克羅格 (KR) 2008 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the third quarter 2008 Kroger Company earnings conference call.

My name is Jasmine, and I will be the operator for today.

(OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded for replay purposes.

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

Carin Fike, Director of Investor Relations.

You may proceed.

Good morning, and 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 prediction, 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 filings.

Kroger assumes no obligation to update that information.

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

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

Thank you, Carin, and good morning, everyone.

Thank you for joining us today, and with me today to review Kroger's third quarter 2008 financial results are Rodney McMullen, Kroger's Vice Chairman; Don McGeorge, Kroger's President and Chief Operating Officer; Mike Schlotman, Senior Vice President and Chief Financial Officer.

In a few minutes, Rodney will discuss details of our quarterly performance.

First, I'll discuss what drove our sales during the quarter, and our outlook in this economy.

Then we'll be happy to take your questions.

Kroger's third quarter sales continued to be strong in a tough economy.

Identical supermarket sales rose 5.6% without fuel, reflecting the strength of our customer-focused strategy that we developed six years ago and continue to sharpen today.

Identical sales growth was positive across all departments and all supermarket divisions.

We're still seeing slowness in sales of discretionary general merchandise and jewelry, a trend we have discussed with you since the fourth quarter 2007.

This slowness continues to get worse.

Overall we are pleased with our strong sales trend, particularly in this environment.

We realize higher product cost inflation continues to play a role, but our business model is designed to deliver consistent results whether the market conditions are favorable or less than ideal.

Sales in regions affected by Hurricane Ike recovered particularly well, thanks to the outstanding efforts of our associates.

Our teams worked tirelessly to get stores back in business quickly to serve families as they recovered and restocked their households.

And we appreciate the dedication of associates throughout our organization who supported customers and colleagues in the aftermath of the hurricane.

Kroger's focus on low prices, quality products and providing a convenient one-stop solution continues to resonate with customers and drive sales.

Several trends we have discussed in the past few quarters, continued throughout the third quarter.

Namely, a growing interest in private label products and prepared foods, as consumers choose to prepare and eat more meals at home, and a sharper focus on price from all customers in all segments.

Customer interest in our corporate brands continues to accelerate in the third quarter for two reasons.

First the current environment is prompting customers to try more of our private-label products.

And second, the overall strength and breadth of Kroger's private label program appeals to shoppers on any budget.

For the second quarter in a record we saw accelerated growth in our corporate brand penetration, both in terms of grocery sales dollars, and units.

During the quarter corporate brands represented almost 27% of Kroger's grocery sales, and 34% of grocery units.

And our proprietary loyalty card data indicates approximately 14% of our customers are trading over in the purest sense, by simply buying the same for less by switching to one of our corporate brands in any of the three tiers we offer.

Our robust corporate brands program is a fundamental part of our customer-first strategy.

Our quality products are strengthening our connection with our customers as we work to earn their lifelong royalty.

Kroger's corporate brand products are produced and sold in three tiers, Private Selection, store banner brand like Kroger or Frys and King Soopers or Ralph's, and our Value brand.

We continue to expand our private label offering across all three tiers.

While our entire private label portfolio is winning over customers, we're seeing particularly strong growth in both our Private Selections and Value tiers.

In fact, as we outlined earlier this year, our premium tier, Private Selections, which includes organic lines and gourmet meats, cheeses, and desserts to name just a few, is enjoying significant growth and on track to reach $1 billion in sales in 2008.

We expect to continue to see solid growth in this important area, even after the economy recovers, and we will continue to invest in Kroger's private label program.

One other advantage of our strong corporate brands program that it offers is to leverage, is as leverage when we have a supplier that approaches us with a product cost increase.

This advantage has become even more important in an inflationary economy, and Rodney will discuss this in more detail in a few moments.

I mentioned earlier that we continue to see growth in prepared foods as consumers choose to dine out less often and eat at home instead.

This is a continuation of a trend that we have seen for sometime.

We did see strong sales in our deli, bakery, and prepared foods departments again in our third quarter, and are pleased that our customers are increasingly looking to us to fulfill their needs for ready-to-eat meals.

Our sushi bars, hot soups, sandwich counters, and refrigerated soups and entrees are all doing well as a result of this shift in consumer behavior.

In fact, the third quarter marked the 11th consecutive quarter of identical supermarket sales above 6% in our deli departments.

This is nearly three years of consistently strong growth.

We will continue to invest in developing prepared food options that are meaningful to our customers.

As we have discussed with you a number of times, Kroger has been investing in lower prices for our customers for the past six years.

Our pricing strategy plays particularly well in this environment, as shoppers are increasingly focused on prices of staples they buy week after week.

And we're seeing signs that prices of staple items are increasingly becoming a deciding factor for customers in determining where they should spend their grocery dollars.

We're pleased that millions of households are choosing Kroger's family of stores because of the value, convenience and quality that we provide.

And we remain focused on investing on lower prices for our customers especially when they need it most.

The strength of our loyalty card program, helps us deepen the connection we have with our customers.

The scope and depth of our shopper card program is unmatched in the industry.

These cards link our customers to savings on groceries, fuel, pharmacy needs, general merchandise, and corporate brands.

We use data derived from our loyal card program to tailor unique coupons for specific households.

A recent mailing went out to more than nine million households.

Of those 95% of those offers were unique to each household because we understand and appreciate that no two customers are alike.

Some may live in the same city, some in the same neighborhood and even in the same street, but we know that they don't have the same shopping habits.

This level of personalization is a direct link to our customer's no other US grocery retailer can replicate.

These are just some of the competitive advantages fueling our sales performance.

In today's environment Kroger's team stands out.

We continue to post positive identical sales growth consistently, because of the unwavering commitment of our associates to our customer-first strategy.

