克羅格 (KR) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1 2010 The Kroger Co.

earnings conference call.

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

We will conduct a question-and-answer session toward the end of this conference.

(Operator Instructions).

I would now like to 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 discussion will include forward-looking statements.

We want to caution you that such statements are predictions and actual events or results can differ materially.

A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings, but Kroger assumes to obligation to update that information.

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

After our prepared remarks we look forward to taking your questions.

In order to cover a broad range of topics from as many of you as we can, we ask that you please limit yourself to one topic with one question and one follow-up question, if necessary.

Thank you.

Before I turn the call over to David Dillon, Kroger's Chairman and Chief Executive Officer, we want to take a moment to invite you to join us here in Cincinnati for our 2010 investor conference on September 28th and 29th.

We will be sharing more details with you soon and look forward to seeing you then.

I will now turn the call over to Dave.

Thank you, Carin.

Good morning, everyone, and thank you for joining us today With me to review Kroger's first-quarter 2010 results are Rodney McMullen, Kroger's President and Chief Operating Officer, and Mike Schlotman, Senior Vice President and Chief Financial Officer.

I am pleased with the strong positive identical sales growth we achieved in the first quarter while striking a better balance on margin investments.

Our "Customer 1st" strategy continues to deliver results through improvements in all four key areas we target; our people, our products, the overall shopping experience in our stores and prices.

As a result, the total number of families we serve continues to grow and our most loyal customers are buying more with us.

We're also reducing debt and returning value to shareholders through dividends and share repurchases.

Identical supermarket sales increased 2.4%, without fuel, during the quarter.

This continues Kroger's trend of positive identical sales growth that is among the strongest in the industry.

Each one of our 18 supermarket divisions had positive identical sales results.

Let me repeat that.

Every supermarket division we operate posted positive identical sales results for the quarter.

I want to thank all our associates for these great results.

Growth in loyal households and strong sales of our own brands and national brands continued throughout the first quarter, demonstrating the strength of Kroger's overall competitive position and the value proposition we provide to customers.

As you know, several years ago we developed a strategy to strengthen our connection with customers.

Our "Customer 1st" strategy focuses on four key areas our customers have told us are important to them; our people, our products, the overall shopping experience in our stores and our prices.

All of these, all of these are important to our customers when they decide where to shop.

Based on feedback from our customers we continue to make good progress in these four key areas as we focus our offering -- on offering shoppers more value for the way they live.

Customers tell us they appreciate the entire spectrum Kroger's unique value proposition offers, including friendly service, quality products that they trust, good prices, a pleasant shopping experience, and a personalized rewards for their loyalty.

As a result, both the total number of families and the total number of loyal households we serve continues to grow.

Equally important to us our most loyal customers are buying more with us.

We are building momentum through our multi-dimensional strategy, which serves Kroger customers, associates and shareholders well in a variety of economic conditions.

Several factors continued to influence Kroger's business in the first quarter.

They include aggressive competition, rising commodity costs, and slow and incon -- and the slow and inconsistent pace of the economic recovery and consumer confidence.

Kroger continues to perform well as the economy struggles to recover.

Our loyalty card data and proprietary analysis point to mixed spending behaviors across several customer segments.

Several signs indicate that customers are feeling more optimistic.

They're spending more money inside of stores on certain discretionary categories, such as organic foods, specialty deli meats, higher-end lines.

Many nonfood categories also show improvement.

At the same time customers who are more price sensitive remain cautious about discretionary spending.

Furthermore, the continued high use of food stamps and other government programs is still causing volatility in our weekly sales trends.

Our "Customer 1st" strategy serves all of these varying customer needs and wants.

Food costs also continue to affect our financial results.

For the quarter we estimate product costs inflation, excluding fuel, was roughly 90-basis points.

Because this figure is an average across several different departments, some additional detail might be helpful to you.

When you exclude milk, which was slightly inflationary and, of course, a big category for us, the grocery department experienced nearly 180-basis points of deflation.

This compares to almost 270-basis points of deflation in the fourth-quarter last year.

We saw very different picture in produce, where we experienced over 700-basis points of cost inflation due to supply issues stemming from unfavorable weather in some growing regions.

This was a trend change from 2009 when we experienced significant deflation in produce costs throughout much of the year.

Our results show we are striking a better balance between delivering solid near-term financial results and investing for the future growth of Kroger's business.

We are committed to improving this balance as the year progresses and as the industry continues to normalize.

To that end we have confirmed our identical supermarket sales and earnings guidance for fiscal 2010.

We expect identical supermarket sales growth of 2% to 3%, without fuel, for the year.

Net earnings are expected to range from $1.60 to $1.80 per diluted share.

We are striving to achieve these results in the upper half of the earnings guidance range and our incentive compensation plan reflects this objective.

The operating environment remains uncertain, and we believe several factors will continue to influence Kroger sales and earnings performance throughout the year.

These factors include inflation or deflation in product and operating costs, the competitive environment, fluctuating fuel margins, and the inconsistency of the economic recovery.

Next I'll turn it over to Rodney, who will provide more detail on our performance during the first quarter.

Rodney?

Thank you, Dave, and good morning, everyone.

The Kroger team did a great job during the quarter to set the stage for the rest of the year.

Our associates' efforts to control expenses enabled us to maintain a compelling price position relative to both discount and traditional grocery competitors.

We are particularly pleased with our associates' continued success in strengthening Kroger's connection with our customers.

This truly is a differentiating factor for our Company.

As a result, the number of total households we serve continued to grow in the first quarter.

Our loyal household count grew at a faster rate, including that our best customers are the primary beneficiaries of the investments we are making in the four key areas of our "Customer 1st" strategy.

We reward our best customers for their increased loyalty.

Increasing purchases from loyal families is an important part of our growth strategy.

Our strong partnership with dunnhumby supports this objective by allowing us to use our shopper data to reward our best customers with offers and coupons tailored exclusively for them.

