克羅格 (KR) 2008 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2008 Kroger Company Earnings Conference Call.

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

We will be conducting a question-and-answer session towards the end of today's conference.

(OPERATOR INSTRUCTIONS) As a reminder, this conference call is being recorded for replay purposes.

I will now turn the call over to Carin Fike, Director of Investor Relations.

Please proceed.

Good morning, and thank you for joining us.

Before we begin, I want to remind you that today's discussions 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 Web site at www.kroger.com.

Before I introduce Dave, I want to remind you that our annual shareholder meeting will be Webcast live on Thursday, June 26th at 11:00 a.m.

Eastern time.

For more information about the Webcast is available on our Web site.

We invite you to join us Thursday over the Internet or listen to the replay.

Now, I will turn it over to David Dillon, Chairman and Chief Executive Officer of Kroger.

Thank you, Carin, and good morning everyone.

And, thank you for joining us to review Kroger's first quarter 2008 financial results.

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

I will begin with a brief recap of Kroger's first quarter results and our updated guidance for 2008.

I will also discuss the progress we are making on our Customer 1st strategy.

Rodney will share additional details about Kroger's first quarter results and the 2008 guidance.

Then we will be happy to take your questions.

We are off to a strong start for fiscal 2008.

Today, we reported record earnings of $0.58 per diluted share for the quarter.

Net earnings in the same period last year were $0.47 per diluted share, and recall that our 2007 results included charges related to labor unrest at one of our distribution centers.

This reduced earnings by approximately $0.02 per diluted share.

First quarter sales were also strong.

Total sales increased 11.5% to $23.1 billion.

Identical supermarket sales increased 9.2% with fuel and 5.8% without fuel.

Growth was broad based across all geographic regions and most departments with particular strength in grocery, nutrition and deli-bakery.

Kroger's performance during the quarter demonstrates the resiliency of our Customer 1st strategy.

Our associates are connecting well with customers as our strategy continues to drive identical sales growth and create shareholder value.

Based on the strength of our first quarter results, we are raising our identical sales and earnings guidance for 2008.

We are -- we now anticipate full-year identical sales growth of 4% to 5.5%, including fuel -- excluding fuel.

Our previous guidance on identical sales growth was 3% to 5%, also excluding fuel.

For earnings, the guidance we gave in March was $1.83 to $1.90 per share.

Today, we are raising the lower end of that to $1.85 with the upper-end remaining at $1.90.

In a few minutes, Rodney will shared additional details on guidance.

Our updated earning guidance reflects 9% to 12% growth over fiscal 2007 earnings of $1.69 per diluted share, which is a solid growth rate in a challenging economy.

Let's don't forget our dividend.

This compares favorably with most -- the most recent earnings per share growth rate for non-financial companies in the S&P 500.

We continue to expect our 2008 earnings per share growth will be driven by strong identical sales, a slight improvement in our non-fuel operating margin and fewer shares outstanding.

I want to take a moment now to talk about how the economy is affecting the purchasing decisions our customers make everyday.

Our latest customer research indicates the two biggest concerns on shoppers' minds today are high gas prices and food costs.

These two factors are driving some of the behavior changes we are seeing lately, such as shoppers combining trips and actively pursuing gas discount offers.

Our research also validates some underlying trends that we have seen for some time.

These include families coming together more often to prepare and eat meals at home and the willingness of customers to try new Private Label products.

We did see solid growth in Kroger corporate brand share in the first quarter, and recall the overall strength of Kroger's corporate brand program has been building for several years.

Our unmatched line of quality Private Label products, Private Selections, our store banner and value brands can only be found in Kroger's family of stores.

For more than a year, our Corporate Brands team has been working to expand the Private Label products we offer customers.

Nearly half of the new corporate brand items introduced last year were under our Private Selections label.

That has led to great new products, such as Private Selections Angus Beef Steaks and Artisan Bread.

Today, Private Selections is our fastest growing brand, and, based on the first quarter trends, Private Selections will be a $1 billion brand for Kroger in 2008.

Listening closely to our customers is the foundation of our Customer 1st strategy.

We focus intently on its four keys -- our people, our products, our prices and the overall shopping experience of our customers.

As a result, our strategy is helping us strengthen our connection with customers at a time when many shoppers are looking for the best options to stretch their dollars.

In addition to the growing Private Label business, we have introduced or expanded several programs in recent months to help customers stretch their household budgets.

They include expanding our $4 generic program to include 90 day supplies for $10.

Giving customers up to $120 in free groceries when they buy Kroger gift cards through our special tax refund gift card promotion.

Offering discounts on gasoline.

For every $100 customers spend in our store they earn $0.10 off each gallon of gas on their next fill-up.

Just in time for summer travel, customers can accumulate and redeem gas coupons by shopping in almost all of our stores from Virginia to Arizona to Alaska.

Rewarding shoppers who have a 123 Rewards MasterCard.

Customer can earn discounts of up to $0.15 off each gallon of gas per fill up at participating markets and earn free groceries every quarter by using their 123 Rewards card.

So far, customers have earned $48 million in free groceries.

These types of programs and our associates exceptional ability to execute them well are just some of the reasons Kroger's business is growing.

We have built the ultimate one-stop shop for customers in thousands of communities we serve.

Our combination stores, many with in-store pharmacies and a growing number of fuel sites help our customers combine shopping trips.

As our first quarter results show, we are making progress in our effort to be a reliable and relevant partner for customers by anticipating their needs and consistently delivering on their expectations.

Through these types of investments, our customers are saving $1 billion annually.

Now, I would like to turn the call over to Rodney for some additional detail on our first quarter result, financial strategy update and 2008 guidance.

