Kroger Company (KR) — Q1 2018 Earnings Call Transcript

Thanks, Jamie. 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, Kate. Good morning, everyone, and thank you for joining us. With me to review Kroger's first quarter 2017 results is Executive Vice President and Chief Financial Officer, Mike Schlotman. As we all know, there is a lot of change in the food retail industry, both in terms of the operating environment and the competitive landscape. The best thing that we can do is to stay on the offense by continuing to focus on our customers, what they want and need today and what we anticipate they will want and need tomorrow, and executing our strategy. We continue to manage our business for the long term and to deliver earnings growth on a 3 to 5-year time horizon. We are making meaningful investments in our digital and online growth. We believe that customers of the future will want to shop with us for anything, anytime and anywhere. In the first quarter, we saw more than 30% growth in new digital customers and a more than 30% increase in digital visits, with faster growth in mobile compared to last year. We are also building on our personalization expertise to benefit our customers. An example of this is My Magazine, which delivers personalized content like recipes to loyal households based on their shopping behavior and interests. In fact, we delivered more than 6 million unique My Magazine offers in the first quarter alone. This also allows us to offer personalized lower prices to our loyal households in addition to low prices everyone can see. This is another example of how we leverage 84.51°'s expertise. We are investing in our people. We are improving customer service by both increasing labor hours in certain areas and increasing starting wages in certain markets. Taken together, these steps will improve the customer experience and improve retention. I share these examples to demonstrate that we are laser-focused on providing our customers with the right value proposition. This is our Customer 1st promise, our commitment to provide friendly service, fresh foods and low prices every day, and this is what we will continue to do regardless of the external factors because it's what our customers deserve, and we know, ultimately, that delivers shareholder value. These investments both maintain and enhance our position in our markets. And while it is still early in 2017, we are starting to see some traction. We are happy with the better identical sales trends in this first quarter compared to the fourth quarter, and we are pleased to see that our current identical sales trend is positive. The last 9 weeks of the first quarter were positive, and so are our second quarter to date. Our teams continue to innovate in new and exciting ways that reflect where our customers are going. Recognizing the demand for convenience, high quality and best value, Kroger's culinary development team has launched an incredible collection of Prep + Pared meal kits that we are currently piloting in Cincinnati stores. We can hardly keep them on the shelves, and it's easy to see why as soon as you try them. Kroger’s Prep + Pared meal kits offer restaurant-quality meals that are easy to cook in about 20 minutes. We think customers will love knowing that they're available in their stores when they are wondering around about 2:00 in the afternoon what's for dinner. Our brands are one of the primary means we have to differentiate ourselves from our competitors. Last year, we commissioned an independent third party to conduct research that would give us an objective view of how our customers view our brands. This included blind taste tests with national brands and other private-label foods. Our research showed that the most loved brands sold in our stores are our brands, above even the national brands. And in the blind taste test, our brands outperformed competitive national brands and other private-label products almost 100% of the time. Our products in Private Selection, Simple Truth and Simple Truth Organic brands rated significantly above their respective competitive offerings. Of course, our journey is never done. So our customers will continue to see rising quality and better value on our brand products in the future. By having brands our customers love that are only available from us, we gain loyalty and advocacy from our customers. Our brands represented approximately 28% of total units sold and 25.6% of sales dollars, excluding fuel and pharmacy during the first quarter. Our customer needs are constantly changing. What doesn't change is the desire for a welcoming customer experience with an abundant variety of food available when and how they want it all at a great value. That's why we regularly evolve the execution of our Customer 1st strategy, while the core strategy itself doesn't change. Too often, American consumers have to make a choice between low prices and a great experience, compromising one for the other. Kroger is uniquely situated to eliminate the need for that compromise, serving customers who are hungry for more than food, who want to be nourished in ways that help them live their lives best. Kroger's purpose is to Feed the Human Spirit, and we are more confident than ever that by living our purpose and delivering our Customer 1st promise, we'll deliver long-term shareholder value that you can count on. We remain committed to delivering our long-term net earnings per diluted share growth rate of 8% to 11% plus a growing dividend. And here is Mike to go into more details on our first quarter results. Mike?