No other US grocery retailer offers this level of personalization and rewards.

Our goal is to earn a customer's loyalty for life.

Growing market share is an important part of Kroger's long-term strategy.

We look at numerous resources to evaluate market share changes in our industry.

The resources we review all show Kroger's continues to gain share which is consistent with our loyal household growth and our strong identical sales growth relative to most of our competitors.

One of the most reliable and independent resources we regularly review is Nielsen Homescan data.

Their reporting shows that Kroger's overall market share continued to grow in the first quarter.

Our strong corporate brands also strengthens customer loyalty.

We serve millions of loyal households.

All but 5,000 of these households purchased at least one corporate brand item during the quarter.

Or in other words, if you think about it we have millions and millions of loyal households who shop every day in our stores.

Only 5,000 of these households did not purchase a corporate brand item for us.

That's less than the number of people that could fit into the Radio City Music Hall.

There would still room left over.

This is an outstanding indicator of the acceptance of our own brands and Kroger's ability to build lifetime loyalty with customers with our exclusive and preferred brands.

Corporate brands represented about 26% of our first-quarter grocery department sales and approximately 34% of grocery sales units.

We are pleased that we have maintained share at this level because we have expected some adjustments in customer's purchasing behavior as the economy improves.

Kroger now has more than 20,000 corporate brands items.

On average, approximately 11,000 of these items are available in an individual store based on store format and the specific preferences customers who shop that store.

The overwhelming acceptance of our corporate brands demonstrates customers recognize the quality and price advantage these products offer.

Increasingly we are introducing items, which fulfill an unmet need.

One example -- and this one I'm especially proud of our team -- is our line of Fresh Selections bag salads with food tracing technology.

The harvest mark technology we use on these salads allows customers to trace the origin of the salad through information listed on each bag.

One other new entry includes two cereals without high fructose corn syrup.

We developed these cereals based on feedback from parents who wanted cereal options that are free of high from fructose corn syrup and include whole grain.

Products such as these are "mom approved" before they arrive on store shelves because they were created based on what moms, and increasingly dads, have told us they want for their families.

We also continue to make strong progress on our sustainability agenda, which includes reducing energy use and our carbon footprint, reducing and recycling waste, and engaging our customers by offering them sustainable products to purchase.

Our associates also support our efforts to save energy and reduce waste through their actions.

In fact, our associates have helped Kroger reduce the energy we use by more than 27% in the past ten years.

This is enough energy to power every single-family home in the city of Memphis, Tennessee, for one year.

Through another initiative we have reduced the amount of plastic used in our Big K one and two-liter bottles.

As a result, we will remove more than 275,000 pounds of plastic from the waste stream annually.

Last month we reduced another milestone in our transition to using LED lighting in refrigerated cases in our stores.

Now more than 1,700 of our nearly 2,500 stores are using LED lighting in glass door refrigerated cases.

This LED lighting uses 75% less energy than traditional fluorescent lights.

Turning now to labor relations, we completed successful contract negotiations for our associates in Dallas and we reached a tentative agreement with the union representing our associates in Michigan.

Negotiations continue in several markets, including New Mexico, Houston, Portland and Seattle.

We begin negotiations soon with the teamsters in Southern California and with the UFCW with Cincinnati, Fort Wayne, Little Rock and Toledo.

Rising healthcare costs and retirement plan contributions continue to be an issue.

Our objective in every negotiation is to balance competitive costs with compensation packages that provide good wages, high-quality affordable healthcare, and retirement benefits for our associates.

Now Mike will offer more detail on the first quarter and Kroger's financial strategy.

Mike?

Thanks, Rodney, and good morning, everyone.

As Dave mentioned, Kroger reported positive identical supermarket sales, excluding fuel, of 2.4% for the first quarter.

Recall from our comments in March that the timing of the Super Bowl and snowstorms in many regions we serve benefited the beginning of our first-quarter identical sales trend.

On the flip side, the timing of Memorial Day negatively affected our identical sales trend at the end of the quarter.

Of course, our second-quarter identical sales results will benefit from this timing change.

Kroger's strong identical sales growth produced solid earnings that were in line with our expectations for the first quarter.

Net earnings totaled $373.7 million, or $0.58 per diluted share, compared to $435.1 million, or $0.66 per diluted share in the same period last year.

Last-year's first quarter results benefited from commodity costs, particularly dairy and diesel fuel, that were unusually favorable to our business.

This year stronger profits from Kroger's retail fuel operations helped soften this difficult comparison.

Our retail fuel operations added approximately $0.04 per share to Kroger's first quarter earnings on a year-over-year basis, as we expected.

I'll provide some additional color on our retail fuel operations in a minute.

Let's turn now to some of the details of our first-quarter results.

Excluding retail fuel operations FIFO gross margin decreased 77-basis points.

Most of this decline was driven by Kroger's investment in supermarket selling gross margin, which declined 71-basis points, excluding fuel.

This sequential improvement from the 126-basis points decline in the fourth-quarter selling gross margin demonstrates we are seeing better balance between price investment and tonnage growth.

Our more moderate margin investment yielded mid single-digit tonnage growth, excluding fuel and pharmacy.

Kroger recorded a $15.4 million LIFO charge during the quarter, a decrease of $7.7 million from the same period last year.

Excluding retail fuel operations, the LIFO charge decreased four-basis points as a rate of sales.

We continue to anticipate a full year LIFO charge of $50 million for fiscal 2010.

Excluding retail fuel operations, OG&A increased 13-basis points from the same period last year.

Healthcare, pension costs, and credit card fees continued to pressure Kroger's OG&A rate.

These rising expenses were mostly offset by identical supermarket sales leverage and the benefit from productivity improvements, process changes, and our efforts to reduce energy usage.

The higher OG&A rate also reflects expenses associated with The Little Clinic and i-wireless.

