Kroger Company (KR) — Q1 2016 Earnings Call Transcript

Thank you, Laura. 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 first quarter press release and our prepared remarks from this conference call will be available on our website at ir.kroger.com. After our prepared remarks, we look forward to taking your questions. I will now turn the call over to Kroger's Chairman and Chief Executive Officer, Rodney McMullen.

Thank you, Cindy, and good morning, everyone, and thank you for joining our call today. With me to review Kroger's first quarter 2015 results are Mike Ellis, Kroger's President and Chief Operating Officer; and Mike Schlotman, Senior Vice President and Chief Financial Officer. Kroger delivered strong first quarter sales and earnings results, and we are pleased with our start for the year. We achieved our 46th consecutive quarter of positive identical supermarket sales growth. We exceeded our goal to slightly expand FIFO operating margin without fuel on a rolling 4-quarter basis, and we continue to invest and innovate to grow our business, expanding our use of technology and our digital capabilities. Kroger has produced consistently remarkable results for so long that it might be easy to take a quarter like this for granted, but these results don't happen accidentally. They happen because we lead and drive our business toward these goals. Customer 1st and our 4 keys: our people, products, shopping experience and pricing, remain our fundamental strategy. We strive for balance across these 4 keys, and each quarter, we do a little better in each. And when we do that consistently for as long as we have, our results are more powerful. Based on the strength of our first quarter results, we are raising our identical supermarket sales growth guidance for the year, and we are on track to deliver our long-term net earnings per diluted share growth rate of 8% to 11%, plus the dividend, in 2015. One of the ways we continuously improve the shopping experience is by bringing new technology and digital capabilities to our business. Mike Ellis will provide an update on several digital efforts in a moment, but I wanted to mention what I think is a great example of how we're expanding our use of technology. Our recent decision to establish 84.51°, which replaced our previous joint venture, dunnhumbyUSA, 84.51° is helping us to continue to use data science for the benefit of our customers and to deliver a more personalized experience, both in store and online. We are so excited to welcome the talented associates at 84.51° to the Kroger team, and we are already beginning to see their daily involvement in the business helping to accelerate our efforts. Just little things, like 84.51° CEO Stuart Aitken participating in our senior officer meetings is making a big difference. We expect 84.51° to be an innovation engine and a game changer for Kroger and our customers. We are pleased to see the economy moving in the right direction, albeit, as we've mentioned for several quarters, slowly. One of the important ways we are able to deliver so consistently is that we offer attractive values for all customers all the time. When you want to splurge, you can splurge. When you want to save, you can do that too. So while Murray's Cheese, Starbucks, and Boar's Head, for example, are performing very well, so are our entry-level price point brands. Now I will turn it over to Mike Ellis to outline our operational performance. Mike?

