Kroger Company (KR) — Q3 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 third 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 would like to thank you for attending our 2015 investor conference in October. We appreciated the opportunity to share with you our strategy and to give you a chance to hear from other members of our senior management team. 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 us today. With me to review Kroger's third-quarter 2015 results is Mike Schlotman, Executive Vice President and Chief Financial Officer. Hopefully, you saw our announcement earlier this week that Cindy Holmes has been promoted to Senior Director of Pension Investments. I wanted to take a moment to thank Cindy for her service in Investor Relations. Both Mike and I appreciate Cindy's efforts these past several years, which you know have been exciting and transformative years for Kroger. We know she will continue to contribute to Kroger's success in her new role. I'd also like to introduce Kate Ward, who has been promoted to Director of Investor Relations. Kate joined Kroger in 2001 and has held a number of leadership roles in our audit and finance departments. We hope you'll join us in welcoming Kate to her new role. We often say that Kroger's success starts and ends with our more than 400,000 associates connecting with our customers every day. Our third quarter results are a terrific example of our team's ever-deepening connection with customers. We achieved our 48th consecutive quarter, that is, 12 consecutive years, of positive identical supermarket sales growth, with very strong ID sales of 5.4%. We exceeded our goal to slightly expand FIFO operating margin without fuel on a rolling 4-quarter basis, and we continue to manage costs so that we can continue investing to grow our business for the future while delivering today. Based on Kroger's strong third quarter performance, we are raising our identical supermarket sales guidance and our net earnings per diluted share guidance for the year. During the third quarter, we contributed $80 million to the UFCW Consolidated Pension Plan. This is the latest in a series of steps we've taken during the last four years to help stabilize pension benefits for our associates while continuing to deliver strong shareholder value. In January 2012, we agreed to establish the UFCW Consolidated Pension Plan by working with the union to consolidate four multiemployer pension funds into one. This agreement protected pensions already earned and provided greater stability for future benefits for more than 65,000 Kroger associates. In June 2014, we announced similar agreements with two additional multiemployer pension funds. All of these steps reflect our strategic decision to increase the certainty of pension benefits for our associates. These are examples of how we identify opportunities to use our financial flexibility. We are very excited about our pending merger with Roundy's. We have filed our tender offer documents, and while we wait for the conclusion of that process and regulatory approval, I simply want to reiterate how much we are looking forward to welcoming Roundy's team to the Kroger family of stores. The economy overall continues to slowly improve, and customers continue to feel more optimistic. But the bifurcation in the economy remains. Some customers are willing to spend more while others are worried about their job or next paycheck and are more focused on saving. We find that all customers want quality products and a great shopping experience. For the customer who's more focused on natural and organic products, we have our own Simple Truth brand. We also have many entry-level price point items of excellent quality. For customers looking for incredibly high-quality products like Boar's Head or Murray's Cheese, just to name a couple, we have that, too. Our job is to understand and deliver for our diverse set of customers so that they can save where they want to save and splurge where they want to splurge. Finally, before I turn it over to Mike, I would like to note that there is an important global dialogue taking place that underscores the positive role businesses can play in sustainability. Kroger's team has been making progress to integrate sustainable practices into our everyday business operations. For example, our stores and manufacturing facilities have made significant progress by reducing the amount of waste sent to landfills. In five years, the number of stores recycling food waste has increased 73% from 290 to more than 1,000 this year. Thirty of our 37 manufacturing plants are sending zero waste to landfills, an increase of nine facilities since 2013. Taken together, along with a lot of other efforts, Kroger is sending 69% less waste to landfills than we used to, and we will continue to work toward zero waste. This is only possible due to the thousands of individual activities our associates are doing on a daily basis. Their efforts are helping make each community we serve a better place to live, and they have helped Kroger earn a spot on the Dow Jones Sustainability Index for the third consecutive year. More than 600 companies in North America are evaluated each year, and only the top 20% are listed on the index. This is obviously something we're very proud of. We look forward to sharing our new five-year sustainability goals with an eye toward pushing even faster and having more accelerated progress in the near future. As you can see, we have a lot going on at Kroger. I am thrilled with our financial results and what we are doing for our associates, our customers, our communities, and shareholders. Now Mike will offer more detail on Kroger's third-quarter results, provide an update on labor relations, and an update on our guidance for 2015. Mike?

