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Fourth Quarter 2008
Investor Conference Call Prepared Remarks
March 10, 2009
Carin Fike, Director of Investor Relations:
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 no obligation to update that information.
Both our fourth 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.
Comments by: Dave Dillon
Thank you, Carin. Good morning everyone. Thank you for joining us today.
With me today to review Kroger’s fourth quarter and full-year 2008 financial
results are Rodney McMullen, Kroger’s Vice Chairman; Don McGeorge, Kroger’s
President and Chief Operating Officer; and Mike Schlotman, Senior Vice President
and Chief Financial Officer.
Today we reported solid results for the fourth quarter and outstanding results
for fiscal 2008. The Kroger team did a remarkable job throughout the year of
consistently delivering results in an environment that was more difficult than
we assumed when we set our original guidance.
Our performance during the quarter was solid in an environment that was
uncertain. Total sales were $17.3 billion compared with $17.2 billion for the
same period last year. If you exclude fuel sales at our supermarkets and
convenience stores, total sales increased 4.4% over the prior year. Keep in mind
that retail gas prices fell considerably in the past year. In fact, the average
retail price for a gallon of gas sold at Kroger’s fuel outlets was 41% lower
than it was in the fourth quarter last year.
Our fourth quarter identical supermarket sales, without fuel, increased 3.8%.
Several departments posted identical sales well above the company average,
including Meat, Grocery, Nutrition, Pharmacy and Deli/Bakery. Strong sales in
these areas were tempered by continued slowness in sales of discretionary
general merchandise.
We are finding that customers are basing their purchasing decisions more on what
they need versus what they want and we are addressing their needs in a variety
of ways. Our efforts to help customers and their families navigate this tough
economy are driven by our Customer 1st strategy. As a result, we offer customers
a unique combination of values no other competitor can match.
We believe many of the same money-saving strategies shoppers employed in 2008
will continue throughout 2009 including:
- Combining trips in order to save fuel;
- Eating out less at restaurants;
- Choosing Kroger brands more often;
- Entertaining at home; and
- Using more coupons and food stamps
At Kroger, we see these changing trends as opportunities. And many of these
opportunities play to our strengths. We have unique tools that enable us to
identify and act on changes in consumer behavior more quickly than our
competitors. I want to update you on how we are doing that in a recessionary
environment, beginning with Kroger brands.
Kroger Brand Growth
Our customers recognize and appreciate the quality and value of our
comprehensive store brands, which today number more than 14,400 items. We
leverage our manufacturing and procurement capabilities to innovate and
introduce new items that add value for our customers.
During the fourth quarter, 27% of Kroger’s grocery sales came from our own
brands and grocery unit sales of Kroger brands reached a record-high 35%. These
results continue the exceptionally strong growth in Kroger brands we saw in the
third quarter. And, as expected, Private Selection exceeded $1 billion in sales
in 2008. Customers are increasingly turning to our premium line of products
because of the value and high-quality they offer. In addition, our Value brands
enjoyed strong growth as well.
Once again, our $12.5 billion Kroger brands portfolio enjoyed strong
year-over-year growth and fueled Kroger’s overall grocery volume growth in 2008.
We continue to see our own brands as a strategic asset in growing our business
in 2009 and beyond. Our Kroger brand portfolio has offerings that meet our
customers’ varied needs and budgets.
Lower Prices
We continue to drive cost savings made in any area of our business back into
lower prices for our customers. Keeping prices low is one of several key drivers
of our identical supermarket sales.
Generic Drug Program
Our $4 generic program – which includes 90-day supplies for only $10 – continues
to drive growth in our pharmacy business. Our pharmacy teams consistently hear
directly from customers how much they appreciate this value. Through this
generic drug program, Kroger customers have saved over $150 million in the past
year.
Fuel Rewards
Our fuel rewards programs offer additional value by giving customers discounts
on gas when they shop in our stores, pharmacies, and gift card malls. In 2008,
Kroger customers saved more than $100 million on fuel through these programs.
Even with gasoline closer to $2 per gallon, Kroger fuel rewards programs offer
customers a great value and thanks them for their loyalty.
Market Share
Kroger also made significant gains in market share in 2008. In the major markets
we serve, Kroger gained 61 basis points of additional market share, according to
the internal methodology we use to estimate market share. This is the fourth
consecutive year Kroger has achieved significant market share gain. Over the
past four years combined, Kroger’s share in our major markets has increased
roughly 225 basis points. Rodney will offer more insight into our market share
gains in a few moments.