And as Rodney will describe, we have the financial wherewithal to leverage our powerful financial strategy, even in a difficult environment.

We are on track to deliver another year of solid results.

We have confirmed our identical supermarket sales guidance for the year and raised our earnings guidance for fiscal 2008.

We're also looking forward to another year of earnings per share growth in 2009, driven by continued strong trends in identical sales, even with the current forecast of a less inflationary environment.

Now I would like to turn the call over to Rodney for some additional detail on our third quarter results and 2008 guidance.

Rodney?

Thank you, Dave.

And good morning, everyone.

We are pleased with Kroger's third quarter results, particularly against a backdrop of this tough economic environment, and believe they illustrate the strength and flexibility of Kroger's business model and varying economic conditions.

Today I will offer some perspectives on certain elements of our results, including the effect of Hurricane Ike, LIFO expense, and strong fuel margins.

I will also discuss Kroger's financial strategy, pension issues in today's environment and share additional color on the guidance.

I will begin with Hurricane Ike and it's effect on our third quarter earnings.

Our results included a pre-tax charge of $25 million, or approximately $0.03 per diluted share, related to property damage, and the disruption of our business caused by Hurricane Ike this past September.

The $25 million figure represents Kroger's retention under its property insurance and business-interruption coverage.

Our total losses exceeded that amount.

The effect of the hurricane on our business was far reaching.

Ike and its remnants disrupted our operations in Texas and several inland states including parts of Indiana, Kentucky, and Ohio, causing property damage, extended power outages, and fuel supply issues in several additional markets.

While we did incur some expenses, we also realized some benefits as customers restocked their households after the hurricane.

We believe these two outcomes likely offset each other.

Further, we are preparing a claim under our insurance coverage, and in compliance with GAAP accounting rules, we'll record a receivable once an agreement on the reimbursement amount is determined.

As Dave said, our associates did a terrific job to serve customers in the areas affected by Ike.

To give you just one example of how quickly our teams moved, our Kroger store in Galveston which sets on the Galveston Bay was the first major supermarket to reopen after Ike.

The island was devastated, but our associates partnered with coworkers in other areas to get the right resources to Galveston quickly to get our store there in shape to serve that community when it needed it most.

We want to thank our associates again for a superb job.

Without efforts like this, the effect of Ike would have been much worse.

Another unanticipated item during the quarter was the magnitude of our LIFO charge.

We certainly expected a LIFO charge, but the detailed analysis we conduct at the end of each quarter to update our estimate, produced a result significantly different than our previous expectations.

Recall that when we reported our second quarter results in September, we were estimating a full-year LIFO expense of approximately $160 million for 2008.

We now anticipate the figure will be closer to $200 million.

The incremental $40 million applies to the entire year and disapportionately burdens our third quarter results.

It's important to remember that the LIFO charge is an estimate for the first three quarters, because we calculate our actual LIFO expense in the fourth quarter.

Of all of the estimates required for our quarterly financial statements, LIFO expense may involve the most variability particularly during periods of product-cost changes as we have seen over the past year or so.

The LIFO calculation is complex, and depends on a variety of factors, but the two primary drivers are year-end inventory level and product-cost inflation at a particular point in time during the year.

For Kroger that's snapshot is the 48th year of a 52 week fiscal year.

For the past two years determination of the LIFO charge, has added significant volatility to our financial results.

We don't enjoy the volatility anymore than you do.

When product cost inflation was non-existent to moderate, the impact on our financial results was not as significant.

Now with grocery inflation at levels we have not seen in almost 20 years, the effect of the volatility is magnified.

During the third quarter, our estimated product cost inflation was roughly 6%, with levels of over 7% in many center of the store grocery categories.

To give you just one example, canned vegetables is one category where we saw high product cost inflation in the second quarter, and even a higher percentage increase in the third quarter.

The dollar amount on that inventory is also high.

Even with the added earnings volatility, our objective in using the LIFO method of accounting for our product inventories remains the same, and that is to reduce Kroger's cash tax obligation.

So while the non-cash LIFO charge hurts earnings, and can increase the variability of our projections, it ultimately helped cash flow, and we believe that's a wise tradeoff.

In order to maximize this benefit, Kroger carries over 95% of its inventory balance on LIFO.

This is a higher -- this is higher than nearly all of our supermarket peers.

Kroger has been using the LIFO method for a longer period of time than many of our industry peers.

And this also affects the magnitude of our expense.

As you consider the effect of LIFO accounting on other food retailers, keep in mind that some of our discount competitors, carry a significant amount of general merchandise inventory in addition to grocery inventory.

For those retailers, deflation in certain general merchandise categories can mask inflation they may experience in their grocery inventories.

We understand that -- that raising our full-year LIFO invest for 2008 may seem counter intuitive to many of you at this time, when certain commodity prices have declined from historical highs.

And while in general prices of some commodities have leveled or dropped, we continue to receive cost increases from several of our product suppliers during the quarter.

Those higher costs are the primary driver of the higher LIFO estimate.

As you would imagine, we are discussing pricing issues with many of our vendors to make sure that the price they charge Kroger reflects the appropriate input costs.

As we have described for you several times, Kroger's manufacturing business and strong corporate brands portfolio gives us additional leverage in these discussions.

As product costs do come down, keep in mind that we plan to pass along that benefit to our customers.

We do not view lower product costs as a margin expansion opportunity.

This mindset and approach is in line with our overall customer focus strategy.

Now I would like to comment briefly on our retail fuel operations.

We did see exceptionally strong margins in our fuel business, reflecting our typical margin experience when wholesale fuel costs declined as they did throughout the quarter.

Considering the following year on year comparison, the cents per gallon fuel margin for our convenient stores and supermarket fuel centers was $0.239 , compared to $0.087 in the prior year.