Kroger's first-quarter operating margin, excluding our retail fuel operations, declined 85-basis points, primarily as a result of the year-over-year changes in FIFO gross margin and OG&A expenses I described for you.

The year-over-year decline is a sequential improvement from the fourth quarter of 2009 when Kroger's operating margin declined over 120-basis points, excluding the benefit of a lower LIFO charge.

As Dave said, we're striking a better balance between delivering solid near-term financial results and investing for the future growth of Kroger's business.

We're committed to improving this balance as the year progresses and as industry conditions normalize.

For the 2010 full year we continue to expect a slight decline to a slight improvement in Kroger's non-fuel operating margin.

Turning now to our retail fuel operations, both sales and earnings were strong.

Fuel sales increased at both our supermarkets and convenience stores due to higher average retail fuel prices and a strong increase in the number of gallons sold, both in total and on identical gallon basis.

The cents per gallon fuel margin was $0.117 per gallon for the quarter compared to $0.082 for the same period last year.

On a rolling four quarter basis the cents per gallon fuel margin was $0.116 in the first quarter compared with $0.143 in the same period last year.

Our guidance for fiscal 2010 assumes a normalized margin for this business of approximately $0.11 per gallon.

I'll now update on you our long-term financial strategy.

We are very focused on allocating the substantial cash flow of Kroger's business to reward our shareholders, both today and in the future.

We plan to invest approximately $1.9 billion to $2.1 billion in capital projects during 2010, with a strong bias towards remodels and infrastructure projects.

We are doing so because we see plenty of opportunities in this environment to expand Kroger's competitive advantage and generate strong returns through capital investments.

These investments are designed to keep our store base fresh and appealing to our customers and reduce operating costs.

All of these investments are squarely focused on delivering our "Customer 1st" strategy and are generating returns higher than our cost of capital.

We're also committed to maintaining Kroger's strong balance sheet and solid credit rating.

At the end of the first quarter net total debt was $7.1 billion, a decrease of $339.8 million from a year ago.

On a rolling four quarter basis Kroger's net debt to EBITDA ratio, adjusted for the Southern California impairment charge in 2009 and Hurricane Ike charges in 2008, was 1.91 compared with 1.77 during the same period last year.

Our objective is to manage the leverage ratio in a range that maintains our current BBB rating to three major rating agencies.

While capital investments and balance sheet strength position our Company well for future growth, we realize that it is important to provide near-term rewards to our shareholders through a program of regular stock buybacks and quarterly dividend payments.

During the quarter we invested $79.5 million of Kroger's free cash flow to repurchase 3.6 million shares of Kroger stock at an average price of $21.89 per share.

After the quarter ended, we purchased an additional 1.9 million shares of stock at an average price of $20.25.

Approximately $240 million remains under the $1 billion stock repurchase program announced in January of 2008.

During the quarter we returned $61 million to shareholders in the form of dividend payments.

Our Board has increased the dividend each year since it was established in 2006.

Kroger's dividend yields adds 1.5% to 2% to total shareholder return.

Now I will turn it back to Dave.

Mike, thank you.

Throughout the difficult operating environment the Kroger team has stayed squarely focused on delivering on our "Customer 1st" strategy.

Kroger has had the courage in this challenging economy to invest in our stores to keep them fresh, to invest in many cost savings projects, and to invest in improving our customer shopping experience.

Our customers have noticed and are rewarding us with their loyalty.

We believe these investments will continue to differentiate Kroger today and will position us well for profitable growth for years to come.

As we move forward throughout the year we are focused on balancing investments in our business and returns for shareholders as we work to create long-term value.

We now look forward to your questions.

(Operator Instructions).

Your first question comes from the line of Andrew Wolf.

Please proceed.

Good morning and congratulations on the quarter.

Thank you.

Are you -- can you break down the ID sales growth between transactions and basket size for us and give us a sense of how that's been -- trended into the quarter?

Well, I'll give you a sense of the total picture, and I'm not sure, Mike, if we have the trend through the quarter.

If you have something you want to add, feel free, but for the whole quarter the biggest gain was in customer count when you think of customer transaction count.

That was by far the biggest gain, but our average sale, that's the sales rung up for each transaction, also was up but it was only up slightly.

Do you want to add anything to the trends?

Well, when you look at the trends through the quarter obviously it started out well because of the factors I talked about at the beginning of the quarter, that being the Super Bowl and the weather.

If you were to just look at it in absolute terms at the end of the quarter, the last quarter -- the week of this year was up against the Memorial Day last year so it was not as strong a comparison, so it gets a little murky.

I think if you look at -- when you look at the transactions on a monthly basis, which is most relevant, I think, we continued to have, as Dave said, strong growth in the transactions, as well as the number of units those households bought on a monthly basis, which is one of the ways we track it versus each time they come into the store.

And to follow up, some of the operators have begun talking about unit inflation or deflation and back of the envelope seems pretty obvious here.

Item deflation in this quarter from last quarter was down a lot, and it's not all -- some of it's explained by less deflation in product costs and less investment on your part, but is the rest of it explained by consumer behavior in terms of a dramatic shift in trading down or can you give us a little light on that?

I think the best thing to do is just think about inflation the way we have described it in the material we gave earlier.

We saw the average as inflation at 90-basis points, so 0.9%, but that doesn't even begin to tell the story because you have to disaggregate it to see where those pieces fell.

Produce tends to run the inflationary number up a bit because it was a 7% inflation in the quarter.

Grocery you can't even look at by itself because dairy was slightly inflationary, and that tends -- because it's such a big category it tends to offset some of the rest of the grocery department.

But even in the rest of the grocery department, which is the area that I think actually is of the biggest interest to your question, that area in the fourth quarter our deflation was 270-basis points and the first quarter was 180-basis points.