Thanks, Rodney, and good morning, everyone. Like Rodney said, we were glad to see the better results compared to the fourth quarter for identical food store sales, and for the second quarter to date, our ID sales are positive. Tonnage continued to be positive during the first quarter. We continue to focus on the areas of highest growth like natural and organic products as well as areas where we are serving customers time, such as ready-to-eat meal solutions. Visits per household were flat in the first quarter. Basket size and price per unit were down, but those were offset by household growth. Loyal households grew 3.2% compared to last year's first quarter and our loyal households had positive ID sales growth in the first quarter. In the first quarter, our gross margin was down, operating costs were up and FIFO operating profit was down. While this is not representative of our typical expectations, it is important to keep in mind that we're making very deliberate and targeted investments in line with our Customer 1st Strategy. As Rodney outlined earlier, we have made conscious decisions to increase starting wages in certain markets to improve associate engagement and retention that will create a better experience for our customers. We continue to invest and grow our digital business. Our digital revenue more than doubled in the first quarter compared to last year. This includes revenue from ClickList, Harris Teeter's ExpressLane and Vitacost.com. As we continue to invest in price, we also remind you, Kroger's investment in price can be seen very clearly if you look at gross margins in the early 2000s compared to today. Kroger has invested more than $3.8 billion to lower prices for our customers over that time period. We have no intention of giving up the momentum we've gained on low prices. These investments enable us to connect with our customers in a deeper way and increase our market share over time. We are pleased that Kroger's market share, as traditionally calculated, was up in the first quarter. That said, we recognize there is no perfect metric for capturing market share. We are doing a lot of work to better define or perhaps redefine the market as a share of stomach rather than share among traditional grocery stores. We see food as a massive $1.5 trillion market and we have a substantial growth opportunity in that market. I also want to stress that we're committed to lowering costs as a rate of sales. Many of the things we are doing to pull costs out of the business today set us up for savings in the future. We will only further intensify our process improvement efforts. Now for an update on retail fuel. In the first quarter, our cents per gallon fuel margin was approximately $0.171 compared to $0.143 in the same quarter last year. The average retail price of fuel was $2.28 versus $1.92 in the same quarter last year. Our net total debt-to-adjusted EBITDA ratio increased to 2.33x compared to 2.12x during the same period last year. This result is due to the merger with ModernHEALTH and the repurchase of shares. Over the last 4 quarters, Kroger has used free cash flow to repurchase $1.5 billion in common shares, paid $438 million in dividends, invested $3.4 billion in capital and merged with ModernHEALTH for approximately $390 million. The flexibility to return value to shareholders is a core strength of our financial strategy. We are committed to balancing the use of cash to maintain our current investment-grade rating. Return on invested capital for the first quarter on a rolling 4-quarters basis was 12.75%. On the labor relations front, we are currently negotiating agreements with the UFCW for store associates in Atlanta, Dallas and our Food 4 Less warehouse stores in Southern California. Our objective in every negotiation is to find a fair and reasonable balance between competitive cost 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 don't face. Kroger continues to communicate with our local unions, which represent many of our associates, on the importance of growing Kroger's business and profitability, which will help us create more jobs, incur opportunities and enhance job security for our associates. Turning now to our guidance for fiscal 2017. We have previously indicated that the environment during the first half of this year would be similar to the back half of 2016, and that is what we are seeing. As Rodney said, there is a lot of change in the retail food industry. That, coupled with the transition from deflation to inflation, creates a challenging operating environment. The deflationary environment was less severe in the first quarter compared to the fourth quarter, coming in at 20 basis points deflationary without fuel. Grocery was essentially flat during the quarter, but had fluctuations up and down during it. Meat continued its deflationary trends. And produce, while deflationary for the quarter, showed inflation in the last 4 weeks of the quarter, and pharmacy was inflationary. As a result, we increased our expectations for LIFO to $80 million, a $55 million increase over our initial expectations. We have also made some incremental investments in price in certain markets that had very hot features on milk and eggs. While this affects gross margin in the short term, it is less expensive than regaining a customer's loyalty later on. These two, plus the incremental investments in hours and wages, are the primary factors causing us to lower our guidance for the year. Our GAAP net earnings per diluted share guidance for 53 weeks is now $1.74 to $1.79. Our adjusted net earnings guidance range is $2 to $2.05. The previous adjusted net earnings guidance range was $2.21 to $2.25. See the Form 8-K we filed this morning for additional information on guidance. Because this is an unusual year, we're going to provide a quarterly cadence relative to last year rather than compare it to our long-term guidance rate as we've done in the past. For net earnings per diluted share, we expect the second quarter to be down compared to last year, the third quarter to be up slightly compared to last year and the fourth quarter to be flat excluding the 53rd week. We continue to expect identical supermarket sales, excluding fuel, to be flat to 1% growth for 2017, and we continue to expect capital investments excluding mergers, acquisitions and purchases of leased facilities, to be in the $3.2 billion to $3.5 billion range for 2017. Over the long term, we remain committed to achieving a net earnings per diluted share growth rate of 8% to 11% plus a growing dividend.

