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First Quarter 2009
Investor Conference Call Prepared Remarks
June 23, 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 first 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 first quarter 2009 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 are pleased to report very solid results for the first quarter of
fiscal 2009. We are off to a good start for the year, particularly considering
the environment in which we are operating. Our Customer 1st strategy continues
to serve Kroger customers and shareholders well. By paying close attention to
the changing needs of today’s shoppers, Kroger continues to refine the value
proposition we offer to our customers through a combination of better service,
improved product variety and quality, a shopping experience that is appealing
and convenient, and lower prices. This approach allows us to report the first
quarter sales and earnings results that we are discussing with you today.
Sales
Let’s begin with sales. Total sales in the first quarter were $22.8 billion
compared with $23.1 billion for the same period last year. That comparison may
look a bit unusual, and it reflects the year-over-year decline in retail fuel
prices. As a point of reference, during the first quarter of the current year,
the average retail price for a gallon of gas sold at Kroger’s fuel outlets was
41% lower than it was during the corresponding quarter last year. When you
exclude fuel sales, Kroger’s total sales for first quarter increased 3.9% over
the prior year.
Identical supermarket sales, without fuel, increased 3.1%. Several departments
posted identical sales growth above the company average, including Meat,
Pharmacy, Deli/Bakery, and Grocery. Strong sales in these areas were tempered by
continued slowness in sales of discretionary general merchandise as well as
deflation in Produce. Even so, all but one of our supermarket divisions posted
positive identical results.
As you know, we believe that identical sales growth, excluding fuel, is a very
important metric for evaluating Kroger’s business. Internally, we also look at a
few other measures, and I thought sharing color on some of those measures would
give you better insight into our first quarter sales trends. Some of the other
metrics we look at include customer traffic, unit sales growth (or tonnage), and
corporate brand share. In each of these areas, we saw positive trends in the
quarter.
Our corporate brands enjoyed another quarter of double-digit growth, in both
dollar and unit sales. In the Grocery department, corporate brands represented
26% of sales dollars and 35% of units sold. As in the third and fourth quarters
last year, our overall tonnage growth in Grocery was driven by corporate brands.
National brand grocery unit sales declined slightly, but at a slower rate of
decline than we saw in the third and fourth quarters last year. Based on these
results, it is clear to us that customers continue to look to our own
high-quality store brands and the value they offer. And while this shift affects
Kroger’s identical sales results, since our store brands typically carry retail
prices significantly lower than the national brand equivalent – some as much as
50% lower – it is a trade-off we are happy to make for the long-term growth of
our business.
Our identical sales growth is also affected by product cost changes, but the
impact can vary considerably across different product categories. Take a
deflationary category like milk, for example. While we sold more units, lower
retail prices for milk pressured our first quarter sales results. On the
flipside, higher inflation in tobacco helped our sales growth but depressed unit
sales of these products. Naturally, product cost changes have always been a
factor in our retail pricing decisions. But in the current environment, we are
seeing much greater variability and we expect it to continue throughout the
year. This adds even more complexity to our business as we manage through this
environment.
2009 Outlook
This morning we confirmed our guidance for fiscal 2009. We are forecasting
full-year identical supermarket sales growth of 3% to 4%, without fuel. This
guidance reflects our outlook for product cost inflation of 1% to 2%.
Our full-year earnings expectation for fiscal 2009 remains at $2.00 to $2.05 per
diluted share. Our first quarter performance was a strong start to the year –
but it is still early. And, while our earnings per share results were well ahead
of the consensus estimate, they were only slightly ahead of our internal budget.
Looking forward, there are several variables that will likely influence Kroger’s
financial results for the balance of the year. These key trends include:
- Commodity Costs – Our manufacturing plants enjoyed an outstanding quarter as
we benefited from strong volume and lower commodity costs. However, based on
rising costs for many commodities today, we do not expect that to continue for
the rest of the year.
- Diesel Fuel Costs – Our Logistics operations benefited from lower diesel fuel
costs during the quarter. Again, based on a number of variables from a global
perspective, we do not expect to have the benefit of lower diesel costs for the
remainder of the year.
- Consumer Behavior – Shoppers remain cautious in this economy and we do not
anticipate that changing any time soon. We expect customers’ spending patterns
to continue to reflect their uncertainty.
As you think about Kroger’s outlook for the full year, recall that – as we
described last March when we first shared our 2009 expectations with you –
margins for our retail fuel business are expected to be much lower in 2009 than
they were in 2008. The toughest comparisons will be in the second and third
quarters of the year. This headwind will be offset somewhat by lower LIFO
expense. Excluding the benefit of lower LIFO expense, we anticipate a slight
increase in Kroger’s non-fuel operating margin. This operating margin expansion,
plus 3% to 4% identical sales growth, creates the earnings growth reflected by
our EPS guidance for fiscal 2009.