Thanks, Rodney, and good morning, everyone. I'd like to echo Rodney's comments regarding Cindy and also welcome Kate to the team. First, I want to take a few moments to discuss our quarterly results in each of the key performance areas outlined in our long-term growth plan. Our first metric is identical supermarket sales without fuel. As Rodney mentioned earlier, we are very pleased with our 5.4% growth in identical supermarket sales in the third quarter, which showcases the strength of our core business and the increasing connection our associates have with customers. This growth was fueled by strong tonnage growth as well as an increase in the number of households shopping with us and the frequency of their visits. Our goal remains to grow the number of loyal households at a faster rate than the total number of households shopping with us, and I’m happy to say we continue to meet this target consistently. All regions and supermarket departments experienced positive sales growth excluding fuel this quarter, with our deli and produce departments leading the way. Additionally, we’ve seen remarkable double-digit sales growth in our natural foods department. Our second metric is FIFO operating margin without fuel. Several items are excluded from our calculations for the third-quarter rolling four quarters, specifically some adjustments from earlier years and contributions to the Kroger Co. Foundation and the UFCW Consolidated Pension Plan. We believe it's important to accurately report our operations' performance. Accordingly, FIFO operating margin increased by 18 basis points in the third quarter. Our margin has expanded beyond our expectations thanks to two main factors: stronger than anticipated identical sales and the sustainable investments we’re making in our Customer 1st Strategy based on insights from 84.51°. This isn't just a new normal for margin expansion; it reflects our careful approach to investments. Our return on invested capital over the last four quarters was 14.16%. We’re not providing a comparative number this quarter as last year's third quarter did not include a full year of Harris Teeter results. We anticipate a rise in return on invested capital for fiscal 2015 compared to 2014, which is vital as we increase our capital investments to drive future growth. Before we delve into more detailed third-quarter results, I want to address how we’re effectively navigating the current inflationary landscape. Inflation continued at a reduced rate in the third quarter, estimated at about 1.1% without fuel, though certain commodities experienced high inflation while others saw deflation. We noted inflation in produce, while meat, seafood, deli, and milk experienced deflation. Inflation remains evident in pharmaceuticals. Now, let’s discuss our third-quarter results in more detail. We don't provide guidance for total sales due to the unpredictable impact of fuel prices. Total sales in the third quarter were influenced by lower retail fuel prices, similar to previous quarters. The average fuel price was $2.30 this quarter compared to $3.22 last year. Total sales in the third quarter rose 0.4% to $25.1 billion compared to $25 billion in the same period last year. Excluding fuel, total sales increased 5.5% in the third quarter from the same time last year. Our net earnings for the third quarter were $428 million or $0.43 per diluted share, compared to $362 million or $0.36 last year, which included a $0.02 benefit from certain tax items. Excluding this, Kroger's net adjusted earnings were $345 million or $0.35 per diluted share for the third quarter of fiscal 2014. Please note that these figures may not sum due to rounding. Kroger also recorded a $9 million LIFO charge in the third quarter, down from an $85 million charge in the same quarter last year. We’ve lowered our total LIFO expectation for the year to $75 million from $90 million previously. The FIFO gross margin, excluding retail fuel operations, experienced a decrease of 4 basis points from last year. Strong identical supermarket sales growth and effective cost controls enabled Kroger to manage core operating expenses as a rate of sales in the third quarter, which saw a 23 basis point decrease in total operating expenses, excluding retail fuel operations and contributions to the Kroger Co. Foundation and UFCW pension plan, compared to last