Thanks, Mike. We are making the investments necessary to continue being the best food retailer in the country. We know there is a lot of upheaval in the food retail industry. Our strategy is to focus on our customers. As their wants and needs change, we'll be right there with them. We are confident that we will continue winning with our people, our food and the customer experience, and we will not lose on price. Now we look forward to your questions.

So guys, just to start off, is there any way to quantify, maybe directionally, the investments in labor, in SG&A versus the investments in price? Labor being some multiples of the investment in price or maybe it's equally split. And then when you think about the investments in price, is a lot of that proactive on your part? You talked about dairy. Or is that more reactive given what competition is doing?

I'll start, and Mike, just fill in. On the mix between labor and price as you look forward, I would think it's probably pretty close to 50-50, plus or minus 10%. In terms of price, we would not be leading on price as a strategy, but we're not going to let somebody have price. Now if you look at some of the competitive changes and what we see going on in those situations, we would be proactive versus reactive. And then Mike, anything you want to add to both of those comments?

No, I absolutely agree. And the whole trick here, John, is just how quickly the lines cross and our price investment creates more gross profit margin dollars. And as we said in the prepared remarks, there's really two things relative to labor. One is adding some hours to certain service departments, as well as increasing starting wages, which we believe over time will reduce our turnover, which has a great payback when we can have a higher retention of our associates who then are more productive and give a better shopping experience. So that one has a little bit longer runway relative to when we see the benefits of those investments.

As a follow-up, considering the differences since March, is it mainly the pace of reflation? Also, it seems you anticipate higher inflation this year than previously expected, but you didn't incorporate that into your comp. Is the impact of higher cost inflation balanced out by price investments, resulting in a net zero effect?

Yes. The main point is regarding our expectations for identical sales moving forward and the anticipated improvements. While we do expect continued improvement, it will likely happen at a slower pace than we initially expected. From the perspective of inflation, Mike provided some details on LIFO, which will be a significant factor. The change in LIFO impacted earnings by approximately $0.04 per share, I believe.

Yes. Kind of around $0.035, $0.04, in that range. John, it's not necessarily that it's dramatically different today than we were expecting. But when we look forward based on the movements we're seeing in the underlying commodities, we do think there could be a little more inflation by the end of the year than we originally thought. But the accounting convention is whatever your year-end estimate is, you expense that ratably throughout the year. So it's really more reflective of where we think the end of the year is going to be, not necessarily what would happen in the first quarter, but we're required to ratably expense that over the year.

A couple of questions. I guess in general, since you're taking the opportunity to lower guidance, I guess I have 2 questions. One is, why not take the opportunity to widen the range to give yourself a little more wiggle room? But I guess more importantly, why wouldn't you lower guidance more? Because if I look at your revised guidance, I would still say this seems pretty optimistic, especially given the competitive landscape has only really just begun to heat up. And within your guidance, originally, there was some assumption that there would be operating expense opportunities, and it now sounds like that's off the table, which makes me even more confused about how we get to the full year numbers.

We discussed various factors in determining the guidance range. We assessed our current position, reviewed forecasts for the remainder of the year, and considered trade-offs, settling on the range of $2 to $2.05. While we could have chosen a wider range, we are confident in the range we presented. We are encouraged by the progress in ID sales, which we believe will support that guidance. Regarding operating cost reductions, I am confident that we will continue to achieve the savings we are targeting. We made a specific decision to add service hours in certain departments and raise starting wages in select markets to reduce turnover, which negatively impacts customer experience and incurs additional costs from hiring and training. This adjustment is not applied nationwide, but it does represent a significant expense. We've accounted for all these factors, and the savings from our initiatives are aligning closely with our expectations for the year.