We had described last quarter and still believe that gradually as you go through the rest of this year that we'll see deflation turn into slight inflation, which it did in the quarter, and we think that trend will continue then through the rest of the year.

But it's going to be in different sectors and in different ways.

Grocery, though, is the one that I look at the most closely, and I think taking milk out of it gives you a clearer view as to what's happening, and the rate of deflation in grocery clearly has become a little less.

I don't think that's driven more by mix change, which is the question you were asking about customer behavior.

I think it's more driven simply by the cost of the product.

Yes, I was just -- the only thing I would add, Andy, to that is if you look an awful lot of -- we're starting to cycle a lot of the items that is were deflationary a year ago.

So if you look at the produce example on the inflation, part of that inflation was created because there was so much deflation a year ago, part of it was created because it was a poor quality -- poor quantity year for amount of produce out there.

So a lot of the change is really where we're starting to cycle deflation a year ago, so it's not so much the change in customer behavior.

Now, as Dave mentioned in his prepared comments, we are seeing some areas where people are starting to spend a little more money in terms of if you look at our non-foods areas we're having some growth there, organic food and some of those things, but it's really -- most of it's driven by cycling deflation a year ago.

Just lastly in the same vain, what can you tell us about the ability of the market to absorb increases at retail as protein has really shown some inflation lately and dairy, as well?

Are these being passed through?

Dave, you're starting to use the term normal, which I'm glad to hear.

Are you seeing signs that there's some normal ability of the market to pass through inflating product costs?

On the whole the answer to that question in my view is yes.

There's always -- when it comes to this question there's always qualifiers because it depends on the competitive environment, it depends on the particular items, and when you look, for instance, at produce, when you have high inflation in produce, you clearly have a mix change by customers within produce.

Same thing in meat.

When you have some inflation or deflation it tends to drive a different consumer behavior within that department.

That's not quite as true in grocery, except perhaps in milk.

In milk you do see -- tend to see a little gallonage change, not maybe as much as inflation or deflation but you see some gallonage change as that changes.

But in the whole of grocery, in the bulk of grocery, excluding dairy, generally speaking as costs go up,\ the retail goes up and follows suit.

And so I'd say it is the normal -- we would see the current environment as more normal in that sense, and we do expect that cost increases will be passed through.

In some cases that may hurt volume of a national brand vendor who raises prices, but they take that into account when they make a decision whether they're going to raise the costs, but that's certainly our objective.

Okay, thank you.

Thank you, Andy.

Your next question comes from the line of Chuck Cerankosky with Northcoast Research.

Please proceed.

Good morning, everyone.

Hi, Chuck.

Good morning.

When you look at your capital spending, call it about $2 billion this year, can you give us some ideas on what you're looking to expand square footage and maybe break down how that'll be driven between new stores, remodels that go outside the four walls, as well as replacements, and are you keeping some powder dry to go after some in-market acquisitions because I haven't heard much about that lately?

And then can you give us some examples on what you're doing in terms of infrastructure spending to make you more competitive or perhaps projects that you've completed and willing to talk about?

Mike?

Thanks, Chuck.

I will handle the questions on the square footage and the like and I'll let Rodney talk about the infrastructure projects.

If you look at our current forecast we would expect somewhere between 40 and 50 net new relocated and expanded stores, somewhere between 150 to 175 within-the-wall remodels of a major variety.

These things are always in the -- they can always fluctuate.

And that would give us square footage growth, if you exclude operational closings and any acquisitions, of about 1.5% or so would be where we are today.

Relative to keeping powder dry, $1.9 billion to $2.1 billion would exclude any dollars we would spend to buy in a property that's currently leased because as you know, over the last 18 months or so we've been fairly successful at doing that at pretty attractive cap rates.

It would also exclude any dollars we would spend on an acquisition.

We would review those acquisitions independent of our normal capital program and look at the return they would generate and the EBITDA they would add relative to the spend.

And, Chuck, remember one of the reasons why we do that on acquisitions is we don't want to build a business plan around where we have to have acquisitions to deliver what we've committed to from a return standpoint because we think that causes companies to chase acquisitions relative to than only doing acquisition when is it makes sense and that's the reason why we do what Mike just said.

In terms of infrastructure projects, the biggest buckets would be things that we've invested in to improve the shopping experience for the customer; technology, warehouse, and energy.

And if you think about the LED lighting that I talked about as an example, that would be something where we allocated capital to support an energy project that has a good return and it's also good for sustainability.

There's several things that we would have done on shopping experience, things like that.

Technology, it's really trying to figure out ways to make things easier for our associates, both in our stores, warehouses and plants, to do their daily job.

And I don't -- can't think of any that specifically I can talk about other than as you think about there would be some capital involved to support.

Some of the things we've done with dunnhumby, for example, would probably be something that would be reasonably easy to see.

And then on --

I --

Go ahead.

Sorry.

I don't mean to imply that you would have acquisition spending buried somewhere in your CapEx budget, but I'm just wondering if there's a [pause] in it that suggests that there might be some opportunities breaking loose all of a sudden, say in the remainder of the fiscal year?

We don't see our capital budget as being a barrier to those kind of acquisitions.

Those rise and fall purely on their individual merit.

Acquisitions so far wouldn't be much different than what we've seen in the past.

We see quite a bit of things, but the pricing that people expect is still more than what you can really justify and get a good return on the investment.

Chuck, you referenced pause I think in your follow-up question there.

We don't really -- we view our current capital program as spending in the neighborhood of $2 billion a year, which is where we were last year and we'd expect to be the next two or three -- the next couple of years after this year.

If you remember back in March we talked about at one point in time that would have been about $1 billion higher over those three years.

We just felt in this environment given what we were trying to do with the balance sheet and maintaining the rating it was more targeted towards that, somewhat influenced by our results last year and the desire to make sure that we didn't put too much pressure on the organization to maintain the credit ratings where we wanted them given that our results last year weren't where we wanted them.

