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Safeway Q3 Sales and Comps Rise, Profits Dip Due to Texas Closures

PLEASANTON, Calif. -- Safeway said its mid-single-digit gain in identical store sales for the third quarter are a sign that the company's new marketing strategy and Lifestyle store execution is paying off, though quarterly profits took a 3 cents per share hit, due to costs related to a Texas impairment charge.

The chain said yesterday it will close 26 underperforming stores under the Tom Thumb and Randalls banners, as part of a scheme to revitalize its Texas division.

For the quarter, Safeway's sales increased 7.2 percent to $8.9 billion in the third quarter ended September 10, 2005, up from $8.3 billion the previous year.

Comparable store sales increased 5.7 percent and identical store sales (which exclude replacement stores) increased 5.4 percent for the third quarter. Excluding the effect of fuel sales, identical store sales still increased 3.4 percent.

"We are pleased with the progress we made this quarter on several fronts," said Steve Burd, chairman, president and c.e.o. "Our identical store sales are the strongest they have been in over four years, we gained U.S. market share in 35 of the last 36 weeks, operating and administrative expense as a percentage of sales declined significantly in the quarter, and our capital investments and Lifestyle stores continue to exceed expectations."

During the quarter, Safeway we also initiated a strategic solution to improve operations in Texas, made progress on the labor front with a tentative agreement with the UFCW in Chicago, and completed an employee buyout in the Bay Area, according to Burd.

"In addition, we have decided to utilize a lower tax rate under the American Jobs Creation Act of 2004 to repatriate funds from Canada, allowing us to pay down debt in the United States in the near term," he said. "In short, we have been busy and are satisfied with the results."

Safeway incurred a $54.7 million pre-tax impairment charge (8 cents per share) on the Texas stores in the third quarter of 2005, and said it expects to incur a charge of approximately $59 million, pre-tax, for store exit activities in the fourth quarter of 2005. The impact of closing these stores is expected to be cash neutral in 2005.

Fuel and energy prices increased significantly over last year. Safeway avoided a portion of this increase with the use of fixed price natural gas and electricity contracts. However, the net impact of higher fuel and natural gas prices increased store utility costs, store supply costs, and distribution costs. It also lowered operating profit from fuel stations. Safeway estimates that higher energy costs reduced net income by approximately $23 million, pre-tax, or 3 cents per share in the third quarter.

Primarily because of fuel sales, which have a lower gross margin, gross profit declined to 28.58 percent of sales in the third quarter of 2005 compared to 29.56 percent in the third quarter last year.

Operating and administrative expenses declined to 25.90 percent of sales in the third quarter of 2005 compared to 26.03 from last year. Operating and administrative expense in 2005 included a $54.7 million pre-tax Texas impairment charge, a $21.9 million pre-tax employee buyout charge and a $14.6 million pre-tax expense for stock options. Operating and administrative expense in 2004 includes a pre-tax $19.7 million health and welfare contribution.

Net income for the first 36 weeks of 2005 was $387.7 million, or 86 cents per share, compared to $357.6 million, or 80 cents per share the prior year. The gross profit margin was 28.84 percent in 2005 compared to 29.63 percent. Operating and administrative expense was 25.67 percent of sales in 2005 compared to 26.49 percent.

Safeway invested $856 million in capital expenditures in the first 36 weeks of 2005. The company opened 13 new Lifestyle stores and completed 156 Lifestyle remodels. For the year, the company expects to spend approximately $1.5 billion in capital expenditures and open approximately 25 new Lifestyle stores and complete approximately 290 to 295 Lifestyle remodels. By year-end 2005, approximately 26 percent of Safeway's store base will be in the Lifestyle format.

Net cash flow from operating activities was $1,287.4 million in the first 36 weeks of 2005 compared to $1,526.0 million last year. This change was primarily because of higher income tax payments in 2005 and lower prepaid expense in 2004.

Safeway expects 2005 identical store sales (excluding fuel and excluding Vons for the first quarter of 2005) to be at the top end of the previously provided range of 2.5 percent to 2.8 percent. The company is comfortable with current analyst consensus earnings estimates of $1.44 per share for 2005 (excluding any voluntary employee buyouts and the closure of Texas stores) as posted by Thomson First Call.

Shares of Safeway dropped 5.6 percent on the quarterly results, and closed at $23.02, off $1.37.
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