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Second Quarter 2007
Investor Conference Call Prepared Remarks
September 18, 2007


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

Now I would like to introduce Mr. David Dillon, Chairman and Chief Executive Officer of Kroger.

Comments by: Dave Dillon

Thank you Carin and good morning everyone. We’re pleased you could join us to review Kroger’s second quarter 2007 financial results. With me today 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.

I’ll begin with a recap of Kroger’s second quarter and year-to-date results. I will also update our guidance for 2007. Rodney will then provide additional details on Kroger’s second quarter results. After that, we’ll be happy to take your questions.

Second Quarter Results

Kroger delivered another quarter of strong sales performance. Total sales for the second quarter increased 6.6% to $16.1 billion and identical supermarket sales increased 5.8% with fuel and 5.1% without fuel. This is the ninth consecutive quarter Kroger has reported identical supermarket sales, excluding fuel, in excess of 3%.

Our strong identical sales growth continues to be broad-based across the Company’s geographic regions and merchandise departments. All of our divisions and departments experienced positive identical sales growth. In addition, our convenience stores turned in another strong quarter of identical sales growth.

Net earnings in the second quarter totaled $267.3 million, or $0.38 per diluted share. Net earnings in the same period last year were $209.0 million, or $0.29 per diluted share.

Our fuel business had a strong second quarter this year – in sales, gallons and margin. While fuel margins for the quarter were strong, on a year-to-date basis they were more normalized. In the fuel business, it is not uncommon to see variations from quarter to quarter. To account for these fluctuations, we encourage investors to consider a longer view when analyzing fuel margins.

We are very pleased with our results this quarter. Our associates understand the importance of placing our customers first in their daily decisions. These results show we are connecting with our diverse customer base in a variety of ways, including service, price and products.

Year-to-date Results

Turning to year-to-date results, total sales increased 6.7% to $36.9 billion during the first two quarters of fiscal 2007. For the same period, identical supermarket sales, excluding fuel, increased 5.1%.

For the first two quarters of fiscal 2007, net earnings were $603.8 million, or $0.85 per diluted share. Net earnings for the same period in fiscal 2006 were $515.4 million, or $0.71 per diluted share.

Fiscal 2007 Guidance

Kroger’s earnings per share growth in fiscal 2007 will be driven by strong identical sales growth, a slightly improved operating margin, and fewer shares outstanding. Our performance through the first half of 2007 exceeded our expectations, and our momentum heading into the second half of the year causes us to raise our identical sales and earnings guidance for fiscal 2007.

Kroger now anticipates identical supermarket sales growth of 4 – 5% for the full year, excluding fuel sales. We expect to earn $1.64 – $1.67 per diluted share in fiscal 2007, up from the previous range of $1.60 – $1.65 per diluted share. Our updated guidance equates to 12 – 14% growth from adjusted fiscal 2006 earnings of $1.47 per diluted share. In addition, Kroger’s dividend currently adds slightly over 1% to shareholder return.

As we mentioned at the onset of fiscal 2007, we expected the timing of certain items in 2006 would affect our quarterly earnings per share growth in 2007. We anticipated that our earnings per share growth rates in the first and fourth quarters would be lower than the second and third quarters. This has held true for the first half of 2007, and we believe it fairly describes our expectations for the second half of the year. As a reminder, the fourth quarter of fiscal 2006 benefited from an extra week that we believe added approximately $0.07 per diluted share to our results.

Looking beyond 2007, we believe our Customer 1st strategy will allow us to grow identical supermarket sales in the 3% to 5% range, with a slightly improving operating margin, excluding fuel sales.

Now I would like to turn the call over to Rodney for some additional details on our second quarter results.
Rodney?

Comments by Rodney McMullen:

Thank you, Dave, and good morning everyone.

As Dave mentioned, we are very pleased with Kroger’s results this quarter, and they are in line with our expectation that the Company’s EPS growth rate for the second quarter would be higher than the growth rate for the full fiscal year. I’ll now discuss some of the income statement components that produced our earnings per share growth in the quarter.

Gross Margin

Let’s begin with gross margin. Kroger’s second quarter FIFO gross margin increased 47 basis points to 23.94% of sales. Excluding the effect of retail fuel operations, FIFO gross margin increased 51 basis points from the prior year. Of this increase, 23 basis points was attributable to lower shrink, distribution costs, and advertising expense as a rate of sales.

The FIFO gross margin increase also reflects our decision to pass along higher product costs during the quarter. Inflation is on many people’s minds these days, so I will take a minute to comment on how inflation is affecting Kroger’s business.
You may recall that we also experienced inflationary pressure across several product categories in the first quarter of the current fiscal year. At that time, we made strategic decisions not to immediately pass along all of our product cost inflation in retail prices based on specific market conditions. Second quarter market conditions allowed for a general pass-through of cost increases.