I want to thank our associates in every store, plant, warehouse and office for
the role they play in driving market share gains in so many of the markets we
serve. These gains are a direct result of their commitment to our Customer 1st
strategy.
Moving now to our outlook for 2009, we are optimistic and, at the same time,
cautious as we help our customers navigate through today’s challenging economy.
We expect full-year identical supermarket sales growth of 3% to 4%, without
fuel, in fiscal 2009. This guidance reflects our outlook for product cost
inflation of 1% to 2% compared to our earlier forecast of 2% to 3%. Kroger is
positioned well to win with customers in 2009 and beyond.
Now I will turn to Rodney for additional color on the quarter, the full year and
our 2009 outlook. Rodney?
Comments by Rodney McMullen:
Good morning, everyone. As Dave mentioned, we are very pleased to deliver value
to both our customers and shareholders during such difficult economic times. We
firmly believe our ability to do so is the result of the sustainability of
Kroger’s long-term Customer 1st business strategy and our flexible business
model. Our strategy, which is unlike any other operator in our industry, allows
us to consistently deliver solid near-term results for shareholders. At the same
time, it enables us to invest in Kroger’s future growth. Since it is a long-term
strategy, I plan to spend most of my time discussing Kroger’s full-year 2008
results. But first I’ll share some additional color on the quarter.
Fourth Quarter 2008 Results
Kroger’s fourth quarter net earnings were $349.2 million, or $0.53 per diluted
share. This compares with net earnings of $322.9 million, or $0.48 per diluted
share, in the same period last year. The strength of our core grocery business
drove this solid year-over-year earnings growth. In the fourth quarter, Kroger’s
retail fuel operations had minimal impact on total earnings per share. We did
benefit from a LIFO charge that was $13 million lower than the same period last
year. Note that this lower year-over-year LIFO charge does not reflect lower
food inflation rates; rather, it reflects the timing of LIFO expense recorded
throughout 2008 compared to timing in the prior year.
Heading into the fourth quarter, we had a better understanding of the timing and
amount of a settlement related to a Visa/MasterCard lawsuit associated with
interchange fees. This prompted us to accelerate certain planned 2009 price
investments to offer customers additional value during the holidays. The
after-tax benefit of $11.7 million we realized in December as a result of the
settlement offset the cost of these accelerated price investments. The net
impact on Kroger’s fourth quarter results was not material. We believe these
strategic investments improved customer loyalty to Kroger and will drive future
sales growth.
The Visa/MasterCard settlement did help our OG&A rate. Excluding the settlement
amount, Kroger’s fourth quarter OG&A rate, excluding fuel, increased 9 basis
points compared to the prior year. Better control over wages and store supplies
helped offset rising health care costs.
Full-Year 2008 Results
Turning now to Kroger’s full-year 2008 results: Our team produced outstanding
results. The full-year identical supermarket sales growth of 5.0%, without fuel,
we reported is within the guidance we raised throughout the year. We are
especially pleased to produce these results in such a tough economy.
Earnings Per Diluted Share
Kroger’s strong non-fuel identical supermarket sales growth contributed to
strong earnings results. Today we reported fiscal year 2008 earnings of $1.92
per diluted share, excluding expenses we incurred during the third quarter for
damage and disruption caused by Hurricane Ike. This exceeds the upper end of the
guidance that we shared with you in December and represents 13.6% growth over
fiscal year 2007 earnings of $1.69 per diluted share. On top of that earnings
per share growth, Kroger’s quarterly dividend adds over 1% to total shareholder
return.
Operating Margin
We met our earnings per share target for the year even though Kroger’s non-fuel
operating margin did not expand slightly as we had originally forecasted.
Rather, our non-fuel operating margin declined 15 basis points, partially due to
a $42 million year-over-year increase in LIFO expense, which reduced Kroger’s
non-fuel operating margin by 5 basis points.
LIFO
As we have discussed in earlier quarters this year, Kroger’s LIFO charge was
driven by levels of food inflation that we had not experienced in almost 20
years. During the fourth quarter, food inflation remained at these higher
levels. Our estimated product cost inflation, excluding fuel, for the quarter
was 5.9%, with inflation in the Grocery department approaching 8%. Many consumer
packaged goods companies have not reflected lower commodity costs in their
pricing. This presents an opportunity for Kroger brands to continue to gain
share.
