Kroger Company (KR) — Q3 2017 Earnings Call Transcript

Good morning, and welcome to The Kroger Co. Third Quarter Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mike Schlotman, Executive Vice President and CFO. Please go ahead. Thanks. Kate couldn't be with us here this morning, so I will wish you a 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 will now turn the call over to Kroger's Chairman and Chief Executive Officer, Rodney McMullen.

Thank you, Mike. Good morning, everyone, and thank you for joining us today. To start, I want to say that I'm proud of our associates for their continuing objective of connecting with our customers in a very difficult operating environment. Their efforts helped us grow both total households and loyal households during the third quarter. As expected, deflation persisted during the third quarter. And as we've said before, transition periods create a difficult operating environment. This is the third time we've had deflation in 30 years. And in previous instances, deflation lasted from 3 to 5 quarters in a row. We're in the middle of the cycle right now, and it's not fun. Still, our tonnage continues to grow. Our total market share continues to expand, and we're focused on executing our strategy. A silver lining of deflationary environments is that it reveals to us how we can run our business better by shining a light on areas we can improve. It is really tough when you're in it, but we'll be in a position to benefit from changes we're making today once we're out of this cycle. We are firmly focused on our long-term strategy of improving our connection with customers and associates and continuing to work on process changes to lower costs. We don't change our strategy based on quarterly swings in results. We remain committed to delivering on our long-term earnings per share growth rate target of 8% to 11%, plus an increasing dividend on a 3- to 5-year time horizon. We will continue to try to win every customer meal by driving our strategy and reacting appropriately to the environment. Looking at the broader economy and customer shopping behavior, what we're seeing is mixed. Typically, our data shows our customers' economic concerns mirror what they see in the headlines. For example, health care costs continue to be a worry for customers. Consumer confidence retreated during the quarter, with customers telling us they expect the economy to get worse in the next three months. It's important to remember this survey was completed in October, and it's too early to say what the mood of our customers is since then. Natural, organic, and health and wellness continue to be food megatrends, and we're riding these trends well. Our natural and organic sales continue to outpace total sales growth. Simple Truth continued its strong double-digit growth. Simple Truth organic kombucha is very popular as more customers focus on digestive health. We've also recently launched a 24-pack Simple Truth vapor distilled water with electrolytes. It's priced fantastically, it's a great product, and it's selling really well. Our produce, fresh-prepared, deli package departments, sushi, Starbucks, wine, and liquor sales all saw comparatively strong growth during the quarter as well. If you can drink it or snack on it, it's selling. A few on-trend examples are protein snacks such as Simple Truth, Private Selection, and Simple Truth paninos, which are imported cured meats wrapped around creamy cheese, as well as handcrafted and real sugar sodas. As I said at our investor conference here in Cincinnati four weeks ago, Kroger's earnings growth has outpaced our peers over both the last five years and last ten years, and we still see incredible growth potential as we look forward. We can clearly identify where we have over 100 billion in market share growth opportunities in our existing markets alone. But good enough today won't be good enough tomorrow. That is why we're both embracing change and accelerating change. For example, 84.51° is helping us spot trends and create unique customer experiences to drive growth. We continue to focus on solving customer needs on their terms. We now offer ClickList in more than 550 stores. That is 50 more locations than we were operating just four weeks ago. We're connecting with tens of millions of customers digitally, online and through our mobile app. Customers have now downloaded more than 3.5 billion digital offers. We know that the typical customer eats 35 to 45 times per week. Increasingly, we are positioning ourselves to solve for all of those meals or snacks in addition to our historical model of solving for meals at home. We've built a strong Customer 1st foundation over the last 15 years, upon which we can confidently accelerate change. In doing so, we can deliver even better results for our customers, associates, and shareholders.