Our sales continue to show improvement, and we anticipate this trend will persist. Considering the current quarter is just a few weeks in, we expect to exceed the midpoint of our annual range, and this quarter has seen enhancements compared to the first quarter, which was already better than the fourth quarter. Regarding expenses, some of the costs are one-time items. As we progress through the year, we expect that some of our investments will start to pay off, reducing the initial start-up costs. In terms of digital initiatives, while there are substantial start-up costs when launching digital services in a store, as these stores mature, this will shift from being a challenge to a benefit.

Okay. But just so I understand, in terms of the operating expenses reductions that you've identified, that we did not see any of that really in this quarter, but we will see more in the second, third and fourth?

I would say we observed some progress this quarter. The savings we've achieved and the run rate for the year align closely with our original expectations and business plan. Additionally, the investment in starting wages has been beyond our initial plan, but we believe it has proven to be beneficial. We aim to manage the business dynamically, rather than hesitating to pursue good opportunities just because they weren't part of the original plan. Sometimes these decisions yield positive results, and other times, they don't. The investments we made in milk and eggs helped us retain customers, despite competitors trying to attract them. If milk and eggs had performed like typical retail items, we would have likely reported positive comparable store sales in the first quarter, rather than a decline, which also impacted our gross margins. There are always trade-offs to consider. However, we want to emphasize that we’ve made deliberate choices to invest more in our Customer 1st Strategy, alongside the impact of a $0.04 higher LIFO charge.

Is there any color you can provide on the ID sales impact from digital orders at this point? I believe you mentioned you doubled your digital sales. So when looking at your data, how are you thinking about what's incremental versus what might be coming at the expense of in-store volumes?

It's a great question, Zach, and it's one of those that's always hard to answer because you don't know what a customer would have done. The best we can tell, if you would give a range of between 40% to 60%, you're probably within that range. But it is a hard number to guesstimate because you really don't know for sure.

It's a great question, Zach, and it's one of those that's always hard to answer because you don't know what a customer would have done. The best we can tell, if you would give a range of between 40% to 60%, you're probably within that range. But it is a hard number to guesstimate because you really don't know for sure.

40% to 60% incremental, you said?

Yes. It is clear that those ClickList customers spend incremental dollars with us. To put your finger on the exact number, would they have grown their loyalty with us without ClickList? Perhaps. But you try to take the household trends as a whole and see where they've been going and where they are today.

And is it large enough to say that it's having a meaningful impact on the ID sales line yet?

Not when you look at the total. The cost of the start-up would be much greater than the benefits we would gain from it. However, when we merged with Harris Teeter, they had been operating for 10 years. The level of maturity we are experiencing with Kroger is akin to that of Harris Teeter, but there will be challenges for a while.

Okay. And I also wanted to address the headlines around Aldi and Lidl. Conceptually, how do you think about the role of the hard discounters in the U.S. and how that compares relative to the U.K? And in your mind, what are the structural differences between the 2 markets that you'd call out? And given that, do you think that those guys would have the same competitive advantages here versus the U.K. market? Any thoughts on that?

Yes, Zach, I love the question. A couple of things, for sure. One, just obviously the sheer size of the countries are different. I think the biggest structural, I guess, two big structural differences, if you look at the cost that it takes to operate a supermarket in the U.S, it's meaningfully less than the U.K. If you look at the price spreads that they're able to achieve in the U.K. versus the U.S., the price spread isn't as much either. So you have, both from a cost standpoint and a retail advantage for the customer standpoint, not as big a spread. Also if you look at the base experience of a supermarket in the U.S, we would typically offer more services in terms of every store would have a butcher that's there, ready to help. The produce would be much more variety, fresher. So there's a lot of aspects from the experience standpoint that would be different in the U.S. than the U.K. as well.

Rodney, one of the first things you said, and I'll paraphrase, was that the environment for food retail has changed. So I guess, I'm curious. Why was it surprising, given that, to see these hot promotional prices on milk and eggs? Shouldn't that have been sort of expected given that the environment has changed? Or maybe you were talking about something different, which is why I'm asking the question. And I guess for my follow-up, I'm curious what is in your guidance in terms of what you're assuming for competitive pricing as we look ahead? Because if things do get worse, and as Karen Short was pointing out, they likely will in terms of competition, I just want to understand what you guys are thinking and how much that's factored into your numbers at this point.