FIFO Gross Margin
On an annual basis, Kroger’s FIFO gross margin excluding our retail fuel
business declined 16 basis points. Supermarket selling gross margin declined 32
basis points. Improvements in Shrink as well as Warehouse & Transportation
expense funded a portion of our continued investment in lower prices for
customers.
OG&A
Kroger’s OG&A rate, on a full-year basis without fuel, declined 3 basis points.
Cost control across all areas of our business remains a priority for the
Company, so we can continue to invest to improve our customers’ shopping
experience.
Retail Fuel Operations
While LIFO was a headwind for the year, strong fuel margins – particularly in
the second and third quarters of the year – provided some offsetting tailwind.
In the fourth quarter, the cents per gallon fuel margin for our convenience
stores and supermarket fuel centers was 9.7¢ compared to 12.8¢ in the prior
year. We continued to experience strong gallon growth both on an absolute and
identical basis. On a rolling four-quarters basis, the cents per gallon fuel
margin was 14.7¢ this year compared to 11.4¢ for 2007. Our guidance for fiscal
2009 assumes a more normalized fuel margin of 11¢ per gallon as well as
continued strong growth in gallons sold.
Financial Strategy
Kroger’s strong earnings results would not be possible without our prudent and
balanced long-term financial strategy. Kroger’s business generated $2.9 billion
in cash from operations, an increase of $315.5 million over the prior year. We
believe it is important to allocate that cash flow to maximize its benefit for
our fixed income and equity investors.
Capital Investment
During 2008, Kroger invested $2.15 billion in capital projects, excluding
acquisitions. Our return on assets measure improved by 27 basis points. For
2009, we expect to invest $1.9 to $2.1 billion in capital projects. Our emphasis
on store remodel activity and infrastructure investments will continue.
Debt Reduction and Share Repurchase
Our leverage metrics are also improving. On a rolling four-quarters basis,
Kroger’s net total debt to EBITDA ratio was 1.89 compared with 2.03 during the
same period last year. We ended the year with $7.7 billion in net total debt, a
decrease of $24.1 million from a year ago.
Under current market conditions, our bias continues to be toward debt reduction
and away from share buybacks. We believe this approach supports an appropriate
level of liquidity and leverages Kroger’s financial strength to continue
delivering on our Customer 1st plan. However, we did repurchase 451,000 shares
during the fourth quarter, using proceeds from employee stock option exercises.
As market conditions change, we’ll evaluate and adjust our buyback activity
accordingly. At the end of the quarter, we had $493 million remaining under the
$1 billion share repurchase program authorized by our board in January 2008.
Dividends
Kroger’s dividend program continues to reward shareholders. During fiscal 2008,
Kroger paid $227 million in cash dividends to shareholders. This compares with
$202 million in dividends paid during the prior year. As I mentioned earlier,
the current dividend yield on Kroger stock adds over 1% to total shareholder
return.
Market Share Detail
Dave outlined the significant gains in market share Kroger made in 2008 and I
will offer some additional detail. These market share figures are based on an
internal methodology we have used consistently for the past several years to
calculate market share. This methodology considers the potential for sales in
each market from all retail outlets where customers can purchase products Kroger
sells – including supercenters and other non-traditional retail formats such as
dollar stores, drug stores, and warehouse clubs. Most third-party market share
data providers would show that Kroger’s market share increased by a larger
amount than our internal methodology indicates.
At Kroger, we define a “major market” as one in which we operate nine or more
stores. We serve customers in 42 major markets. For 2008, Kroger held the number
1 or number 2 market share position in 39 of our 42 major markets. Kroger’s
overall market share in these 42 major markets grew by 61 basis points during
2008, on a volume-weighted basis. Kroger’s share increased in 36 of those 42
major markets, and declined in six.
Kroger competes against a total of 1,418 supercenters – an increase of 78 over
last year. Supercenters have achieved at least a number 3 market share position
in 35 of our major markets. Kroger’s overall market share in these 35 markets
grew 87 basis points during 2008, on a volume-weighted basis. Our share
increased in 30 of those 35 major markets, and declined in five.
Of the 1,418 supercenters that I mentioned, 1,125 are operated by Wal-Mart, an
increase of 60 over last year. Wal-Mart supercenters have achieved at least a
number 3 share position in 33 of the major markets where Kroger faces
significant supercenter competition. Kroger’s overall market share in these 33
markets rose 86 basis points in 2008. Our share increased in 29 of those 33
major markets and declined in four.