year. FIFO profit excluding fuel and mentioned adjustments rose by approximately $66 million from the prior year. Regarding retail fuel operations, the cents per gallon fuel margin was around $0.238 this quarter, compared to $0.232 in the same quarter last year. Fuel results have become harder to forecast than usual, and we foresee a decline in margins during the fourth quarter. The volatility of weekly fuel costs will affect our fourth-quarter outcomes. Corporate Brands performed strongly in the third quarter, making up about 27.7% of total units sold and 25.9% of sales dollars excluding fuel and pharmacy. Simple Truth continues to achieve remarkable growth, setting record sales for total and weekly sales throughout the quarter. Our new brand, HemisFares, has gained significant popularity, prompting us to work with our Sicilian gelato supplier to expand capacity while maintaining product quality. I will also provide a brief update on labor relations. We ratified contracts with the UFCW for store associates in Denver and with the Teamsters covering our Southern California distribution centers. Currently, we are negotiating a contract with the UFCW for store associates in Portland, aiming to balance competitive costs with fair compensation packages that include solid wages, quality health care, and retirement benefits. Kroger's financial outcomes are facing pressures due to rising health care and pension costs, which not all of our competitors deal with. Kroger and the local unions representing our associates share the goal of enhancing Kroger's business and profitability, which will help create more jobs and strengthen job security for our associates. Kroger's long-term financial strategy is to leverage its financial flexibility to foster growth while also returning capital to shareholders. Maintaining our investment-grade debt rating is crucial, allowing us to use cash flow for strategic opportunities, continue our share repurchase strategy, and fund dividends expected to rise. Our strong financial standing has enabled us to return $1.1 billion to shareholders through buybacks and dividends over the past four quarters. In the third quarter, Kroger repurchased about 853,000 common shares for an investment of $31 million. Capital investments, excluding mergers, acquisitions, and purchases of leased facilities, totaled $832 million for the third quarter, reflecting an increase from $681 million last year. We expect these investments to slightly exceed $3.3 billion for the year, supported by a strong pipeline of high-quality projects and positive results from our new stores. To ensure a steady project flow and increase the total number of store projects, we are currently investing in stores set to open in 2016 to meet our target timelines while also reducing project completion times. Our net total debt-to-adjusted-EBITDA ratio has improved to 1.99 from 2.27 during the same period last year, and we expect it to remain under 2.2 following the completion of our Roundy's merger transaction. Kroger's net total debt stands at $11.3 billion compared to $11.5 billion last year. As I noted last quarter, we have effectively maintained our absolute debt levels while returning $1.1 billion to shareholders through buybacks and dividends in the past four quarters, alongside a $3.2 billion investment in capital and an additional $160 million for mergers, acquisitions, and leased facilities. In essence, we are fulfilling our commitments to bondholders and shareholders while creating opportunities for our associates. Now, I’d like to update our growth objectives for the remainder of 2015. Given our strong performance year-to-date, we have raised our net earnings per diluted share guidance to a range of $2.02 to $2.04 for fiscal 2015, up from the previous range of $1.92 to $1.98 per share. This new range exceeds our long-term growth rate of 8% to 11% for net earnings per diluted share. Shareholder return will further improve with a dividend expected to rise over time. As with our third-quarter results, the performance of fuel during the fourth quarter will greatly influence where we land within this range. For the fourth quarter of fiscal 2015, we expect identical supermarket sales growth excluding fuel to be between 4% and 4.5%, which suggests an annual guidance range of about 5% to 5.25%. Now, I will turn it back to Rodney.

