Safeway Inc. (SWY)

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Safeway, Inc. (SWY)

Q3 2009 Earnings Call Transcript

October 15, 2009 11:00 am ET

Executives

Melissa Plaisance – SVP, Finance and IR

Steve Burd – Chairman, President and CEO

Robert Edwards – EVP and CFO

Analysts

John Heinbockel – Goldman Sachs

Chuck Cerankosky – Northcoast Research

Scott Mushkin – Jefferies

Karen Short – BMO Capital Markets

Charles Grom – JPMorgan

Deborah Weinswig – Citi

Ed Kelly – Credit Suisse

Andrew Wolf – BB&T Capital Markets

Meredith Adler – Barclays Capital

Joe Parkhill – Morgan Stanley

Bob Summers – Pali Capital

Neil Currie – UBS

Presentation

Operator

Welcome to the Safeway third quarter 2009 conference call. (Operator instructions) I will now turn the call over to Ms. Melissa Plaisance, Safeway's Senior Vice President of Finance. Please go ahead.

Melissa Plaisance

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

Let me remind you that this call may contain forward-looking statements. Such statements may relate to topics such as sales, margins, earnings, earnings growth, operating improvements, cost reductions, capital spending, debt financing, dividends, free cash flow, growth of Blackhawk, depreciation, product development, Lifestyle stores, additional growth vehicles, guidance and other related topics.

These statements are based on Safeway's current plans and expectations and are subject to risks and uncertainties that could cause actual events and results to vary significantly from those implied by such statements. We ask you to refer to Safeway's reports and filings with the SEC for further discussion of these risks and uncertainties including those set out under forward-looking statements and risk factors in Safeway's annual report to stockholders included in Safeway's most recent Form 10-K and subsequent quarterly reports on Form 10-Q.

With that let me turn the call over to Steve Burd.

Steve Burd

Thank you, Melissa. Let me start with net income. Net income for the quarter was $128.8 million. This compares to $199.7 million in the same quarter in 2008. When you express that in earnings per share, we earned $0.31 a share this year versus $0.46 a share one year ago. As expected our earnings this quarter were well below last year's third quarter, but as you can see they are above the consensus estimate which were at $0.29 per share.

The earnings shortfall or difference from 2008 level was largely the result of three factors. The largest factor is represented by expense increases that are unrelated to third quarter sales and I'll cover that in more detail when we talk about the O&A expenses. Most of which these increases will not be repeated in 2010.

The second, the decline in volume obviously had an effect on the quarter and then third is deflation which happened in a number of categories but the most pronounced deflation was in produce and dairy, in fact much greater than we had even in the second quarter and more than we had previously forecast. These three negatives were partially offset by a very aggressive cost reduction effort.

But turning first to sales, total sales decline 7% versus last year's. The decline in total sales is explained by lower fuel prices, fuel prices are down 34% from last year. Secondly, a reduction in average ring per item. Some of that's trading down, some of that is deflation and then finally a decline in the Canadian exchange rate.

ID sales excluding fuel which is the number I think people are most interested is were a negative 3% of the quarter. While our volume levels are still negative, our trends continue to improve. Our perishable volume is now positive and was the best result we've had in perishables in some 11 quarters.

Our non-perishable volume while still negative represents the best result in non-perishable volume in some five quarters. The negative ID of 3% was largely the result of deflation, trading down and price investments. In fact if you bundle all those together, they explain more than 250 basis points of the 3% decline in sales.

Deflation as expected increased. We contemplated that you'll recall a quarter ago when we announced the second quarter we said that we thought produce deflation would be greater in the third quarter and then began to subside in the fourth quarter and that certainly played out in Q3 and we're seeing evidence of the decline in produce deflation in the early part of Q4.

We also experienced an increase in dairy deflation. The dairy deflation has let up a little bit here in the fourth quarter but not as much as produce, and then if there was a surprise in the quarter on the deflation front it was actually in the meat category, very modest deflation in quarter two and then that picked up significantly in quarter three and has frankly picked up in the early part of Q4 as well.

Our transaction counts which have been positive for several quarters continued to get better. Household counts which have also been positive for several quarters improved just slightly. Items per transaction which has been the main reason why non-perishable volume continues to be down, remained negative but continued to improve so, we think all the trends are certainly working in a positive direction.

Turning to gross margin, our total gross margin rate increased 78 basis points from last year, more meaningfully, when you exclude fuel sales. The gross margin on non-fuel business declined about six basis points. Now, the six basis points decline in gross margin is relative to quarter three of 2008, and while that may appear to some to be a quite modest decline in gross margin, when compared either to quarter three or to quarter two of 2003. You need to keep in mind that we're lapping really the start of very heavy investment in price, which occurred in the third quarter of last year.

In addition, our price in advertising investments were masked by several enhancements to gross margin and I'm going to first give you a comparison to last year, which is what that six refers to and then I'll give you a comparison to the second quarter just to kind of give you a sense for the enhancements.

In terms of the comparison to last year, the biggest improvement came in the LIFO expense area. You'll note we didn't have a LIFO expense this quarter and that's a very positive comparison to a year ago, which of course is reflective of the kind of deflation that we're experiencing.

Transportation expense which is included in the gross margin calculation improved considerably because energy costs are down. And then, we've had a long-term effort to improve our cost of goods through working different elements of the supply chain and that was the third major contributor.

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