While the effect on Kroger's earnings were quite favorable, we have been in the fuel business long enough to know the fuel margins do tend to normalize over a longer period of time.

On a rolling four quarter basis, the cents per gallon fuel margin was $0.156 this year, compared to $0.109 last year, but even that rolling four quarter figure is skewed by two quarters of very strong fuel margins this year.

We expect a more normalized fuel margin would be approximately $0.11 plus or minus a little.

Next, I would like to update you on our financial strategy.

Our Company's financial strength has long been a competitive advantage, and is even more so in the current environment.

Kroger's balance sheet is strong, and our financial position gives us the flexibility to continue investments in our successful customer-first strategy and store base, that will create value for our shareholders in the future, while delivering near term financial results.

We have aligned Kroger's cash flow priorities to leverage of our financial strength, and support an appropriate level of liquidity necessary under current economic conditions.

We are now allocating cash flows primarily to capital investments, debt reduction, and dividend payments.

Given our current bias towards debt management, we were less aggressive in buying back shares during the quarter.

Under current market conditions, this continues to be our position regarding share buybacks.

As market conditions change, we will adjust our buyback activity accordingly.

We are on track to invest $2.0 billion to $2.2 billion in capital projects for fiscal 2008.

For fiscal 2009, we expect capital investments similar to 2008.

Our emphasis on store remodel activity and infrastructure investments will continue.

Our debt leverage matrix are improving.

On a rolling four quarter basis, Kroger's net total debt to EBITDA ratio was 1.96, compared with 2.02 during the same period last year.

At the end of the quarter, total debt was $8.0 billion, an increase of $553 million from a year ago.

As a reminder, the third quarter is typically our seasonal peak for debt levels, as we built inventories to prepare for the holiday season to make sure we have inventory for Thanksgiving and Christmas.

While the credit markets remain under stress, Kroger has ample sources of funding available to meet both short and long-term financing needs.

The Company's $2.5 billion committed five-year credit facility maturing November 2011, continues to be available.

Even on peak borrowing days, we expect to have more than $1.2 billion of this facility would remain available.

We also maintain uncommitted money market lines totaling $75 million.

Furthermore, our access to the commercial paper markets has improved, and we continue to obtain short-term funding as needed.

Our long-term funding sources are also well managed.

In 2009, our only significant debt maturity is $350 million in senior notes due on June 1st.

Under normal market conditions, we would typically refinance that debt within a few days of maturity.

Current market conditions are anything but normal, so when we saw an opportunity this past November to issue debt, we did so.

We were pleased to place $600 million in long -term bonds with a coupon rate of 7.5% particularly in this environment.

This was -- there was significant demand for this offering.

This illustrates bond investor's assessment of the strength of Kroger's balance sheet and business.

Now I wanted to spend a few minutes just talking about pension.

Many investors are wondering how the current market conditions are affecting both the Company-sponsored and multi-employer pension plans.

For the Company-sponsored defined benefit plans, we expect 2009 expense to be comparable to 2008.

We expect to contribute between $150 million and $200 million to those plans in 2009.

This is more than the 2007 and 2008, but comparable to 2006.

For the Company's 401K plan, we expect a slight increase in our cash contributions and expense.

This is the result of higher enrollment by our associates as they respond to our efforts to encourage employees to save for their retirement.

For multi-employer plans, we do not expect a significant increase in contributions, and therefore, expense in 2009.

Should current market conditions persist in to 2010, we would expect contributions for the Company-sponsored defined benefit plans and multi-employer plans to increase during 2010.

Regarding labor relations, we are currently negotiating agreements that cover our store associates in Las Vegas, Phoenix, and Portland.

Looking to next year, we will enter negotiations covering store associates in Albuquerque, Atlanta, Dallas, Dayton, Denver, and Rowen Oak.

Our objective is to achieve competitive cost structures in each market, while meeting our associate's needs for good wages and affordable health care.

The likely increase in pension costs, and how they align with other labor priorities will need to be addressed in bargaining.

Our ability to balance competitive costs with associate benefits allows Kroger to invest in our business and create new job opportunities for existing and future associates.

Now turning to guidance.

As Dave said, we are confirming our identical sales and raising our earnings per share guidance for fiscal 2008.

We expect identical supermarket sales growth of 4.5% to 5.5% excluding fuel for the full year.

Excluding $0.03 cents per diluted share charge related to Hurricane Ike, full-year earnings are expected in the range of $1.88 to $1.91 per diluted share.

This equates to an annual growth rate of 11% to 13% over fiscal 2007 earnings of $1.69 per diluted share, and implied a fourth quarter earnings range of $0.49 to $0.52 per diluted share.

Kroger's dividend yield of more than 1% further enhances shareholder return.

This guidance range considers the cautious mindset of many consumers this holiday season.

Looking to 2009, we are currently projecting identical supermarket sales growth, excluding fuel of 3% to 5%.

We do think inflation will be lower next year than in 2008.

Our current expectation for product cost inflation would be in the range of 2% to 3%.

This identical sales growth will enable Kroger to generate earnings per share growth that -- that combined with our dividend, will create a solid return for shareholders.

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

Thanks, Rodney.

Before we take your questions, I would like to offer some additional thoughts on Kroger's third quarter performance.

On the whole, we are pleased with our strong sales in the quarter, particularly considering the difficult economic environment.

Our identical supermarket sales are among the best in the industry, and we achieved those even with the considerable challenges Hurricane Ike presented.

Our sales show our customer-first strategy is working.

We are increasing customer traffic in our stores, and selling more to customers who already shop with us.

Our industry-leading corporate brands are gaining momentum, and our pricing strategy is resonating with shoppers.

We are making our customer's lives easier by offering them a one-stop solution for their daily household needs.