All right, thank you and good luck over the remainder of the year.

Thanks, Chuck.

Your next question comes from the line of Deborah Weinswig with Citigroup.

Please proceed.

Good morning, two questions.

First of all, can you talk a little bit more -- I think, Dave, you referred to aggressive competition, are you seeing that across all geographies and maybe if you can elaborate if that's also across the store?

Okay, you were a little hard to hear, Deborah, so if there's more to your question in a minute talk a little louder.

Okay, I'll --

I got the first part.

The first part was on what did we mean by aggressive competition?

I think what we're seeing, while there's been a lot of marketing noise written about what's happening in the industry, I think it's very much like what we saw last quarter where it varies widely by market and by competitor and it's based on the interaction, really, of competitive behavior in each particular market.

So we think it is strong competition.

It has kept some focus on selected prices.

For instance, there's some hot deals out there right now in soft drinks and in milk, as a couple of examples and categories, but those are -- and those are competitively driven, but on the whole I'd say the environment's pretty much like what it was last quarter.

Rodney, do you want to add anything to that?

No.

Did you have another part, Deborah?

Yes.

And then just in terms of -- a separate question, in terms of general merchandise performance and maybe if you can even focus on Fred Meyer and the multi-department stores, is that -- if you can maybe just discuss the general merchandise performance and even jewelry?

I'll let Rodney give any description he may want on both jewelry and on Fred Meyer, but I would like to add maybe this overall comment on general merchandise.

In the past you'll note that maybe a year ago or so we talked about general merchandise as an indication of customers spending less and discretionary categories, and that was one of the categories, so we felt pretty good about this quarter seeing identical sales in general merchandise being positive.

And that's when we in the past have often combined HBC and/or the drug and GM categories together, but when we split out GM is actually was positive in the quarter on an identical basis.

So, Rodney, do you want to add any more?

Yes, I'll add a couple comments.

One, I am just delighted with our Fred Meyer team and our jewelry team both.

If you look at the performance on general merchandise it's very broad-based in a lot of categories, which is very exciting.

The other thing I find increasingly exciting is the Fred Meyer team is doing a better and better job of working across the whole Company on general merchandise to help us sell more general merchandising through all Kroger stores, not just the Fred Meyer.

And then on jewelry, if you look at the identicals there -- the identical there, if you look at the peer groups, they would be the best of any company that's reported from an identical standpoint.

How much of that is driven by the economy and how much is that driven by some of the changes we've done and how much of that is driven because so many competitors have gone out of business I think would be hard to speculate.

But overall in both fronts it's nice to see the continued improvement versus where we were in the fourth quarter.

So, Rodney, is the Fred Meyer team helping bring in more SKUs into Kroger or just improving the overall quality of the SKUs that are in Kroger?

Both and that's the area where we're really focused on working together to try to identify those items that customers would really find helpful and a good value for their money and it's really both.

That's great.

All right.

Well, thanks so much and best of luck, guys.

Thank you.

Your next question comes from the line of Charles Grom with JPMorgan.

Please proceed.

Thanks, good morning.

Just a question on OG&A up 13-basis points on the quarter and I think you said healthcare, pension and credit card fees.

Just wondering, Costco talked about their healthcare costs starting to come down a little bit and just wondering if you can give us a little bit of sense for what you think the OG&A line on the core will look like over the next couple of quarters?

I will let Mike in a second comment about the forward thinking on OG&A, but you identified them correctly but to add to that the way OG&A is calculated for us.

It also includes -- the other element we included was expenses in iwireless and The Little Clinic, both of which are affected in a negative way, too.

We felt that a lot of those costs were offset, in part at least, by productivity improvements, process change and what we've done in energy, so we actually felt it was pretty good.

Healthcare, though, is problematic and it was -- at least in the quarter, and it was more problematic in our Company plan than in the plans covered by the Taft Hartley funds and that's mostly because they are structured differently.

In one case in the union plans it's really we pay in based upon either hours worked or some other formula.

And the Company plan is self-insured, we basically pay the claims as they happen.

But it is true we experienced higher healthcare costs in the first quarter.

Do you want to comment going forward on OG&A?

Yes, I won't give exquisite -- specific guidance on OG&A but clearly our goal is to drive down our operating costs on an annual basis, so our components of our incentive plan were without a reduction in operating costs and that would be OG&A plus rent and depreciation, as well as the expenses in gross profit.

If we don't manage those expenses well on an annual basis it limits the amount of our potential bonus payout so we're incentified to do that.

I think Dave's point is the key point.

If you look at the operations of the Company you have pension, healthcare and credit card expenses caused some headwinds at the operating level, but the productivity improvement, the process changes and the energy savings essentially offset those so they performed very well.

That OG&A line in total did have the expenses from iwireless and TLC in it, and this is the first quarter we owned all of The Little Clinic versus just a portion of The Little Clinic, which is one of the reasons that would have affected it for the first time like it did.

Okay.

Could you quantify that, the iwireless and the TLC for us?

I wouldn't get specific on it.

It would be a good chunk of the 13, but it's not like it's 90% of it, but it's a good chunk of the 13.

That's the only reason we called those two out.

There really wasn't anything else out there that was remarkable enough to quantify.

Okay, helpful.

And then just to follow up on the former question on the competitive market and just wonder if we could dig into the, obviously, 900-pound gorilla here in the room with Wal-Mart.

And since they started their rollback campaign on April 1st and they started to do their deep discounts on May 1st, just wondering in markets where you specifically overlap with a Wal-Mart Super Center have you seen any discernible trends since they began that rollback activity?

Let me talk generally about Wal-Mart and how we see our markets for a moment.

We don't often talk about individual competitors, but many of you've asked about them and so it's probably worth commenting.

Wal-Mart affects any of the marketplaces in which they operate like any other competitor affects those marketplaces.