Rodney.

Thank you, Dave, and good morning, everyone.

Dave highlighted Kroger's strong sales and earnings results for the first quarter.

We realize that some investors want to know if our Special Tax Rebate Gift Card promotion drove those strong results.

Overall, the promotion had no material effect on Kroger's first quarter sales or earnings.

Let me give you a little bit more detail on how the promotion works.

Under this special promotion, which started May 2nd and ends July 31st, customers can receive up to $120 in free groceries from Kroger if they buy Kroger gift cards.

We are evaluating this promotion internally based on several metrics to understand how this is affecting customers' shopping behavior.

So, far we are pleased with the trends we are seeing.

Some investors have asked us how we are accounting for the 10% bonus associated with the promotion.

While the accounting is straightforward, an example might be helpful.

A customer who turns $300 into a Kroger gift card will receive a card valued at $330.

Kroger recognizes sales revenue of the $300 as the card is used by the customer.

The $300 in revenue reflects gross sales of $330 minus the $30 discount.

So, the 10% bonus reduces sales and gross margin as customers use their gift card in our stores.

This is the same accounting treatment we use for other in-store promotions that are funded by Kroger.

Our popular fuel discount program is another example.

The cost of the fuel discount reduces our in-store sales and gross margin.

If you have additional questions about how we account for these items, please follow up with Carin off-line after this conference call.

It is important to note that merchandising strategies, such as our Tax Rebate Gift Card program and our expanded Generic Drug program are merely components of customers overall Customer 1st strategy to deliver value to our customers.

These merchandising strategies are not incremental to our regular investments and they are contemplated in the fiscal 2008 earnings guidance Dave provided.

There have also been some investor questions about the volatility of Kroger's earnings -- quarterly earnings due to fuel margins.

Kroger operates over 700 supermarket fuel centers and nearly all of our 778 convenient stores sell gas.

As we have said before, in the fuel business, we do see margins fluctuate from quarter-to-quarter.

Over a longer timeframe, margins in this business are more normalized.

On a rolling four quarter basis, the blended cents per gallon fuel margin for our convenience stores and supermarket fuel centers was $0.114 this year compared to $0.117 last year, a decline of $0.003 per gallon.

In the first quarter of 2008, the blended cents per gallon margin was $0.092 cents compared to $0.087 cents in the prior year.

While our gallons sold were up on a year-over-year basis, our retail fuel operation had no impact on Kroger's first quarter earnings per share growth in 2008.

This is largely due to the impact of higher credit card fees on fuel sales compared to the prior year.

Our retail fuel business is a highly valuable asset particularly because it strengthens our connection with customers.

Our Fuel Centers eliminate an extra trip for shoppers, and customers know they can count on a competitive fuel price at Kroger.

Now, let's turn to the performance of our core grocery operations.

Excluding the effect of retail fuel operations and the non-recurring labor expense of the prior year, FIFO gross margin declined five basis points.

Improvement in shrink expense helped fund continued investments and good prices for our customers.

Kroger's supermarket selling gross margin on non-fuel sales declined nine basis points year-over-year.

Like many food retailers, Kroger continues to experience product costs inflation at levels not seen in several years.

We estimate that our product cost inflation during the quarter was 3.5%, excluding fuel.

This relatively high inflation rate is reflected in our $40 million LIFO charge in this quarter.

This amount is almost $20 million higher than the previous year and reduced Kroger's non-fuel operating margin by nine basis points.

The year-over-year increase in LIFO mainly reflects the timing of when inflation affected our business in 2008 compared to 2007.

Recall, that our full-year LIFO charge for fiscal 2007 was $154 million after rising product costs inflation caused us to increase our LIFO charge estimate every quarter last year.

If that full year expense had been recognized ratably during the year, our LIFO charge for the first quarter of 2007 would have been more consistent with our current experience.

I will talk more about LIFO in a minute when I provide some additional color on our 2008 earnings guidance.

As you know, the LIFO charge is a non-cash expense that results from the Company's choice after accounting method for it product inventories.

But, beyond the mechanics of the LIFO charge, we realize that what many investors want to understand is how inflation is affecting our business.

On the whole, as we have said several times, we believe that a moderate level of food inflation is a positive for our business.

At moderate levels, we are generally able to pass suppliers product cost increases onto customers without negatively impacting unit volume.

And, we get the benefit of the additional sales leverage over fixed costs in our business.

We would describe current levels of product cost inflation as moderate.

Some of that additional sales leverage is reflected in our OG&A rate.

Excluding the effect of retail fuel operations, OG&A declined 17 basis points.

The improvement in our OG&A rate is primarily due to strong identical sales leverage.

We also benefited from lower benefit costs associated with some labor contracts.

While the effect of this this particular benefit will diminish over time, we continue to identify other ways to reduce operating cost as part of our ongoing strategy.

A great example of our success in this area are the initiatives we have in place to control our utility costs.

Since 2000, we have reduced overall energy consumption by over 22% or 1.6 billion-kilowatt hours.

That's enough electricity to power every single family home in Denver, Colorado for a year.

Many thanks to all of -- to all our associates who have made this possible.

You can read more about our energy reduction and recycling efforts later this week when our new sustainability report is published online at Kroger.com.

Let's continue down the income statement with operating margins.

During the quarter, Kroger's non-fuel operating margin expanded two basis points.

This also excludes the non-recurring labor expense in the prior year.

As a reminder, our fiscal 2008 earnings guidance incorporates a slight expansion in Kroger's non-fuel operating margins on a full-year basis.

Our tax rate for the quarter was 37% compared to 38.1% in the prior year.