Thanks, Rodney, and once again, good morning, everyone. I want to also thank our associates for their hard work and focus on connecting with customers. As a result, both household and unit growth were up during the quarter as was market share. As we said at the investor conference, the last two weeks of the quarter would drive our identical supermarket sales results, and our IDs came in at the low end of our expectations for the quarter. Deflation has not only persisted but has increased with overall deflation, excluding pharmacy, growing from 1.3% in the second quarter to 1.5% in the third quarter. Additionally, pharmacy inflation declined 130 basis points to 3.3% during the third quarter. Over the last four quarters, we have relocated or expanded 49 strong performing stores. This takes them out of our identical supermarket sales calculation. Further, we have opened 42 new stores over the same time frame. Both of these create a headwind to identical food store sales. By way of comparison, last year, there were 19 new stores opened that affected nearby stores. Operating costs, excluding fuel, Roundy's, and an $80 million contribution to the UFCW consolidated pension plan in the third quarter of 2015, grew by 19 basis points, of which 15 basis points were related to depreciation due to increases in our capital program. We can clearly do better, and we're redoubling our efforts to reduce these costs as a rate of sales over time. While the environment is difficult, managing operating expenses is something that is in our control. Our Customer 1st strategy is funded by saving costs in areas of the business that customers don't see in order to return value to our customers in the form of lower prices on products they want, improved service, and a shopping experience that makes them want to return. Now for an update on retail fuel. In the third quarter, our cents per gallon fuel margin was approximately 17.9 cents compared to 23.8 cents in the same quarter last year. On a rolling four quarters basis, we were at $0.17 this year compared to $0.188 last year. During the third quarter, corporate brands represented approximately 28.1% of total units sold and 25.5% of sales dollars, excluding fuel and pharmacy. As Rodney said earlier, Simple Truth continues to have an impressive growth rate. Our net total debt to adjusted EBITDA ratio increased to 2.35 compared to 1.99 during the same period last year. This result is due to the mergers with ModernHEALTH and Roundy's Inc. At year-end, Kroger expects net total debt to adjusted EBITDA to be near the high end of the company's targeted range of 2 to 2.2x. It's worth noting that over a longer-time horizon, we do expect our net total debt to EBITDA ratio to grow if we continue to successfully negotiate the restructuring of troubled multiemployer pension plan obligations to help stabilize associates' future benefits, as we did in the second quarter. We would not expect this increase to adversely affect our credit rating as rating agencies already factor in our multiemployer pension plan obligations in their evaluations of our credit ratings. When we take on additional debt to fund these plans, this reduces the off-balance-sheet amount of our estimated multiemployer pension plan obligations. Over the last four quarters, Kroger has used cash to repurchase $1.4 billion in common shares, pay $418 million in dividends, invest $3.8 billion in capital, in line with our commitment to reduce planned capital expenditures for the year, merged with Roundy's for $866 million, and merged with ModernHEALTH for approximately $390 million. The flexibility to return value to shareholders is a core strength of our financial strategy. Return on invested capital for the third quarter was 13.63%, excluding Roundy's, compared to 14.16% for the third quarter of 2015. I will now provide a brief update on labor relations. We recently agreed to a new contract with UFCW, covering Fry's associates in Arizona. We are currently negotiating contracts governing store associates in Atlanta, Michigan, and North Carolina. We are also negotiating a new contract with the Teamsters for our Roundy's distribution center. 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 continues to communicate with our local unions, which represent many of our associates, the importance of growing Kroger's business and profitability, which will help us create more jobs and career opportunities and enhance job security for our associates. Turning now to our guidance for the remainder of the year. We narrowed our net earnings guidance to a range of $2.03 to $2.08 per diluted share for 2016. The previous guidance was $2.03 to $2.13. On an adjusted net earnings guidance range per diluted share for the year, it's $2.10 to $2.15, which excludes the $0.07 charge from the company's commitment to restructure certain multiemployer pension plan obligations in the second quarter. The previous adjusted guidance range was $2.10 to $2.20. For the fourth quarter of 2016, Kroger expects slightly positive identical supermarket sales growth, excluding fuel. The persistent and increasing deflation has caused us to adjust our view of identical store sales for the fourth quarter. We continue to expect capital investments of $3.6 billion to $3.9 billion for the year, excluding mergers, acquisitions, and purchases of lease facilities. And we expect Kroger's full-year FIFO operating margin in 2016, excluding fuel, to decline compared to 2015 results. Finally, I want to take a moment to look ahead to 2017. We're completing our business plan process for 2017 now, and we'll provide specific guidance in March as we normally do. We anticipate both positive identical supermarket sales and net earnings per diluted share growth, excluding the 53rd week. Net earnings growth will likely be below the low end of the company's 8% to 11% net earnings per diluted share long-term growth rate guidance. We expect the operating environment in the first half of 2017 to be similar to today. The second half of 2017 should show improvement as we cycle the current environment. As you know, we define long-term as over a 3- to 5-year time horizon, and we are committed to achieving our net earnings per diluted share growth rate guidance of 8% to 11%, plus a growing dividend. We expect 2017 capital investments of $3.6 billion to $3.9 billion, excluding mergers, acquisitions, and purchases of leased facilities. We will continue to make investments to reward our customers, and we'll increase our intensity in finding cost savings for these investments. Now I will turn it back to Rodney.