Wal-Mart has become publicly more aggressive in what they're saying that they're doing, and if you look at what's happening in the stores in their markets, just like we said the last two quarters -- I think probably each of the last two quarters -- the marketing behavior, merchandising behavior of Wal-Mart is a lot more consistent with a traditional grocery supermarket operation than it is consistent with what Wal-Mart used to do.

It's a lot more feature items.

Sometimes the features are on a little longer than a week, but it's feature items, and when you operate that way there's items that come down in price, which get lots of publicity, but there are also items that go up in price that don't get much publicity.

So we see the behavior as -- there's a lot of marketing noise around it, but we see the behavior as pretty much what happens in a lot of grocery markets that we've been involved in for our entire history.

As a result, the most important thing I think for you to think about is that our behavior in those markets and in every market is based upon our plan and what we believe to be consistent with our "Customer 1st" strategy and what we think our customers want.

We can't do that with a blind eye to what competition does, but we also can't let competition dictate to us what we're going to do in those markets and we've chosen not to.

To we're approaching this from -- purely from the point of view of what do we think our customers want from us in this kind of environment and we're using our data and insight in order to drive that.

Rodney?

Yes, just to add a couple of other things.

That's one of the reasons why in Dave's call -- in his prepared remarks he talked about we had positive identicals in all divisions, to try to give everybody a perspective of our broad-base on our strength and of our identical sales.

The other thing that I would add to that is, from our perspective Wal-Mart really started getting more promotional on specific items really Thanksgiving lasts year when they started running turkeys at $0.40 and some of those things.

So they branded it a little differently this year than they branded it last year, but they really did start looking more like a traditional supermarket in the way they go to market late last year by getting aggressive on pricing on a few items from a promotional standpoint.

Okay, that's helpful.

And then just last question would be on the 2.4% comp.

Sounds like there's a little bit of a Memorial Day shift and just wondering if you've had a chance to go back and quantify that?

And then I guess since the Memorial Day period I know there's the flip flop in the calendar, just wondering how your June sales are looking so far?

Let me address the latter question and if Mike wants to add anything on Memorial Day specifically he can, but we've only had three weeks in the quarter so far -- three and-a-half weeks in the quarter so far and if you adjust for the fact that Memorial Day's in this quarter now, if you adjust that out, it looks to us that the trend in those three weeks is about the same, consistent with what we had achieved in the first quarter.

So that gives you a sense of where we are at this point.

Mike, do you want to add anything on Memorial Day?

Yes, I wouldn't make any adjustments to the first quarter as a result of Memorial Day because it really helped offset the strong start we had right at the beginning from the Super Bowl and the weather.

So if you look at th,e quarter by itself it negated it somewhat.

And as Dave said excluding Memorial Day, so far this quarter we're right in line with where we were in the first quarter (inaudible).

Okay, great.

Thanks very much.

Thank you.

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

Please proceed.

Hi, good morning, guys, and nice quarter again.

Thanks, Ed.

Good morning.

You've mentioned that you're incentivised basically to improve expenses, either in the gross margin or the OG&A line.

Can you talk a little bit, though, about how you tracked against those goals so far in the first quarter?

Does this ramp throughout the year?

Maybe provide some color on the key initiatives that you have in this area?

Do you want to comment about tracking?

So far this year I would say we're not where we need to be to have that limiter come off of the bonus plan so it would limit our ability to achieve certain payout metrics under our bonus plan.

It is early in the year and we clearly have plans in place to achieve those because we'll be mutually rewarded if that occurs.

As far as specific items that we have in place, some of those we've talked about and I don't think we'll get any more specific on process and productivity improvements, but we continue to see the opportunity to implement different energy-saving projects, for example, to continue to drive those costs down.

Rodney talked about the investments we're making in infrastructure, both from a technology and a warehousing standpoint, that we would expect to pay rewards as time goes on, as well.

Okay.

And another question for you on your fuel centers.

You've been adding each quarter, literally, somewhere between, I don't know, 15 and 30 fuel centers.

It's clearly a strong driver of growth in your gallons sold.

My guess, though, it's also an important part of -- maybe not important part of the comp but it does help the comp for the stores where you add the fuel centers.

Is that a fair assessment and what happens to those super centers when you add -- or these food stores when you add fuel center, and then also what's the runway left for adding fuel centers?

Is there still a fair amount to go?

We've -- you've assessed it pretty well as we see gas.

Our customers really like fuel at our stores, so when we add fuel that becomes an additional convenience, an additional reason for people to stop with that.

As a result we continue to add them.

Our identical gallonage growth, which would be just the places that had fuel in both years, continues to grow, in addition to growing as a result of new additional gas stations.

We do continue to see opportunities to add.

We're going to add 100 or so this year, I suspect, don't know that we've given a specific number, but it's certainly in that ballpark and that's consistent with what we've done the last couple of years.

We just -- we're bullish on it, think it's a good deal for our customers and they seem to like the added convenience, so it's a benefit.

It's an area where convenience stores really helped us accelerate what we can do in the supermarkets and it's their knowledge that's helping us and they really help us run it across the Company.

It also helps with sales within the box so it's driving traffic to the stores, is that fair?

Well, it helps a little bit with the traffic in that sense, so, yes, there is benefit there.

Okay.

And then just last question for you real quick.

On the share repurchase side it looks like you ramped things up a little bit opportunistically post the end of the quarter.

How do we think about share repurchases for the rest of this year assuming your business trends do continue to improve?

And like you said, if you're hopeful to get towards the higher end of the range is there an opportunity to get more aggressive there?

I want to make sure you understand that the purchases since the end of the quarter they weren't opportunistic as you describe them.

We would have been in a blackout period and precluded from operating opportunistically in that timeframe.

Okay.

As we go throughout the period of time where we're ready to go into a blackout period we put a 10b5-1 plan in place that would obviously -- well, maybe not obviously but intellectually would be designed to buy more when the stock is low and less when the stock is high and we also put a dollar limit on that plan so that things don't get too out of hand from spending cash at a point in time where we really can't moderate our plan.