These are impressive market share results, and they demonstrate that Kroger’s
long-term strategy is working. As population growth continues in the major
markets where we operate, we intend to continue to grow Kroger’s business by
maintaining our existing strong market share and by building on additional
opportunities for sales growth. We calculate that approximately 45% of the share
in our major markets – as much as $100 billion – is held by competitors who do
not have Kroger’s economies of scale. We estimate that the market share of those
competitors has declined about 1% during each of the last four years. We
continue to look for ways to capture additional market share.
Fiscal Year 2009 Guidance
Turning now to our outlook for fiscal year 2009, we do believe that today’s
challenging economic conditions will persist throughout 2009 and perhaps weaken
further as unemployment rises in many parts of the country. Against this
uncertain backdrop, forecasting is difficult. But, as Dave said, we are one of
the best positioned retailers for these times. While many other retailers are
forecasting flat or declining sales for 2009, we continue to believe Kroger’s
connection with customers will generate solid identical sales growth as we help
customers feed their families.
We have factored two major variables into our sales outlook for fiscal 2009. The
first is moderating food inflation. For fiscal 2009, we expect product cost
inflation of 1% to 2%. This is significantly lower than the level of inflation
we experienced throughout much of 2008. The second factor is the economy and its
effect on consumer spending, which Dave outlined for you earlier.
Our full-year forecast for identical supermarket sales growth in 2009 is 3% to
4%, excluding fuel sales. This growth will be driven by the continued execution
of our long-term Customer 1st plan. Five weeks into 2009, our identical sales
trend is within this guidance range.
We expect the combination of strong identical sales growth and expansion of
Kroger’s operating margin – both excluding fuel sales – will produce full-year
earnings of $2.00 to $2.05 per diluted share for fiscal 2009. We anticipate that
the expansion of Kroger’s non-fuel operating margin will be larger than normal
due to a significantly lower LIFO charge in 2009 compared to 2008. Our current
forecast for LIFO expense in 2009 is $75 million, which is $121 million lower
than our 2008 LIFO expense. Excluding the benefit of lower LIFO expense in 2008,
we expect a slight increase in operating margin.
The earnings benefit of lower LIFO expense will be offset somewhat by lower fuel
margins in 2009. These offsetting items, coupled with no significant reduction
in Kroger’s outstanding share count, reflects our belief that the underlying
strength of Kroger’s core grocery business will drive the above-market earnings
per share growth implied by our 2009 earnings per share guidance. This growth,
plus Kroger’s dividend, should generate a solid return for shareholders,
particularly in today’s environment.
Our 2009 guidance incorporates several other assumptions, which we outlined in
the
8-K we filed earlier today.
I want to emphasize that Kroger is forecasting growth for both identical
supermarket sales and earnings per share in fiscal 2009, reflecting our
commitment to creating value for our shareholders, bondholders, and customers.
Our continued growth also benefits our associates by creating job opportunities
for them.
Labor
Now that you know our expectations for the year, I want to give you an update on
where we are regarding labor relations. In another sign that our business
continues to grow as others retract, Kroger has added jobs in a time of rising
unemployment. Our growing business created approximately 16,000 new jobs in 2008
bringing the total number of full-time and part-time associates we employ to
326,000.
In 2009, we will negotiate agreements for store associates in Albuquerque,
Arizona, Atlanta, Dallas, Dayton, Denver and Portland. Already this year, we
have completed successful contract negotiations in Roanoke, Virginia and Las
Vegas.
One emerging and difficult issue on the labor front stems from the turmoil in
the equity markets. Taft-Hartley pension funds to which we contribute have
experienced significant declines in the value of their assets. Inevitably, this
will lead to some reductions in future pension benefits and also to increases in
the contributions we make. In 2008, we contributed approximately $220 million to
these pension funds. This amount is not expected to grow significantly in 2009
but, over the course of the next several years, contributions to pension funds
are expected to increase. Depending on how the markets affect asset values, as
well as other factors, our annual contributions could easily double. The need to
increase pension contributions will undoubtedly create a difficult environment
to negotiate wages and benefits.
Nevertheless, our objective in every negotiation is to achieve competitive cost
structures in each market that help us provide value to our customers and, at
the same time, meet our associates’ need for good wages and affordable health
care. 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.
Before I turn it back to Dave, I want to take a moment to thank all of our
associates for delivering results this quarter and throughout the year in spite
of the considerable challenges we faced. We appreciate the efforts our teams
made in every part of our business. Customer 1st is not just something we talk
about – it is part of what we do every day in every part of our company and I
want to thank you for taking it so seriously. It clearly distinguished us in
2008 and will continue to keep us winning with customers as we navigate 2009.