Kroger’s supermarket selling gross margin on non-fuel sales rose 38 basis points during the second quarter. This increase primarily reflects our decision to pass along product cost increases. On a year-to-date basis, Kroger’s selling gross margin, excluding fuel, declined 11 basis points. This slight decline illustrates the timing factor associated with product cost inflation and retail prices in our business, as well as Kroger’s continued practice of strategic price investments. Delivering value to our customers remains an important part of Kroger’s Customer 1st strategy.

We estimate that our product cost inflation during the quarter was 2.6%. This figure excludes fuel and utilizes CPI to estimate our inflation for our Pharmacy department. We are experiencing inflation across many core grocery and perishable categories. Inflation in core grocery is at a level not seen in several years.

The current inflationary environment has caused us to increase the projected LIFO charge in our business plan for fiscal 2007. We now anticipate a LIFO charge of approximately $110 million for the full year. This is $60 million more than the projection embedded in our original earnings per share guidance for 2007. The updated EPS guidance that Dave outlined earlier incorporates the $110 million LIFO charge.

Operating, General and Administrative (OG&A) Expenses

Turning now to OG&A, operating, general and administrative costs increased 2 basis points to 17.52% of sales. Excluding the effect of retail fuel operations, OG&A increased 16 basis points. This fluctuation may appear unusual to those of you who understand the business model that supports Kroger's Customer 1st strategy, so I am going to provide some additional color on what caused our OG&A rate to increase compared to the prior year.

Kroger's second quarter OG&A rate in the current year includes pre-opening and transition costs associated with the Scott's and Farmer Jack acquisitions that we described to you during our first quarter earnings call. We closed on these transactions during the second quarter. There are obviously no comparable costs in the prior year's OG&A rate.

Kroger's second quarter OG&A rate in both fiscal 2007 and 2006 benefited from adjustments that reduced our closed store lease liabilities. The magnitude of this benefit was higher in 2006 than 2007. These adjustments are part of our normal quarterly assessment of lease commitments.

Excluding these items, Kroger’s second quarter OG&A rate on non-fuel sales would have been lower in 2007 when compared to the prior year. This is line with our business model objectives. Compared to the prior year, we continue to expect our annual OG&A rate in fiscal 2007, excluding fuel, to decline as a rate of sales.

Operating Margin

The gross margin and OG&A factors I just discussed, plus approximately 9 basis points of leverage from rent expense, resulted in a slight expansion of Kroger’s non-fuel operating margin for the second quarter. While Kroger’s second quarter operating margin performance is consistent with our plan, we do not believe that a single quarter’s operating margin is the best gauge of the success of our business strategy. This is due to the timing of operating cost savings and investments in our business.

Kroger’s operating margin on a year-to-date basis increased 5 basis points, excluding fuel and first quarter charges for labor unrest in 2007 and certain legal expenses in 2006.

For the full year in fiscal 2007, we continue to anticipate a slight increase in Kroger’s non-fuel operating margin, which is one driver of our annual earnings per share growth.

Share Repurchase and Dividends

Kroger’s earnings per share growth in fiscal 2007 is also driven by fewer shares outstanding. We aggressively bought back shares during the second quarter, reflecting our judgment that Kroger shares represent a compelling investment. Under our stock repurchase programs, Kroger repurchased 21.2 million shares of stock in the second quarter at an average price of $27.21 for a total investment of $587.1 million. At the end of the quarter, $612 million remained under the $1 billion stock repurchase program we announced in June 2007.

As we told you last quarter, the financial strategy that supports Kroger’s business has evolved to reflect our progress in reducing Kroger’s leverage over the past few years. Our long-term financial strategy is to use free cash flow to repurchase shares and pay dividends while maintaining a solid investment grade rating.

Our share repurchase and dividend programs deliver substantial value to shareholders. Over the past four quarters, Kroger has returned $1.2 billion to shareholders in the form of share repurchases and dividends.

Debt

Net total debt was $6.7 billion, an increase of $362 million from a year ago. Total debt was $6.7 billion, a reduction of $274 million from a year ago. The difference in net total debt and total debt is invested cash, principally last year. Kroger’s net total debt to EBITDA ratio was 1.77, compared with 1.87 during the same period last year. Our strong EBITDA on a rolling, four-quarters basis enabled us to improve our leverage ratio while investing $2 billion in capital projects and $1 billion to repurchase 40.7 million shares and pay $192 million in dividends.

Capital Investment

During the second quarter, Kroger invested $566 million in capital projects, including acquisitions. This includes the acquisition of 37 stores in northeast Indiana and metropolitan Detroit that I referenced earlier. We invested $85.5 million to acquire these stores. Excluding acquisitions, Kroger invested $481 million, compared to $361 million a year ago. Total capital projects included 13 new or expanded stores and 30 remodels. During the second quarter, we closed 11 locations. All of these were operational closures and five of these closures followed the completion of the two transactions I mentioned earlier.