Thank you, Rodney. Good morning, everyone. Our associates continue to deliver an exceptional experience in ways that make a difference for our customers. Over the past year, more customers have noticed improvements in Kroger's product selection, product freshness and customer service. Our strong identical supermarket sales growth was primarily driven by an increase in the number of households shopping with us in the first quarter. We also met our goal to grow the number of loyal households at even a faster rate than total household growth again in the quarter. We're especially proud of our loyalty and sales results when you consider the current operating environment that we're in, which has less certainty than normal. We are addressing the volatility we see out there every day. Fuel margins, for example, have returned to normal compared to where we ended last year. Another factor is product costs. Some commodities are up, some are down. We are seeing deflation in milk, produce and seafood, which is driving more tonnage volume. Milk is one of our most price-elastic categories that we have. When milk prices come down, people tend to buy a lot more. We're at an advantage because we have a vertically integrated supply chain for milk. When our dairy plants run at higher volume, we become more efficient and productive. We continue to see inflation in generic pharmaceuticals and in certain commodities in the meat department. Overall, inflation continued, but at a lower rate during the first quarter, which is in line with what we had expected. Tonnage growth was very strong during the first quarter. In fact, we saw the strongest first quarter tonnage performance since 2010, which is a clear indication of our ability to get pricing right for our customers. If you look back over the past several years, we've had periods of high and low inflation, and we’ve shown that regardless of the environment, we will deliver greater value and convenience for our customers. Corporate Brands had a solid first quarter, accelerating company sales growth and representing approximately 26.9% of total units sold and 25.4% of sales dollars, excluding fuel and pharmacy. A key driver of sustainable growth is Customer 1st innovation, and as Rodney said, we are actively expanding Kroger's use of technology, which we see as a catalyst for improving our connection with customers and growing our market share. Kroger's digital team has developed a popular mobile app that our customers use millions of times each week. In April, we were one of the first food retailers to release an app that is compatible with the Apple Watch. And this month, we reached a new milestone, more than 2 billion digital coupons have been downloaded from our digital properties since we began offering digital coupons in 2009. It took 4 years to reach our first billion and only 15 months to reach our second billion, and the third billion will take even less time. Also this month, our Cincinnati division began inviting local customers to try our order online, pick up at the store solution we are learning from Harris Teeter, which we have been beta testing for a few months and is now available in 2 of our Cincinnati area stores to all customers. Our integration with Vitacost.com continues to go very well, and just this week, Vitacost helped us launch a new natural and organic e-commerce website called King Soopers Live Naturally that is open to King Soopers customers who live in and around the Denver Metro area. The website, which utilizes Vitacost's technology platform and fulfillment network, creates an endless aisle experience with ship-to-home service for thousands of additional health foods, vitamins, minerals and supplements that are available in our Denver area stores today. We are excited to see the results of this new pilot program. And now I will provide a brief update on labor relations. We recently agreed to new contracts in both Las Vegas and Louisville, and we agreed to a Master Agreement with the Teamsters covering several distribution and manufacturing facilities. Four of the 5 Teamster locals have also ratified this agreement. We are currently negotiating contracts with the UFCW for store associates in Columbus, Denver, Memphis and Portland. Our objective in every negotiation is to find a fair and reasonable balance between competitive costs and compensation packages that provide solid wages, good quality affordable health care and retirement benefits for our associates. Kroger's financial results continue to be pressured by rising health care and pension costs, which some of our competitors do not face. Kroger and the local unions which represent many of our associates should have a shared objective: growing Kroger's business, profitably, which will help us create more jobs and career opportunities and enhance job security for our associates. Before I turn it over to Mike Schlotman, I'd like to say a little more about the culture of opportunity we work hard to create here at Kroger. Being a Kroger associate means being part of our family, part of something bigger. Every day, we hire people who come to Kroger for a job, then decide to stay for a career. In fact, 2/3 of our store managers today started as an hourly clerk, stocking shelves or bagging groceries. We continue to increase our investment in training to build skills so our associates are ready for opportunities to advance and lead others. We offer so much more than a job, a chance to connect with their community, to be part of a giant team stretching from coast to coast and to work with colleagues who want to make a difference, too. We think this opportunity culture is a differentiator for us today and will continue to be into the future. Now Mike Schlotman will offer more detail on Kroger's financial results and update our guidance for 2015.

