Safeway Inc. (SWY)

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Safeway (SWY)

Q2 2011 Earnings Call

July 21, 2011 11:00 am ET

Executives

Melissa Plaisance - Senior Vice President of Finance & Investor Relations

Robert Edwards - Chief Financial Officer and Executive Vice President

Steven Burd - Executive Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Edward Kelly - Crédit Suisse AG

Joseph Feldman - Telsey Advisory Group

Colin Guheen - Cowen and Company, LLC

Meredith Adler - Barclays Capital

John Heinbockel - Guggenheim Securities, LLC

Neil Currie - Dahlman Rose & Company, LLC

Scott Mushkin - Jefferies & Company, Inc.

Mark Wiltamuth - Morgan Stanley

Karen Short - BMO Capital Markets U.S.

Robert Ohmes - BofA Merrill Lynch

Deborah Weinswig - Citigroup Inc

Stephen Grambling - Goldman Sachs Group Inc.

Unknown Analyst -

Andrew Wolf - BB&T Capital Markets

Presentation

Operator

Welcome to the Safeway Second Quarter 2011 Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Melissa Plaisance, Safeway's Senior Vice President of Finance and Investor Relations. Please go ahead.

Melissa Plaisance

Good morning, everyone, and thank you for joining us for the second quarter conference call for Safeway. With me today this morning is Steve Burd, Safeway's Chairman, President and CEO; and Robert Edwards, Executive Vice President and Chief Financial Officer.

Before I turn the call over to Steve, let me remind you that management will make statements during this call that include forward-looking statements within the meaning of the federal securities laws. Forward-looking statements contain information about future operating or financial performance. Forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. However, we undertake no obligation to update or revise any such statements as a result of new information or future events. For a list and description of those risks and uncertainties, please see our filings with the SEC.

And with that, I'd like to turn the call over to Steve Burd.

Steven Burd

Thank you, Melissa. Let me start with net income. Net income for the quarter was just under $146 million. This compares with $141 million from the same quarter one year ago. When you express those earnings in earnings per share, we earned $0.41 this quarter as compared to $0.37 last year, which is an earnings increase per share of 11%. Now this marks the third consecutive quarter of double-digit earnings improvement.

Making just a few general comments at the outset, our earnings per share results were above first call consensus estimates, and frankly, above our own internal expectations. Sales were softer than we expected, but strong enough to produce our sixth consecutive quarter of improvement.

We had a small improvement in O&A when you adjust for both fuel sales and the Blackhawk accounting change, which we talked about for the first time one quarter ago. Our gross margin rate was lower than last year, largely because cost inflation, while being passed along to consumers, is being passed along with just a bit of a delay.

Our operating margin, excluding fuel on a year-to-date basis, is flat with last year. And you recall in our guidance that operating margin will be flat to up slightly on the year. So we're on track with that guidance.

Turning first to sales, our total sales increased 7.1% over last year. This strong increase in sales was largely the result of higher fuel sales, which are a combination of gallons being up double digits, as well as prices being up over 30%, our price per gallon. Also a change in the Blackhawk accounting, a third item would be an improved Canadian exchange rate. And then lastly, an increase in nonfuel-related ID sales. ID sales, excluding fuel, increased 0.5%, which is just up slightly from the first quarter.

Sales were relatively strong early in the quarter, but then softened -- they always soften the week after Easter, but they were soft for about 3 weeks after Easter. As we've looked at that, we believe the softening was largely the result of Easter occurring late in the calendar month. And it's always true that our sales spike during pay periods, which currently happens twice a month, and it's also true that really want to spend for the holiday. And if you look at the retail sales in general, I think most retailers experienced the same kind of Easter. So I think the calendar had something to do with that.

Sales then strengthened significantly in the last 5 weeks of the quarter. If we combine the last 5 weeks of quarter 2 with the first, really, 4.5 weeks now in quarter 3, we're running just below 1%. And we believe that, that momentum will build as we move through the quarter.

Inflation has been stronger than we expected and was north of 2% in quarter 2. When you couple stronger inflation with the fact that fuel retails are up considerably over the last year in our markets expressed in cents per gallon, retail prices are up $0.94 a gallon, which is about 32%. Those 2 things in combination, food inflation plus a rather large inflation on the fuel side, we believe has a dampening effect on demand, and that's particularly true for that segment of our shoppers that believe we're still in a recession, which is the largest segment, I might add. As a result, we continue to see a modest decline in market share, but virtually at the same rate that we've seen for the last 2 quarters.

Turning to gross margin, our total gross margin rate declined 155 basis points from last year. When you exclude fuel sales and the accounting change, our gross margin declined just 19 basis points from last year. Now this decline in growth is largely the result of the delay in recouping cost inflation that I mentioned earlier, coupled with the fact that we had a higher LIFO charge because of inflation in the quarter. Now these declines in gross margin were largely offset by a dramatic improvement in shrink reduction, which we've been experiencing since the fourth quarter of last year, an improvement in the Blackhawk gross margin dollars, and then a reduction in advertising spend.

Turning to O&A expenses. O&A expenses, expressed as a percentage of sales, declined 127 basis points from last year's second quarter. Now, excluding fuel sales, and again, the accounting change, the O&A expense ratio actually declined or, if you will, improved 4 basis points. The largest positive in the quarter were lower labor expenses and lower depreciation as we backed off on our capital spend from the days when we were remodeling 300 Lifestyle stores per year.

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