During the quarter, we are in a good position to take advantage of the opportunities afforded by strong margins in our fuel business, but as Rodney mentioned, fuel margins do vacillate from quarter-to-quarter, and tend to normalize over a longer time frame.

We do not run our business based on margins.

Still, we could have done a better job in managing expenses during the quarter.

Our OG&A performance was disappointing, and we will improve.

We must be relentless in our efforts to reduce expenses so we can continue to drive cost savings back in to lower prices, and an overall better shopping experience for our customers.

We are keenly aware the economy will continue to put pressure on our customers and our organization.

Our customer-first strategy is designed to give us the flexibility to perform well in good times and in bad.

We are focused on maintaining our strong financial position so that we can continue to invest in our successful customer-first strategy and produce a solid return for our shareholders.

Now we would like to take a few minutes to answer your questions.

Jasmine, let's have some questions.

(OPERATOR INSTRUCTIONS).

And our first question comes from the line of Karen Short of Friedman Billings Ramsey.

You may proceed.

Hey, great quarter.

Thanks for taking my question.

Hey, Karen, thank you.

Just a clarification our your sales guidance for the full year.

On the identical sales range of 4.5% to 5.5%.

I mean that implies a pretty wide range for the fourth quarter, so wondering if you could comment where sales are turning right now?

And what would make you think they would decelerate enough to get you to the low end of the range for the full year?

And then I guess, just to follow up on that note, to talk a little bit talk about the potential for a deflationary environment and what you think that would mean for retail prices?

Well, the -- Karen, thanks for the question.

It is a wide range, of course, but now times are such, that it's a little less predictable than you might want.

But to just give you a feel, we have four weeks under our belt in the quarter.

The calendar is a little bit different this year in that Thanksgiving was at the end of the month, very end of the month, and we had a two-day shift -- had a two-day shift in the first of the month back from February, all the way to now, and each month has produced some unusual results.

But even with all of that, in the first four weeks in the quarter, we are just slightly below just a tick below 5% IDs without fuel -- is where we are right now.

That gives you a sense of -- of the picture today.

We described some of the discretionary products, have been an issue all year long.

In fact, we started describing it, I think fourth quarter last year, and it's gotten a little worse.

Fourth quarter is an important time for that.

That would be one of the reasons for leaving a little room -- breathing room on those numbers.

But generally, you can see we're bullish in what we have achieved and our connection with the customer has been strong.

So I'm actually feeling pretty good about things, given the environment that we're operating in.

One other piece that might be help to you, generally speaking.

It would be a little different in the holiday moments, but generally speaking the discretionary items we're talking about are roughly 10% of our sales.

It wouldn't be just some general merchandise items, but general merchandise and some other items in the store, but roughly in that range, and it's not 50% of our business, but its also not 1% or 2%.

It would be a bigger part of the business for Fred Meyer.

That would give you a feel for that too.

And then thinking about the -- the inflationary environment going forward, we -- we do recognize with commodity prices there is some likelihood that prices will begin -- the retail prices will begin to plateau, maybe even decline.

In fact, in some categories in some items we have already seen that happen already.

And certainly our efforts as you know because of the pricing position we take we're going to push the price side of things if we can to make sure we come out on the side of our customer in times like this.

And as we look at inflation as it does subside, it of course takes a little bit out of our sales lift that may be due to inflation, but thats not the only thing happening in our sales lift.

A lot of it is the more relevant connection we have with our customer.

To me on a deflationary environment, I feel very comfortable we'll perform very well relative to our competitors and better than many.

And we think manufacturing always gives us a competitive advantage, because we'll be able to take those lower costs and give them to our customers sooner than some of our competitors will be able to, which should further allow us to gain some share.

So that doesn't mean that it's going to be easy, but I don't think any environment is easy in retail, and I feel very good about our ability to react and adopt to whatever the environment is, and utilize some of the strengths that we have.

Okay.

Just a quick question on gas prices coming down.

I guess two things.

One is, are you seeing any change in consumer behavior, higher traffic with the lower gas prices or -- shift in traffic versus basket?

And then could you just give us what the fourth quarter gas margin was last year?

Well, let me talk about traffic first and Mike will check and see what we have given on gas margins if -- I don't know that we have that out there yet, but we'll see.

Anyway on customer traffic, we saw customer traffic as we've seen really all year long.

Customer traffic is measured by transactions has increased both on a total and on an identical basis.

Our transaction size has increased, but you should recognize that there's quite a little bit of inflation in that number.

And so I would have to say, once you take the inflation out, we have had actually stronger increase in transaction size -- or in transactions -- the number of transactions than we have actually even in the average sale.

But the average sale is strong too, but in part because of the inflation

Okay great.

And the gas margin?

Gas margins the fourth quarter last year would be a little over $0.12, about $0.125, and that was a little bit higher than the rolling four quarter number.

Thanks very much.

Thanks, Karen.

Your next question comes from the line of Neil Currie of UBS.

You may proceed.

Good morning, and thanks for taking my question.

The sales performance you are achieving right now is outstanding, and I hear your -- your sort of cautious tones for next year, and I note that -- the beginning of this year, you also forecast 3% to 5%.

To what extent is the current economic environment actually a benefit to you right now?

You have clearly driven a good price image amongst your consumers who see you potentially as a place to save money.

Is the current environment actually do you think sort of driving more people to your stores, helping you to gain market share?

Rather than being -- I agree with you being cautious in this economy, but is this something that is actually helping you right now?

Neil, that's a great question, and if you look at the way we have described that throughout the whole year, there is certainly parts of the current economy that have helped us.

In particular, the parts related to customers when they decide that it is less expensive to either get prepared meals at Kroger or to buy ingredients and make meals at home.

We're a great way to save.