The first quarter rate was lower in the current year due to the resolution of certain tax issues.

We now anticipate a full-year tax rate in the range of 37% to 37.5%.

Capital investment excluding acquisitions totaled $637 million compared to $556 million in the prior year.

We continue to project fiscal 2008 capital spending of $2 to $2.2 billion, excluding acquisitions.

This investment is expected to cover 70 to 80 major store projects and 175 to 200 store remodels plus other investments to support our Customer 1st strategy.

Our 2008 capital budget also includes approximately $160 million for several high-return projects in Kroger's logistics network.

These products -- projects will cause our logistics capital spending in 2009 to be higher than normal as well.

Turning now to free cash flow, Kroger remains committed to a solid investment grade rating.

Our long-term financial strategy is to manage free cash flow to repurchase shares and pay dividends while maintaining a leverage ratio that supports our investment-grade rating.

On a rolling four quarter basis, Kroger's net total debt to EBITDA ratio was 1.95 compared with 1.85 during the same period last year.

And, 2.03 for the fourth quarter of fiscal 2007.

So, you can see that since year-end we have improved our ratio.

Total debt was $7.8 billion an increase of $1.2 billion from a year earlier.

Our share repurchase and dividend programs delivered substantial value to shareholders.

During the first quarter, Kroger returned over $430 million to shareholders in share repurchases and dividends.

Of this amount, $381 million was invested to repurchase 15 million shares of stock at an average price of $25.46.

At the end of the first quarter, approximately $644 million remained under the $1 billion Stock Repurchase Program announced in January of 2008.

At current share --share prices, we expect this amount will be sufficient to fund repurchases through the remainer of fiscal 2008.

Kroger paid nearly $50 million dollars in dividends to shareholders during the first quarter compared to $46 million during the same period of the prior year.

I want to now turn back to updated 2008 earnings guidance Dave shared with you.

As we mentioned, we are raising the lower end of our earnings per share guidance from $1.83 to $1.85.

The upper-end remains the same at $1.90 per share.

Given Kroger's strong first quarter results, some of you may wonder why we did not raise the upper-end of our earnings per share guidance.

There are several moving pieces to our thought process so let me walk you through several of the highlights.

First, there's uncertainty surrounding the economic outlook for the remainder of 2008 and how it will affect our customers.

So far, we have not seen major shifts in our customers purchasing behavior.

Our strong identical sales trends have continued through the four weeks of our second quarter.

We are tracking at the high end of our updated identical sales guidance for 2008.

As Dave described, we are doing everything we can to help customers stretch their budgets.

With over seven months to go in our fiscal year, it is too early to make predictions on how continued economic pressures will affect customers.

Second, like many businesses, Kroger is facing headwinds in the form of higher energy-related operating costs, such as diesel fuel, utility expenses and even higher bag costs.

In the first quarter, Kroger's strong sales performance and the lower benefit costs associated with some labor contracts allowed us to absorb these higher costs and report strong earnings growth.

While we expect our strong identical sales growth trend will continue, the effect of reduced health care cost will diminish over time.

The third factor is LIFO, which could actually help mitigate some of our higher energy-related operating costs in the back half of 2008.

Based on our current estimates, our updated 2008 earnings guidance incorporates a full-year LIFO charge of $130 million, which is about $25 million lower than 2007 and the preliminary estimate for 2008, which we provided in March.

Our current expectation declined from our original 2008 projection, largely due to current commodity outlooks that suggest dairy prices will be at the lower -- will be lower at the end of the year.

Our actual LIFO expense for 2008 will be determined in the first -- fourth quarter based on inflation rates at that time.

Given the current challenging economic environment, we believe that an EPS growth rate of 9% to 12% over fiscal 2007, plus the dividend yield of slightly over 1%, should be a positive for Kroger to deliver solid value to our shareholders while continuing to invest in the long-term health of our business.

Kroger's first quarter results and our annual guidance reflect the balance required for our long-term sustainable business model.

Although we did not give quarterly guidance, please keep in mind our comments in March on quarterly earnings per share growth rates.

We said in the first quarter -- we said that the first quarter growth rate would be higher than the annual growth rate.

Clearly, that forecast was accurate.

We also said that the fourth quarter growth rate would be higher than the annual growth rate.

The lowest year -- year-over-year growth rate will likely occur in third quarter due to last year's tax benefit, which benefited Kroger's third quarter results by roughly $0.02 to $0.03 per share on a net basis.

I will wrap up with some comments on labor relations.

During the quarter, we reached agreements in Memphis and Louisville and last week, our associates in Indiana ratified a new agreement.

I understand that we reached a -- an agreement in Nashville yesterday, subject to employee ratification.

This year, we have labor negotiations covering store associates in Columbus, Las Vegas, Phoenix and Portland, and every negotiation we work to achieve competitive cost structures in each market while meeting our associates' needs for good wages and affordable health care.

Now, I will turn it back over to Dave for some closing remarks.

Thanks, Rodney.

We are off to a strong start in fiscal 2008.

Kroger's performance during the quarter demonstrates the resiliency of our customers.

Our associates are connecting well with our customers as our strategy continues to drive industry-leading identical sales growth and create shareholder value.

The underlying strength of Kroger's long-term business model is illustrated by our solid first quarter results and updated guidance.

We continue to balance investments in our customer overall shopping experience with current economic conditions, including inflationary costs.

Now, we'd be happy to take a few moments for your questions.

(OPERATOR INSTRUCTIONS).

Your first question will be from the line John Heinbockel of Goldman Sachs.

Please proceed.

Yes, a couple of things.

How would you break the comp down between traffic and ticket?

It looks like traffic is actually fairly robust.

