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Fourth Quarter 2009
Investor Conference Call Prepared Remarks
March 9, 2010
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.
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. I will now turn the call over to David
Dillon, Chairman and Chief Executive Officer of Kroger.
Comments by Dave Dillon:
Thank you, Carin. Good morning everyone and thank you for joining us today. With
me to review Kroger’s fourth quarter and full-year 2009 results are Rodney
McMullen, Kroger’s President and Chief Operating Officer, and Mike Schlotman,
Senior Vice President and Chief Financial Officer.
The Kroger team delivered solid quarterly and full-year results for both our
customers and our shareholders during what continues to be a difficult operating
environment. We are strengthening Kroger’s overall competitive position by
increasing the number of households that are loyal to Kroger and earning a
greater share of their business. As a result, we continue to generate tonnage
growth in both perishable and non-perishable categories that is among the
strongest in the industry.
Identical supermarket sales increased 1.2% in the fourth quarter, without fuel.
For the year, identical supermarket sales, without fuel, increased 2.1% over
2008. Sustainable identical sales and earnings growth remains one of Kroger’s
key long-term objectives. We continue to widen the gap between Kroger’s
identical sales growth trends and those of most of our competitors. We believe
this has extremely positive implications for our associates, customers and
shareholders both now and as we grow our business.
As we described for you last quarter, several factors continued to influence
Kroger’s business in the fourth quarter. They include deflation and the slow
pace of the economic recovery, which continues to restrain consumer spending. In
the fourth quarter, we estimate our product cost deflation, excluding fuel, was
nearly 100 basis points, a further drop from the 80 basis points of deflation we
experienced in the third quarter. This compares to product cost inflation,
excluding fuel, of approximately 590 basis points during the fourth quarter of
2008 – so in other words, a year-over-year swing of almost 700 basis points. The
swing is even more staggering when you isolate the Grocery department. In 2008,
we experienced nearly 800 basis points of inflation in Kroger’s product costs
for the Grocery department during the fourth quarter. In the fourth quarter of
2009, on this same internal measurement, we experienced approximately 285 basis
points of deflation. I’ll do the math quickly for you – that is a swing of over
1,000 basis points on a year-over-year basis. This is unprecedented in my time
in the grocery industry.
The economic recovery continues to be sluggish and unemployment levels remain
high, suppressing consumer spending. The slow pace of the recovery will continue
to influence how customers feel about their own spending decisions.
Against this backdrop, our team performed well in a number of areas and we
believe our financial results, while good on a relative basis, don’t fully
reflect the progress Kroger is making. We made significant strides in 2009.
These include positive trends in feedback from our customers, a strong rise in
the number of loyal households we serve, continued growth in tonnage, and market
share gains. We also made meaningful progress in our sustainability efforts,
which Rodney will share with you. We are proud of what our associates
accomplished throughout the year and we look forward to building on this
momentum.
Rodney and Mike will update you on Kroger’s performance in these important
areas. Rodney?
Comments by Rodney McMullen:
Thank you, Dave. Good morning everyone.
Customer Tracker
As you know, a fundamental part of our strategy is listening to what our
customers tell us is important to them and acting on that information. Every
quarter, we track what our customers are saying about us in four key areas: our
people, our prices, our products and services and the overall shopping
experience in our stores. We measure our progress in specific categories, such
as the friendliness and attentiveness of our store associates, for example.
In 2009, our customers told us we improved more in each of the four key areas
than in any year since we began these customer surveys in 2004. We saw a good
balance of improvement across all four keys. These surveys, which track feedback
from more than 50,000 customers each quarter, provide meaningful insight that we
can act on immediately and we will continue to seek feedback from our customers
and incorporate what they tell us into our future business plans. We believe it
also demonstrates the sustainability of the strong sales and tonnage growth we
are producing.
We conduct similar surveys of our associates and continue to make improvements
based on what our associates tell us is important to them. Associate engagement
is an important part of our Customer 1st strategy.
Loyal Household Growth
During the quarter, the total number of households we serve increased over the
prior year. We saw even stronger growth – in the mid-single digits – in the
number of loyal households that shop our family of stores. These households
represent our very best customers. Our data show these customers are making more
trips to our stores and over the course of a month, these households are buying
more total items from Kroger than they did a year ago. This is another
indication that our strategy is resonating with our best customers.
