Ladies and gentlemen, welcome to the Albertsons Companies Third Quarter 2019 Conference Call, and thank you for standing by. [Operator Instructions] This call is being recorded. If you have any objections, please disconnect at this time. I would like to turn the call over to Melissa Plaisance, GVP of Treasury and Investor Relations. Thank you, you may begin.

Hello, and thank you for joining us for the Albertsons Companies Third Quarter 2019 Earnings Conference Call. With me today from the company are Vivek Sankaran, our President and CEO; and Bob Dimond, our CFO. Today, Vivek will touch on our recent results and provide an update on our strategic priorities. Bob Dimond will then provide an overview of our third quarter results, and Vivek will then make some closing comments. I'd like to remind you that management may make statements during this call that include forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are not limited to historical facts but 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. Additional information concerning factors that could cause actual results to differ materially from those in forward-looking statements will be contained from time to time in our SEC filings, including on Forms 10-Q, 10-K and 8-K. Any forward-looking statements we make today are only as of today's date, and we undertake no obligation to update or revise any such statements as a result of new information, future events or otherwise. Please keep in mind that included in the financial statements and management's prepared remarks are certain non-GAAP measures, and historical financial information includes a reconciliation of net income to adjusted EBITDA. And with that, I will hand the call over to Vivek.

Thank you, Melissa. Good morning, everyone, and thank you for joining us today. As many of you read this morning, we've continued to make very good progress and are delivering solid results. During our third quarter, we had identical sales of 2.7%, and our adjusted EBITDA was $634 million. The Q3 identical sales was our eighth consecutive quarter of identical sales growth, and we grew market share during the quarter. In addition, the proceeds received from our sale-leaseback transactions have allowed us to significantly reduce our debt by over $1.8 billion this year and by over $3.1 billion since the end of fiscal 2017. This has reduced net debt leverage to 3x at the end of our quarter and significantly reduced interest expense, down $105 million year-to-date versus last year. As many of you know, over the last few years, we have brought together iconic retail banners with rich heritage and a strong local following. We are now pivoting to the future and aspire to build deep and lasting customer relationships through an easy, exciting and friendly shopping experience. As I mentioned last quarter, we're focused on 4 main areas to grow our business. The first is our stores, our core business and our foundation for growth and profitability. We're investing in multiple areas to enhance the customer experience and improve store performance. For example, we're expanding our self-checkout capabilities and enhancing our staffing capabilities in the checkout lanes. We're also exploring other innovative technologies to make the store shopping experience easy for our customers. We're building on our already strong share in fresh and expanding into exciting new meal solution offerings. We're enhancing our pricing and promotions capabilities with more technology to improve sales and protect margins. We're making our stores more productive by enhancing our ordering and staffing…

Thanks, Vivek, and hello, everyone. Total sales increased $263 million, or 1.9% to $14.1 billion during the third quarter of fiscal 2019 compared to $13.8 billion during the third quarter of fiscal 2018. The increase in sales was primarily driven by our 2.7% increase in identical sales, partially offset by a reduction in sales related to store closures in fiscal 2018 and the first 3 quarters of fiscal 2019 and lower fuel sales driven by lower average retail fuel prices. Identical sales continued to benefit from our growth in online home delivery and Drive-Up and Go sales and Own Brand sales growth. Identical sales in the third quarter benefited approximately 30 basis points from the timing shift from the Thanksgiving holiday. Our gross profit margin increased to 28.3% for the third quarter of fiscal 2019 compared to 27.8% in the prior year. Excluding the impact of fuel, the gross profit margin increased 40 basis points. Shrink expense was better than a year ago as we continue to execute on our shrink reduction efforts. Gross margin is also benefiting from increases in our Own Brands penetration, which, as we noted, reached another high for the company at 25.6%. Selling and administrative expenses increased to 27% of sales during the third quarter of fiscal 2019 compared to 26.5% of sales for the third quarter of fiscal 2018. Excluding the impact of fuel, selling and administrative expenses as a percentage of sales increased 40 basis points during the third quarter of fiscal 2019 compared to the prior year. The increase in selling and administrative expenses was primarily attributable to strategic investments in digital and technology initiatives and increased rent and occupancy expense due to -- in part to the sale-leaseback transactions. Interest expense was $154.8 million during the third quarter of fiscal 2019…