If you look it has been in the first quarter, it is pretty consistent the way it has been for the last couple of years.

It is slightly favorable to traffic versus ticket, but not hugely so.

It is about 55% one, 45% the other.

So, as you can see it is pretty balanced between the two.

And, then, within ticket, what do you see with the number of items that make up someone's basket.

Obviously, there's some inflation there.

Are there less items per basket or about the same?

It would be about the same, and, as we have said before you can see, it in a cut back in certain discretionary items.

That you can see.

But, certainly, if you look at it on the food side, it is great growth there.

And, the if you look at price elasticity, we have talked about this before, price elasticity of the customer, the effectiveness of promotions.

And, sometimes the elasticity is not there to get it all why.

It would seem in this environment, the elasticity is greater.

The all why the price promotions is better.

Money that you would spend in the circular is better.

Is that true?

Is the all why tracking better than it might have in the past?

What's the color on that?

John, I don't know that I would answer it quite the way you have described it.

I think it all depends on the promotions.

Certainly, in this environment customers are responding to offers that really hit home with them, are important to them.

But, just as true in the past, sometimes promotions even in today's environment, may not be the appropriate ones to run.

So, we are trying to actually balance that out pretty well and the use of data when we work with [Dum Hunda] to evaluate our loyalty data helps us figure out which ones are the right ones to target.

Yes, we would have a pretty sophisticated analysis on what our items to target and how does different types of customers react to those items.

But, in general you can't say that promotional -- the promotional spending is more efficient today because of the environment than a year ago.

It sounds like it is about the same or,.

We think it is more efficient in today's environment because of improvements we have made in how we spend --

Yes.

not because of changes in consumer behavior.

Okay.

Then what would you -- would you characterize, you said today's inflation is moderate at 3.5%.

Where would it be not moderate?

How high would it have to go is 5% not moderate, or what --?

I don't know that I am going to speculate on that, but Rodney, do you want to on that one?

Yes, yes.

A set up like that.

Yes, I don't know we can say the specific number.

I think it really depends on how customers react, and, as you know, if there's inflation that's beyond what makes sense, that's one thing our wonderful corporate brand.

Yes.

We have, we will not have those cost increases there.

So, that does provide some offset to national brand pricing.

Yes, I think that's really key.

The important thing for us to remember is it is not so much how high inflation is, it is what is the effect on customers and behavior.

That is not always able to be predicted.

Okay.

Finally in your inflation, what you put together, most people think meat pricing, protein pricing is going to go higher later this year pm into next year.

Have you worked that in, and is that a concern?

Or, do you think dairy will offset that?

Mike, do you want to comment.

That's exactly what we see out there as well, John.

We have factored that in to our expectation for LIFO, our sales guidance and earnings guidance.

Okay.

So, that protein is not going to push inflation higher it will be offset by other things moderating om price?

Well, that individual category we would expect to be higher.

Yes.

But, what we're looking at today is the guidance we gave you.

Okay.

All right.

Thanks.

Thanks, John.

Your next question will be from the line of Deborah Weinswig of Citi.

Please proceed.

Hi, Deborah.

Good morning.

Morning, hello.

Morning.

And, congratulations on an amazing quarter.

Thank you.

Thank you.

You mentioned on the call high return projects in the Kroger logistics network.

Can you -- without giving any company secrets, can you elaborate on what we'll --- what we should expect to see in '08 and '09?

If you look, it is actually over the last four or five years, we have usually averaged one major logistics project every year.

If you look at '08 and '09 in terms of number, it is about the same.

The difference is the areas of the -- of those warehouses being done is a higher cost area for construction.

So, that's the reason why the cost is a little higher than what it has been for the last couple of years.

In terms of specific locations I don't think we will get into that level of detail other than saying what we are doing is consistent with other projects we have done, and we have been very pleased with the financial returns we've had from those.

So, are there any new technologies, or it is just consistent with what you've been doing in the past?

Consistent with what we have been doing, but you will have to know that what we put in would be something that would be a lot of new technology relative to the U.S..

You will find quite a bit of it in Europe, but you don't see much of it in the U.S.

if any.

Okay.

And, then, obviously with the store models, I think numbering this year between 175 and 200, can you talk about kind of the changes that you are seeing in those stores after remodel is complete and maybe if you can just give us kind of some feedback in terms of what customers are saying as well.

Good results.

We do a lot of focus group work both before and after remodels, and our feedback has been excellent.

And.

the sales results excellent.

I don't know if you want to offer any particulars.

The return on investment has been good, particularly good on remodels actually.

Yes, the remodels are achieving above their budgeted expectations right now in sales and EBITDA.

The met new stores are above the cost of capital, but not all of them are at budget.

But, that picture continues to improve.

And, then last question, you, obviously, gave some kind of qualitative measures around Private Label and kind of with Private Selections making about $1 billion in sales this year.

How should we think about Private Label growth versus the rest of the store?

Is there anything in terms of actual quantification you've seen in the quarter and expect for the year?

Well, a lot of the discussion we've kind of heard just out in the trade has to do with the economy maybe driving people to buy for Kroger brand or Private :abel.

Well, while I am certain there's a certain degree of that going on, we actually think most of our improved results, and our first quarter was a good improvement.

We actually think most of your improved results was -- was because of the plan, because of the team, because of the focus we've had on that area.

Certainly, because the share growth has grown we have some customers who are buying more.

That's the only way you grow the share of Kroger brand.

But, in addition to that, when we dissect some data, and we look at our very best customers.

Our very best customers are buying both more Kroger Brand and more national brand, not just more Kroger brand.