Thanks, Mike. Kroger had another outstanding quarter, marking our 12th straight year of positive identical sales growth in supermarket sales. When you achieve such consistently impressive results each quarter, it's easy to overlook them. Over the past few years, we have focused on investing in our unique and multifaceted business model, which we believe has significantly contributed to our success. We continually aim to innovate for our customers while fulfilling our commitments to our shareholders. At a time when many other retailers are struggling, Kroger stands out because of our exceptional associates. Now we look forward to your questions.

It's actually Judah on for Ed. Congrats to Cindy and Kate on the new roles. First, just wanted to ask about the Q4 comp guidance. Is that an indication of where you're running Q4 to date? Or is there just some conservatism built into that given that you're early on in a big quarter?

So far, it's still early in the quarter and we're comparing against very strong numbers from a year ago, which means we would be at the top end of the range we provided. It's not about being conservative; it's just that we're up against some impressive figures and inflation is slightly decreasing. Additionally, we can't predict how the weather will affect us. Snow is beneficial for the business, but it's unpredictable. Also, as Mike pointed out, this year we won't have a Super Bowl in the fourth quarter, unlike last year.

Okay, that makes sense. And then touching on the gross margin performance. I mean, you've lapped Harris Teeter fully now, and we still don't see a lot of investment in margin. I mean, maybe Mike referenced it in that you're doing good work with 84.51°. But is this kind of a new normal, like a less than 10 basis point investment in ex-fuel gross margin?

I'll hesitate to give what a normal is for an investment because we do continue to make investments in price in a variety of areas of our store. I'd say it's a reflection of prudence on how and when we make investments. Additionally, the mix. When you look at the strength of brands like Simple Truth, when you look at the strength of natural and organics, all of which have a little bit higher gross margin, that certainly plays into the overall mix of business. But if you were to look at gross margins by department, you'd probably have a little bit different view of exactly how and when we invest. But we will continue to invest not only in price but all four keys of our Customer 1st Strategy.

And we continue to have strong growth in our fresh departments, and most of the fresh departments have higher gross as well.

So you guys are very good at data analytics and targeted marketing. So I was wondering, what are you seeing in terms of available promotional dollars and how they're being allocated in store versus out of store? And I guess the question is kind of for the industry and more specifically, if it's any different for you at Kroger.

Well, obviously, we really don't know what's going on across the industry because we only know what's happening for us. What we've tried to do is to work with our CPG partners, and we really do view them as partners. And what we're trying to focus on is how to grow their business and grow our business both. And it's really trying to make sure that we effectively spend the money that they provide to us that we then, in turn, provide to our customers. So it's really taking that data and helping our CPG partners to most effectively spend their money. So all I can do is talk for what we're doing. I really don't know what's going on in the industry.

Congratulations to Cindy and Kate on the new roles. I think most folks were pleased with the results and the outlook, and it seems like you might be taking a somewhat conservative approach because of things like fuel, gross margin, inflation, and weather. So wondering if you could run us through some of the puts and takes in the fourth quarter. And more specifically, what type of fuel gross margins are you baking in?

Yes. When you look at the puts and takes, as Rodney said, weather is often difficult to predict. Last year actually was a pretty favorable weather event for us. Not only did we have the Super Bowl right at the end of the fourth quarter, we also had a fairly large snow event in the Midwest at the end of the fourth quarter, and both of those served to have some pretty strong sales that very last week of the quarter. As I said in my prepared comments, the ability to predict fuel margins this year has been more difficult than I can remember since we've been in the fuel business, which is really since 1983 when we merged with Dillon Companies. It's not just where weekly retails and supply and things like that wind up; it's really the day-to-day volatility of fuel on the open market because we don't have fuel contracts; we buy everything in the open market. And frankly, we feel good about where our core business is going, the day-to-day runnings inside of our store, and the ability to predict that and the strength of our ID sales, as we noted with the guidance for the fourth quarter. Where we wind up in the $2.02 to $2.04 will be wholly predicated on where fuel margins wind up for the quarter.

Great. And as a follow-up, what are you sort of expecting in pharmacy margins? And also, I don't know, it might be too early, but any color on 2016 puts and takes as well?

Pharmacy operations continue to face challenges as they have throughout the year, with significant changes occurring. Our main focus is on assisting our customers effectively. We have a dedicated team of friendly and knowledgeable professionals who are committed to helping our customers achieve better health more quickly, which simplifies their experience. Overall, we believe our business model is robust, and the diversity of our operations allows us to invest in pharmacy while still performing well across the entire business. Regarding our guidance for 2016, I can make a few comments, and Mike may want to add to this, but we will provide full details in March when we meet with our board to review our objectives, and we will not disclose any information publicly until we have full alignment with the board. I want to reiterate a couple of points that tie back to what Mike and I have previously mentioned. We anticipate that fuel margins will normalize. Additionally, we expect inflation to continue to decrease. Our long-term objective is to grow earnings per share by 8% to 11%, along with an increasing dividend. More details on our 2016 plans will be provided later.

This is actually Erica Eiler on for Rupesh. Just following up on your inflation comment just now. Just curious if you have any specific expectations for Q4. And then specifically, next year, I mean, you mentioned you expect it to go lower. I mean, any thoughts with regards to how we should think about generic drug inflation for the upcoming year?