Thank you, Bob. We were pleased to see the momentum during the first 3 quarters of fiscal 2019 as our efforts, both in-store and online, are resonating with our customers. But we're working to enhance the customer experience and drive growth from our core stores, eCommerce, Own Brands and our loyalty program and win in the marketplace. To do so efficiently and effectively, we are enhancing productivity, strengthening supplier relationships, using technology to find a better way to do everything, modernizing assets and infrastructure and adding to our talent pool. And finally, we made great progress on our leverage profile and plan to continue to invest in the business and pay down incremental debt as we generate significant free cash flow, further reducing interest expense and increasing our financial flexibility. I will now turn the call back to the operator for questions.

[Operator Instructions] Our first question is from William Reuter, Bank of America Securities.

You laid out a couple of new items, which it sounds like you've expanded in terms of your cost savings or, I guess, productivity initiatives. You mentioned purchasing and shrink. I guess, have you been able to try and quantify the timing -- or I guess, quantify the amount as well as the timing of when you'll achieve these?

Yes, it's Vivek here. Here's how we're thinking about it. We have multiple platforms of productivity. Shrink is one such. Labor is one such, purchasing indirect goods is one. Working with our suppliers is another. Operate -- automating our DCs is another. So we have these multiple platforms. And the way we think of these is these are all multiyear platforms, right? These are not things that you just do it once and stop. We see productivity over multiple years, and we are laying out our plans so that we can have a steady flow of productivity that will offset inflation and give us the money to continue to generate investments back to growth. That's how we're thinking about it. We've got it and we are working it all through our P&Ls.

All right. That's good to hear. Your SG&A, obviously, you guys had some new union contracts which were recently signed. SG&A, I'm sure, was increased because of that a little bit. Can you talk about your labor pool as a whole, what the year-over-year percent increases you're seeing at this point is?

Yes, Bill, this is Bob. Actually, interesting that in the third quarter, we did a very nice job in controlling our labor and it wasn't a significant increase year-over-year. I think on a year-to-date, when you get our 10-Q and see the basis points breakout, it was a small effect but still less than 10 basis points, I believe. So overall, our operators have done a great job. Part of that is due to some of these initiatives that we've already begun rolling out that are starting to bear some fruit. Some of it is just other activities that we're doing within the stores that help offset it and make us work smarter.

That's great. I'm sure that's not easy in this environment. Just lastly from me. You mentioned a couple of micro fulfillment centers. As you kind of think about the future of this business, how many of those do you expect that you may have at some point across the country? And I guess, about how much are you spending either on each of these, or how much CapEx should we think about allocating annually to these?

We -- these are still early days. What I can tell you, Bill, is that we're seeing a lot of promise. It's the early days. It started to work like we imagined. If it works, I mean, our intent is to continue to roll these out, right? We haven't got to a place where we've said, how many should we put in, because we just need to continue to see if this thing delivers what we expect it to. But we will have more information as this thing goes through the next couple of years.

Our next question is from Karru Martinson, Jefferies.

As you guys look at the store base, what is the difference in terms of the stores that have been remodeled in terms of what they contribute to same-store sales growth here versus your older fleet?

What we see typically when we do a remodel, and we remodel about 10% of our store base consistently, right, about half our capital goes towards remodels, and we see about a 2- to 3-point ID lift over our average. And so we feel good about that, right? We feel good about it. And we're getting sharper about what we remodel and how we remodel it. And I think that's part of the -- part of what's giving us the return.

Okay. And when you look at those remodels, are you targeting certain geographies, or are there areas when you want to expand into? Or should we think about the footprint being the same here going forward?