And the investments we have made in our retail pricing for the last six years continues to resonate well with customers, they recognize it, they see that, and they have responded.

So in -- in an economic environment like this that certainly helps.

It also helps that -- when the gas prices were high, now at the moment they are lower, but when they were high, certainly customers saw us as a ready access for gasoline, a one-stop shopping.

They liked that combination and it seemed to work well.

The convenience of our store to a neighborhood also worked well in the high fuel price moments.

But we still see traffic strong, even despite the fact that gasoline has dropped a bit.

What we described earlier in the year, though, was that if -- if conditions did not worsen, and clearly, as an economy things have gotten a little worse across the country.

And I think you can see that in some elements of our business too, and the things that we have released today.

And on the whole as a result, there are some things that are negatively tugging at our business in the economy, but there are plenty of things that are working for the positive.

Bottom line for us is that when -- when the economy is bad, people are still going to eat, and -- and somebody, some retailer is going to do well, and we're -- we're really committed to it being us.

The other thing is we look as 2009 expectations and what we have outlined is really trying to make sure we position the Company for us is containable growth and not just for 2010, but 2010 and beyond.

We want to make sure that we position it appropriately so that we have a long runway in front of us, and not just a one-year runway too.

Thanks, and just to touch on some of these comments, also in -- with regards to people eating out less, do you think -- could you give us some color on how your convenience meals are doing or prepared foods?

I know you had new (inaudible) introduced anyway by [Greencore].

Maybe on some of other prepared type meals and deli items that you have, are you seeing strong sales there?

We are.

We have a wide variety of products that would fit that category and so I wouldn't single any of them out, but one of the comments I had in our prepared comments was that for 11 quarters now, almost three years, our delis have run in excess of 6% identical sales.

And that's a long time, and that's important to note, because that means that we have been responding to that trend for a long time, and that we keep getting better, and our customers keep recognizing that, and it has now been year after year after year.

Great.

Thanks, and outstanding quarter.

Congratulations.

Thanks, Neil.

Thanks, Neil.

Your next question comes from the line of Scott Mushkin of Jefferies.

You may proceed.

Hi guys, this is Bakely actually filling in for Scott here.

I just wanted to ask about share gains.

I mean, implied with your -- comp results -- your results you are picking up share.

Where do you think you are getting it from?

Is it from super centers, from conventional competition, from all of the above, or what are you guys seeing?

We are getting -- first of all we don't give any public share changes until once a year, and we'll do that in March, when we'll come back and look at that data.

But clearly, the business that we're getting, though, is from lots of different places.

As we have pointed out in most of our markets, that even if you take us and others of -- of large scale in our business, there's still roughly half the market that is up for grabs.

And in addition to that, the most important, I think is to recognize how much restaurants are a piece of the eating action anymore.

That's the trend.

In the last 20 years, that's probably the single biggest trend that occurred in US communities as the people started eating at restaurants a lot more frequently.

Well that doesn't have to change very much for it to be a very healthy thing for supermarkets.

And I think we continue, clearly to see that being -- working to our advantage, and that's partly driven by the economy.

It's partly driven by the kind of products we're offering now, and the experience customers have.

And its partly driven by the price structure and pricing practices we have.

And its partly driven by people's desire to have more meals at home with families.

So all of those work, really, to our advantage.

Okay.

Thanks, and I just wanted to ask about, in an environment where gas prices are obviously coming down, or have come down, how do you view, the sort of $0.05 discounts or -- have you guys strategized, what you are going to do with gas in more like a $2.00 per gallon environment or below?

Well, our gas strategy is a lot more than just discounts like that.

The real value is the convenience of having gas at a location where you can do most of your shopping, most of the household kinds of needs that we would have, and at a retail price, our street price is very competitive.

In fact, I have had customers actually thank me for when we open gas stations in their neighborhood, because we tended to bring the prices down in that area that got -- that were posted at the pump, not only us, but then others would match our price.

So on the whole I think customers see us as both convenient and a good priced place to get gas.

And the gas promotions that you are describing are helpful too, in that they do tie together people's -- it does reward people who shop with us more regularly.

Okay.

Thanks very much.

Thank you.

Your next question comes from the line of Chuck Cerankosky of FTN Midwest.

You may proceed.

Good morning, everyone, good job.

Could you briefly talk about the convenience stores?

How they did in the quarter?

The C-stores had a great quarter.

They had both strong identical inside sales and strong gallon growth, and we're very pleased and then obviously the margin -- strong gas margins were on top of that.

So one of the things we always do internally is look at our performance relative to the other public companies.

And we felt we are had an unusual good performance relative to the other companies this quarter.

Rodney, does the gas margin information you provided earlier include the convenience store element.

Yes, it's C-stores and supermarkets added together.

All right.

Looking at gasoline and customer's response to the promotion aspect of it, how -- how has it changed with gasoline coming down at least in Ohio level of $2.00 a gallon?

I don't think it has really changed very much.

It's an ongoing program that we have had for a long time.

All right.

So people still want it?

Yes.

Well, yeah, they still want it.

I think the biggest difference is that when gas got up over $4 a gallon, people were pinched because as they filled up the tank, they had less cash.

And I think it was noticeable to people's budgets.

Now that the gas is back down at the moment under $2.00, I don't know how long that will last, but at that moment that's where it is, customers have a little bit more spending cash, but how they'll spend that is anybody's guess.

Whether they'll go back to restaurants a little bit more -- I mean that's one of the values of -- of us having given you an indication of where we are through four weeks in the quarter, just to gives you a sense that things haven't changed much.

And that was our objective so you can see that, even since gas has been low in this current quarter.

Okay.

You bought 3 million shares of stock in the quarter.

Was that early in the quarter, and -- and -- I mean, what is your philosophy on stock buybacks here?