And, we take from that, we believe that the way to read that is that there is, of course, a shift from restaurants and other places to buying more food in our stores.

We think there's a shift to preparing food at home more, and we think our new product introductions in the categories like Private Selections that we mentioned help contribute to that.

So, we think those are the primary things driving our good, strong Kroger Brand Private Label performance.

But, I want to remind you this is a trend we have seen for several years.

And, while the quarter was good and we certainly recognize some due to the economy, we think most of it is due to the trajectory of the work we have been doing.

Okay.

Great.

Thanks.

And, just in terms of some of the specific, if you look at on the grocery department as an example, on retail dollars corporate brand share improved 1.4%.

If you look at it on units.

it improved 0.33%.

Obviously, 0.33%share change in one quarter is very strong as Dave mentioned.

The dollars is a little more than the units because there are inflation in several of the categories.

Great, thanks for the caller.

And once again congratulations.

Thank you.

In fact, Deborah I would adjust one other thing on that brand is that the Private Selection as we mentioned is going to be -- this year we expect it to be a $1 billion brand.

And, that's more of an up scale brand.

And, the fact that it's our fastest going brand should suggest a little more evidence along the lines that I had illustrated earlier.

So, thank you, Deborah.

Thank you.

Sorry, to keep adding on, but Dave talked about the long term trend.

If you look at the last 15-quarters, corporate brand has gained in 12 of those 15 quarters.

So, that just shows you the consistency over time.

Yes.

Okay.

Great.

Thanks again.

Your next question is from the line of Ed Kelly of Credit Suisse.

Please proceed.

Hi, Ed.

Hi.

Good morning, and great quarter.

Thank you.

Thank you.

My question for you is on your fuel business.

It is clearly a competitive advantage for you.

I think you've got fuel in about 30% of your stores.

But, you mentioned that consumers are responding more to fuel promotions.

I was hoping you could comment on that as well as maybe help us dissect the performance of the idea that stores with fuel versus stores without.

Well, the things we would say about that is that it is hard to know exactly what happens here.

But, when you put a fuel station in, it gives the convenience of having fuel at the store.

We price our fuel stations really well on the street price.

And, so, that drives some of the business too.

So, that the mere quantity, the growth of more fuel stations certainly helps drive that.

And focuses squarely on the one stop shopping idea.

You were asking specifically about the fuel promotion, which I am sure is part of this too, but I want to look at it as more of a full package because I think just the existence is going to help us a lot.

The tie in to the store helps remind people we have fuel, and it has been reasonably successful.

You have seen though it at many other retailers around the country.

I wouldn't try to describe it as more significant than that.

Could your stores that have fuel, the non-fuel IDs of those stores be 100 to 200 basis points higher than the ones that stores don't have fuel.

I don't think we would comment on where that would be.

Okay.

Second question for you on rent expense.

It was a little higher than we were expecting.

Was there anything in there one time related may be associated with future lease obligations or asset impairments.

There was some store closure activity in there.

There was at least buy-outs in there.

Some of it also was affected when you look at it as compared to the prior year.

In the prior year, we actually had some positives going the other way which helped lower rent expense a little bit last year and some payments.

We had reserves for our rent liability that we are able to get out of those leases for less than our reserve with the landlord last year, and that wound up being a credit in last year's first quarter.

So, when you pull that out it would have been a quarter like you normally would have expected.

But because with the store closure in both years, you came away with a little bit different picture.

Okay.

And, last question for you, could you comment on whether you are seeing any change in mix in regards to how customers are actually paying?

Wal-Mart recently mentioned that they have seen a significant shift away from credit card which clearly helps the gross because you lose the fee.

Are you seeing any of that?

I didn't look at this last quarter specific numbers, but my impression is that we continue to see more of a shift towards credit card.

That has been true now for, I don't know, 10 or 15 years, and it continues down that path.

And, debit cards.

Yes, put them all together.

And, we have called out specifically, called our credit card and debit card fees, credit card in particular both at the fuel pump because it gets escalated just purely because of the cost of fuel because it is on a percentage basis, which is not a good way really to look at fuel.

And, also because of the increased use of the card in our stores that has driven that fee higher and higher, which is problematic of course for us.

So, that's an issue, but that's what we are seeing.

We are not seeing the opposite.

Okay.

Great.

Thank you.

Thanks, Ed.

Your next question will be from the line of Scott Mushkin of Jeffries.

Please proceed.

Hey, guys.

Hi, Scott.

Can you hear me okay?

Yes, we can.

Great.

So, just wanted to Rodney talked a little bit about the union.

I just wanted to get the temperature on how they're handling negotiations.

We are hearing some rumbling from other retailers that employee cost could rise as we get into '09 as we do get some wage inflation.

Do you guys have a thought on that?

Well, the comment I would offer is really the same thing we have said every quarter is that we try to approach our negotiations in a balanced way.

There are, obviously, in individual markets depending on the contract and situation, things that our associates need us to take a look at.

And, we discuss those of course and try to solve for those issues.

Sometimes it is wages.

Sometimes it is health care but there are legitimate things that need to be reviewed there.

On the other side, in order for your strategy to be successful, I think the union sees this and understands that we have to be able to balance our overall costs because our whole strategy is to reinvest where we have savings into things that is matter and are important to the customer.

That's what's driven our sales.

That's what ends up with the business model working.

So, it is striking that balance, and it is really a market-by-market situation.

And, I don't think today's economic climate makes that any different than it has before.

We got to look at it one place at that time, one contract at that time.

Rodney described the contracts that we have -- that we had before still and of course a settlement that was just reached yesterday in Nashville.

We have been particularly pleased at the pattern and discussions and the active dialogue we've had with our union partners.