Generics continue to have a good amount of inflation in them. We really don't see anything as we look into 2016 that would necessarily cause a moderation. Part of that was driven by prices had gotten so low; some folks got out of the manufacture of those products. With good old supply and demand and just basic economic forces, if underlying costs for those continue to be high, at some point, other folks will get back into the manufacture of that business and perhaps put pressure on that economic cycle. Relative to inflation for the fourth quarter, our view would be it would be in the range of where the third quarter was and in the low 1s. And as we look into next year, we would certainly expect full year inflation for next year probably to be comparable to where inflation is for this year. We don't see a lot out there in the overall supply chain that would cause this to be different.

Okay, that's very helpful. And then just switching gears to your loyalty program offering. I mean, we've seen a number of the specialty grocers recently discuss plans for new loyalty programs with different propositions for consumers across each. Clearly, Kroger has had success with fuel points in recent years. I guess I'd just be curious, how often do you tweak the value proposition with your loyalty card offering? How important is the points part of the offering versus maybe some of the other components that your program offers? Any thoughts that you could share, that would be really helpful.

We view our loyalty program as a continuous improvement process rather than something we just tweak. We leverage insights to enhance what we offer to our customers, adapting based on their behavior. This means we are always refining our offers to be more personalized. The examples you mentioned are just minor aspects of our broader loyalty offerings. The crucial aspect is to ensure that what we provide holds real value for our customers.

Cindy, we will miss you, and Kate, I look forward to working with you. I wanted to revisit 2016 from a broader perspective. Can you elaborate on the Medicare Part D component? It seems that reimbursement rates could decrease significantly, which could present a larger challenge for you in 2016. Additionally, gas margins are unpredictable. However, as I consider potential advantages for 2016, the contribution from Roundy's could be more beneficial than you have suggested, and inflation seems to be neutral. Can you provide any further insights on these topics?

We won't discuss 2016 in detail right now. As Rodney mentioned, the points you've raised are very much aligned with our business plan, which we're finalizing to present to our board at the end of the month for our January discussions. All those topics are being considered as we determine our plans for 2016 with our board. Rodney has reaffirmed our commitment to a long-term earnings per share growth target of 8% to 11%. It wouldn't be wise for either of us to precede our board with further comments on 2016 before our March call.

Okay, that's fair. Looking at the O&A growth rate this quarter, excluding rents and depreciation, it has remained fairly consistent around the 5.5% range over the last three quarters. I understand that Roundy's will affect that figure next year, but do you think this is a reasonable run rate for a more sustainable outlook?

I haven't calculated our OG&A growth precisely, and I'm unsure if you've excluded one-time items when considering our core business. Our rate to sales depends on whether fuel is included. If we exclude fuel, year-to-date growth is under 5%, which accounts for the pension contribution. We view our service investments similarly to our price investments, and we have a clearly defined and diligent plan for our departments, outlining how we intend to make incremental investments in all aspects of the Customer 1st Strategy. Some of these investments are more apparent, such as those affecting gross margin, while others, particularly in service, may not be as obvious, as they can be overshadowed. The main goal of enhancing service in certain departments is to drive sales, which is how those investments are ultimately justified. Overall, we expect to keep operating costs down and use that as part of our strategy to continue investing.

Cindy and Kate, congratulations on your new roles. I have two questions. First, I'm following up on an earlier question. Many consumer packaged goods companies, particularly those in the packaged food sector, such as Kraft, are implementing the 3G playbook and are vocal about their efforts to move away from relying heavily on promotions to focus more on baseline sales. I'm not referencing any specific vendor, but are you witnessing any signs that this is occurring, where some of your larger food vendors might be scaling back on deal-backs? Or do you believe this situation hasn't impacted anything yet from your perspective?

I will address your question partially. We work with a variety of CPG companies, and at any given time, different companies pursue different strategies. Our team collaborates with these CPGs based on their specific approaches. We have observed that when CPGs raise prices without economic justification, our Corporate Brands tend to gain market share. This highlights the advantage of having a robust corporate brand program, as customers recognize when something isn’t economically sensible. Generally, for nearly any comment made regarding a CPG, there’s likely a company implementing that particular strategy, each with its own unique approach.