Thanks, Mike. We are both clear-eyed about the challenges before us and optimistic about Kroger's future. Transitions are no fun, but they do create opportunities to improve the way we run our business. We will continue to focus relentlessly on our customers and our associates. We'll continue to accelerate our adoption of technology to deliver additional value, to provide convenience for and to our customers and take costs out, as Mike mentioned. All these things set us up to grow our business. We have a unique opportunity for strong growth in the $1.5 trillion U.S. food market. Our best days are still ahead of us.

Just one quick question for clarification. I know you wrote this, but I have received a couple of questions on it. When you're guiding to below 8% EPS growth in fiscal '17, is it reasonable to assume that's on a like-for-like basis, which excludes the benefit of the 53rd week?

Well, it does exclude the benefit of the 53rd week. Essentially, our business planning is based on like-for-like comparisons, and then we estimate what the 53rd week will ultimately contribute to that result. I'm not going to predict whether we'll be at 8% or 9% with the 53rd week because that would reveal our thoughts on the matter without it. However, the only guidance we are providing is that on a 52-week basis, we would expect to be below 8%.

Got it. Okay. And then, Mike, I wanted to follow up. On CNBC, you were sort of, at least to my ears, talking about maybe deflation ebbing a little bit here. You were pointing to some commodities maybe rising. But you're also guiding, I guess, to a similar operating environment well into fiscal '17. So I just wanted to kind of make sure I understood. If deflation's the primary reason for the challenging environment today, and if you think deflation is going to get less bad, then why wouldn't early 2017's operating environment be a little bit less bad than what we're kind of seeing right now?

Yes, what I was going through on CNBC is where some of the raw material markets are trending over the last four weeks. A lot of those, when you look at them on a year-on-year basis, they're still quite negative. But there is some trend up in some of those categories in the input costs over the last four weeks, but still down on the prior year. Milk and cheese looks like it may be bottoming, but that doesn't mean things turn around on a dime as raw material input costs change. There's usually a lag from that bottom and a slight blip up in those costs until you start to see any effect on retail pricing. So we would expect this to persist. Some of that is just based on the last two cycles of inflation and deflation we've had. And we have a 5-year rolling average chart that we look at a lot. If you think about the waves of where that happens with inflation and deflation, this cycle looks very similar to the last couple, maybe a little closer to 2002 than 2009, which was a little bit more persistent, but that's what's in the back of our minds.

It's Steve Forbes on for John today. Given the pace of the ClickList and ExpressLane rollout thus far this year and the uptick over the past couple of weeks you mentioned, can you touch on what your thoughts are for 2017 as it relates to these initiatives?

We wouldn't be, at this point, sharing specifics, but obviously, it's something that continues to be important and we'll continue to roll it out. Now at some point, it will slow down a little bit just because the stores that are easy to add, we will have added them. We have identified overall how many stores we think makes sense, and it's over half of our stores we think would make sense to have ClickList. But obviously, you do the easier ones first, and it will slow down just because of the difficulty getting it installed.