Thanks, Mike, and good morning, everyone. I'd like to spend a few minutes discussing our results for the quarter in each of the key performance target areas for our long-term growth plan. Our first metric is identical supermarket sales without fuel. We are pleased with our first quarter identical supermarket sales growth of 5.7%. This strong performance was supported by identical supermarket sales growth in every department and every supermarket division. We continue to see outstanding double-digit identical sales growth in our natural foods department. Our meat, deli and pharmacy departments also posted strong identical supermarket sales growth. Rolling 4 quarters FIFO operating margin, excluding fuel, the 2014 and 2013 adjustment items and the contributions to the pension and foundation in the third and fourth quarters of 2014 increased by 10 basis points. This exceeded our commitment to grow the rate slightly over time on a rolling 4 quarters basis. Return on invested capital on a rolling 4 quarters basis was 14.03%. We are not presenting a comparative number this quarter because the prior year first quarter calculation does not include a full year of Harris Teeter assets and results. We do expect return on invested capital for fiscal 2015 to increase slightly from the fiscal 2014 result. This is an important metric as we continue to increase our capital investment to drive our future growth. Now I'll share our first quarter 2015 results in more detail. As you know, we don't provide guidance for total sales because of the unpredictability of fuel margins on our results. Total sales in the first quarter increased 0.3% to $33.1 billion compared to $33 billion for the same period last year. Excluding fuel, total sales increased 6.4% for the first quarter compared to the same period last year. In the first quarter, our net earnings totaled $619 million or $1.25 per diluted share. Kroger's net earnings during the first quarter last year included charges related to the restructuring of certain pension obligations to help stabilize associates’ future benefits. Excluding the effect of those charges, Kroger's adjusted net earnings in the same period last year were $557 million or $1.09 per diluted share. We recorded a $28 million LIFO charge during the first quarter, consistent with the same quarter last year. We raised our annual estimate to $90 million from $75 million, primarily due to pharmacy inflation. FIFO gross margin, excluding retail fuel operations, decreased 7 basis points from the same period last year. Strong identical supermarket sales growth and cost control has allowed Kroger to leverage operating expenses as a rate of sales in the first quarter. Total operating expenses, excluding retail fuel operations and pension agreements, decreased 15 basis points as a result of sales compared to the prior year. This really does demonstrate the leverage of strong ID sales as we simultaneously invested in areas other than price to provide a continually improving shopping experience for our customers but leveraged our ID sales to drive the rate down. Now for retail fuel operations. In the first quarter, our cents per gallon fuel margin was approximately $0.116 compared to $0.131 in the same quarter last year. Our long-term financial strategy continues to be repurchase shares, have an increasing dividend, fund increasing capital investments and maintain our current investment-grade debt rating. Our strong financial position has allowed us to return $1.1 billion to shareholders through share buybacks and dividends over the last 4 quarters. During the quarter, Kroger repurchased 8 million common shares for a total investment of $585 million. Capital investments, excluding mergers, acquisitions and purchases of leased facilities, totaled $915 million for the first quarter compared to $709 million for the same period last year. We continue to expect capital investments, excluding mergers, acquisitions and purchases of leased facilities, to be in the $3 billion to $3.3 billion range for the year. Our planned increased capital investment on an annual basis remains in place. We are pleased with the early returns from these investments, and we continue to have a long list of strong projects that will compete for these investments. The company's net total debt-to-adjusted EBITDA ratio decreased to 2.09 compared to 2.40 during the same period last year. Kroger's net total debt is $11.3 billion consistent with last year. It's constructive to understand that we have maintained our absolute debt level while returning $1.1 billion to shareholders through share buybacks and dividends over the last 4 quarters and investing $3 billion in capital on a rolling 4-quarter basis, plus an additional $411 million on mergers, acquisitions and purchases of leased facilities. In other words, we're keeping our commitments to our bondholders and our shareholders. Now I'd like to update our growth objectives for 2015. Based on our strong first quarter results, we raised our identical supermarket sales growth guidance, excluding fuel, to a range of 3.5% to 4.5% for 2015. The original guidance was 3% to 4%. We're confirming our net earnings guidance range of $3.80 to $3.90 per diluted share for 2015. This range is within our long-term net earnings per diluted share growth guidance of 8% to 11%. Shareholder return will be further enhanced by a dividend expected to increase over time. As we look at quarter comparisons in relation to our 8% to 11% annual growth rate, we believe that quarter 2 will be slightly above the range, quarter 3 will be at the high end of the range and quarter 4 will be below the range. For the full year, we expect to be within the range, and it is still somewhat dependent on where fuel margins shake out. Now I will turn it back to Rodney.

Thanks, Mike. This is another terrific quarter. Our associates are making a difference for our customers by providing excellent service and product quality and selection. As I said earlier, results like this don't happen by accident. We create these results by connecting with our customers through our powerful Customer 1st Strategy. When we take care of our customers, we create sustainable value for our shareholders. Now we look forward to your questions.

So my first question, I guess, is just related to the guidance. So I guess, maybe more for Mike, but you obviously raised your ID guidance for the year. You had a good, strong quarter but you maintained the EPS guidance. So I'm just kind of curious, at this point, Is it just early and you want to be conservative? Or are there other incremental offsets that are maybe new?

It’s a mix of factors, Ed. Firstly, it's early in the year, and as we mentioned in our release and prepared comments, the operating environment is somewhat volatile right now. There's significant fluctuation in fuel prices, which have quickly returned to a more typical range compared to the end of last year. We anticipate this to be a challenge in the fourth quarter, and it was factored into our original guidance of 8% to 11%. Our actual results for the first quarter, while better than expected, were just slightly above the 8% to 11% range. We had initially expected to be closer to the high end of this range, which was part of our original timeline predictions. Additionally, there is considerable inflation volatility. While some categories have seen deflation, pharmacy inflation has reached levels not seen in several years, hovering around double digits in the first quarter. There are also concerns regarding the avian virus affecting poultry flocks and how that might impact input costs and product availability later this year. After reviewing all these factors, while we are pleased with our first-quarter performance, we believe it’s prudent to maintain our guidance range due to the current uncertainty and volatility. We indicated in March that if fuel margins declined, we might find ourselves at the low end of the range. While we are not committing to that position, we are retaining the range as that scenario has indeed occurred with fuel.