So while it appears it was opportunistic it wasn't independent decisions made every day; it was just merely the design of the grid caused us to be in the market at the prices the stock was on a more regular basis.

You had mentioned something about the upper end of the range.

Keep in mind our gui -- we're talking about the top half of the range, not necessarily the upper end of the range.

I think we view our stock as we sit here today as attractive, attractive, and would expect that when our blackout period is lifted we would implement a new 10b5-1 plan and continue to be in a market on a regular basis.

Great, thank you.

Thank you.

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

Please proceed.

Hey, guys, thanks.

I wanted to go back.

I know you commented a little bit on Wal-Mart's activity and I wanted to explore the idea that maybe Wal-Mart's since April, because our data would show that it has been more aggressive versus where they were last November, they certainly would think they are.

They also made comments that they're having a hard time passing on some of the inflation, which I think Dave you mentioned that you're not seeing as hard.

Do you think it's instead of Wal-Mart doing anything maybe it'd demonstrating there's more loyalty in the customer -- in the Kroger customer base and how do you play that up and play it out?

I think you went through some data about loyal households, maybe you want to talk to that a little bit, if that's okay?

Sure.

First of all, I do think Wal-Mart has made some changes, of course, now from November, but it's a similar kind of a course of activity so I wouldn't suggest otherwise.

And they've certainly been very visible in public about that in papers and all of you have written guite a little bit about it.

But the most important part to think about here, I think, is what's happening in Kroger for us and we do think that one of the reasons we don't as affected by some of our competitors, including Wal-Mart but others too, is because we're focused on building loyalty over a period of time.

So there's lots of things that cause a customer to shop with us.

Last week I did a couple of shop-alongs and that's a case where you go with an individual customer.

You meet them and talk through a little of how they shop and then you go see how they shop in a store.

We do a variety of those, Rodney's done some recently.

And as we do those we get a sense of the complexity of how customers behave.

It's not generally because of one item or one price, it's generally because of the overall combination of things put together in a store.

In our case we think looking at what we call our four keys is essential.

It cannot be just about price.

If it's just about price that really is Wal-Mart's game and not our game, and so we don't focus just on that and that's one of the reasons even our capital is accenting other areas, too, this year, not just about price.

So overall I'd say we're playing our game, we're on our court.

We think it's working well for us.

We see -- we've even identified that even in the first quarter we see our market share has improved.

We also identified in the first three weeks of this quarter that our sales continue similar to what they were in the first quarter, all of which should describe to you that since the time period you're saying that we don't -- we're not seeing a particularly large impact or some big sea change of events.

So, Dave, along the same lines, some of the CPG companies -- I just had a call this morning -- called Wal-Mart's activity very disruptive, and the idea here that maybe you honestly benefit, that as the promo -- some of the people that aren't involved in the promotions that are going on as your biggest competitor may be willing to help you out a little bit.

Have you seen a step up in help from the channel now that Wal-Mart's doing what they're doing?

Well, I think we saw -- not for that reason but I think we saw, as we've described before, that many of the national brand vendors, wanting to get their tonnage moving again, have been out in the market generally with more promotional dollars.

And even when they may raise their list prices, they often will have money out there to promote the product.

And we've already indicated we had a very solid quarter on national brand tonnage, very pleased in those results, and the vendors who have worked with us on partnerships, common deals, joint projects, to produce better sales have shown really good results.

So anybody who's partnered with us I think would go away saying, hey, that's worked really well and I want to do more of it.

But I wouldn't say it is just about us or just about Wal-Mart.

It's really what are they doing to try to drive their sales and it's not -- I don't think it's focused like you're describing.

So then my final question -- thanks for taking them -- is, I just wanted to make sure I understood what you were saying about the consumer.

You said there was little mixed signs, vis-a-vis kind of sequentially last quarter.

Do we think things have slowed down with consumer improving or is it just -- because I know food stamps have taken off a little bit again.

Where do you think the consumer is, are we at a plateau or are things still slowly improving?

I'm just trying to gauge what you said.

Well, actually what we were describing is that we look at customer segments and that there is gurgling going on in some of the segments that would tend to could be fuse a person because the customers in those segments are a little confused themselves.

So we pointed out some things on the positive side, so, for example, we talked about some of the higher-end lines being better, (inaudible) meat has improved for us.

Se did not identify it but it's true, Starbucks has improved for us.

We identified, I think, organics, natural foods have improved, floral has improved, general merchandise sales I talked about a little bit before.

All of those are signs that people are spending some discretionary money, but it is by segment where that happens.

We're also seeing, though, on the other side a lot of week-to-week swings, much of which is driven by food stamps and other situations where people have money one week and not have money the next.

And within the segments we're seeing them -- the people we interview in those segments describing their world a little different.

So the consumer confidence in some of the upscale customers is stronger than the customer confidence in some of the people who are more price sensitive and that affects their behavior.

So I think it's -- you almost have to look segment by segment and say what's happening.

We certainly do that and we even design our marketing plans around the different segments.

So do you think sequentially it's improving or not really?

Scott, Thanks for your questions.

We to want move on so we can get to more folks and have their questions asked.

Your next question comes from the line of Robby Ohmes with Banc of America-Merrill Lynch.

Please proceed.

Thanks.

Hey, guys, just a quick follow up actually on Scott's question.

I think you guys are now coming up upon that time last year where your tonnage really picked up and just curious related to where Scott was going on the vendor support outlook, are you planning or how are you thinking about those comparisons in terms of maintaining the comp trend through the next couple of quarters?

Do you expect the tonnage trend that you put up, the sort of mid single-digit tonnage gains you put up in this quarter you just reported to continue or will the way you got to your idents, the way you're planning, should that shift a little bit?

Thanks.