Our robust fuel discount programs are one example of how Kroger is able to build
customer loyalty by developing unique offers that reward customers for shopping
in our stores. In 2009, Kroger customers saved over $200 million through fuel
discount programs tied to our loyalty cards. And we continue to expand our fuel
discount programs for our most loyal customers. We recently introduced a
partnership with Shell in select markets. This industry-leading program gives
customers more opportunities to save on gas at Kroger fuel centers and
participating Shell stations.
Tonnage Growth
As Dave mentioned, we continued to maintain strong overall tonnage growth that
was driven by both Corporate Brand and national brand sales. In the fourth
quarter, we saw mid-single digit growth in sales of our own brands and national
brands. This is on top of the double-digit growth we saw in our own brands
during the same period last year.
During the fourth quarter, corporate brands represented about 27% of our grocery
department sales dollars and approximately 35% of our grocery sales units,
consistent with trends we saw in the fourth quarter of 2008. So while we are
seeing good growth in national brand tonnage, the popularity of our
industry-leading Corporate Brands has not diminished with customers. We believe
this is another indicator of the health of our business.
Kroger’s strong tonnage growth is a direct result of several different
customer-focused efforts. The customer insight we derive through our unique
partnership with dunnhumbyUSA enables our associates to strengthen Kroger’s
connection with our customers. Our strong tonnage growth is also a direct result
of our associates providing better service, and the broad, high-quality product
assortment we offer at good prices.
Retail Fuel Operations
Turning now to our retail fuel operations, we continued to see strong gallon
growth – both in total and on an identical basis – for the fourth quarter and
full year. Other retailers are reporting gallon declines, and the overall market
indicates that U.S. consumers are buying fewer gallons of gasoline. But they are
buying more gasoline at Kroger’s supermarket fuel centers and convenience
stores.
While margins in our retail fuel business had a significant impact on Kroger’s
annual earnings per share results, they did not materially impact the
year-over-year change in EPS for the fourth quarter. This was largely due to
cents per gallon margins that were fairly consistent with last year: 9.4¢ per
gallon for the fourth quarter of 2009 compared to 9.7¢ for the fourth quarter of
2008. On a rolling four-quarters basis, the cents per gallon fuel margin was
10.6¢ in 2009 compared to 14.7¢ in 2008. Our guidance for fiscal 2010 assumes a
normalized margin for this business of approximately 11¢ per gallon.
Sustainability Efforts
One area we have not talked a lot about but are very proud of what our
associates have accomplished is our sustainability efforts. Kroger continues to
make considerable progress in our top sustainability focus areas. These are:
waste reduction, plastic bag reduction, energy conservation and transportation:
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In partnership with our customers, we have increased the
amount of plastic we recycle from 9 million pounds of plastic in 2007 to 22
million pounds in 2009.
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We saved nearly 200 million plastic bags last year – about
20% of the way to our goal of saving 1 billion plastic bags. Our approach
includes engaging our associates in more efficient bagging techniques and
engaging customers in using reusable bags.
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Our energy teams have helped us achieve impressive utility
cost reductions through technology such as LED lighting and energy-efficient
motors in our freezer cases.
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Our fleet efficiency improved by more than 7% in 2009,
meaning our Logistics team delivered more cases of products per each gallon
of fuel used.
Labor
During the quarter, we continued to make progress in labor relations. We
completed successful contract negotiations for our associates in several markets
including Fry’s in Arizona, King Soopers and City Market in Colorado, Fred Meyer
in Oregon, and Kroger in Atlanta and Savannah, Georgia.
In 2010, we will negotiate agreements with the UFCW for
associates in Albuquerque, Cincinnati, Dallas, Detroit, Ft. Wayne, Houston,
Little Rock, Portland, Seattle and Toledo. We will also negotiate agreements
with the Teamsters for associates in California and Portland. Rising health care
costs continue to be an important issue in our labor discussions.
Pension contributions and expense will continue to be an issue
as well. During 2009, we contributed approximately $233 million to several
different multi-employer pension funds. In 2010, we expect to contribute
approximately $250 million to these funds. We continue to work diligently and
cooperatively with other employers, union groups, and legislators to address the
underfunded status of many of these funds. While we have made progress through
these efforts, and plan asset values have risen along with the market recovery,
we continue to believe this is a serious issue for all participants. The
ultimate solution will be a combination of benefit reductions, legislative
changes, and, yes, increased employer contributions.
Last year at this time, we thought our annual multi-employer
pension contributions had the potential to double in the next few years. Based
on current market conditions, we believe the potential for that scenario to
develop over the next five years to be unlikely. We still anticipate meaningful
increases in expense each year as a consequence of the increased contributions
that Kroger – and other participating employers – will be required to make in
order to rehabilitate the funding status of many of these plans.