And Mike, historically, you've kind of said about $0.14 or so a gallon in fuel. Obviously, this quarter's lower, but kind of like the slope of the curve was rising. Is there anything else that's changed in the marketplace or maybe it's become a bit more competitive, where you're a little concerned about the $0.14?

I wouldn't say we've focused on any one number. Our practice on fuel is to follow the market, and then give our most loyal customers a really good value on fuel by our fuel rewards program, which I'll remind everybody, the cost of that reduces our ID sales; it doesn't reduce the fuel margin. It's really just what's happening in the marketplace as we follow the marketplace and stay right on the market price but then give that incremental reward. I wouldn't say there's anything unusual in the first quarter. Any short period of time in fuel is an interesting result but a longer period of time is what's more important.

Internally, we typically use a rolling four-quarter figure. However, this year we didn’t do that due to the strong fuel margins in the third and fourth quarters. As Mike noted, we may not be accurate on a daily basis, but over the course of a year, our estimates tend to be fairly close.

So I just wanted to follow up a little more just on inflation. For this upcoming year, have you guys changed your inflation forecast?

Yes, we still expect it to be in the 1% to 2% range. We are currently at the high end of that range in the first quarter, largely due to pharmaceutical inflation, particularly in the generic sector. We also anticipate some potential inflation in poultry flocks as the avian flu situation develops. The impact of this on various products that use liquid eggs as an ingredient remains uncertain. We believe that the 1% to 2% forecast is accurate, and so far, that is what we are observing.

Thank you for the insights. Shifting to the topic of competition, we've been hearing a lot about growth in the specialty grocery sector and some commentary regarding the hard discount channel. What are you observing in terms of competitor openings from a full-service grocery standpoint?

From a full-service perspective, I would say our growth has been fairly consistent over the past 3 to 4 years. It hasn’t been particularly aggressive. If you look at niche merchants, their growth is significantly higher, but we see everyone as a competitor. Therefore, we don't categorize them differently than most might expect.

So I'm just curious on, well, maybe this is just semantics, Mike, and maybe I'm overreading, but just to clarify on your guidance by quarter, you said just now that 3Q, you expect it to be at the high end of your guidance? I think last quarter you said it would be slightly above?

Yes, if you look at second and third quarter, actually I think second quarter we said at high end and third quarter above. We just flipped flopped those a little bit. It takes $8 million flipping between quarters to do that, and it's just our best thinking today. So it doesn't affect the year. I think if you look back to what we just said in March, the guidance on those 2 quarters just flipped between quarters. We still expect a very strong year.

Okay. Regarding tonnage, I'm not sure if you're able to provide a specific percentage. Additionally, it seems your O&A growth rate is higher than I anticipated. I recall that in previous discussions, you mentioned tonnage affecting that figure, so any insights on those two points would be appreciated.

Yes, relative to tonnage, we won't give an actual number. As Mike said in his prepared comments, it was the strongest we've had since 2010, and we haven't given a specific number, but we're very pleased with where it is. If you think about in the comments I made on OG&A, we're very pleased with the leverage we've got of a 15 basis point reduction in that as a rate of sales. We did make conscious decisions to invest in other keys of our 4 key strategy versus price to provide a better shopping experience to our customers, both through making sure the products are on the shelves in a timely basis, having our associates friendly and we keep our products as fresh as possible. So there was some conscious decision to invest in incremental services for our customers, which provides more jobs and hours for our associates as well.

The other thing regarding tonnage is that we always aim to provide an outline of our status and the overall feeling, but it can be quite challenging to quantify. When a customer purchases a 24-unit item as opposed to a 12-unit item, we internally count that as one and one.

Or water, the common package for bottled water today is 32 bottles. It used to be 24. That's still a unit.