This guidance reflects our commitment to delivering solid near-term financial
results – even in a tough operating environment – while investing in the future
growth of our business. On top of that earnings growth, Kroger’s dividend adds
over 1% to shareholder return. That kind of return should look attractive to
investors in this market.
Now I will turn to Rodney for additional details on the quarter. Rodney?
Comments by Rodney McMullen:
Thanks, Dave. Good morning, everyone. As our first quarter performance
indicates, our associates understand the importance of our Customer 1st strategy
and its focus on people, products, lower prices, and the overall shopping
experience in our family of stores. The strength of our Customer 1st strategy
and the flexibility of our business model enable us to continue to deliver value
for both customers and you, our shareholders, in this difficult environment. At
the same time, we are investing in Kroger’s long-term growth as we work to
emerge in an even stronger position once the economy recovers. Let’s take a
closer look at our performance during the quarter.
First Quarter 2009 Results
Kroger’s first quarter net earnings were $435.1 million, or $0.66 per diluted
share. This compares with net earnings of $386.0 million, or $0.58 per diluted
share, in the same period last year. We are pleased to report strong earnings
results for the quarter, yet these results are only slightly above our own
internal expectations. There is extreme volatility in many of our input costs
and it is still early in the year. We encourage analysts to keep that in mind as
you think about our guidance for the year.
FIFO Gross Margin
Turning now to Kroger’s gross margin performance. FIFO gross margin, excluding
Kroger’s retail fuel operations, rose 5 basis points on a year-over-year basis.
We continued to make investments in lower prices for customers, as reflected by
our supermarket selling gross margin, which declined 48 basis points compared to
the same period last year. Improvements in shrink, advertising, and warehouse
expense as a rate of sales, as well as lower diesel fuel costs, funded Kroger’s
investments in lower prices. As Dave mentioned, we do not expect the benefit of
lower diesel fuel prices to be as significant for the rest of the year.
LIFO
We recorded a $23.1 million LIFO charge during the quarter, a decrease of $16.9
million from the prior year. This decline benefited Kroger’s non-fuel operating
margin by 9 basis points as a percent of sales compared to the prior year. Our
estimated product cost inflation for the quarter, excluding fuel, was 3.6%. Cost
inflation across several store departments – including Grocery, Drug/General
Merchandise, Nutrition, and Deli/Bakery – was tempered slightly by deflation in
Produce and Dairy.
For the full year, we continue to expect a $75 million LIFO charge, which would
be $121 million lower than the prior year.
OG&A
Kroger’s first quarter OG&A rate, excluding the Company’s retail fuel
operations, was flat compared to the prior year. I believe the Company’s OG&A
performance was actually better than that comparison suggests, so I’ll take a
moment to explain why.
Kroger has three non-wholly owned investments: dunnhumbyUSA, The Little Clinic,
and i-wireless. Excluding both our retail fuel operations as well as the effect
these investments have on OG&A, Kroger’s first quarter OG&A rate declined 14
basis points as a percentage of sales.
This decline reflects strong cost controls as well as our ongoing efforts to
control utility costs through several efficiency initiatives we have
implemented. We do see continued opportunities in these areas, which will help
us offset ongoing cost pressures Kroger faces in pension, health care expenses
and credit card fees.
Operating Margin
Kroger’s first quarter operating margin, excluding our retail fuel operations,
expanded 20 basis points. As you may recall, our 2009 guidance indicates that we
expect a slight expansion of Kroger’s non-fuel operating margin, excluding the
benefit of an expected lower LIFO charge. On this basis and excluding the effect
of the three non-wholly owned investments I mentioned earlier, Kroger’s first
quarter operating margin expanded 18 basis points.
This expansion is significantly higher than the slight non-fuel operating margin
expansion incorporated in our 2009 guidance and long-term business model. The
outperformance was driven primarily by the benefit of lower diesel fuel costs,
which we don’t expect to continue for the balance of the year.
Retail Fuel Operations
Several of you are interested in the performance of our retail fuel operations.
In the first quarter, we sold more fuel gallons compared to the prior year – on
both an absolute and identical basis – which reflects customers’ strong interest
in this part of our retail offering. While gallons were up, cents per gallon
fuel margins were down, year-over-year. The cents per gallon fuel margin for our
convenience stores and supermarket fuel centers was 8.2¢ in the first quarter
compared to 9.2¢ for the same period last year. Our retail fuel operations did
not materially impact total company earnings or year-over-year EPS growth.
Because of the margin volatility inherent in selling large volumes of fuel, we
always encourage investors to take a longer view of this part of our business.