Yes, we work real hard -- real hard with your union partners.

We understand the associate need for good wages and a very affordable health care plan and we work really hard to accomplish that in each market we operate in.

Okay.

Then, I guess I was a little bit surprised by the change in lower the LIFO down, giving DOW just its raised prices 25%.

And, I hear you on dairy, but it just seems to me you would want to be pretty cautious as we are seeing people putting huge price increases.

So, I just wanted to get your thoughts -- a little bit more thoughts on why you would actually lower it this early?

It is actually a little bit of the inverse last year of why we raised it every quarter last year.

We have a pretty firm methodology on how we estimate our annual LIFO charge.

And, when we look at that calculation this year's first quarter and try to project out the various categories and commodities are going to wind up by the end of the year, which is what we try to do, it indicated to us at the end of this first quarter, that overall we will have a lower LIFO charge than we originally expected.

Well, I understand what you are see saying, why not be cautious and keep it a little higher right now.

It is primarily because of the accounting approach and methodology we picked estimated on a quarterly basis.

We don't go about changing that every quarter based on where a particular quarter comes in or what our needs are.

We do it consistently every quarter, and that's the result it gave us at the end of the first quarter.

Yes, and as we mentioned on the call it is driven by expected dairy.

Dairy is a huge driver of our ultimate LIFO charge ends up being, and right now it looks like dairy is going to come in nicely lower at the end of this year than it was at the end of last year.

And, keep in mind LIFO calculation is a point in time calculation done in the fourth quarter, and all we are trying to do is to estimate that point in time is then.

It is not an accumulation of inflation during the year.

It is actually inflation at that one point in time in the fourth quarter.

How much -- ?.

Scott, one -- Scott, one way I like to think about LIFO too is in addition to the one point in time, is it is a reflection of the inventory mix we hold not a reflection of the actual inflation we have experienced in the sales.

There are two different mix calculations.

And, so, you have to really understand it to understand how it can happen, but that's why dairy can drive it so strongly.

You had a follow-up?

How much is dairy?

I am not going to get into the specific components of the LIFO charge, but just the fact that as fast as milk moves in our stores and the fact we produce most of the milk, so --not only at the store level, but in the dairy -- in the manufacturing level as well.

We have a lot of dairy inventory.

So, when those prices move it can change the LIFO calculation.

Great.

And, just one quick one.

Did I understand you right you said the rebate had no sales effect?

We said it had no material effect on sales or earnings for the quarter, and keep in mind for the quarter the program was out there for three weeks.

And, if you look at sales trends and profit trends before and after the launch of that program, you would see nothing material that happened during the quarter.

And our trends as Rodney said in the prepared comments for the first four weeks of the second quarter continued at the high end of our guidance for the year.

Yes, remember, the way those cards work is you don't record any sales at all untill the card is actually used as it is being used.

So, that's why.

It is potential that we could see a lag here because it was three weeks, and it could be $1,330.

So, we can see a lag effect.

You really won't know if it is having a major effect until we get to the second quarter.

Is that a good way to look at it?

Keep in mind, the $120 in that $1,320 never gets reflected as a sale.

Right.

Yes, that's one thing we were trying to illustrate on the prepared remarks is if you look at for the quarter it really didn't have much of an effect.

When you look at it overall, it is too early to really give you insight other than what we are seeing we are pleased with overall.

Okay, guys.

Great.

Thanks for answering my questions.

Thanks, Scott.

Your next question will be from the line of Karen Short of Friedman, Billings and Ramsey.

Please proceed.

Hi.

Thanks for taking my call.

Great quarter.

Thank you.

A couple of questions actually just on food stamps I guess are you guys seeing an increase in food stamps, and i guess how do you think about that from a positive-negative standpoint.

And, then, is it, is there any geographic focus if you are seeing an increase?

The answer is we are looking around and don't know the answer.

We have looked at that but I don't have a specific answer for you on that today.

Okay.

And, then on Ralph, there's some press releases or things that hit the trade journals on your strategy on changes in your strategy at Ralph.

Can you just elaborate on that a little bit?

I don't really plan to elaborate more on Ralph strategy other than what they would describe to their customers, except to say this that we are pleased with the strategy they have developed as a management team.

We are real focused on improving results in California and Southern California.

It is a terrific market both for us and the potential is also there strongly for both Ralph's and Food 4 Less.

And, they're meaningful players in our organization.

So, I would really just offer our support for what they're doing in the strategy, but would not add any elaboration to it.

Okay.

And, then, on Private Label, I guess, obviously, you have talked a lot about inflation.

How do you think about maintaining gross profit dollars versus margin with what we're seeing in Private Label.

I mean, obviously, there's some benefit to you guys from consumers trading into Private Label, but I would assume you are also seeing some cost pressures from your own -- for manufacturing on your side.

So --

Rodney pointed out that we are seeing some inflation of course cost pressures in our own Kroger brand.

And, that was one of the reasons that the dollars were up on the numbers he gave.

But, we are -- we look at this from a point of view as a profit we make on Kroger brand is typically a higher percentage than National brand and frankly even a higher percentage profit when you add into it the profit that is produced in our manufacturing plants.

That's a very important point not to forget because that's what actually makes well over half of our Private Label sales are products we produce in our plants.

So, on the whole that works pretty well for us.

In our pricing strategy we typically look at the relationship of what customers buy and what price they buy, and how much below a National brand you want to be targeted in order to get those sales.

We also recognize occasionally we will make a little less profit on our -- a Private brand because it will help the overall picture of what Kroger brand can do.

The more customers we convert to more Kroger brand the better off we are, and the better we like it.