And then as a follow up, maybe kind of a bigger picture question about what you've seen historically as it relates to the return to an inflationary cycle. Right. If you think about the competitive environment today, how do you think about '17, right, if we do get that eventual reinflation cycle? After such an extended period of deflation, I mean, do you foresee yourself and competitors rapidly passing through price increases once inflation returns? Or in the context of what we've experienced in the past and what we're experiencing now, is there any risk, right, that price increases occur on a slower basis than we may expect?

It's a great question. Looking back over the last 20 years, every short statement in economics tends to be inaccurate. It partly depends on how inflation returns. Will it come back strongly or just at a modest rate of 2% or 3%? Currently, we expect that when inflation does occur, it will be relatively mild based on what we're observing. However, it's important to note that we're still very early in this process, so our expectations are preliminary and could change as we progress. Competitively, everyone is paying attention to market developments. Typically, there will be a slight delay initially, but eventually, companies will implement price increases. This is why I often emphasize that transition periods are challenging, whether moving into or out of inflation and deflation.

But the pace of increase, I guess, what you expect as you look out to '17 is very dependent on where the absolute level of inflation returns to.

Absolutely. Currently, most grain-based crops have not yet been planted, although some winter wheat is in the process. These crops will significantly contribute to inflation, and it is too early to make definitive predictions. In 2016, it seems we may see a record crop for the fifth consecutive year, but eventually, unfavorable weather conditions will affect yields.

Never had six.

I don't think we've ever had five before, so you never know. However, we don’t see anything that would lead us to a different conclusion. In produce, that situation can change quickly since the growing seasons are much shorter.

Can you provide more clarity on your guidance? At the Analyst Day, you reaffirmed your full-year outlook but mentioned that the end of Q3 was hard to predict. Today, you've lowered your forecast slightly. What has changed since the Analyst Day? Did you conclude that the end of Q3 was softer than expected? Additionally, how is Q4 performing so far in terms of IDs? Are you seeing low single-digit growth at this point?

If you consider our progress since the Analyst Day, I encourage you to take a broader perspective. It requires approximately $23 million in sales to change our identical store sales by 10 basis points. When you fluctuate around $23 million or even $40 million in just a few days, and see identical sales increases of around 4% or 4.5%, it doesn’t significantly impact the overall picture. However, when your identicals are stable and vary between flat and 50 basis points, it represents a substantial shift in your figures. Given that we generate $23 billion in ID sales each quarter—approximately $1.5 billion to $2 billion per week—the possibility of a few days impacting sales by $20 million is certainly plausible. You've all heard me talk about how our daily sales can fluctuate with calendar changes and holidays, which explains why grocers often experience stress early in their careers. Such variations happen frequently and have a significant impact. The influence of milk, eggs, and cheese remains substantial. This year, these products are a considerable headwind to our identical sales compared to last year, representing a significant percentage. While I won’t specify the exact figure, it is indeed noteworthy. Rodney seems to acknowledge this. There could be as much as a 50 basis points impact on identical sales in the quarter due to these three items, primarily because of the price deflation this year compared to last year. These factors are quite significant.

I would like to add to Mike's earlier comment. When he provided guidance at our Analyst Day, he mentioned the uncertainty due to calendar shifts. Our results align with his outline regarding the uncertainty for the next few days. Looking at the fourth quarter so far, we are slightly negative. However, compared to last year, the first four weeks of last year’s fourth quarter were significantly stronger, and performance declined through the quarter. Therefore, we will begin to see numbers from a year ago that are quite different from what we have experienced so far this year. This is why we felt confident in providing guidance for a slightly positive outlook for the fourth quarter.

Great, and just a follow-up. On the gross margin, Rodney and Mike, your gross margin this period during this deflationary cycle has been remarkably resilient compared to historical trends regarding margin and IDs. The competitive environment seems to be more challenging based on what we hear. Can you provide some insight into what's really happening with the underlying gross margin? I understand you are consistently investing in pricing, but it appears that you are not as affected by the competitive environment as we’ve observed in other areas. Any additional information on this would be helpful, particularly regarding your outlook for the next few quarters.