It's not that we're trying to avoid the question. It's just that there's an awful lot of assumptions behind that, and what we try to do is give everybody a general feel for what's going on.

Okay. And then just on the ClickList, I guess, in Cincinnati. I mean, obviously, I know you guys are always very conservative and want to make sure your customer is getting the best experience, but it definitely seemed like it was a pretty long test phase. So I guess, maybe can you clarify or give some color on what you ironed out, and what made you feel comfortable to roll it out now, and how quickly you think you could accelerate that?

Yes, the test duration may appear lengthy because it became public sooner than we expected. A journalist discovered the website we were using for testing with our associates. It's not that the test was extended; rather, it was public for a longer time than usual. If you compare it to our original plan, we're progressing exactly as anticipated and feel positive about it. Additionally, Mike mentioned that we just added our second store, either this week or last week.

And again that's in a beta test and you kind of have to know it's there. It's a new experience for us, and we just want to make sure it's right.

I wanted to ask you first about really the private label, in particular the Simple Truth, if you could just give us a quick update in terms of where that brand is today? If over the first quarter there had been any updates in terms of product expansion and how big that particular segment is for you right now.

We are very pleased with the brand. Currently, there are around 2,600 SKUs available in our stores, and we are focused on connecting with customers in a meaningful way. Customers have embraced the brand, aligning with their current preferences. Additionally, the products are now available on Vitacost.com, so even if you're not shopping at a Kroger market, you can still access them. Overall, we are completely satisfied with the progress we are making, and there are many new items set to be released soon.

Okay. And then as a follow-up, focusing on the natural segment, as you continue to learn about the Vitacost division and now that the Soopers site is operational, have you made any additional progress? I know it's still quite early, but is there anything more you can share regarding the integration of some of the products historically associated with Vitacost into your other brands?

Well, today, we have a pretty good selection of natural foods, supplements, body building products, health care products in our stores. Vitacost really just helps us fulfill that long tail of items that are smaller in some cases, and on the King Soopers website now, you can pick up 25,000 to 30,000 additional SKUs than what you'd find in a typical Kroger store. So it's really helped us take natural foods, natural products to the customer in a much broader way. We're really pleased with where we're headed. There's a lot of work still to do. We're approaching our first anniversary with Vitacost next month, and so we're actually moving pretty fast as a company and we're pleased with where we're headed.

Rodney, I want to start by discussing your performance this quarter. I know you tend to be self-critical. When you reflect on your skills or business lines, where do you feel you still have significant gaps, not just minor ones? Additionally, could you address the importance of improving speed to market as a key skill set to focus on in the coming years?

The shortest hard question to answer, and when I did my own performance review with our Board, somebody asked the same question. And you've followed Kroger for a long time, and you realize when you look at our culture overall, we're always very proud of what we've accomplished. But at the same time, we feel like we have a tremendous opportunity to get better, and a lot of times, we like to use the words that our to-do list is longer than our done list. And when you look at what's out in front of us, we are incredibly excited about the opportunities that we see to continue to get better. And the hardest thing that we have to do is actually make sure that we're trying not to improve on all things at once, but what are the things that are most important to the customer and put all our resources against that. So I guess that the way I would say overall is obviously, we're delighted with the quarter, delighted with the progress we're making. We're even more excited about the opportunity to continue to get better. So I feel very good about where we are, but I feel even better about the opportunities we have in front of us.

Are there specific product categories, businesses, or customer groups that you're not fully connecting with yet? What, if anything, ties those areas together?

I'm thinking about the best way to respond to your excellent question. It’s more about opportunity. If you consider apparel, we’ve added it to what I believe is over 70 marketplace stores. We’re still figuring out the best product selection for these stores. The Fred Meyer Group provides insights and helps us procure products through that channel, but we’re still understanding what items are most suitable. There are many similar situations occurring, so it’s challenging to pinpoint one specific item or customer. It’s much broader, involving numerous aspects rather than just one thing we need to improve.

Lastly, regarding pricing, it appears that there has been some stabilization, whether considering traditional competitors or mass retailers. It doesn't seem like we're in a race to the bottom. Is that an accurate assessment? At this point, are we mostly where we need to be? Looking ahead, do you think future adjustments will focus more on specific areas, like addressing pricing for hard discounters and private labels? Are we largely stable now, with just a few selective issues to tackle?