Now, Mike will offer more detail on the fourth quarter and
full-year 2009 results and our outlook for 2010. Mike?
Comments by Mike Schlotman:
Thanks, Rodney. Good morning everyone.
Fourth Quarter 2009 Results
As we described for you last quarter, from an operational perspective, our
fourth quarter was very similar to what we experienced during the third quarter.
From an earnings perspective, a lower LIFO charge and tax rate caused Kroger’s
earnings to be higher than the high-end of the forecasted range we shared with
you in December.
Full-Year 2009 Results
Kroger’s net earnings for the year, adjusted for the asset impairment charges in
the third quarter, were $1.71 per diluted share.
These results represent a decline of 10.5% compared to our
fiscal 2008 earnings per diluted share of $1.91, excluding Hurricane Ike
charges. As you review our financial results, keep in mind that the lower LIFO
charge was offset by lower fuel margins.
For the full year, we are very pleased with our cost controls.
Our positive identical sales and cost savings efforts allowed us to leverage our
OG&A. Excluding fuel and one-time items, our OG&A rate declined 3 basis points.
This was an outstanding result in a period of deflated retail price points,
mid-single digit tonnage growth and increasing credit card fees. Our
sustainability efforts Rodney described earlier also contributed to this result.
We also had good results with some of the expenses that are accounted for on the
gross profit line. For example, our warehouses handled significantly more
tonnage with essentially the same warehouse cost as last year. We are committed
to process and productivity improvements to continue this result.
Market Share
Another topic of interest to investors is market share. Growing market share is
an important part of Kroger’s long-term strategy. Nielsen Homescan Data shows
that Kroger’s share overall rose approximately 60 basis points during fiscal
2009. This data also indicates that our share increased in 13 of the 17
marketing areas outlined by the Nielsen report, declined in three and remained
unchanged in one. Wal-Mart is a primary competitor in 12 of these marketing
areas. In those 12 marketing areas, Kroger’s overall market share grew
approximately 100 basis points. Our share increased in 11 of those 12 markets
and declined in one. According to our internal tracking of competitive store
openings, Kroger divisions compete with about 1,190 Wal-Mart supercenters, an
increase of roughly 60 new supercenters over last year.
The reason we cited Nielsen’s Homescan Data is because we
learned the government data used as part of our internal methodology has not
been updated to reflect the impact significant deflation and restrained consumer
spending had on grocery sales in 2009. Using the government data as it currently
exists showed Kroger’s overall market share declined in 2009. We do not believe
that accurately reflects our market share results for 2009, particularly
considering our strong tonnage growth and positive identical food store sales.
Adjusting the government data to include the decline in CPI, our analysis showed
Kroger’s overall market share increased.
We plan to continue to grow our business by maintaining
Kroger’s existing strong market share and building on additional opportunities
for growth.
Guidance
Turning now to guidance for fiscal 2010, we anticipate identical supermarket
sales growth of 2% to 3%, without fuel. We expect net earnings to range from
$1.60 to $1.80 per diluted share. Kroger’s quarterly dividend enhances total
shareholder return by approximately 1.5% to 2.0%.
We believe several factors that influenced our business in the
last half of 2009 will continue at least through the first half of the 2010
fiscal year. Inflation or deflation in product and operating costs, the
competitive environment, fluctuating fuel margins, and the pace of the economic
recovery are uncertain and cause us to be cautious about our fiscal 2010
forecast. We expect trends in these areas to influence our results throughout
fiscal year 2010.
Five weeks into fiscal 2010, our identical sales trend is
slightly ahead of the guidance range we have outlined. Please keep in mind this
trend benefited from the timing of the Super Bowl and snowstorms in many regions
we serve.
We do see plenty of opportunities to invest capital and
generate strong returns on those investments in today’s environment. We expect
to invest approximately $1.9 to 2.1 billion in capital projects with a strong
bias towards remodels and infrastructure projects. Our remodeled stores continue
to generate favorable returns and we believe pursuing a steady course of
remodels keeps our assets fresh and inviting for our customers. Infrastructure
projects we undertake are designed to enhance the overall shopping experience
for our customers, which helps drive sales, or improve efficiencies, which
generates cost savings we can invest in our strategy.
We expect to use free cash flow to maintain our current debt
coverage ratios and reward our shareholders – both through share buybacks and
quarterly cash dividends.