The environment is changing, and I wouldn't link it directly to milk and eggs; that's just one example. People are altering their eating habits, and we are committed to supporting them in this transition. If you consider our comments on Prep + Pared and our digital engagement, you'll see that customers engage with us both online and in-store. All these factors contribute to the changing eating habits of customers, and we plan to be there to meet their needs as they evolve. As for guidance, Mike, I’ll hand it over to you.

Yes. Again, in response to Karen's question, you never know when somebody in select markets is going to run some hot feature and you have to make independent decisions as those features hit the street, because if somebody just runs an ad for a couple of weeks trying to get some business in the store or they're going to do something longer term. And when those kinds of ads stay there for a little bit longer, particularly when it's two important commodities like milk and eggs, ultimately, we're going to react and not allow our customers to think they have to go somewhere else to get the best value for those kinds of products. It just so happens those two commodities are big, big commodities, and it's expensive when hot features hit versus some other commodities. And to say we do or don't have something exactly built onto our business plan, that's difficult to say. But we did make the decision to react to those prices and to keep the customers inside of our stores.

Can I ask a quick question to clarify? Is the message that you cannot really predict it, so you’re not necessarily considering more competitive prices as a general rule? Or is the message that you are considering them, but it's harder to be specific about it?

I think we all agree that the industry will continue to become more competitive each year. The price adjustments we've implemented from our initial pricing plan are having a positive impact. We also allocate funds to enable us to respond to competitive pressures. Therefore, the guidance we've provided, which has been lowered, reflects both aspects. While it may not cover everything that could occur, as Rodney mentioned, it represents our best estimate at this time.

This is actually Erica Eiler on for Rupesh. So I guess, should the environment remain challenging from here, can you maybe just talk about your flexibility to further reduce CapEx and perhaps redeploy the buybacks or other avenues to increase shareholder value?

As you know, we are continually making adjustments to our capital investments. Over the past year, we have reduced our expenditures on stores and have increased our investments in digital and infrastructure. We strive to keep our stores current and appealing. We recognize that customer preferences are constantly evolving, necessitating changes in stores to meet those needs. We believe we can continue to lessen our capital spending if it does not yield returns. We approach every dollar spent with a focus on whether it generates value over time. If it fails to do so, we are prepared to pivot. We have shifted our focus towards enhancing our digital infrastructure and other areas while downplaying the addition of new stores. Mike, do you have anything to add?

I absolutely agree with that.

Okay, that's helpful. And then just switching gears to private label. You talked quite a bit about private label in your prepared remarks. It seems that a lot of groceries out there are increasingly pushing private label lately. Some cases, select players are even lowering prices on private label. So are you at all seeing step-up efforts from the leading CPG players to support their products, whether it's through more promotional dollars or through other avenues? It just seems that there would be much more of a sense of urgency at this point, given what seems to be this increased retailer focus on private label.

Well, as you know, our brands have been incredibly important to Kroger since the founding of the company. And the research that we did last year, we wanted to make sure that we weren't just biased because we're so close to it, and we did the research with our customers. Our customers gave us glowing feedback on how strong our brands were, how great the products were in a blind panel. So they didn't know it was us. If you look at our Private Selection and Simple Truth and Simple Truth Organic, we just crushed the competitors in that space. So for us, our brand has always been massively important, and we will have a world-class approach to our brand. And it's important for our customers. It's important in terms of being able to make money as well. So we don't look at it in terms of trying to do something versus a CPG. We really look at it as our brand and building our brand and doing the things the customer wants.

In sort of thinking through the cut to the guide, I'm curious to know how you're planning food margins for the balance of the year relative to Q1. Do you think the year-on-year gross margin pressures bottomed? Or are you planning for that to get worse?

Yes. When we analyze gross margins overall, there are various factors involved. I believe you will see us continue to reduce gross margins over time. Over the last 12 or 14 years, we have invested $3.8 billion in price reductions corresponding with drops in gross margin. Expect this trend to persist. It's common in retail to see margins decrease; I wouldn't focus on just one year or quarter. Our business model is built on the assumption that gross margins will decline. We require stronger sales than we have seen in the past few quarters, and we need to enhance our productivity to lower operating costs in relation to sales, which will help improve our operating profit margin. While our current results may not reflect our long-term expectations, we occasionally face cycles that require us to adjust our internal metrics. We believe we have effectively responded to the changing environment regarding labor, pricing investments, and strategies for sustainable growth.