Do you stop it all together, or do you -- are you going to be in and out of the market, but just overall less aggressive?

In this market, Chuck, we will be cautionary on the amount of stock we buy back.

We still have a buyback plan in place that puts us in the market at certain prices.

But just given the backdrop of the liquidity and debt markets today, we feel it's prudent to maintain as much flexibility from a liquidity standpoint as possible, and not be out buying shares when there is uncertain access to debt markets.

Now that said, we have had no problem accessing the debt markets and the commercial paper markets have opened back up for us to some extent.

It is not always the best rate, but we do issue commercial paper from time to time to keep our name out there.

Overall, it has gotten a little better, but until we see marked improvement, we are likely to remain cautionary and devote our cash to debt pay downs, dividends, and keeping the capital program.

Any thoughts on improving the dividend yields at, say, the current stock price?

I'll defer to our Chairman.

(Laughter.)

Obviously that's a choice that the board makes.

Well, we have that choice, the shareholders and the market has another choice if the stock price drops, of course that increases our yield, but that's not our objective.

(Laughter) Thats not the way I was asking it.

Chuck, actually, I mean, obviously we haven't had a dividend for that long.

And there's two things when you reinstitute a dividend you want to make sure of.

One, that you can continue to maintain the dividend, and we do think it is appropriate to over time to continue to increase the dividend, in terms of the a dividend per share.

And that would be our long term goal without getting specific of what we would do in any one fiscal year.

And I think in an environment like this, you would have to consider all of the current factors too, as we always do.

And I won't speculate now on what the Board would want to do with that.

Okay.

Can you give us any insight on how gift card sales are tracking?

So far so good, but it's still very early, and as Dave mentioned before, the calendar has shifted so much, that you really don't know for sure until where the holiday ends, but so far so good, but won't be able to really give you a definite answer until after the holidays.

Alright thank you.

Thanks, Chuck.

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

You may proceed.

Hi, good morning.

Good morning, Ed.

One of the biggest surprises to me this quarter, I think even more so than the LIFO charge was the OG&A rate.

And, you guys it a little bit, but it was up about 7.6%.

That growth rate is higher than what we have seen historically.

And I think with ex-the Ike impact, the ratio was up 23 basis points.

So can you talk a little bit about what happened this quarter.

Yeah, Ed, that's actually a great question.

In my mind too, that is the soft spot in our quarter.

And I agree with the comments you made.

Let's just get the perspective just for a moment.

The number we indicated was a 40 basis point increase, but if you adjust that for the deductible in Ike, it was 23 basis point increase without the fuel.

We described healthcare as being 13 basis points of that, and we described energy-related and oil-related kinds of products like utilities and bag expense and supplies, and that sort of thing as being 5 basis points of that.

All of that is helpful to explain where we are, but our bottom line is that we could have done a better job of managing expenses.

That our OG&A performance was even to us disappointing, and that we will improve.

You know, if you look at, you know, some of your competitors, you know, specifically Safeway, who, now is really growing SG&A, or really not growing SG&A, it's kind of flattish.

And I get the Company's focus more on SG&A, when the top line is maybe not going as well, and clearly that's that is not what is happening with you.

But, you know, what is the opportunity for you going forward to control SG&A a lot more aggressively.

Safeway will talk about how they can do it at no impact their IDs.

Is there that something that you think is an opportunity going forward?

Yes, we do agree it is a opportunity going forward.

And if you look at our history, '06, '07, and in '08, only one quarter did your OG&A actually go up.

All of the rest, it was declining numbers, and that is our objective.

That is our future objective.

We believe the opportunity is there.

The caution for us internally is to say that we want to make sure we don't mess up our offering to the customer.

That is real important.

We could slash OG&A expense pretty easily simply by cutting costs.

That's not our objective.

We're trying to change processes.

We're trying to change some of our conventional mindsets on how to serve customers.

And we are trying to do it in a way that the customer will actually see things as improved, not as worse.

So with all that in mind, that's a long-winded way of saying I agree with you.

All of everything you said was right.

We should have done better.

We can do better.

We expect to do better in the future.

We are committing to ourselves, and by saying what we have done, we're committing to you that we're going to work on that hard in the future quarters.

Okay.

Great.

And just one last question for you.

Safeway is now slowing down its lifestyle remodel strategy.

I assume it had at least some impact on you in the past.

You know, do you see a benefit going forward now to your IDs just from that program itself rolling off?

I wouldn't think that we would have see anything specific as to that, plus I'm not going to comment on any one competitor's specific strategies on what they try to do or not do.

I said in the past, that I admire what Safeway does and has done.

I think they have done a great job with that program, and I suspect they are slowing it, because they have covered most of the stores they planned to cover.

But its still means we are competing with a lot of the stores that have been converted.

So it's not like those stores goes away.

They are a great competitor, and we think we have fared well in those markets, as well as other markets.

If you look, as Dave mentioned for the quarter, we had strong identicals across the whole Company, and all division were positive.

And you should assume that in order to get that that that means the identicals were pretty consistent against competitors too.

So it's very consistent across the whole Company, and across all competitors.

That's a good addition -- I would agree completely with that.

Okay.

Great.

Thanks so much.

Thanks, Ed.

Your next question comes from the line of Meredith Adler of Barclays Capital.

You may proceed.

Thanks, guys.

I like the quarter too.

I have a couple of questions, maybe following on a little bit on some of the recent questions.

First, in talking about expenses, you did particularly call out healthcare, and I don't remember you mentioning it so much recently.

Could you talk a little bit about whether the increases were particularly at the corporate level or for your unionized plans?

Or maybe that is already set in stone so -- but -- and then what are you going to do to manage that?

Is it manageable?

Well, it was disproportionately more in the Company plan, than in the plans covered by union agreements that are jointly managed stress funds.