On a rolling four-quarters basis, the cents per gallon fuel margin was 14.3¢
this year compared to 11.4¢ for the same period a year ago. Please keep in mind
that the fuel margins we realized in fiscal 2008, particularly in the second and
third quarters, were exceptionally strong. Our expectations for the current
fiscal year are based on a more normalized fuel margin of 11¢ per gallon.
Financial Strategy
Kroger’s Customer 1st strategy is supported by the disciplined and balanced
approach we take regarding our long-term financial strategy. We believe it is
important to allocate cash flow to keep our store base current, reduce Kroger’s
leverage, and provide a solid return for shareholders.
Capital Investment
Capital investment, excluding acquisitions, totaled $654 million for the first
quarter, compared to $637 million in the prior year. We did not invest in
acquisitions in the first quarter of this year, compared with $80 million
invested in the same period last year.
Capital projects during the quarter included 10 new, relocated, or expanded
stores and 37 remodels. Our return on asset measures improved, year-over-year.
We continue to project fiscal 2009 capital spending of $1.9 to $2.1 billion,
excluding acquisitions.
Debt Reduction and Share Repurchase
Net total debt was $7.4 billion, a decrease of $243 million from a year ago. On
a rolling four-quarters basis, Kroger's net total debt to EBITDA ratio was 1.78
compared with 1.95 during the same period last year. This compares favorably to
the 1.77 ratio we reported in the second quarter of 2007, which was the lowest
ratio since our leveraged recap in 1988. We expect to continue to improve
Kroger’s debt coverages on a year-over-year basis. Kroger’s bias toward debt
reduction and away from share buybacks remains. We believe this is the right
approach in the current environment to maintain an appropriate level of
liquidity, and allow the financial flexibility to take advantage of any
opportunities.
Labor
We have some progress to report on the labor relations front. Earlier this year,
we successfully completed contract negotiations in Roanoke, Virginia and Las
Vegas. Last week, our Smith’s associates in New Mexico ratified a new agreement.
We are currently in some tough negotiations in Denver and have contract
extensions in Arizona, Dayton, and Portland. Later this year, we will negotiate
agreements for store associates in Atlanta and Dallas. In addition to the normal
pressures on our business, the twin challenges of rising health care costs and
underfunded pension plans will have to play out at the bargaining table.
Before I turn it back over to Dave, I want to thank our associates for their
efforts during the quarter. We delivered value to our customers – and our
shareholders – in an environment that is incredibly trying. We are able to do
this because of your commitment to our Customer 1st strategy. Listening to
customers and responding to their needs is a critical part of our strategy to
earn customers’ loyalty for life. It is also an important part of our objective
to create a sustainable business model that rewards shareholders with long-term
value creation.
Now I will turn it back to Dave for some closing remarks.
Comments by Dave Dillon:
Thanks, Rodney. As you can see from the results we reported this morning and the
information we shared with you today, Kroger established good momentum in the
first quarter. We are focused on maintaining this momentum throughout the year
by investing in what we offer customers and adapting along the way to meet their
changing needs. We expect to emerge on the other side of this recession as an
even stronger player.
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.
Thank you for your individual contributions to our results this quarter. In our
industry, operating successfully in any environment is a challenge. Performing
well in the current economy is remarkable.
It’s clear your commitment to our Customer 1st strategy continues to
differentiate our family of stores from our competitors. I hear, see and
experience great customer service in our stores every week. It is gratifying
when others recognize it too.
Recently, one of our exceptional associates in Nashville, Tennessee was featured
in the local paper for her customer service skills and her commitment to the
neighborhood where she works.
Described by her store manager as the “heart and soul” of the Bellevue store,
Joe Hughes has been working for Kroger since 1968. Everybody knows Mrs. Joe.
“I just love my customers,” Mrs. Joe says. “I know some by first names, some by
last name and some I know their faces and they know me. I see this store still
as a corner grocery that is involved in the community. They realize we are here
for whatever they need.”
Earlier this year, I had a chance to meet Mrs. Joe. She is a great example of
the tone John Hackett, our Mid-South President, has set for the whole division.
Mrs. Joe is Customer 1st at its best – many small, simple acts of kindness
practiced every day that make customers want to return. I want to thank Mrs.
Joe, the whole Bellevue store, and the entire team in our Mid-South division for
all they do to create a great environment in our stores for our customers.
I also want to thank all of our associates for the extra efforts you make every
day on behalf of our customers. We appreciate 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,” “project,” “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; number of shares outstanding; 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 changes 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 will be affected primarily by food inflation during the year. Our fuel margins could fail to normalize at 11% if the pattern of rapid changes 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 margins 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. If our estimates of product cost changes prove incorrect, it could affect our ability to achieve our identical supermarket sales growth and earnings per share growth projections. Our ability to continue to improve our debt coverage could be affected by unanticipated increases in net total debt, our inability to generate free cash flow at the levels anticipated, and our failure to generate expected earnings. 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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