Yes. I have a few comments before Mike wraps up. First, when you consider the impact of Roundy's, it has influenced some of the year-over-year changes since Roundy's yields a higher gross margin compared to Kroger. Additionally, our purchasing teams have made significant improvements in how we acquire products, particularly in managing the cost of goods. We have many corporate brand items that we buy directly, and these adjustments have positively affected our cost of goods, contributing to better gross margins. Mike, I'm sure you have some other points to add.

Yes. I want to delve a bit deeper into the corporate brands. As we continue to expand our Private Selection line, it's worth noting that Simple Truth is growing at nearly double digits. These products generally yield a higher gross margin as they become a larger part of our offerings, which somewhat skews historical comparisons. This quarter's figures are challenging to interpret due to the dairy segment, where a significant percentage consists of corporate brands. Additionally, the fresh mix plays a role. Rodney mentioned our focus on food trends and snacking, which often come with a higher gross margin. However, their impact on overhead or operating profit may not be as strong due to higher labor costs, more shrink, and fixed expenses like electricity. All of these factors contribute to the overall situation. Rest assured, we continue to invest in pricing and provide value to our customers, which has been a cornerstone of our strategy for the past 14 years.

I wanted to take a different approach and discuss the non-fresh and branded side, particularly since recent data has indicated that volumes are declining in the measured channel. I'm also curious about e-commerce, especially with Walmart acquiring Jet.com and Amazon making significant strides in consumable and everyday essential categories. Given this context, I would like your insights on the future of margins and these categories, as well as how you plan to respond to a rapidly changing environment.

Well, there's about ten questions within that. So I'm trying to...

So you don't get a follow-up, Scott.

I'll try to summarize it in a helpful way. Our relationships with the consumer packaged goods partners are expected to continue growing. However, the trends they are experiencing are somewhat different from ours. During our Analyst Day, we observed that competition is becoming broader than in the past. We are focused on meeting customer demands in terms of timing and method. Amazon is one approach, but not all customers prefer having multiple packages delivered to their door. We've noticed that many customers appreciate having groceries picked up, and we are beginning to test partnerships with third parties for delivery. Our priority is to let the customer choose how they want to engage with us in a seamless manner. We have consistently stated that our gross profit margins will likely continue to decline over time, which is why we are dedicated to reducing costs and collaborating with 84.51° and our technology teams to fundamentally transform our operations. Mike, do you have anything to add?

No, I completely agree with Rodney regarding e-commerce and deliveries. Our customers live within 2 or 3 miles of their preferred store, making it very convenient for them to order online and stop by on their way to or from work or other activities. A good indicator of a retailer's enthusiasm for something is whether they are increasing or decreasing their efforts in that area. As Rodney mentioned, we are continuing to expand our ClickList locations.

This is Sean on for Karen. Can you provide some color on tonnage trends this quarter versus the first two quarters of the year?

Tonnage trends for the quarter remain positive. There is some softening from the second quarter to the third quarter in tonnage. However, we continue to have overall positive tonnage and are increasing our market share. We're especially pleased with the tonnage growth in several categories. Tonnage can be challenging to assess due to numerous pack-size changes. Previously, consumers might have bought different sizes of bottled water in increments, but now they often purchase larger packs. Each of these is counted as one unit despite an increase in the number of bottled water units sold. There are also trends with multipacks and larger packages. Additionally, with ClickList, customers are opting for bigger packs for convenience since they don't have to fill their shopping carts. For instance, they might choose to buy a 12-pack of paper towels instead of a 4-pack because they don't need to be concerned about cart space, as long as their trunk can accommodate it. We remain satisfied with our tonnage growth, which is a fundamental aspect of our business.

Okay, that's helpful. Then, I guess, my follow-up would be just some color on the extra week next year and the impact to earnings per share. We went back and looked at 2012 as sort of a proxy for that and thought that the merchant flow-through would maybe equate to about $0.09 a share. Just wondering if you could give some comments on that.

Well, one extra week out of 52 is just over 1.9%. The factors involved and what occurs during that week influence the benefits it brings. Historically, I would agree that it's in that range, but it's challenging to predict what will happen in the first week of late January or early February of 2018.