Okay.

And, guess just the last question I mean there was a little bit of noise that you might have prior to your earnings release you might have been seeing some weakness on general merchandise sales at -- in the marketplace and Fred Meyer's stores.

Do you have any comments on what you are seeing general merchandise?

Sure.

There are actually two major product categories we are seeing noticeable weakness.

We've commented on these before.

One is in general merchandise and the other is in jewelry if Rodney wants to add anything on jewelry.

That area reports up to him.

He may want to do that.

But, in general merchandise, we are seeing some weakness there, not just at Fred Meyer.

Fred Meyer, of course, has more general merchandise than other places.

It would show up there, but it is also showing up in other stores as well.

And, it's showing up in our seasonal merchandise sales, patio sets and things like that in the summer.

But, it is driven by a couple of thing, particularly that seasonal.

It is driven not only by the economy and lower amount of spendable income we think, but it is also driven by weather.

Weather has been noticeably different this year in many parts of the country, cooler, and by being cooler people were not inclined to go scout buy a patio set for the summer as an example.

And, then you get deep enough into the summer, and they say well we will wait until next year.

We, of course, track everyday every week our sales are and what our sell-through is on things like that.

And, it is a little less than where it was last year, but our merchants are taking close watch of that and are devising strategies to help give our customers -- already have been giving our customers some really good deals.

In terms of jewelry, if you look at for the whole company for a year, it is less than 1% of our business so just so that everybody recognizes that.

If you look at our performance in the quarter, it would be very similar to the other public jewelry companies.

If you look at Signa and some of the other ones, obviously, negative identicals.

If you look at in the last few weeks, the trends have been a little bit better than what we were early in the quarter and what they were in the fourth quarter last year.

So, we are seeing some improvement, how much of that is a tax rebate check and how much of it is trend changes, that's too early to say.

Okay.

Great.

Thanks a lot.

Thanks, Karen.

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

Please proceed.

Hi, Meredith.

Hey, great quarter.

Thank you.

I was wondering if you could talk -- I think you said that you haven't seen price wars in a really long time.

I just want to confirm that you are not really seeing any significant change in the competitive environment with this slowing economy.

Well, I tend to define a price war as more irrational pricing behavior.

And, I have not seen that sort of thing in our industry in a long time.

You occasionally see some tiny erratic changes in individual markets, and there's always something like that going on but nothing that would be noteworthy.

I think the industry is quite rationally.

The industry recognizes as we recognize that you need to go a return on your assets, and I think that's been the picture of this kind of industry for actually ten or 20 years.

And, when you look at, you guys don't usually talk much about the boost in total volume or units that comes form making acquisitions.

But, you did do a couple last year, and I was just wondering it would be great actually if we had that on a regular basis, maybe it is not significant, but what the outlook is for more of those kinds of local acquisitions?

They're highly accretive I think.

We like those a lot.

Rodney, you want to--.

Yes, I was just going to say we always like end market acquisitions for us.

It seems to work very well.

And, we are always on the outlook for it.

We want to make sure we don't build our business model around, where we have to do those in order to make our numbers work.

And, that's one of the reasons why you don't hear us talking about it, but -- except when we actually do something.

But, any time something becomes available, we will take a look at it.

We think it is important to make sure that we pay a fair price for the seller and for us as the buyer, and that is what we are always looking at something that ties in and works for us.

And, we have been very pleased.

And, the two you talked about that we did last year, both of those are working very well.

Our in-store teams have done a great job of integrating it into Kroger and providing something additional for the customers.

Also, keep in mind the new stores haven't been around long enough to be in our identical sales calculation yet.

Okay.

And, would you say that this environment makes it more likely that you will see opportunities or not really any change?

We -- there's no shortage of things that we see.

There's still a gap in valuation, and we see -- we are seeing probably right now we see a little bit more where people put things on the market and then actually nothing happens.

I assume that means that they weren't satisfied with the price, but I don't know that for sure.

Okay.

Then another comment or question really is you haven't commented at all about the flooding in the Midwest.

I guess you presumably you have got that baked in somehow into your outlook for inflation.

Did it have any impact on your business itself?

I am not sure whether flooding compares to where your stores are.

but is that something that's going on right now.

Well, we've had some disruption, but it has not been significant or material.

Do you want to comment on any specifics?

We had a couple of stores, a C store in Iowa, a grocery store in Indiana.

A C store in Indiana.

And, a C store in Indiana that were affected by floods and all of those -- the cost of any of that is reflected in our results already.

I would add to that we also had a few stores that had major power outages because of storms and things like that.

And, I want to add even though it is maybe not relevant to, Meredith, what you are asking, but it is relevant to anyone else listening on the call.

The employees and that management teams and that -- all of the employees associated with those geographic areas when that happens have to absolutely work their fannies off, and they really do a wonderful job.

And, this last series of storms was a really good illustration of that.

They recovered quickly, got back open quickly in nearly every case, minimized the damage and helped our customers because customers in times like that really need our services more than almost any other time.

So, trying to get us back in a position like that is a huge thing to do.

So, I don't want to reduce the impact of that by saying the financial impact is not going to be important here, but the -- but the contribution that our associates make is significant.

Okay.

Great.

Those are all my questions.

Thank you.

Thank, Meredith.

Your next question will be from Neil Currie of UBS.

Please proceed.

Hi, there.

This is Doug Cooper in for Neil Currie.

Hi, Doug.

A couple -- I have a of questions here.

First question is can you quantify or tell us a little bit more about where you are gaining share from.

Wal-Mart had made comments to the point that higher incomes were now shopping -- higher household incomes were now shopping in their store.