I encourage you to take a look at the 8-K we filed earlier
today. It contains additional details on Kroger’s 2010 guidance that may be
helpful to you.
As we give annual guidance, we are often asked how we see
earnings play out over the course of the year. This question is particularly
important this year given the volatility of 2009. We anticipate our first
quarter 2010 results will be below the results we reported for the first quarter
of 2009, assuming many of the operating conditions we experienced in the second
half of 2009 continue into fiscal 2010. The second quarter should be more
comparable to the prior year as we begin to lap many of the significant price
investments we made in 2009. We expect solid growth in the third and fourth
quarters of 2010, assuming favorable trends in product and operating costs, the
competitive environment, fluctuating fuel margins, and the pace of the economic
recovery.
Now, I will turn it back to Dave.
Comments by Dave Dillon:
As we move forward in 2010, I am inspired by the overall performance of Kroger
associates in 2009. During a year that proved to be extremely trying, Kroger
successfully achieved identical sales growth, increased the number of households
loyal to Kroger stores, and generated strong tonnage growth. In addition, we
reduced debt, increased the dividend we pay shareholders and prudently invested
capital to keep our stores and other assets fresh and innovative, strengthening
our competitive position.
During the last two years, we added 24,000 new jobs to support
our growing business, a direct reflection of the health of our business. All of
these achievements strongly support the continued growth of our Company.
As our performance during the quarter and throughout 2009
demonstrated, Kroger’s strategy generates value in good times and bad. Our team
knows how to compete effectively – in any operating environment – to strengthen
the connection we have with our customers. We believe Kroger will continue to be
in the best position to deliver shareholder value now and as the economy and
consumer confidence improve.
Now, we look forward to your questions.
Comments by Dave Dillon:
Before we end the call, I want to share some additional thoughts with our
associates.
First, thank you for your hard work – not only in the fourth quarter but
throughout 2009. It was a tough year. The economic environment was unyielding
and that affected all of you – and all of our customers. Still, you accomplished
what many others in our industry could not: You found ways to build even
stronger connections with our customers through your creativity and enthusiasm
for selling. Our customers noticed. They continue to spend more in our family of
stores each quarter and we thank you for making their experience with us
rewarding.
The challenges ahead in 2010 will be similar to the ones we
faced last year. I am confident in your ability to continue to make a positive
difference in the lives of our customers and your co-workers through your
efforts every day.
Recently, Katy Barclay joined Kroger to lead Human Resources.
I want to welcome Katy and recognize the work of our HR team, especially Katy,
Della Wall and Chuck Shaffer in improving the process of our Associate Tracker
Survey. Soon, you will be hearing more from your managers and supervisors about
the results of our most recent Associate Tracker survey. Thank you for taking
the time to complete the surveys and share your feedback with us. We heard from
246,000 associates across the U.S. We value your input and use it as we work to
improve Kroger and make it a great place to work.
Thank you for all you do. That completes our call today. Thank
you for joining us.
###
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
“believe,” “guidance,” “expect,” “should,” 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, as
well as the timing that those earnings occur within the year, 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; unexpected changes in product costs; the state of the
economy, including interest rates and the inflationary and deflationary trends
in certain commodities; the extent to which our customers exercise caution in
their purchasing behavior in response to economic conditions; the number of
shares outstanding; the success of our future growth plans; goodwill impairment;
volatility in our fuel margins; 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.
Earnings and sales also may be affected by climate change and adverse weather
conditions, particularly to the extent that hurricanes, tornadoes, floods, and
other conditions disrupt our operations or those of our suppliers; create
shortages in the availability or increases in the cost of products that we sell
in our stores or materials and ingredients we use in our manufacturing
facilities; or raise the cost of supplying energy to our various operations,
including the cost of transportation. The extent to which our quarterly dividend
enhances shareholder return will depend on the continued declaration of a
quarterly dividend by our Board, and the amount of such dividend, as well as the
price at which our stock trades. 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; our logistics and technology or
store projects are not completed on budget or within the time frame projected;
or if current operating conditions fail to improve or worsen. Our ability to use
free cash flow to continue to maintain our debt coverage and to reward our
shareholders 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. Our fuel margins could fail to normalize at 11¢
per gallon if the pattern of rapid changes in fuel costs continues. Should asset
values in the multi-employer pension funds further deteriorate, or if employers
withdraw from these funds without providing for their share of the liability, or
should our estimates prove to be understated, our contributions and pension
expense could increase more than we have anticipated. 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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