It was a combination of things.

It was in some parts bad experience on some individual claims, and some increases in claims generally.

The way we managed that and expect to manage it going forward, and have managed it in the past is working hard at plan design, which we have made lots of design changes over time, and not simply trying to shift costs to employees.

That's not the objective of the plan design.

The plan design changes are designed really to cause the associate to have some skin in the game, where they have actually have some of their money they are spending, and so they have to let the market make some choices for them, about what they do in their own healthcare.

And do they want to be healthier in their own personal lifestyle and so forth, to reduce their costs.

We have put a lot of emphasis, for instance, on health-savings accounts, and those programs do that very well.

But we plan to continue some of the same strategies that we have had in the past.

And I do think it's manageable over time, individual quarters, even individual years occasionally may perk up a bit.

You are might we have not called it out in this particular way for some time.

But we are paying close attention to it.

But it's an area we think we can do a lot with.

Great.

And another question -- I have been getting this question a lot from investors about inflation.

I member 18 months ago, Dave you said that food inflation was probably a neutral on the perishable side, and a modest tail wind on the packaged-goods side.

We still do have packaged-goods food inflation, but can you talk about -- that was -- but you were forward-looking at the time.

Did in fact you believe that on the packaged-goods side it was modest positive to profits, and what happens when you get deflation?

I think the -- my personal opinion, based on the observations I have seen over the last several quarters, is that inflation is a moderate plus just like we hypothesized at the time.

But that when inflation either becomes erratic; that is occurs quickly, or is a much higher number, which -- both of which occurred in the last quarter or so, then it starts to chip away at that net-net positive, and makes it harder.

And I think what has made this harder the last quarter or two, is lay that on top of an economy that went south in a very fast hurry.

I think this year has been for all of us one for the record books.

I don't think any one has expected many of the radical changes that occurred at the pace they changed.

They occurred with a high variability.

I think all of that degree of uncertainty, and so forth, layered an additional element on top of just inflation at work.

Had it just been inflation at work, it may have continued to be a net-net positive.

Now I see it as more neutral than I did.

I don't see it as a harshly negative thing, though.

Now you -- asked about deflation.

Deflation is another animal.

I think it is going to depend on how it comes.

We have seen commodity prices plateau, subside a little, and in some cases even decline from last year.

How that gets translated in to lower costs, and how quickly it does, and then how it gets played out in the markets, and what happens in the consumer behavior in terms of the economy and the spending patterns, I think will all determine whether or not, the -- less the moderate rate of inflation, less -- the lower rate of inflation will create a positive or just be neutral.

Rodney do you have --

I was just going to add one other comment.

On inflation, when you go back and and look at as we put together our Customer First plan overall -- and where we were -- what we assumed would happen, and as you remember one of the things we had always assumed was like Testco would come to the U.S.

One other major assumption we had made long term, was that inflation would be somewhere between 0% and 1% a year.

So our fundamental belief on a longer-term basis is that inflation will be very modest.

Obviously the last year or so it has been higher than that.

But longer term we don't think it will be, and we have tried to build our business model around that assumption that it wouldn't be.

You are not looking at it and saying, "Oh my God", we benefited so much from inflation, and now that we have deflation, it's going to hurt?

No, we are not saying that.

But we're cautious saying, we're in unchartered territory in what's occurred in the last six months.

And it makes it a little bit hard to forecast.

And it makes the future a little hard to forecast, because what we are going to experience is different than maybe has been experienced before.

Yes, I feel very comfortable, if you look at it over a year or year and a half the business will be able to adjust accordingly.

But inflation went from 6% positive to 6% negative in one quarter, I think it is going to take a little while to adjust to that.

Oh, I would agree with that.

But longer term, and when I say it longer term on that comment, I mean a year to year and a half, I think the business will re-adjust and things will be fine.

To further illustrates why look at this business on an annual basis instead of just a quarter-to-quarter basis, and it also illustrates why we try not to manage it simply by margins.

We're trying to look at our connections to customers over time, and what business we have with them over time.

Great.

And then a related question and then a very quick question.

When you think about -- I believe branded manufacturers are still raising prices on packaged goods, partially because they lock in higher commodity costs.

Do you have a philosophy at this point about the gap in pricing between your corporate grand brands and the national brands?

Will you be widening that or is it, category by category.

It is item by item actually.

It depends on what works well for the customers.

When you look at what happened in the quarter, our tonnage on Kroger brand and corporate brand products increased.

But as you can see from our sales, and also the rate of inflation, our tonnage on the whole, really grew a little but not a lot as a Company.

And that, you can just do the math and know what happened with national brands.

National brands plateaued or even declined in many cases.

And that will on their parts, will require some rethinking on how they want to approach that business.

But our view is that if the customers were interested in -- we're not trying to beat the national brands with corporate brand necessarily.

We think it is a great offering, but many of our customers want the national brands, and we see that as actually our friend.

So our interest is in getting our customers what they need, which is lower prices, and if it's our Kroger-brand products, then the national brands don't follow suit, then that's fine.

We'll just pick up even more market share than we're already picking up in the corporate brands, and that will put further pressure on the national brands to get right on their pricing.

Great.

And just a real quick final question.

You said that the higher LIFO had a particularly bad impact on the third quarter, but you are anticipating that it will be higher than your original plan in the fourth quarter too, is that right?

And did that contribute to the fact, that the growth rate in the fourth quarter, which originally you thought would be faster than the rate for the whole year, will in fact not be, based on your current guidance?

If you look at it relative to expectations, LIFO in the fourth quarter will be higher than what we were thinking before.

Not necessarily higher than last year, but certainly higher than prior expectation.

And that impacts the guidance for --

Yes.

3/13th of the extra $40 million falls in the fourth quarter and 10/13th is in the third quarter.