During the quarter, total supermarket square footage grew 1.6% year over year, excluding acquisitions and operational closures. We continue to anticipate supermarket square footage growth of 2.0% for fiscal 2007. We still expect to invest $1.9 - $2.1 billion in capital projects during fiscal 2007. This estimate excludes spending on acquisitions. In terms of capital allocation, our emphasis remains on store remodels, and we are very satisfied with their performance. We have completed 101 remodels year-to-date through the end of the second quarter. That compares to 73 remodels during the same period last year.

Kroger carefully evaluates acquisition opportunities for their potential to enhance shareholder value along with our existing business. We also focus on improving our returns from capital investment. Our return on assets improved 85 basis points, on a pre-tax basis, excluding the effect of the 53rd week in fiscal 2006. This is on the same basis that Kroger has consistently used to calculate return on assets.

Labor

Before turning back to Dave, I’ll discuss progress we have made in labor relations. We recently reached agreements with unions representing our Associates in Southern California, Seattle and Toledo. We are currently in negotiations in Cincinnati, Memphis, West Virginia and in Southern California with Food4Less.

In every contract negotiation, we work to reach a balanced agreement that meets our cost efficiency objectives while fulfilling our commitment to provide our associates with solid wages and benefits. Maintaining this balance allows Kroger to invest in our business to provide new job opportunities for existing associates and create new jobs for more people. Fair and balanced contract settlements continue to be our objective in all negotiations.

Now I will turn it back to Dave for some closing remarks.

Comments by Dave Dillon:

Thanks, Rodney. We made solid progress during the second quarter in achieving our business objectives for the year. We are on track to successfully execute our business plan and generate value for our shareholders.

In addition to the factors we just discussed, I want to update you on progress we made during the quarter with one of our key competitive strengths – Corporate Brands.

Our Corporate Brands team recently launched an expanded line of private label organic products under Kroger’s exclusive Private Selection brand. Organic and Natural Foods continue to be a growing area of our business and with this expansion, Kroger’s family of stores now carry more than 60 Private Selection Organic products. Items range from staples such as milk, ketchup, butter and eggs to new items like cereal, salads and snacks.

These Private Selection Organic products are integrated throughout our stores and are available on shelves right next to our customers’ favorite products. This makes it easy for customers who want to try organic foods to do so at their own pace – without having to go to a special section for the organic items they want. We are excited to expand this growing segment of our business.

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

Closing comments after Q&A:

Thank you. Before we sign off, I would like to offer some additional thoughts to our associates listening in today.

As expected, 2007 is shaping up to be another successful year – thanks to you! Many of us in senior management have had the opportunity in the last few weeks to visit many of you – in stores, or during visits to plants, distribution centers and offices. I always come home inspired by your enthusiasm and engagement with our customers.

I had another great experience this past weekend while visiting a store we recently expanded. During my visit, I was inspired by one gentleman who was spot-cleaning the floor – and proud of his work. Next, I saw the cheese steward introducing new varieties of cheese to customers who had never tried them. Throughout my visit in the store, I saw numerous examples of talented associates engaging customers. From the creatively stocked salad bar to the wonderful prepared foods to the delicious pastry bar, the enthusiasm on display from our associates was inspiring.

These visits always remind me of the families we each go home to at the end of our work day. During another recent visit, I was admiring a fabulous Halloween display with a store manager when his young son approached us. His son was excited – and a little frightened – by the costumes on display and was soon busy trying to decide what to be for Halloween. Watching the excitement on this young boy’s face reminded me that our holiday season is just beginning – both at work and at home. This is a special time for our customers and our families. We appreciate the efforts you make during the holidays to create unique experiences for our customers. You are already off to a terrific start. I know you will all look for ways to make the holiday season bright for all of our customers. Happy selling!

Thank you all for joining us today. Goodbye.

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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 “expectation,” “will,” “believe,” “strategy,” “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. Square footage growth during the year is dependent upon our ability to acquire desirable sites for construction of new facilities, as well as the timing of completion of projects. These same factors, and our ability to generate free cash flow, could affect the extent to which our strategic plan is successful in increasing our identical supermarket sales, and the extent to which we are able to create value for our shareholders by investing in our store base, repurchasing stock, and paying cash dividends, while maintaining a solid investment grade rating. Our plans to use free cash flow to repurchase shares and to pay dividends will depend on our ability to generate free cash flow, which will be affected by all of the factors identified above, and the extent to which those repurchases can be made and dividends be paid while still maintaining a solid investment grade rating. The extent to which our maintenance of a solid investment grade rating provides us with the best cost of capital and the flexibility to execute our growth strategy will depend primarily on the way in which the capital markets view an investment in Kroger debt instruments as compared to other investment grade alternatives. Our estimate of LIFO charge could be different than anticipated if the mix of our products sold or product cost inflation changes. Our ability to increase our non-fuel margins is dependent primarily on our ability to pass along product cost increases, as well as our ability to reduce shrink, distribution costs, and advertising expenses as a rate of sales. Our anticipated capital expenditures may be affected by our ability to obtain suitable store, logistics, and other projects, and the timing of those projects. 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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