We do always try to break that out and provide that insight because we don't take credit for that extra week in terms of achieving numbers. As we mentioned in our prepared comments, we are in the middle of our business plan process and just wanted to give you a little bit of flavor of what we're seeing next year's shape up to be and letting people know the 53rd week, we're not taking credit for achieving the numbers.

You mentioned several times during the call, just a focus going forward on taking costs out. Can you talk a little bit about what this means for things like employee costs, wages, health care, store productivity initiatives, pension, stuff like that?

I would say that all of those are things we are actively working on. Over the past several years, we have made process changes to improve how work is done, and we continue to find significant opportunities in this area. We are collaborating closely with our R&D and technology teams to transform our work processes. For instance, during our investor meeting, Mike mentioned temperature monitoring, which is a project we developed internally. We have implemented it and it saves about $25 million annually. While it does require initial capital investment, the second year and subsequent years provide substantial value. Labor remains the area with the greatest potential for savings, which we plan to achieve through process changes. We believe this is extremely important.

Okay. And just a follow-up. I know it's still early days here, but are there any metrics you can provide on the performance of your ClickList stores? Maybe is there data to suggest that sales are incremental? And do you view ClickList as a potential driver of market share or rather just an added convenience for your customers over time?

Yes, I will do my best to address your questions, though we are still in the early stages, so I may not have complete answers. You raised some excellent points. At this stage, we anticipate a mix of gaining market share and providing additional convenience for customers. Each customer will experience a unique combination of these factors. We believe that, over time, this initiative will help us better understand how to deliver what customers want, in the way and at the time they prefer. We view this as more than just ClickList; it’s about enhancing our connection with customers in a meaningful way. Some of the business growth will be incremental, and when we assess the company overall, we notice a significant range in performance. Initially, this could act as a headwind financially. If we reflect on some of the original Harris Teeter locations before our merger, you could find that shopping through ClickList or in-store feels similar to customers. However, looking at the stores as a whole, the rollout of ClickList still represents a considerable financial challenge.

I just wanted to drill down a little bit on your ID sales by region. Did you guys see any significant regional differences in ID sales during the quarter? Anything that you could call out?

Yes. We always see ID sales ranges by region. When we're in 30-something states plus D.C., it's like anything else; there's somebody that's at the top of the list and somebody at the bottom of the list. We typically don't go into specific geographic descriptions of where we saw relative strength and where we saw relative weakness, if you will, or towards the bottom end. Broad-based, again, I would say the story is pretty much the same for all of the regions with the persistent deflation. And a continued focus on trying to drive tonnage is the story that we're trying to drive home with all of our geographies.

Okay, that's helpful. Earlier this year, you mentioned that Roundy's was a 30 basis point headwind to the comp. Since you'll be cycling that in the fourth quarter, is that correct? Has it indeed been around 30 basis points? As we move into the fourth quarter, do you expect this to contribute to the improvement in comp sales?

Yes. When considering Roundy's more broadly, it remains in that same range. We have successfully opened 13 stores in Wisconsin, completed in our preferred manner, and are very pleased with the sales and tonnage growth in those locations. We have also transitioned those 13 stores to the Kroger systems, which is happening at remarkable speed for a merger, as we aim to integrate them into all our processes swiftly. We are very enthusiastic about this merger and the opportunities we foresee, especially regarding the Wisconsin assets. Economically, the merger presents significant advantages, particularly our entry into Chicago at the cost of the entire merger. With Michael Marx and his team leading Wisconsin, we anticipate continued positive outcomes in the future. While the process will take time and effort, the team is ready for the challenge.

Yes. I have been very pleased with the engagement of our store associates at Mariano's and in the Wisconsin stores like Pick 'n Save, Copps, and Metro. They have been very supportive and excited. Although we are seeing slightly better improvement in tonnage compared to identical sales results due to some changes lowering retail prices, I am truly thrilled with our teams and their enthusiasm for being part of Kroger, much more than I had anticipated at this early stage.