I wanted to ask about your helpful commentary regarding the macro environment and the factors influencing consumer spending behaviors. If we consider that alongside your natural, organic product offerings, particularly your Corporate Brands, which continue to perform well, what insights can you share from your loyalty data? Have you observed any significant changes in terms of categories or products being added to baskets more or less? Additionally, are you adjusting your space allocations in any way that you could share with us?

There are constant changes occurring in the product offerings, which isn't entirely new. However, the trend in fresh departments has been ongoing for a long time and shows no signs of slowing down. The focus on natural and organic products is also significant. Space allocation is crucial and should be addressed regularly. For instance, I would not have been optimistic about the coffee category three or four years ago. But due to innovations from Starbucks and Keurig Green Mountain, the category has experienced substantial growth. We are consistently increasing space for these products in our stores because customers demand it, and this change is largely driven by innovation and how customers respond to it.

Okay. All right, that's helpful. And maybe just a quick follow-up, just on Roundy's, just checking, does it still look like the deal should be closing before the end of this calendar year?

As Rodney said in our prepared comments, we filed our tender offer. And we filed with the regulators, and it's pending both of those coming to a closure.

Two questions. One, just on the inflation, I thought the commentary about produce is inflationary and meat, seafood, deli, et cetera, deflationary. Mike, I think you've made comments in the past about there's good deflation and bad deflation. And so as you're looking into fourth quarter and then into the 2016 overall inflation being similar, can you maybe speak to the components, sort of how inflation is playing out right now, if you guys think that produce still inflationary, sort of the same dynamics? And then remind us if these are better dynamics than other ways to get to this sort of lower level of inflation. And then if you can maybe just weave in what you're seeing in the competitive environment right now. Is it same, worse, better?

Certainly. Regarding inflation, the situation remains quite varied, especially in fresh departments like produce, meat, and seafood. Produce tends to fluctuate significantly throughout the year. When there’s significant inflation in produce, it typically means a poor growing season in the affected region. Earlier this year, we experienced substantial deflation in produce due to two factors: last year’s strong inflation in the first quarter and this year’s favorable growing conditions. This has resulted in a return to a more typical crop scenario for produce. An analysis of the first quarters of last year and this year indicates they were slightly inflationary when considered together. While the fourth quarter did show slight inflation, it was minimal. Meat prices have received considerable attention due to their prolonged high costs. Over time, as prices remain high, demand tends to decrease, leading to an increase in supply, which eventually results in falling prices. When looking at inflation metrics over two years, we’re still above where we were a couple of years ago, but significantly lower than last year’s peaks. Overall, the outlook suggests that these trends may continue into 2016. One unpredictable factor remains the trajectory of pharmaceutical inflation, which has been exceptionally high in recent years. Concerning the competitive landscape, Rodney and I have consistently highlighted the intense competition within our industry. With low barriers to entry, our main objective is to strive every day, alongside our over 400,000 associates, to offer a better value to customers today compared to yesterday. We monitor the competitive environment closely, knowing that many firms are vying for our market share. Our focus remains on improving daily to ensure customers choose Kroger each morning.

Great. And just a quick follow-up. Could you guys give us a ClickList update on those, I think it was 19 non-Harris Teeter stores and how that's progressing?

Yes, we are still in the early stages of the test. We are continuing to roll it out for customers. Some customers really enjoy it, and it adds another reason for them to shop at Kroger.

So I just wanted to get back to something you mentioned on the gross margin, which was with the mix shifting. I wanted to get your perspective on kind of what inning we're in on that mix shift. I mean, obviously, you've got fast-growing categories like private label, been a few private label, you have the fresh categories. I do believe you guys are in the process of updating your prepared food area as well, which tends to have a lot better gross margins. So as we look out, and this is really not next year, it's really more of a 3-year outlook, it seems to me that this mix shift should remain and maybe even accelerate and be helpful. Am I off base on that?