I guess two related sort of follow-up questions. The first would be the milk and eggs example. How widespread is that issue? And the second would be maybe qualitatively, as you think about the guidance and passing through the cost inflation that you're seeing, what's generally built in? Like how long are you sort of guiding so that you can hold the line on price longer than you think others will? Or is that a little different for any reason?

As Rodney mentioned earlier, we generally avoid leading our market by lowering prices, except in specific strategic investment areas. You won't see us, as we did in the '90s, reacting in ways that promote popular features that ultimately do not enhance customer loyalty but instead drive foot traffic for additional purchases. We will respond to these situations to ensure they do not divert our customers to other stores. However, if you look at our approach over time, we intend to remain proactive in our investment strategies.

Okay, fair enough. And just lastly on meal kits. I know it was about 4 stores some weeks ago. How fast is that being rolled out? How fast can it be rolled out? And if you'd give us a feel for how incremental the sales are, maybe how you're pricing it versus kind of the group of ingredients in those kits, that would be helpful as well.

Yes. A great question that I won't get into all the specifics, because obviously, competitors would appreciate that knowledge as well. What we're finding is the quality of that meal is the same as going to a restaurant and getting a meal, but people like to prepare something at home, and they find it easy and they love the variety that we offer. So a lot of the price comparisons is what the price is versus going to a restaurant, but being able to do it at home. And when it takes you 20 minutes, it's just as fast as picking it up at Kroger's than it's going to a restaurant and going through all that hassle when you're at a restaurant. And we're getting great feedback. We'll continue to roll it out based on the ability for the facilities to handle the volume. And so far, it's been very good, and we appreciate, and look forward to where it goes.

I just wanted to kind of like broaden it out a little bit and try to understand kind of where you guys think your business is. And I heard Mike talking about gross margin pressure. As we look at the market, it seems like it's almost like the headline would be more Amazon moving into consumables, more Walmart price investments, more Walmart click-and-collect, more Aldi, more Lidl. And so with this natural pressure on gross margins, there's also seemingly a natural pressure on cost. And so as you look forward, I know you guys kind of reiterated your 8% to 11% EPS growth rate. I'm just trying to understand over a number of years how that's going to be possible in this environment? And do you need to make more aggressive, more offensive moves here with the business given this environment?

It's really making sure that we're using the advantages we have. Obviously, the data that we have, our average customer only has to drive a mile to get to one of our stores. So it's using that personalization to connect with the customer directly on a one-on-one basis and having where they can engage with us any way they want to. So if they want to pick up their groceries, if they want it delivered or if they want to shop and go the old-fashioned way, for lack of a better word, we continue to add services. And all of those services is part of the model in terms of making it an easy place to stop. So if you think about fuel and some of the others. So it's really the sum of all those pieces together that we're offering, and we're doing it in a seamless way. So I don't disagree with the more, more, more, but there's also things that are a huge advantage for us. And when you look at all those things, when a customer comes into our stores, we still give them a great experience on a friendly face, we have incredibly fresh product, and it's important for us to continue to improve on those aspects because that's what will be a point of difference.

So then my follow-up question would be about scale. Does Kroger have enough scale to compete in this environment against Walmart and Amazon, which generate substantial cash? As you assess the business, you're clearly a large company, but many investments are necessary. Do you need more scale?

Yes. From everything, from our perspective, we would have plenty of scale. And certainly, as a $115 billion revenue company, we would have the scale. The other thing is if you look at like our own brands, the strength of our own brands and the strength of the experience the customers enjoy. All those things, obviously, add to that scale as well.

So I just want to clarify. You did say tonnage was positive, but if you just take out the inflation or the deflation rate, it looks like it might've slowed sequentially.

I didn't catch the first part of your question. The what was...

Tonnage.

I want to know if tonnage has slowed. You mentioned that tonnage growth is positive, but based on the numbers provided, it seems like it may have slowed sequentially. Can you confirm that?