All right. I appreciate that color. So just in terms of kind of thinking over the next year or two, this is going to be something that, obviously, Mike, you said, you guys have done some conversion. You still have a lot more to go. So this would be something that will probably be a multi-quarter effort. We shouldn't expect to see any significant tailwinds then from Roundy's over the next couple of quarters.

Yes. We are approaching the one-year anniversary of the merger's closure, which took place on December 18 of last year. This is a relatively new segment of our business, and we will continue to focus on it as time goes on. However, I wouldn't consider the past experience in Wisconsin from 2017 as a positive factor for our overall business plan; while specific stores may show some benefits, the overall impact is not significant.

This is Andrew Ruben on for Vinny. I just had a question on deflation, bigger picture. You characterized being in mid-cycle. Just curious what drives that characterization. And given that you've been through a few of these cycles, as you referenced, any color on how the cycle that we're in compares to the few you've experienced over the past 30 years?

The broader perspective suggests that this situation resembles what we saw in 2002, which lasted about five quarters. The most challenging phase occurred in the middle of that cycle, similar to our current position. The cycle's progression will depend on the factors that led us into it and how we will exit. Currently, we anticipate a modest improvement when we emerge from this cycle, primarily influenced by supply conditions. In contrast, the downturn in 2008 and 2009 was significantly tied to economic factors. The 2002 scenario was more supply-driven due to an abundance of supply in the market. Unless there is a notably poor crop year in 2017, we expect this situation to more closely align with 2002. Also, as Mike mentioned regarding dairy pricing, if milk drops from $3 to $2 per gallon and remains at $2 the following year, the comparisons will be made against $2 rather than $3. This illustrates why pressure on prices diminishes. Mike, do you have anything else to add?

No.

Andrew, is that helpful?

My first question is about traffic. Your press release indicates that you once again experienced growth in loyal households. Can you provide insights into how your traffic performed in this quarter compared to Q2? I’d like to understand how the traffic figures aligned with your expectations.

Yes. If you look at it versus expectations, it's pretty similar. It continues to be positive. In terms of playing out, you always want more traffic than you had, but I would have said that every quarter. I don't know, Mike, from your perspective. I think it really well played out the way we would expect.

I agree with you.

We anticipated that the third quarter would be quite challenging given the circumstances. However, some of those factors will begin to cycle.

Fuel has certainly been unpredictable over the last few years and even more so in the past few days and weeks with questions surrounding OPEC's actions. They ultimately announced a decline of 32.5 billion barrels, which translates to a reduction of 500,000 barrels per day. The fluctuations in price, dropping $1.50 one day and rising nearly $4 the next, can be confusing, especially considering that the overall production cut is relatively minor in relation to global oil supply. However, this kind of volatility is typically beneficial for us because many of our fuel centers at supermarket locations receive multiple deliveries each day. Therefore, daily price changes allow us to capitalize on market fluctuations.

Yes. During our business planning process, we consistently utilize a 5-year rolling average, which we find to be the most accurate measure. As Mike pointed out, looking at a rolling four quarters, fuel margins have decreased by just under a couple of cents. However, predicting future outcomes is highly uncertain. I often find it amusing that when gas prices are at $100 a barrel, people predict it will reach $150, and when prices are at $50, they say it will drop to $20, neither of which has ever been accurate. In our planning, we adhere to the 5-year rolling average. Additionally, when assessing whether our shareholders receive a return from our involvement in this sector, we apply the same approach.

We essentially plan the non-fuel business, add the fuel business, and then incorporate the 53rd week.

Rodney, for people like me who were not covering this industry back in '02, I was hoping you could maybe give us some insights. How does this deflation and promo environment change the way your customer is shopping? Or does it? Like for example, you called out snacks and drinks, maybe some color on other categories. Or also, does sort of the balance of fill-in versus stock-up change? How does the reaction to promos change in sort of a multi-quarter deflationary environment? And maybe some color on what happens in center-store when you're in an environment like this? And I have to ask because I don't think anybody did, but just the question you love getting, what's Walmart doing right now promotionally? Are they investing more and more in price in the markets you're in?