Scott, it's an ongoing trend, and it would be naive for me to predict exactly where we are in the changing preferences of consumers. We conduct extensive predictive analytics not just from what we observe in our stores, but also from the broader economic landscape to gauge consumer direction. It appears that the move towards healthier lifestyles is likely to continue, possibly moving away from traditional center-store categories and towards fresher options. However, it's important to note that many center-store categories now feature natural and organic products, such as our Simple Truth brand with its sauces and salsas. In the dog food aisle, for instance, growth is notably in grain-free and natural varieties, indicating that even our pets are embracing healthier choices. While some may chuckle, our responsibility is to ensure we meet customer expectations when they arise. We're committed to maintaining our course in this regard. As for predicting consumer trends, I'll refrain from speculation, but we are pleased with our overall product offerings, our growth trajectory, and the dedicated team focusing on both the center-store and fresh departments throughout our stores.

Scott, you've followed Kroger for a long time, and you know one of the things that we try to do is make sure we design our business model so it's successful regardless of the environment and try to really play to what's going on in the environment. And some of those examples, that's what's going on now, but customers change and we try to make sure that we stay nimble enough to be able to react to those changes.

Okay, perfect. And then I actually had a question, at the Analyst Day, you guys laid out a very compelling case about market share and how that drives returns over time and that one of the big growth drivers you see for Kroger is taking some markets that maybe are a little bit below where the ideal share is and driving them up. As I survey your business, one of those areas seems to be the Mid-Atlantic and Southeast that happen to be with Harris Teeter. How do we think about those areas geographically and what you can do to maybe get the market shares up over 20% to really drive some handsome returns?

We provided specific information about one market during the Analyst Day, but we generally prefer not to share details. We evaluate all opportunities thoroughly. When we merged with Harris Teeter, one of the reasons for our excitement was the potential in several markets they serve. We are even more enthusiastic about those prospects now than we were at the time of the merger. Beyond this, I won’t discuss any particular market further, but we view this as a long-term opportunity across numerous markets.

So densifying would definitely help you in those markets.

Well, it would help us in most of our markets.

Yes. As we've long said, the higher our market share, the higher our ROA in a particular market, and that's really the cornerstone to increasing the number of markets with that high correlation.

It's actually Steve on for John today. As it relates to the capital development program, is there a focus on speeding up the pace of investments here, I guess, to capitalize on some opportunities? Or should we still assume the $200 million of incremental spend annually looking out?

I won't discuss our guidance for 2016, but we are excited about our robust pipeline of projects and the progress of our early initiatives. As we move into 2016, we expect to increase our capital compared to 2015. The target of $200 million is one we anticipate maintaining, with annual increases for the next few years. It’s important to remember that as I raise capital and expand our store network, I will also need to invest in maintenance to ensure our existing stores remain attractive over time. This means our spending will not only focus on new store openings but also on supporting our current operations.

And part of the thing that Mike talked about on speeding up is really our real estate teams, our facility engineering teams, our division teams, and our attorneys working together to take time out of the process on how long it takes us to get a store open. So it's really everybody working together, actually taking weeks out of construction time, which is causing some of the acceleration of capital investment.

Right.

And just a follow-up. As we try to figure out the impact here of the development program, can you touch or remind us of, I guess, the normal comp maturation of a marketplace or the maturation of the store-level EBITDA margin?

When you said the normal comp maturation, what do you mean?

I think the store opens at an initial productivity of around 70%. In the first and second years, there will be a benefit on the comparable sales side. Do you anticipate a significant increase in both comparable sales and profitability at the store level, especially in the first year?

Clearly, when you open a store, the first six to twelve months of that store opening, with all the preopening costs that get expensed on the day you open, it takes a while for that store to turn black on an EBITDA standpoint. It doesn't become a comp store until the fifth full quarter that it's open, the way we do IDs. So it's a while before they contribute to IDs. In some markets, as we densify, you have the potential to have a little bit of sister store impact. So from a total sales standpoint, you're getting exactly what you wanted. From an ID standpoint in a particular geography, you may have a little degradation in a particular geography from their ID sales as you densify in a particular market. Now some of these markets, our market share is low enough where that won't be as big of a deal, but we continue to monitor that as well.

On the ID sales, I want to compare them to Q2 because it was kind of the same number both for the print and for the inflation. So I think I recall in Q2, you said it was very much volume-driven, and I'm not sure you said that here. I think I hear you talking a little bit more about mix. Should we take away from that, that, that number has a better mix element this quarter than last quarter?

