributions being lower.

In terms of fuel costs, are you looking for ID's with fuel to be higher than ID's without fuel or are looking for them to be the same?

We really don't estimate identical dollars with fuel sales because we really look at that on a gallons basis rather than a dollar basis.

Because we obviously weren't -- our ability to project what retail fuel prices will be we really don't think that's our business.

Your comment on pension, Meredith, the guidance we gave is our cash contribution will be that much less to the company-sponsored pension plan.

That has no relationship to what we have to expense for those plans based on the wonderful world of FASB 87.

The book expense and the cash expense for those do not equal.

Our book expense won't necessarily be down by that amount.

That's just the cash we have to fund the plan by.

Can you comment at all about what pension expense will be higher?

It will be incrementally higher in '06 versus '05 for the company-sponsored plans.

Okay.

Thanks.

Thank you very much.

It is not like it is a $0.05 or anything like that, but it is higher.

It is not lower like the cash is.

It is a relatively modest increase.

Okay.

Anything further, Meredith.

Okay.

Thank you.

Your next question comes from the line of Chuck Cerankosky of KeyBank McDonald.

Please proceed.

Good morning, everyone.

Nice quarter.

If we can talk a little about how you determine the dividend size, I would be interested in that.

Did you pick a specific yield?

What were you looking at in terms of free cash flow trade off's especially with stock re-purchase activity or amounts?

Rodney or Mike, you want to comment on that?

On the dividend yield it really was looking at where was the S&P 500 overall?

What type of cash capacity did we think was appropriate and the trade off of using free cash flow for the dividend versus buying back stock, and the Board looked at all three of those as an ongoing part of that deliberation, and really got comfortable the $6.05 per quarter would put a yield similar to the S&P 500 at this point and not create any constraints from a cash standpoint that would cause the Company to have to change the business plan of that we're on.

It is really all three of those factors together on paper.

Mike, if you want to add anything else?

I agree with you.

That's exactly correct.

Just clear housekeeping on the restatements announced the other day, is there any cash component to that?

No.

Dave, you mentioned you continue to like the strategy of developing multiple store formats.

How about when you're looking at a single market and you have more than one format?

Can you address what you're doing to customize stores to individual neighborhood demographics?

Well, there is a variety of ways to look at this.

Our format certainly distinguished from one type of customer to another.

I actually look more often within a format and the easiest one at that toy would be a combo store, traditional combo store.

Within a combo store there is a wide variety of ranges of kinds of stores that we'll try it run and are trying to run today.

Some are more towards the value end of the equation even though they may not be a Food 4 Less they still focus on that area, and there are certain things we do in those stores to try to appeal to the customer base in that area.

On the other extreme we have many of those combo stores that serve areas that are higher income and interested in more prepared foods and more perishable foods and so forth.

The emphasis in those would be in that particular arena.

We're really trying to do it pretty logically, I think, although the Company data helps us quite a bit in understanding what the customer base is now and the census data helps us understand what the customer base potentially could be if they're not already shopping in our store.

That helps guide us as well.

There are as many variations on the theme I described as there are you can think of.

You have overlays for ethnicity as an example, local particular issues and interests, local skills in one of our divisions and some of our divisions have different skills than others.

All of those play out, too.

In a market where we have multiple formats, the same thing is still true, except now you have some more extreme examples.

You might have for instance in Phoenix you would have the marketplace stores plus a regular combo that Fries operates is an illustration of that.

The marketplace store addresses itself with a particular approach to merchandising.

It doesn't really conflict with what we're trying to do with the combo stores.

In fact, in some way it complements it.

Some customers will shop both stores depending on the objective part of their trip, what they're after.

In another markets where we have a Food 4 less and the combo store, the Food 4 Less is clearly addressing the value side.

We may have still some combos that address the value side but not the same extreme as a Food 4 Less would.

In that same market, we may also operate high-end stores if we had customers and stores in the areas where we have customers like that.

I realize that is not very specific.

But that's the overall picture

The other thing we found, there is things that work in a Food 4 Less store you can take across your combo store where it is appropriate and the same is said for Fresh Fair.

There's things we've learned from that you can take -- obviously that would be more at the upscale end.

One of the things we've all found with a combo stores, it is very flexible to change based on what the customer needs are.