If you compare 2002 to today, the most significant change from a customer perspective would be that they now buy prepared food much more often. During our Investor Day, we showcased various changes we've implemented, allowing customers to eat in our stores or take food home, which marks a substantial shift since 2002. Additionally, customers tend to shop more frequently but with smaller purchases now. Back then, we didn’t have a loyalty card or the level of analysis we have today. Historically, individual basket sizes were larger, but on a monthly basis, they are now greater. Regarding raw materials, the biggest influences remain the prices of inputs like corn for beef, pork, and chicken. The chicken supply cycle is much faster than that of pork and beef, and this consistency has remained since 2002. The main factors are still the raw materials and how well crops are growing, along with the corresponding supply chain effects, which significantly impact protein and center store items. Mike, do you have any insights on inflation?

No.

Both of us were around in '02 as well. We had different jobs.

Thinking back to 2002, can you recall how the competition responded in terms of promotions? Has that changed significantly? Are there more in-store signs or circulars now? What promotional strategies are currently being used, and how do they compare to what the competition did back in 2002?

Well, regarding promotions, in 2002, I can’t recall all the details without the data at hand. Back then, competitors lacked insights and were unsure whether their sales were affected by competition or deflation. Nowadays, however, people have access to much better data, which helps them understand that it's due to overall market conditions rather than just another competitor taking their business. As a result, we all responded differently during the initial stages of deflation back then because we assumed a competitor was winning over customers.

Yes, and that parallels Rodney's comment on basket size. Historically, all we would see is what's the average transaction per customer. And if that's softening, back in '02 when you didn't have the data, you didn't know that that household was coming more times in a monthly basis and it wound up spending more with you on a month because we simply didn't have that technology back then.

Got it. That's helpful. And just quickly, Walmart, any color on any changes in their level of price investment?

Yes. It would be similar to what we've seen before in terms of our comments. As you know, we won't talk too much about specific competitors. We have a ton of respect for them. There is no doubt they continue to improve. But that's the same comments I made at the investor call and I made at the last quarter. All of us would have different approaches in different regions of the country.

I am still a bit unclear about the end of the third quarter. If ID sales have been at roughly 0.5 with two weeks remaining and finished at 0.1, does that suggest the last two weeks saw a 2% decline? Additionally, regarding the calendar commentary, does this mean Halloween sales or related sales are also down, possibly due to the shift from a weekend to a weekday?

Yes. I may not provide a precise answer to your question because daily fluctuations can be misleading, especially with factors like Halloween changing days. We didn't indicate that we were definitely at the low end of our guidance of 50 to 150 basis points for ID; we mentioned we were close to it. Our original guidance suggested that while we expected not to reach the low end in the third quarter, we anticipated the fourth quarter would surpass the low end to fall within that range. Overall, we did not end the third quarter significantly different than we started. It’s possible my communication on November 2 led some to interpret that being near the low end meant we were at the low end. Keep in mind that it takes $20 million in a quarter to change ID sales by 10 basis points. Thus, fluctuations in this range mean that if I missed those four days by $20 million, it would halve my ID sales from 20 basis points to 10 basis points. If I was at 4%, it would drop to 3.9%, which isn’t a substantial change.

Thanks, William. Before we end today's call, I'd like to share some additional thoughts with our associates listening in today. Being part of millions of families' celebrations this holiday season is a great honor and privilege. Our customers count on us to have what they need and more, and you make it all happen. Just last week, nearly 10.5 million customers shopped with us on Tuesday and 13.5 million on Wednesday before Thanksgiving. That's incredible. A huge thank you. No matter where you work, you make the holidays special for our customers, our communities, and each other. I also want to thank our store teams for their outstanding response to our national hiring event in November for all military veterans and family members. We hired 4,000 veterans and family members in one day, which is nearly 3,000 more than last year's event. We are delighted to welcome them to our Kroger family as part of our continuing commitment to active duty troops and the nation's 23 million veterans. Thank you for all you do every day. Merry Christmas and happy holidays to you and your family.