I'm not going to provide exact tonnage numbers. When comparing ID sales with inflation and deflation, the results can be misleading due to the mix of products in those categories. Inflation in some categories and deflation in others makes it difficult to compare directly. However, looking beyond specific tonnage, the number of loyal households we have, combined with a 3.2% growth from them and positive trends in ID sales, indicates strong health for our business over time. While I can't give specific figures, we are pleased with our unit growth in the first quarter.

Okay, great. Last quarter, you mentioned that the growth in market share, at least based on your annual data, was slightly lower than what it had been in previous years. I want to clarify that in the last quarter, you indicated the competition was primarily coming from your traditional store-based rivals operating better stores. Meanwhile, you are discussing a changing environment. I want to confirm if you still consider this the main factor contributing to a more competitive landscape, or are you starting to see influences from the digital side, like Amazon and other online options?

Estimating market share is always challenging. However, our growth in the first quarter suggests that our market share growth was better than in the fourth quarter. As Mike mentioned, we are happy with our unit growth, our improving trend, and the advancements in market share trends as well.

And the loyal household growth.

That's encouraging. Could you share your thoughts on the competitive landscape? It's clear that new entrants are emerging, including store-based competitors like Lidl and Aldi, as well as online players such as Amazon. How are you responding to these developments? Looking ahead, do you believe the competition will remain primarily store-based, or do you envision a future where digital channels, including home delivery and click and collect, play a larger role in Kroger's strategy?

Yes. We really focus on anticipating the customer’s needs. Everything we build in our infrastructure is designed to serve customers in the way they want. From our observations, customers prefer a variety of options rather than just one approach. We are partnering with third parties for deliveries in several markets and are expanding that initiative. We are also increasing the number of items offered and the number of ClickList ExpressLane stores. Customers want to shop on their terms, but they still appreciate visiting physical stores for certain items because they enjoy personal interactions. We believe a strong physical presence is crucial, and it's about integrating all these elements rather than treating them separately.

I would like to follow up on the regional pricing and the competitive pricing in dairy. Could you specify which regions are affected? Is it primarily in the East, possibly as a response to Lidl's entry, or is it more widespread?

Yes, I won't to comment on exactly where we sell those, other than it was not concentrated only there.

Wanted to just go back to the pricing philosophy. Obviously, it'd been talked about a lot, but I think warranted given the fact that for investors today, probably the line that jumped out most within the release was, we will not lose on price. So you talked about obviously being certainly a part of that is proactive. I'm sure some of it in given markets is reactive. But can you just give us a little bit better sense on kind of the true kind of philosophy around balancing that kind of strict price versus, obviously, a lot of the other factors that Kroger has going for it and kind of who that may be kind of most aimed after, that'd be great.

Yes. I think it's important for people not to overplay the price comment. As you know, we do a ton of work on understanding where the customer wants and needs are, and we're incredibly focused on differentiating our experience versus our competitors in terms of the service our associates provide, the products and the quality of the products; the quality, especially in the fresh areas, in produce and meat and seafood and our deli; and the shopping experience itself. So how long did it take me to get into the store? How long did it take me to get through the checkout line? What type of experience? Those are the things that we're focused on and that we will differentiate ourselves. We're increasingly differentiating ourselves in terms of the ability to engage with us any way you want. Price, we're just making sure we don't lose customers because of price. So it's really those pieces together is where we're focused on and focused on delivering for the customer.

Okay. As a follow-up, I'd like to discuss the promotional environment. A key question for everyone on the call is how much of this reflects more permanent pricing changes compared to periodic blockbuster promotions, like the ones you mentioned. With commodity costs improving in the second half of this year, how do you anticipate the frequency of those weekly promotions will change on your end, and how much of this could be more of a lasting shift?

Yes. When considering how promotions will unfold and what weekly features will be, I wouldn't have enough time to analyze how our merchants create their marketing strategies. They are planning weeks in advance. We do make assumptions about how customers and competitors respond during holidays or in summer when vacations may reduce shopping activity and influence promotions. However, it's challenging to pinpoint exact promotional expectations or specify what is included in our plans, other than acknowledging that there will always be markets with significant features and others with moderate activity, including traditional grocery store pricing. Some markets are quite competitive, while others are relatively stable, allowing us to go about our daily routines. Fortunately, the number of markets we operate in means that not all are highly competitive simultaneously, and those that are less competitive can help balance things out. Therefore, trying to predict the competitive or promotional landscape would not be particularly wise.