The way we think of our remodels, it's not a, oh let's take a part of the country and remodel things. That's not our approach. We believe very much, very deeply in this notion of being locally right, locally great. And so we go -- we literally look at it by market area by market area and stores within a market area, and then think about how to prioritize our remodel dollars. And that's combined with -- and if you haven't remodeled a store in several years, even if it's due for it, but then you come back and think about how best to prioritize against it. So what I'd leave you with is it's not a broad market base, it's a store-based approach based on what's going on around in the store and whether the store is ready for a remodel.

Okay. And you guys have done an admirable job in deleveraging the balance sheet and further deleveraging, over time, with cash flow. I mean where do you think that the balance sheet needs to be for an IPO exit for you all?

Yes, we're currently at 3x. As we speak to our investment bankers, I think they're feeling very comfortable with that kind of -- in this ZIP code, it creates a lot of financial flexibility, whether it be an IPO or what other types of things that we may want to do. So we think this creates some real...

We're in the right zone.

Our next question is from Bryan Hunt, Wells Fargo.

I was wondering if you could just talk about where you stand in terms of mix of electronic sales, your Drive-Up and Go and your home delivery? And where do you think a saturation point would be?

Bryan, it's Vivek here. I don't know what the saturation point is, but I can tell you that we have set an aspiration that we'd see this 30% clip, 30% growth in eCommerce continuing, okay, as we continue to expand our Drive-Up and Go capabilities and continue to improve the overall solution that we're offering. So we -- and what I'll also tell you is that we're finding it's incremental. It is meaningfully incremental to our base store IDs. So we see a lot of promise. We're going to continue to invest in it, investing in the talent in it, investing in digital capabilities and investing in some of the assets that you saw, whether it's an NFC capability or more of the simpler Drive-Up and Go capability. So we're going to continue to do that. We are not breaking out the percent of sales at this point.

All right, very good. And you led into my next question. When you think of the micro fulfillment centers, MFCs, obviously, you could -- given the density of your store base and a lot of densely populated areas, you could probably have a significant number of these. How many of your current storefronts could potentially be replaced with micro fulfillment centers over time?

Bryan, the way that we're looking at it, it's not necessarily that it would replace a store.

Yes.

These are -- what's unique about these is they can fit in 10,000 to 12,000 square feet and supply 25,000 SKUs for us, which is a lot of the very fastest-moving items. So what we're focused on now is trying to identify stores that make sense where we have a lot of volume, where we could carve out in a larger store, 10,000 to 12,000 square feet in the back room and utilize that space and still have the store there for the customer to shop.

Yes. And what it does, Bryan, when you do it. So it appends a store, it doesn't replace a store and so you have these 25,000, let's say, really fast-moving items that can go through it. And then when you need a special cut of meat, you just go down to the store and pick it up. So it gives us the ability to do what we're really good at, which is providing fresh, and then having the speed and efficiency for the fast-moving items.

Great. And then my last question is I think you said over the next 2 years, you're planning on having Drive-Up and Go at 1,400 locations. When you look at your total store base today, how many of those stores can handle logistically a Drive-Up and Go, in your opinion?

I think about 2,000 or so could do it, right, we think. And so we've set a target of getting 1,400 stores ready in the next couple of years. And as we feel comfortable -- we feel more comfortable, we'll go faster, but that's the current plan. We think about 2,000 can handle it.

Our next question is from Hale Holden, Barclays.

I just had a couple of quick ones. On the Drive-Up and Go, I was wondering if the expansion there requires additional head count, or if you found some technology offsets to kind of allow for the provisioning there as you take that out further into the fleet.