If you consider the long-term perspective on pricing, we have made significant investments in pricing over the past few years while reducing operating and general administrative costs. Recently, we've been more proactive in investing in services, which means our strategy isn't solely based on price. Our investments reflect the savings we've achieved, allowing us to allocate more towards additional service hours and similar initiatives. It’s an ongoing journey where we continuously evolve in response to our competitors. We are pleased with our current position, but we will keep investing, driven by our focus on reducing costs. Mike, would you like to add anything?

No, I absolutely agree. It's right in sync with the prepared comments we had. And I'll just throw in, when you think about our 4 keys, we're constantly asking ourselves what do we invest in to make sure that we're offering the best balance to the customer based on what the customer wants and the retail environment that we're in. So Rodney's point about investing more in our people in the last few quarters is right on.

One question would just be, real quickly, you talked about where your guidance for inflation was for the year but did you comment on what you thought inflation was for the quarter?

We did not. But Mike...

We're at the high end of that range, mainly due to Pharmacy, which is about 1/8. Without Pharmacy, the figure would have been lower. Our comments about a volatile operating environment reflect the various influences at play globally. Despite all the fluctuations, we take pride in our ability to navigate through these challenges this quarter, which was evident in our results.

Great. And then I was wondering if you would talk at all about the formats that you're testing called Ruler. I think you maybe have about 30 stores, and I was just wondering what your thoughts are. And we do know that Aldi is going to be opening more stores in Southern California is getting a big push, and Lidl is also going to be coming to the U.S. pretty soon, just how do you feel about that format? And do you want to be a competitor in that format?

We're still in the early stages, and this is clearly a test for us. However, we feel positive about the progress the team has made. The format actually originated from our merger with Jay C, who had the format even back then. The team has implemented many changes, and we are continuing to make updates. While I wouldn’t say we are fully ready yet, we are moving in the right direction. This relates to what we've discussed in the past regarding how our customers are bifurcating. We want to ensure we have a format that accommodates all customers, especially those for whom budgeting is crucial, whether by choice or necessity. It's about operating a store efficiently to provide the best prices possible. So, it all connects to that. Mike, do you want to add anything?

Just what we learned from this type of a format has really been helpful to better understand that value segment and how to operate in that value world. So we've really, as a company, learned a lot, I think.

Great. And then just real quickly, I know you said your natural organic department was up double digits. Did you see any changes at all? I think there are some other retailers that have said there was a bit of a slowdown, I think primarily in the dry grocery side, but I don't know, it doesn't sound like you saw anything, but did you?

Nothing that I can put my finger on. It's still real healthy for us. Again, we have good supplies, so we haven't had any issues around that. But no, customers still are as interested in the natural category, the natural foods world, real food, we call it, as they ever have been.

I wanted to follow up on your thinking around the guidance. I think you said the quarter came in slightly above, with fuel, slightly below. So how does that, if we just isolate the stores, does that mean the stores was a little better than that versus internal expectations?

Yes, I think the strong IDs without fuel would demonstrate how happy we are with our core grocery performance, and that’s built into our expectations for the year when we raised ID sales guidance without fuel. So we're very pleased with what's going on inside the 4 walls of the store.

Okay. Meredith inquired about the cadence on natural, but I would like to address it in relation to the overall store performance. It seems from your response regarding natural that there hasn't been a significant decline or volatility on the consumer side. It appears the concern lies more with supply issues, such as the fuel margins and potential fluctuations in some commodities.

Yes, I will address part of your question. I will have Mike or Mike respond to the other part. The changes during the quarter have been primarily influenced by inflation, which clearly caused a slowdown towards the end of the quarter compared to the beginning. The change has been more inflation-driven. Tonnage has remained fairly consistent. For this quarter to date, we are still slightly above the range we provided for the rest of the year. One of the reasons for this is our expectation that inflation will continue to decrease as the year progresses. Regarding avian flu and other factors, Mike or Mike will provide additional insights.

When we took a step back and assessed all the factors at play, we realized that even though we are nearly halfway through the calendar year, for Kroger, we are only a quarter of the way through. It seems premature to adjust our EPS guidance for the year considering the volatility in many commodities due to inflation and the potential unknown effects of the avian virus as the year progresses, along with fuel price volatility. We remain pleased with our current position and believe that achieving an 8% to 11% growth rate from a strong previous year and maintaining the expected results will lead to a successful year.