Just some more questions on margins and the price investments. I guess it seems fair to ask where these hot ads are? Are these traditional supermarkets? Are there any different kind of behavior that you would expect to get better over the next coming quarters from these competitors with these hot ads? And I guess, as you respond to them, how much of your response in terms of price investments is going in personalized efforts, personalized discounts versus your everyday pricing? And are you seeing any different changes in terms of what you would expect in terms of elasticity to those price investments that you are making?

I'm uncertain about where to begin with all those questions. We consistently expect this industry to become more competitive over time, and unfortunately, we are seldom surprised by this expectation as it has always been a competitive market. We believe it will remain competitive. There are periods when competition intensifies and others when it diminishes. We understand that if someone promotes a hot feature temporarily, that's one scenario. However, if a competitor is trying to secure a strong position in key commodities to increase their store traffic, our best response is to maintain our pricing on those commodities. This strategy removes the competitive advantage they might have and ensures our loyal customers have no reason to shop elsewhere. Throughout the 1.25 years, we must determine if a competitor's actions are a temporary tactic that we can overlook or if it's something requiring a response. Additionally, we must balance this with our planned promotional pricing. It's important to recognize that our loyal households benefit significantly from programs like My Magazines, which provided 6 million personalized offers in the first quarter alone—offering these households unique pricing that isn't visible to our competitors. We achieve this without signaling our pricing strategies to anyone else. This approach allows us to reward our most loyal customers without drawing attention from competitors, and we continually leverage our strengths, particularly through 84.51°, to ensure we are rewarding our loyal customers effectively.

And the only other thing I would add, Kelly, to Mike's point, is if you look, typically, you'll have consolidation, and consolidation happens in spurts. And everything that we can see, we're probably at the front end of the next phase of consolidation. You're starting to see some competitors fall out, and it's one of the things that we think is incredibly important, to have the scale that we have and the diversity across the whole country that we have, because it allows us to continue to do what's right for our customers. We'll continue to work on improving the basic operation. And by doing those things, the shareholders continue to get a great return over time as well.

Rodney, could you talk a little bit about how prepared foods did just as a category, all the forms in which you sell in market prepared foods did versus a year ago?

It has shown significant growth compared to last year and stands out as one of our strongest departments. We anticipate that more customers will lean in that direction. As mentioned, we sought external talent for this area, and we feel optimistic about the growth potential and are pleased with the progress we are making.

Is that an area that is going to get more capital dollars when Mike spoke earlier of infrastructure spending?

Yes, it will receive additional funding. But more importantly, it will attract more focus and discretionary efforts from the organization. It's not as capital-intensive to implement the changes we need to make there. The key factor is keeping the menus fresh and up-to-date and the attention we dedicate to that area.

Yes, I wouldn't want to go into too much detail. One of the major focuses lately has been on shrink, with numerous projects and tests occurring in several markets aimed at reducing shrink trends. It's still early in these markets, but the initial results from our tests appear to be positive. We hope that by the end of the year and into next year, this will become more of a benefit rather than a drawback.

Before we end today's call, I just want to make a couple of comments. First of all, the changes that we talked about today and the direction we're headed in, we're making those changes proactively, and it's really based on where we see the customer is going. And we think it's incredibly important to do those changes in advance. And we're massively excited about the growth opportunities for the business going forward. We feel really good about our team in terms of the opportunities and taking advantage of those. So I wanted to make that. And then I also, as you know, I always like to share some comments with our associates who are listening in. As you've heard us describe during this call, we're focused on executing our Customer 1st Strategy and living our company's purpose, to Feed the Human Spirit. Feed the Human Spirit is our purpose because both our customers and you, our associates, told us it resonates powerfully with you. And also because it's authentic to Kroger, it's who we are. We've been living our purpose in large ways and small for more than 134 years, whether it's through providing over 1 billion meals to feed hungry families in our neighborhoods over the last 4 years, committing to be a Zero Waste company by 2020, or simply extending a smile or a helping hand to the customer, we and you make the world a better place one associate, one customer, one community at a time. Thank you for all you do every day for our customers and each other. That completes our call today. Thanks for joining.