Well, I think we've talked generally that in our minds that the tonnage for the year would be a little less of a growth than what we experienced last year.

That's only natural and you can see it in certain areas.

Take produce as an example.

With the inflation we're experiencing in produce we would expect and have seen a tonnage shift a little as customers change that they buy.

Same thing in milk.

As the cost of milk and the retail in milk goes up and where it does go up we see the gallonage decline a little bit.

Our hope is, though, and our expectation is to keep tonnage in the positive range and in order to get our identical sales to come out where we're targeting for this year we actually need to have some growth in tonnage.

But, no, we do not expect it to be as robust as we experienced last year.

So you're baking in ticket or -- and/or inflation improvement as you move sequentially through the rest of this year?

Well, we've said all along that we expect the deflation we experienced last year to gradually turn into modest inflation and so that was baked into what we have said on assumptions, yes.

And we would expect tonnage growth more traditionally what we would have had two or three years before last year.

We thought last year was an unusually high tonnage growth and not what we would typically have and we would expect tonnage growth to get more what we had in the past.

And just very quick follow up.

The vendors I would assume recognize the tonnage comparisons you guys are up against.

Is there a little extra just related to that that you guys are seeing over the next few quarters, a little extra help?

Well, like I said, the vendors see the tonnage growth that they get when they partner with us on various promotions and even longer-term programs and they like what they see.

Great.

Hey, thanks a lot, guys.

Thank you.

I think we have time for one more question.

Your final question comes from the line of Karen Short with BMO Capital.

Please proceed.

Hey, congratulations on the quarter.

Thank you.

Thanks, Karen.

Just wondering -- not to continue to belabor this, but you did a better job of balancing margins obviously this quarter.

Can you maybe talk a little bit about what you did differently in the first quarter versus the fourth quarter, because you obviously seemed to get the same tonnage growth on being less promotional, so I wonder if I can dig into that?

And then just I had one quick follow up.

Well, let me describe -- if I go back to the third quarter what was said on that call, was that we had begun a process to try to balance this out a little bit better, but that we believed changes that we needed to make needed to be gradual and gentle so that they did not disrupt what the customer saw of our programs.

In the fourth quarter you may not have felt you saw it, but it was actually present even in the fourth quarter where we had begun to make changes and it influenced the results but they were gradual.

Those changes began to take a little better hold in the first quarter and you see the results of those.

We do think it's important for the programs that we develop, particularly price programs, that we not pull the customer one way or the other abruptly because it gives them the wrong impression about what we're trying to represent.

And so you'll see, I think, gradual trend changes in what we try to do in this area, either direction based on how we see the market and the situation at the time, and I think that's what you saw rather than some big difference between the first quarter and the fourth quarter.

First quarter had the full quarter having some changes in it and the fourth quarter did not have the full quarter with some of those changes in place.

But it was not a fundamental change in our plans, it was not a fundamental change in our strategy, it was not a fundamental change in targeted areas we had in price.

Rodney, do you want to add?

And it's continuing using our dunnhumby data and other data sources to understand what promotions are working and what things don't work and adjust for those as we go along also, so it's using the insight that we have.

And trying to be more effective in how we spend our money.

Okay, great.

And then just for Mike, totally switching gears, looking at your cash flow, inventories and expenses and trade accounts payable they were all pretty cash flow generative, just wondering if you can comment was there a timing issue or what was the cause?

Not really a timing issue.

If you look at the way we look at working capital, our net operating working capital improved by about $25 million this year versus last year and when we look at that we kind of throw out the taxes and those -- and short-term debt and the things that really don't -- you really can't have any influence over.

But we have clearly -- we are focused on trying to reduce our investment in net operating working capital and it was nice to see that we actually generated $25 million of net cash on the way we measure that and off-line I'd be happy to give you the definition.

You know us, we can't use a traditional definition, we have to come up with our own.

But it's actually a definition that our divisions feel as though they can manage day in and day out because if you put deferred taxes in there they can't do anything about that.

So we try to look at it from the standpoint of something they can manage day in and day out.

Okay, great.

Thanks a lot.

Karen, thank you, and before we end the call today, though, I'd like to share just a few additional thoughts with our associates who we encourage to call in.

First I want to thank you for getting us off to a solid start for the fiscal year.

Our performance is a result of your individual efforts and we really appreciate all you do.

And as you know, safety's one of Kroger's core values.

We continue to strive to achieve our goal of zero accidents in our stores, plants, distribution centers and offices and over the past 14 years we've reduced our accident rate by more than 70%.

We have several great teams to celebrate for their outstanding safety records and each -- for example, each of the following plants received -- recently received an a award, which indicated they received more than a year without an OSHA reportable injury.

These six plants are America's Beverage Company in Irving, Texas; Pace Dairy in Crawfordsville, Indiana; Riverside Creamery in Riverside, California; Tamarack Farms Dairy in Newark, Ohio; [Vanderbord] Diary in Ft.

Worth, Texas; and Westover Dairy in Lynchburg, Virginia.

We also have had many stores that have achieved outstanding safety records.

185 stores, 185 stores have gone a year without an OSHA reportable injury.

Several other stores have gone at least three years without an associate injury.

The top six stores that have gone without three -- gone full three years without an accident are Central Divisions 462 in Whitehall, Illinois; QFC store 804 in Seattle, Washington; Midsouth 906 in Wheatly City, Kentucky; Delta 391 in Paris, Tennessee; Mid-Atlantic Division 300 in Lynchburg, Virginia; and Smith Store 131 in Ogden, Utah.

That is exceptional.

Congratulations to associates in all areas of the Company for keeping your focus on safety, both at home and increasingly at work and increasingly at home, too.

We really appreciate your efforts.

Have a great summer, everyone.

This completes the call today.

Thank you for joining us.

Thank you for your participation in today's conference call.

This concludes the presentation, you may now disconnect.

Good day.