Now I will turn it back to Dave for some closing remarks.
Comments by Dave Dillon:
Thanks, Rodney. Before we take your questions, I want to offer some additional
thoughts on what we are seeing so far this year.
Though shoppers are more cautious than they were even three months ago, we
remain optimistic about 2009. It is clear customers are relying on Kroger
because they trust us to deliver low prices, great quality products, friendly
service and a pleasant shopping experience that continues to improve. We
understand what customers need in this environment better than others and we
offer an overall value proposition that meets their changing needs. We look
forward to continuing to deliver value to our customers and shareholders in
2009.
Now, we would like to take a few moments to answer your questions.
Closing Comments for Associates:
Thank you. Before we sign off, I would like to share some thoughts with our
associates who have joined us today.
First, thank you for your outstanding efforts throughout 2008. In a year when
challenges only escalated, you made a positive difference for our customers by
providing meaningful value in so many ways. I want to congratulate each of you
on a job well done last year.
Your commitment to one initiative in particular paid off in an extremely
powerful way last year. Kroger’s Perishable Donations Partnership, which allows
stores to donate perishable food that is still safe and nutritious to eat but
can no longer be sold in stores, expanded to include more than half of our
stores last year. Thanks to your efforts, our family of stores contributed
nearly 14 million pounds of fresh meat, dairy products, fruits, and vegetables
to local food banks in the communities we serve. This fresh meat and produce
provides much-needed protein and nutritional value to food banks that struggle
to supplement the dry goods and canned foods they typically receive.
Our perishable donation program helps feed hungry families and is gratifying for
you – our associates – who hate throwing away edible food. It’s also good for
Kroger and the environment because it helps us reduce waste. We continue to add
new stores to the program and hope to have 85% of our stores donating perishable
food by the end of 2009. Our goal is to deliver 25 to 30 million pounds of
perishable food annually.
Thank you for all you do. That completes our call today. Thank you for joining
us.
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The remarks contain certain forward-looking statements about the future performance of the Company. These statements are based on management’s assumptions and beliefs in light of the information currently available to it. Such statements are indicated by words or phrases such as “outlook,” “guidance,” “forecast,” “expect,” and “anticipate.” These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially. Our ability to achieve identical supermarket sales and earnings growth and earnings per share goals may be affected by: labor disputes, particularly as the Company seeks to manage health care and pension costs; industry consolidation; pricing and promotional activities of existing and new competitors, including non-traditional competitors; our response to these actions; the state of the economy, including interest rates and the inflationary and deflationary trends in certain commodities; weather conditions; stock repurchases; the success of our future growth plans; goodwill impairment; and our ability to generate sales at desirable margins, as well as the success of our programs designed to increase our identical sales without fuel. In addition, any delays in opening new stores, or changes in the economic climate could cause us to fall short of our sales and earnings targets. Our ability to increase identical supermarket sales also could be adversely affected by increased competition and sales shifts to other stores that we operate, as well as increases in sales of our corporate brand products. Our estimate of product cost inflation could be affected by general economic conditions, weather, availability of raw materials and ingredients in the products that we sell and their packaging, and other factors beyond our control. Our LIFO charge and the timing of our recognition of LIFO expense will be affected primarily by food inflation during the year. Our fuel margins could fail to normalize at 11% if the current pattern of rapid decreases in fuel costs continues. Our capital expenditures could vary from our expectations if we are unsuccessful in acquiring suitable sites for new stores; development costs vary from those budgeted; or our logistics and technology or store projects are not completed on budget or within the time frame projected. Our non-fuel operating margin could fail to expand if we are unable to pass on any cost increases, if our strategies fail to deliver the cost savings contemplated, or if changes in the cost of our inventory or the timing of those changes differ from our expectations. The amount of our pension expense and contributions to our pension plans will depend primarily on the performance of the investment portfolio in the case of our defined benefit plan and the multi-employer plans, and on the number of participants and level of participation in the case of our defined contribution plans. Our estimates of product cost inflation could prove incorrect, which could affect our ability to achieve our identical supermarket sales growth and earnings per share growth projections. We assume no obligation to update the information contained herein. Please refer to Kroger’s reports and filings with the Securities and Exchange Commission for a further discussion of these risks and uncertainties. ###
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