Yes, good question. So let me frame it this way, right? So when you start up the Drive-Up and Go early in a store, to provide the right kind of service, you add labor so that the customer is never disappointed. And as you get scale in that particular store, you're now at a position where you can start optimizing the labor. So that's in the more traditional model. In an MFC kind of model, you're still getting some of those picking efficiencies right away. And so the labor model is kind of different. It's a very different and efficient labor model if you're able to go with that kind of automation. So that's how we see it playing out, and -- or the model, as we go forward and the stores start building enough of a volume of Drive-Up and Go, we see the labor starting to get optimized.

Understood. And then on the MFC, I was interested in that you're provisioning in the MFC and then moving to the store where then, presumably, it goes to either Drive-Up and Go or home delivery from the store, so it's an incremental step. And that format, given, I guess, the throughput that you're seeing on the MFCs is still more efficient than picking in the store?

That's correct. So the -- what the MFC provides us with significantly more picking efficiency, all right? Think like 4x. And it provides the -- since it's connected to a store, it gives us the -- it leverages the distribution to the store and it leverages the rest of the products that are available in the store. That might be longer tail items or fresh items.

Great. And then my last question is, it looks like you guys had a pretty good pharmacy quarter, and I was wondering if you had changed any approaches there or were doing anything differently or if that was just kind of a macro uplift?

Hale, it's Bob. We did have a nice sales quarter for pharmacy this past quarter. I think some of that certainly is driven by what you're reading out there as far as high flu-related sales and things like that. But our IDs have been very strong.

Our next question is from Carla Casella, JPMorgan.

I'm wondering if you could give us a little bit more color on the SG&A increase, how much of it was related to some of these bigger investments that you're doing. And if -- and how long, like where are you in the process? Is this halfway through, et cetera?

Sure. So I think that, as we indicated in the press release, we had really 2 primary drivers that drove that 40-basis point increase. Roughly $22 million was related to the sale-leaseback rent that's incremental. And we'll cycle that as we get past the first quarter this coming year. So that's a piece. And then roughly the same dollar amount, slightly less, was the investments that we're making in our strategic technology spend. And last year, that wouldn't have been in our base because we were just finishing up all of our integration. And so this is kind of a new layer, if you will, of investment than we have in the past. But we think it's going to pay off very, very well for us as we move forward.

Our next question is from Jarrett Brotzman, Legal & General. Jarrett Brotzman; Legal & General Investment Management Limited;Analyst: Just a couple for me really quickly. The first is I was wondering what percentage of ID sales was generated by some of the different buckets of either Drive-Up and Go or third-party delivery services?

Yes. We don't break out all of our different components of ID sales because there's just lots of different things that contribute to that. What we can say is we're happy with the increase. We did indicate that we are up 34% in our eCommerce sales, for example, and that certainly is a driver or contributes to our 2.7% ID. But we have lots of other things. We have a lot of -- well, we have some new remodels that we've done this year that are contributing positively. We also have a whole myriad of merchandising initiatives as well that contribute to it.

And Own Brands is growing faster. Our Own Brands is growing penetration and growing faster than the average in the store, so that's contributing to it, too. Jarrett Brotzman; Legal & General Investment Management Limited;Analyst: Okay, great. And I'm just curious what -- are you guys are able to provide any color around difference in margin profile for the -- either the size or the overall margins for what you're seeing in different delivery or pickup methods. So I mean, for instance, with -- you're using third parties to deliver, how -- if you could provide some way of kind of bucketing that? How much does that impact margin profile on that incremental basket, if you will?

Yes. Jarrett, I appreciate the question, and we do have different methods that we utilize. We're experimenting with new third parties all the time. And so to come out with what each of those financial models look like, we're not prepared to break that out for you. But suffice it to say that we are doing some things to help make the processes more efficient. Our MFCs that we talked about here a little bit earlier is a key part of that. And we'll continue to utilize technology wherever we can to help us be more efficient.

We have reached the end of the question-and-answer session, and I will now turn the call back over to Melissa Plaisance for closing remarks.

Thank you, everyone, for participating today. If you have any follow-up questions, I'll be available along with Cody Perdue for the balance of the day to help you out. Have a great day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.