Anything new going on in prepared foods you want to share with us?

I would say, the first half of that question is yes, and the second half is no.

So, I guess not. [LAUGHTER]

I should have asked it differently.

Prepared foods will always be a changing area, and so we will always have at least as far as I can imagine new things going on.

We'll have some things we tried and didn't like and stopped doing.

We'll have things we tried and do like and keep doing more of and roll out more of and we'll have things we're always in the process of developing, and there are plenty of examples in each one of those categories.

I don't plan to describe those.

The best way for you to find out is go shop in Kroger.

Last question, I guess for Mike, as you exit San Francisco and Sacramento, what kind of impact will that have in the first half and is it in the full year guidance?

It is in the full year guidance.

We didn't give any specific guidance on what that effect would be in the first half of the year, but you do have shut down costs and selling through inventory and maybe some severance so that is factored into the full year number.

Thank you.

You're welcome.

Thanks, Chuck.

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

Please proceed.

Thanks.

Good morning and good quarter.

Thank you.

Dave, is there any update you can provide us on centralizing your procurement?

I have seen some of that through some of the trade pubs recently and moving into further divisional consolidation?

Sure.

What we can tell you is and I think this has been true for some time, but you may have seen something on it recently.

We have what we call coordinated merchandising concept where we have taken a number of the grocery categories and developed a merchandising plan in one location and then rolled those out throughout the whole Company.

Now they're tailored to a certain extent it the local markets in addition to that.

Essentially it is being developed in one place.

Up until recently that had been we pretty much stopped that line where we coordinated out west we didn't go all the way to the West Coast.

Primarily because our systems were not able to capture the information the way we needed to do it in order for those plans to work and for us to track where we were.

As the systems have evolved and we get closer to being able to do that, we wanted to make sure the organization knew where we're headed and where we're headed is to really further the coordination and do the same thing we're doing for two thirds this of the company now do it for the rest of the Company down the road later this year and into next year.

That's simply what has been announced most recently.

In addition to that, we will be increasing the categories that are included in that plan.

We covered a lot of the grocery categories but not all.

We plan to now cover most of those categories and roll that out.

Rod do you want to add anything to that?

The only other thing you may see or hear is that we have long used Fred Meyer and the team there on the procurement side for important seasonal products in the GM area and we will be working toward further integration of planning, utilizing the talents in the Fred Meyer team, and I guess the overall message is this is just a continuation of the things we've been doing for the past several years.

What you probably saw, Jason, was an attempt on our part to make sure our associates and our vendors were informed and communicated with sufficiently on what we're trying to do, but it really is a continuation of what our plans had been before and I think most of the time people who are actively involved in these jobs and this work pretty much knew that process.

In terms of your divisional consolidation, what I am more interested in this potentially added to your divisions with some acquisition opportunities on the horizon, particularly as it relates to your end market, as you've gone in the past.

Can you talk further about your opportunities and the success you have had in that in the past?

The consolidation in the business keeps causing a number of storage to be available in markets, and sometimes those are all divisions of a company, sometimes it is whole company, sometimes it is individual stores.

Our passion really hasn't changed much at all.

We really see the opportunity mostly in the markets we're in today where it gives us an opportunity to further the position we already have in that market.

That's what served us well in the past.

There are occasions when opportunities arise that are bigger than that, that are important to us, that have the potential to be really valuable to the shareholders earthquake and we don't turn them down because U.S. just because they don't fitted the initial descriptions of our strategy.

We take a look at what is out there.

There is not a day that goes by that we don't have something under consideration at this place.

We usually turn down a lot more than we pursue.

I expect this next year to look allotted more like it is the past Q2 years.

Many opportunities here and there and opportunities we'll continue to consider.

Rodney?

A lot of the valuation that is people have in mind and the valuations that really make sense for us as you noticed over the last couple of years we haven't bought as many as we can before and there is really a gap between the valuation and what we found overtime that that teams to come back into line.

That's a really good point because the effort for us is all reflected on cash flow.

Is this a good financial investment on the part of the Company to further our business strategy?

If the numbers don't work, we're not interested and Rodney is right about the valuations of some people who wanted to sell assets want to tell them because they think the price is high and the price ends up not being that high.