I'm not sure if you answered this yet. If you did, forgive me, but in terms of ID sales into 2Q, how are they progressing quarter-to-date, even if just on a qualitative basis? And are there any timing issues, any items we should be aware of as we model that near-term top line?

Ken, as I just mentioned, if you look at the identicals so far this quarter, we continue to be a little ahead of the range guidance we gave for the year. Part of that is driven because we believe inflation will continue to decline during the year, and we would still expect that based on what we're seeing today when you look at the impact on identicals.

I did miss it when you just said it. I apologize. Broader question, we've seen quite a sudden market share shift in food retail in general away from sort of specialty channels back toward, for lack of a better term, the Krogers of the world, more traditional, I know you don't love that term, but more traditional grocers. I think the general thesis out there, which I agree with, is that much of the shift is generated by you and some peers adding natural and organic products, but it seems like better for you isn't quite big enough to move the needle as much as what we've seen. So are there any other drivers that you are seeing out there that would sort of explain this kind of quick shift in consumer behavior? Or is it just too vague and too hard to tell?

I'm not entirely sure I agree with your perspective. Looking at some specialty retailers, even if they've reported lower comparable sales than in the past, they continue to open new stores. While there may be some impact from store cannibalization, many still show comparable sales growth that outpaces the overall market. Therefore, I wouldn't necessarily assume there's a sudden shift in market share away from them. It might indicate slower growth in gaining market share, but not a complete loss. We don't directly ask our customers where they shopped before, but when our comparable sales increase by 5.1%, we believe we're capturing more market share from a wide range of retailers, and we welcome that. Our sales success comes from a diverse customer base and improving our offerings of new and unique products that they can't easily find elsewhere, like Simple Truth. If I were in their position, I wouldn't feel embarrassed by their recent performance.

I will respond to your question a bit differently than Mike did. When examining the Fresh side of our business, including produce, meat, and deli, we are experiencing very strong growth. Part of this growth comes from improvements in freshness, while another part is due to customers' preference for fresher products. This gives us a significant competitive advantage over many of our competitors because of the variety we provide. We have a comprehensive selection, and we offer products that are often hard to find as organic or natural items. This enables customers to complete their shopping with us, strengthening our position and providing us with the opportunity to keep delivering results.

There's been quite a few questions about competitive environment, but I'll tack on another one. Are you seeing anything different in the promotional environment as the quarter progressed, or even over the last month?

We have noticed various competitive activities across the country, which is not uncommon. As a company, we adapt to these changes and strive to meet our customers' needs in the best way possible. However, I can't pinpoint anything specific at the moment; there is definitely promotional activity happening. With the extensive geography we cover, we encounter a wide range of situations over time. So, there's nothing in particular that stands out to me.

I guess, maybe more specifically, are you seeing anything different on the margin environment for your natural and organic food part of the portfolio?

Nothing that I would say is worth reporting, but most of what we see today is just this mainstreaming of natural and organics continues, but I wouldn't say there's additional retail pressure on those categories, I guess. We are pleased with the transactions, the number of households, visits per household, and spend per customer. Overall, it's very healthy for us right now. I prefer not to get too specific about any of the numbers, but the combination of these factors has been driving our ID sales.

Typically, you don't comment obviously on M&A activity, but I was wondering if you perhaps could opine a little bit on if there were to be a merger between Ahold and Delhaize, whether that would at all impact your competitive position in those markets where you do overlap with the 2 companies.

We generally do not comment on mergers, so I won't discuss the specifics of the one you mentioned. However, mergers create various opportunities, and we aim to manage these opportunities effectively, as each merger presents different possibilities. It's essential to evaluate the right strategy for each situation. We treat any merger similarly and anticipate ongoing consolidation in our industry, where we intend to be an active participant. As you may know, we have been involved in several mergers over the past year and in previous years.

Okay. And then if I perhaps may ask a derivative question. Obviously, you've seen the news of CVS and Target working together right now for the operation of the pharmacy stores within the Target locations. I presume that Kroger remains fully committed to operating the respective pharmacy locations you have within your different formats yourselves going forward?

We appreciate the pharmacy business and the value it brings to our customers, and we continue to see strong results in that area. When we analyze average volume per location, we are performing exceptionally well on a per location basis and expect to continue growing.