Oh okay.

I mean, that's just how you have to book it.

We have to get -- year-to-date, and its $40 million more expense for the year, so year-to-date, we have to get 10/13th of the $40 million behind us, and that leaves 3/13th or about $9 million or $10 million bucks for the fourth quarter.

Great.

Thank you very much.

Thanks, Meredith.

Thanks, Meredith.

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

You may proceed.

Good morning.

I wanted to dig in a little more about the gas margins.

Our model was predicting a pretty big margin swing and the number you called out was fairly similar to it.

That sounds like almost an $0.08 or $0.09 swing in earnings per share versus a year ago.

Did you get to reinvest some of that in lower prices or did it come too late in the quarter?

Well, as we mentioned in the comments I made, is the higher gas margins afforded the opportunity to some of the things we were otherwise doing.

But we fully recognize that that's not a permanent solution because gas margins were particularly high.

We got partly by skill and partly by luck in the quarter, but we're not expecting that benefit out in to the future, and as a result, we can't permanently lock in spending that, it can only help us with some of our programs at that particular time.

Did some of the gains carry in to the first four weeks of the fourth?

Yes, well, on the fourth quarter it -- we won't give that level of guidance, because within the quarter it will swing all over the place, and -- but -- and it's way too early to really tell you where we think it will be for the fourth quarter.

Yes.

One other thing on the quarter, the higher LIFO costs about almost $0.03.

Right.

Okay.

And then on pensions.

On your Company-operated plan, you said the contribution may not increase.

Are you just talking about the cash contribution, I would imagine the expense number would be higher because of this years shortfall.

No, actually on the Company plans for 2009, we would expect cash contributions to increase $150 million to $200 million, but we believe though expense related to that will be very modest change.

Did you make some changes to the plan to account for this year's miss or how did you end up after this year's shortfall?

I would imagine that would increase expenses.

Well, keep in mind the way the way you account for a Company-sponsored plan is one-year's loss gets amortized over a several year period of time from a book standpoint

Right.

You don't take all that one year loss in one year.

True.

And then your discount rate goes higher, probably?

The -- the liabilities are discounted at the AA corporate rate, and while the AA corporate rate, the base treasury is the historic lows spreads are historic highs, so as I sit here today I would expect a higher discount rate this year than last year, which would mitigate some of the shortfall from our return.

Okay.

And if you look -- you know, all new -- all recent -- all recent hires -- a few years ago, with we changed the plan to where it's more 401K, because it's really what our associates wanted in today's world.

And that was a change that was made a couple of years ago, which also affects the numbers overall.

Okay.

Well sounds good and thanks for the feedback.

And congrats on the strong sales results.

Thanks, Mark.

I think we have time for one more call, one more question.

Your last question comes from the line of Deborah Weinswig of Citi.

You may proceed.

Thanks.

So with regards to CapEx -- in the guidance was for flat in 2009 versus 2008, can you provide a little bit more color around that, and do you think there's opportunities for take-over locations from other retailers as well?

The guidance on CapEx would be organic CapEx, and would exclude any acquisition opportunities, so there wouldn't be any thing baked in to that.

If those kinds of opportunities come up, you know, oftentimes it winds up accelerating the capital expenditure program.

For instance, when we bought stores in Fort Wayne in Michigan last year, being able to pick up those sites really fills out those markets quite well, and you shift from building new stores to remodeling.

So if those kinds of things are out there, there could be some tradeoff, but we think that kind of a spending level is appropriate given the remodel activity we have planned, as well as some of the infrastructure spend that we'll use those dollars.

Some of these are really good investments for the very long term that we -- that have very good returns and very solid returns on the infrastructure side.

If you look at the dollars overall as we have done for the last several years, we continue to focus more and more on remodels and expansions, and it would have a very similar look in 2009 as what you have seen in '08 and '07, because we feel we are getting much better results out of the remodels and expansion projects.

Okay.

Once again, just going back to the sales guidance for '09 of IDs of 3% to 5% excluding fuel.

When we compare this to the 4.5 to 5.5 for 2008, is the majority of the difference between the two years your outlook for product cost inflation or just a conservative stance or a combination of the two?

At the moment it would be more inflation-driven.

You would probably accuse us of being more conservative.

Probably.

It's a lot easier to be conservative after the fact than it is before.

Okay.

And then one last question on the corporate brand penetration, health and beauty aids versus the rest of the store, what kind of opportunity is there in the HBA side?

I think's big tune the I think in HBC and still in grocery too.

But HBC would have a little more opportunity, of course, than grocery would.

But we see them both as still really ripe for development, and we continue to invest in the opportunity.

Great, thanks so much, and congratulations again.

Thanks, Deborah appreciate your call.

Thank you all for joining us, and before we end the call, I would like to share with -- with you some additional thoughts for our associates who are listening in today.

So for our associates first, thank you for another quarter of strong sales.

Our sales performance is the result of your individual contributions.

The economy is pressuring more and more families every day, and you heard us mention low prices is one of the reasons customers are choosing our stores over others in this environment.

Kroger is able to continue to invest in lower prices because of cost savings that we work to find every day.

And your personal commitment to saving costs no matter where you work in the organization, and no matter how small the savings, makes our lower prices possible, helping to drive customers in to our store.

Every time a customer chooses us, we are in a better position to take advantage of opportunities to grow our business.

As your family members, friends and neighbors celebrate this holiday season, please remind them about our low prices and our great products they can find at their neighborhood one-stop Kroger store.

As we close, I want to thank you for your commitment to our customers and to each other.

I hope you each take time to enjoy this holiday season with those close to you.

Thank you for taking time to join us.

Merry Christmas, and happy holidays.

Thank you for attending today's conference.

This concludes your presentation.

You may now disconnect.

Good day.