Thanks.

You're welcome.

Your next question is from the line of Mark Husson of HSBC.

Just wanted to ask about the market share dynamics.

You talked about volume weighted basis market shares, would that be number significantly different if you did it on a cash basis?

You say cash basis, Mark, help with explanation.

If a market has a billion dollars of revenue, it counts 10 times more than a market with 100 million of revenue.

Okay.

You're not trying to work out your share of volume in the market, you're weighting the markets by the size of markets?

By the size of our dollars within the market.

Okay.

If you look then at -- and that's the way you've always done it, sf?

Correct.

Actually if you do it on an average basis, the number is a little bit better but we never think that's appropriate.

Because it really does need to reflect what's going on in terms of the size of our company.

And if you look at your share of improvement against Super Centers, you would be tempted to argue the more Super Centers there are, the more Wal-Marts there are, the better you would do.

Is that because it creates a nuclear winter of forcing consolidation on everyone else? [LAUGHTER]

Mark, I can always count on you to think about this differently than I might have.

I have never considered the possibly that more Wal-Mart Super Centers might be good for us.

It is an interesting approach.

I think really what it represents is that in those markets you do have a certain amount of fall out, and in that fallout typically we end up doing better than we would had the fallout not occurred and in time we're able to hold our own with the Wal-Marts Super Centers in town.

I know you don't talk about the markets you mentioned but occasionally you do.

One of the markets mentioned n the past is the Delta market which is one of the first markets that has been super centerized, and you said in the past that yourselves are as good as they've been ever then EBITDA margins probably better than they've ever been.

Is that still generally true?

I am not going to speak specifically about Delta.

I will tell you generally about our sales and I neither said this or hinted at it in your comments.

Not only did all supermarket divisions have positive identical, all the departments in our grocery store and supermarkets had positive identicals.

It was very balanced.

The point of that picture to describe to you is that all of our markets did well, we were pleased in our progress really every place, and we didn't have one place that did really well and everybody else was sort of in bad shape.

Our Delta division and other divisions did very well, and I think similarly well and balanced overall through the year.

The other thing, Mark, you see part of it is the maturity and always when a competitor comes in the first year is more painful than when you get two or three years out.

It is no different than if you go and look back years ago when Meyer came, the bad Meyer, came into Dayton, Ohio.

The initial share change -- we actually declined for a couple of years, but then after that period of time you started growing the business again, and your market share started improving after you had some maturity in the market and some of the things that you said in terms of competitive changes happening.

Competitive changes always take longer than what we think they will or should.

That's been true for years.

Wal-Mart becomes a boring old food retailer, eventually.

I wouldn't say or define it that way.

It is just that what we offer is something different Wal-Mart offers and not every customer wants to shop in a super center.

My final question, you may have half answered it.

You tried to increase the percentage of -- maybe not consciously -- of general merchandise you're selling in your stores and increasing the store sizes is one of the ways you can accommodate that.

When are you going to tell us about, like Tesco, the percentage of sales which are general merchandise and whether that has done better than food?

I don't know when we'll begin to tell you that.

You do size up part of our strategy correctly.

It is one of our objectives to increase the sale of general merchandise, and we do that in a variety of ways.

Store size is one.

The skilled teams we have here at general office who work in this area and also the folks out at Fred Meyer who have helped us, too, those two teams have helped us come up with plans that have improved our seasonal and improved our overall general merchandise positioning.

You may recall last year, a year ago, I was not as happy with our holiday sales as I would have liked to have been.

This year I feel just the opposite.

Our holiday sales, and it is just not just general merchandise, but a lot of it is.

Our general merchandise and grocery plans that were developed here, general office plans worked on and developed further in the divisions, plans executed in the stores were much better this year than last year.

So, yes, we're pleased with that direction on general merchandise, expect it will be beneficial to us, but don't plan to at least in the near term give percentages of that number.

I will give you a little more insight--

You're going to give some? [LAUGHTER]

Dave's comment and Don's comment both we view this whole area as a huge opportunity for us, and it is one of the reasons on the organizational changes that Don talked about we're putting in place.

And when you look at the identical in the drug GM area, it would be pretty similar to where we are overall as a company, the numbers that we released.

It is really not that much different.