Can you quantify a little more about where that share gain is coming from?

Doug, we have said before that we are getting it from lots of different places.

At the end of the year, last -- I guess last quarter we released our market share data and when we released that we illustrates that based on our estimates that Wal-Mart's market share actually is growing in the markets where we are growing, too.

So, it is obviously coming from other areas especially, and some of it obviously is restaurants.

Some of it is from other outlets that would not be classified as grocery.

So, local independents and things would not -- would not be under that heading, but then of course then you to have the local independents and and the regional chains that may have given up some market share too.

But, it is all of those things.

And our focus is not -- at Kroger is not so much on individual competitors as it is on our customer.

And, if we draw from and -- our customers needs and fill their needs we will get the business from wherever they were previously going whether it is a supermarket or some other form of business.

And, if you look at the stuff we work with pm, we actually seen the gains really in all types of customers.

It is not just lower income or higher income.

It is really all customers.

Great.

Now, in terms of your Ralph's price cuts that you announced recently the L.A.

Times I guess there was an article.

But, can you quantify a little bit about how you are approaching those price cuts?

No, we are not going to talk about individual markets today.

Okay.

In terms of you say moderate for inflation.

We have noticed year-over-year comparisons are higher for most categories.

Is that compared to absolute relative pricing?

What can you say about absolute pricing?

I'm not sure I understand the question exactly.

But, we characterize it as moderate inflation primarily because lots been written about it.

And, if you read the press, you would think that inflation and food products was like off the charts.

One of the reasons for that is we've had 20 year period of time where we've had basically no inflation, zero.

0.5 point up, 0.5 point down.

But really zero.

So, now, that we've had a year or two now of low level, moderate inflation, people are writing a lot about it and seeing it.

So, that's why we wanted to make sure we characterized it as moderate.

Do you want to add anything?

And, there are some areas where there's deflation.

That's true.

And, if you look at pharmacy as an example, you know, there's significant deflation in pharmacy.

So, what gets the head line are the things you have inflation in, but, when you look at the business overall, we are seeing about 3.5% inflation that we talked about before.

Yes.

And, the deflation and pharmacy has had a direct impact of the up tick in generics.

Or --?

I would say that was the biggest driver of it is certainly generics.

Some of it is our own $4 program and $10 for 90 days.

Yes, okay.

Thank you.

Thanks, Doug.

I think we have time for one more question.

And, that question will be from the line of Mark Wiltamuth of Morgan Stanley.

Please proceed.

Hi, good morning.

You mentioned that you own and manufacture more of your Private Label than competitors.

Is it better to own your own Private Label in an inflationary environment, or is it better to use third parties during that period?

Well, we like it for a lot of reason.

One of which is that we know exactly what the cost increases are.

While you could have -- if you are buying from a third party, you could have potentially some lag between when the cost actually are incurred and when you get increased costs.

But, if you have too much of a lag, the third-party operators actually will need to push the prices up even higher yet than that need to be.

So there's a lot of put and take there in the short term.

In the long term though, I would much prefer to be in the position of owning the assets.

I think it actually works well, and we can control our own destiny better.

Obviously, by cutting out the third party there you have the opportunity for either higher margin or going lower on price.

Which do you lean toward with our own -- own product?

Well, it depends entirely on the product, on how customers in our view would react, how targeted a particular item would be for them.

We are not afraid actually of either way of getting a lower price, but we are also not afraid of getting a higher margin.

Okay.

If you look at our corporate brands overall, about half of those corporate brands we manufacture, half of it we do buy from third parties.

So, we have the opportunity to see both sides of it.

We love owning the plants.

The other thing that by owning the plants, what it allows you to do is improve the supply chain, where you can eliminate any type of wasted efforts that supply chain and give that benefit to our customers.

Okay.

Very good.

Just wanted to ask if the mix of promotional buying from your customers has changed dramatically over the last couple of quarters?

I wouldn't characterize it as a dramatic change, no.

Okay.

And, how about the pricing gap relative to your competitors?

Have others tried to follow your lead on lowering -- lowering prices?

I am not going to comment on our competitors' pricing strategies.

Okay.

Alright.

Great quarter, and congratulations.

Mark, thank you.

Thank you

And, for everybody listening, I want to have a few wrap up comments here before we sign off, especially for some of our associates, who we encourage to listen in on the call.

To our associates, thank you for your contributions to our strong first quarter results.

Our performance is tied directly to the efforts you make everyday, and we appreciate your commitment to keeping our Customer 1st in your daily decisions.

One customer summed it up well in a recent letter to me that he wrote about great service he and his family consistently enjoyed at their local Ralph's store in Porter Ranch, California He wrote that although he and his wife have more than 12 supermarkets in a ten-mile radius of their home, they shop only at Ralph's because of the amazing professionalism and courteous treatment we get from the wonderful staff your have there.

From cashing in our coupons to simply saying hello or asking where something might be found, this staff is fantastic.

We have never encountered anything but the highest level of kindness, respect and cooperation.

He went on to say how proud I should be of the team there and indeed I am.

Rick [Foley] and all of his team members do a really great job.

This is another terrific are example of what does happen when a team is committed to delivering except -- exceptional customer service.

Congratulations to each one of the great team members at our Ralph store Porter Ranch.

Our results tell us that there are examples like this in every store and in every work place throughout our whole Company.

As each of our pay checks reminds us, a satisfied customer made this pay check possible.

Thank you for keeping your focus on our customers.

And, one final note, we hope you and your families enjoy a safe and happy summer.

Good-bye, and thank you all for joining us.

Thank you for your participation in today's conference.

This concludes our presentation, and you may now disconnect.

Have a wonderful day.