So Rodney kind of teed this up because you said you see yourself as a consolidator in the business and so I know, Mike, I think you said your leverage is 2.09. Thinking about your balance sheet, what is your capacity to do further transactions?

Well, I think the answer to that question isn't what my financial capacity is; it's what's the capacity of the organization to do something, it's what assets might be available, and do they fit the metrics that we typically would go after when you would look at a transaction. So we wouldn't sit back and say, oh, Harris Teeter's behind us. We've delevered. Let's go spend another $2.5 billion, get it back up to 2.4 and work our way back down. It's really quite the opposite. It's one of the reasons we try to maintain the ratio where it is if an opportunity does come up, can we take on the leverage of that correct unique opportunity, act on it, have the rating agencies continue to have the believability in us doing what we say, and that is we told them 18 to 24 months we'd get our leverage back down. It took 12, and it went down again this year. And I think the statistics we went through with the return of capital to shareholders as well as what we've invested back in the business, all told, when you add that up, it's about $4.5 billion we either returned or invested. And to maintain debt at a flat level really demonstrates the power of the cash that we can generate as a company.

Okay. My second question is about the natural and organic segment and the broader market landscape. You've mentioned that tonnage growth has accelerated, and it seems like your market share gains are also picking up. What’s driving this change? Why is Kroger gaining market share at such an accelerated pace? Looking ahead, aside from gas and inflation, do you believe that this trend will continue over the next 12 to 24 months?

We have made significant progress, and we owe a lot to our associates. It's their one-on-one interactions that enhance the customer experience and drive our results. Our strength lies in supporting them to provide excellent service. There isn’t a single magic solution; rather, it's about consistently improving in many small ways. Our associates are continuously refining our execution and providing feedback for further improvements. Additionally, we are leveraging insights from 84.51° and will expand our collaborations beyond just that partnership. All of these factors combined are contributing to our success. Well, we would say about Publix the way we would say about tons of competitors, Walmart, Costco and on and on and on. They're a great competitor. We always learn a lot from them because they do a great job running their stores, and we don't look at so much in terms of how do you stop a specific competitor. We're really focused on how do we make sure we keep getting better, and if they're successful in a market, they're successful at somebody else's expense, not us.

I was curious if you could share more about 84.51°. It was interesting that Rodney described it as a game changer, and I understand that the new structure allows collaboration with outside data service providers alongside 84.51°. Could you elaborate on the priorities for expanding the use of that business for Kroger?

Yes, how do I answer your question without our competitors understanding exactly what we're trying to do? I can tell you I've had more discussions, and several of us have, about how we can better utilize the data we have to benefit our customers and improve our business operations. We've engaged in more of those discussions in the last 8 weeks than we had in the 2 years prior because we spent a lot of time on topics unrelated to Kroger. There are many skilled individuals at 84.51° that we're thrilled to have join our team, and I know they’re excited because they will help us accelerate our initiatives. It's challenging to share specifics, but I can assure you we have a long list of ways we can utilize our data to enhance customer experience and improve our business, many of which we hadn’t fully explored for various reasons. We will prioritize those opportunities and explore partnerships with other companies in addition to 84.51°.

That's helpful, and any comments on what's the strategy? Or is there a strategy to grow the 84.51° business with other retailers or clients like Kroger, so the company can grow its own profitability and growth?

Yes, we really won't comment on that at this point. Before we end today's call, I'd like to share some additional thoughts with our associates listening in today. We recently wrapped up our Red, White and Barbecue celebration in stores across our company. Special thanks to each of you for making this exciting event possible, and I can tell you I personally ate way too much on the samples. Our customers loved kicking off the summer grilling season with fresh flavors and fun ideas to share with their family and friends. I also want to thank you for helping show Kroger's gratitude to our active duty troops and our nation's 23 million veterans this summer. Through our partnership with the USO and the Honoring Our Heroes campaign, we hope to raise an additional $2 million for our military men and women. Together, Kroger's associates and customers have raised more than $11.9 million since 2010 to support USO programs. This represents the largest gift to the USO in its history. Visit the Honoring Our Heroes website for more information about how you can help. We also continue to hire our heroes. More than 29,000 veterans have joined our team since 2009, including more than 6,000 associates last year. Thank you for helping welcome them to our Kroger family. That completes our call today, and thanks for joining.