It was heavily driven by volume again. Very strong. I just...

Yes. In my prepared comments, I said it was a combination of very strong tonnage plus an increase in the number of households shopping with us and the number of visits per household during the time frame. So it's a combination of all of those.

But tonnage was very, very strong.

Okay, good to hear. So there's no real update on mix; it's sort of the bifurcated message continues.

It really is the same trend that continues to unfold. However, it is now occurring on top of years where it had already developed, resulting in growth on top of growth.

Yes. Regarding partnerships with other companies, I can't share specifics at this moment, but we continue to work within the guidelines we have. With respect to improving collaboration, we've made progress by integrating our approach and learning continuously. A significant improvement is that the 84.51° team is now part of the same discussions, allowing us to make decisions collectively. Instead of having separate meetings and then relaying instructions, everyone is present to provide their insights. This collaborative input is enhancing our direction and helping us move forward more effectively than simply trying new initiatives.

In the past, when we owned half of them, they weren't always present at the table initially due to our partial ownership and their obligations outside the Kroger world. Do you have another follow-up?

Yes. Just real quick on the $80 million pension contribution. I assume that was contemplated in your guidance, either for the quarter or for the year. I just wanted to double check that.

It is contemplated in the guidance, in the $2.02 to $2.04 for the year. Those are things that, with some of the strong fuel margins, rather than that happening a little bit every so often, we've taken the opportunity to put the money in when we have that tailwind. It gets the money into the fund, and they can start putting it to work faster than if we did it over time.

And I'll just reiterate the good luck to Cindy in the pensions. And I just wanted to ask a question about relative price gaps. I feel like everywhere I turn in the industry, someone's telling me just how aggressive you're being with price. Our studies show something similar, and your gross margin is just holding up remarkably well. You talked about the mix. But I guess I'm just wondering if you could talk about how you feel about your relative price gaps. Do you think you've maintained them, widened them? What do you think the plan for next year is?

If you consider the long-term perspective, we've always anticipated that markets would become more competitive, which has been a fundamental aspect of our business model for years now. This is something we've had to acknowledge, and we don’t expect that to change. While there’s always room for improvement, we are also proud of the progress we've made. It's crucial for us to ensure that we're providing our customers with increasingly better deals. Price is certainly a factor, but service is equally important, and we are focusing on enhancing both the freshness of our products and the quality of our service. We believe that all these elements combined establish a distinctive model for Kroger, which is a significant contributor to our success.

Great, that's helpful. I have a question about the pension contribution. It seems that when you have a strong gas margin environment generating extra cash and earnings, you offset that with these one-time contributions. Is that the correct way to think about it in terms of planning? Also, what is the status of the consolidated UFCW plan at this point?

The status is excellent, and Cindy will ensure it remains that way. We joked internally that this was her parting gift from Investor Relations to the pension group, but that isn't the case. These funds will require money over time, and our enrollment in these plans continues to increase as employees earn benefits. While we have a solid investment strategy, funding will be necessary over time. We plan to allocate these funds at various times, and as I mentioned earlier, when opportunities arise and we have additional resources available, we believe it's wise to invest that money into the fund promptly so that it can start generating returns and providing substantial benefits for our associates.

Thanks, Kelly. Before we end today's call, I'd like to share some additional thoughts with our associates listening in today. As I said a few minutes ago, Kroger's consistent outstanding results are easy to take for granted. The fact is your hard work in our stores and facilities every day makes it all possible. Your commitment to our customers brings our Customer 1st Strategy to life. In large and small ways, each and every day, what you do makes these terrific results possible. The holiday season is such a special time of the year in our stores all over the country. You help millions of customers every day prepare for celebrations at their schools, offices, churches, homes, and more. Thank you for your hard work to make the holidays brighter for each of them. You also make it a season of giving by working with Feeding America, the Salvation Army, and other local community partners who help work with us to donate food and other items where they are needed most. Thank you, and thank you for being part of our big Kroger family. Merry Christmas, and happy holidays to you and your family. That completes our call today. Thanks for joining.