In terms of opportunity we think the opportunity there huge, and the changes we put in place we think will enable us to take better advantage of the opportunity.

That's a good point, Rodney and I think the one other element to think about with this is one of the biggest parts of what makes a marketplace store work is the strategy and general merchandise.

It is not just about that.

That is a big part of it.

Rodney is right about the organizational strategy we have here.

It will impact that as well.

That's what's driving Tesco in their comp-store sales and I know you used Tesco as a model.

One final comment, any thoughts about Tesco coming into the West Coast to one of your big markets?

The south?

We thought about it obviously.

They announced it recently.

Tesco is a competitor we admire, have watched for years from afar.

We prefer it that way.

Once they come to the United States we will see them straight up and we'll see them and welcome them to the environment we have which is a very competitive environment, one that we are beginning to thrive in and beginning to grow in and beginning to see the ways in which as a competitor that we can even improve on our own performance.

In many ways your earlier point about Wal-Mart does actually make us better and I am sure Tesco will make us better, too, is that's probably the only comment I would add to that.

We've always assumed Tesco is going to come to the U.S. at some point.

We just didn't know when.

That's true.

Mark, thank you and we have time for one more question.

Your next question will come from Scott Mushkin of Banc of America Securities.

Please proceed.

This is Bagley Smith [ph] calling in for Scott.

A couple quick points.

In terms of the marketplace store, I was wondering it sounds like it is a strategy for you guys and you spoke about it in this question.

Yet is doesn't sound like you've done a whole lot.

Are do you see marketplace going in the next couple of years?

Could you see it expanding at a more rapid pace?

As you talk over over the next couple of years, I would say it is more what you've seen the last couple and more measured.

We're beginning to learn what the customer really wants and needs in that format and how to connect.

So far we're pleased with the results and at some point in time you will see us more agrees active.

Over the next couple of years I think it will be more of a measured pace to make sure we do it right.

Thanks a lot.

Just one more or two more quick ones.

In terms of you guys give us a lot of color and appreciate all the color on the market and I appreciate it.

My only question is it does sound like doing well in the markets where super centers are operating.

One thing I was thinking about is seeing Albertsons with sales numbers down this morning.

How significant do you think the presence of not just them specifically but other operators?

Are you taking share from other operators as well?

How do you view the marketplace in terms of the other operators?

I think every market is different, and depends on who the operators are there.

Some of the share we pick up.

The way we measure share is it's important to think about all the alternate formats.

We would be drawing we believe from all of those places.

We would be drawing from segments that aren't traditionally looked at as supermarkets.

We will draw from the super center area from some of the competitors and one of the reasons we pointed out our sales were balanced and strong throughout the whole company was to illustrate we weren't drawing sales really, we don't believe, from any one competitor and that's not the reason our sales were as strong as they are.

We think it is more related to our strategy, and we're pretty excited about it.

Okay.

And I guess related to that, kind of dove tails with that, obviously I think pretty much you answered with that comment.

Obviously with more CapEx next year you obviously must be seeing some difference in sort of the marketplace and your competitive advantage is sort of ended, is that correct or could you maybe elaborate on that a little bit?

I think the success we've had this past year in our increase in our market share that we've reported indicates that we think we're on the right path.

That certainly helps us think about how we spend capital.

There are lots of other elements that go into the capital plan as well.

Getting better and understanding how to compete better in today's environment is one of the ways we'll spend our capital money.

Got anything else to add to that?

That's all.

Thanks very much.

Appreciate it.

Thank you.

Before we wrap up, let me close with this.

We encourage our associates to listen in on this call so before concluding the call, I want to thank Kroger's thousands of associates across all of our banners and operations for your tremendous efforts and dedication to our business in 2005.

You are the source of our success.

I am gratified by the big things and the little things you do every day to serve our customers.

You continually raise the bar on how we measure our success in meeting customer needs.

The progress we've made in 2005 builds on our well developed platform for future growth in 2006 and beyond.

You should each see the initiation of a dividend as a major victory.

We have not had a dividend since 1988.

Some of you are shareholders and will directly benefit from this decision.

You've each had a hand in making it possible.

Because of you, Rodney, Don and I are excited about our future together.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect your lines.

Have a great day.