Kroger Company (KR) — Q3 2019 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 discussions 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.

Thank you, Rebekah. Good morning, everyone, and thank you for joining us. With me to review Kroger's third quarter 2018 results is Executive Vice President and Chief Financial Officer, Mike Schlotman. At our Investor Conference at the end of October, we shared several big ideas. The defining idea is that we are transforming our business model through Restock Kroger and then beyond. We will grow market share by both redefining Kroger customer experience and alternative profit streams through complementary businesses and partnerships. Redefining the customer experience means offering customers incredible physical and digital experiences, a fantastic offering and friendly and caring associates. Delivering an exceptional customer experience through the Kroger ecosystem creates incremental new profit streams, which in turn drives the economic model that makes the seamless experience possible. In this way, our new growth model will be a virtuous cycle. This all means that Kroger is also reinventing our financial model. We're moving from a traditional grocer to a growth company with both a strong customer ecosystem that offers Anything, Anytime, Anywhere and asset-light, high-margin alternative partnerships and services. I will break it down a bit in more detail. Successful long-term businesses constantly explore new directions and adjacencies to grow their top-line. At our Investor Conference, we highlighted one of the most successful to date, Kroger Personal Finance as well as several businesses under our 84.51° portfolio, including our Kroger Precision Marketing media offering. Kroger Personal Finance delivered record year-to-date profit and is on track for their most profitable year ever. Our high-margin media business is strong and growing. Revenue for Kroger Precision Marketing, Powered by 84.51°, is up more than 150% year-to-date. One service line, our boosted products and search business, where advertisers can influence how their products show up on our sites, benefited advertisers with more than 700 million product impressions in the third quarter alone, personalized to Kroger shoppers, with click-to-conversion rates that are 2 to 3 times the industry standard. We see tremendous potential in these asset-light, margin-rich businesses built off of a robust grocery supermarket experience, which is being redefined every day at Kroger. Nowhere is this more obvious than digital. Our digital sales grew by over 60% in the third quarter. Our seamless coverage area now reaches more than 90% of Kroger households. This includes Kroger Pickup and Delivery. Kroger Ship is now available in all supermarket divisions. Ship customers can shop from a curated selection informed by 84.51° data and insights of more than 50,000 grocery and household essentials that matter the most to our customers, plus there are 4,500 Our Brand products available only from Kroger. We are aggressively investing to build digital platforms because they give our customers the ability to have Anything, Anytime, Anywhere from Kroger and because they're our catalysts to grow our business and improve margins in the future. As we stated at our Investor Day, we expect to be able to cover not only 100% of our customers but also the entire U.S. population. Our Brands continue to perform exceptionally well with customers and is one of the most profitable parts of our supermarket business. Our Brands made up 28.7% of unit sales and 26.6% of sales dollars, both of which are record third quarter results. Our Private Selection and Simple Truth brands saw strong sales, units and gross margin gains in the third quarter. Simple Truth and Simple Truth Organic is our fastest-growing brand, with sales up double digits, again, in this third quarter. As we've shared previously, Our Brands account for 4 of the top 5 items sold through Kroger Pickup, and 41 of the top 50 items sold on Kroger Ship. We have now been executing for 3 quarters our Restock Kroger Plan to create shareholder value by redefining the grocery customer experience, partnering for customer value, developing talent and living our purpose. We feel good about the progress and how everything is coming together. We are proactively investing for the future in stores and online and in our customers and associates. We are using our assets, especially our love of people and our love of food, to transform our business in ways that drive sustainable competitive advantage. Now here is Mike to share more details on our third quarter results and to update you on our guidance for the fourth quarter of 2018. Mike?

Thanks, Rodney, and good morning, everyone. We are pleased with our net adjusted operating earnings per diluted share result of $0.48 for the third quarter. Strong fuel margins and continued execution of Restock Kroger contributed to this result. We continue to make several Restock Kroger investments in the third quarter, including investments in price, particularly in support of Our Brands, along with space optimization, store remodels, and technology enhancements. These investments will allow customers to buy Anything, Anytime, Anywhere from Kroger. As we discussed at our Investor Conference, space optimization is a massive undertaking, and we expect to end the year with 600 stores completed. Our ID sales for the third quarter were in line with our expectations, led by natural foods, pharmacy, seafood, produce, and deli departments. Regarding gross margin, we were pleased to see continued improvement in our shrink rate during the third quarter compared to last year. The gross margin rate reflects the timing and size of our price investments compared to a year ago, rising transportation costs, and the growth of the specialty pharmacy business, which generates strong gross profit dollars despite being a high-sales, low-margin rate business. Keep in mind that last year's gross margin rate in the third quarter was higher than our typical run rate. For the third quarter in 2018, gross margin, excluding fuel, was actually higher than the second quarter of 2018. These fluctuations show how results can vary based on the timing of our investments. Part of our investments this year supports the Our Brand strategy, where we focus on offering high-quality products at great value. The improvement in unit movement this quarter shows that these investments resonate with customers. We intend to keep investing in price to drive unit growth while also delivering on our bottom-line for our shareholders. We are pleased to report that OG&A costs decreased by 20 basis points as a rate of sales. The significant improvements from our focus on reducing store associate turnover are contributing to this positive movement. We continue to focus on productivity and waste, and improvements in our cost to fill prescriptions, along with increased adoption of self-scan, have contributed to this progress. Our investments in Restock Kroger, which aim to redefine the customer experience, enhance customer value, and develop talent, will be funded by cost savings on goods, strong ID sales, and productivity gains, contributing to generating $400 million in incremental FIFO operating profit through 2020. Now for an update on our retail fuel performance during the third quarter. Our cents per gallon fuel margin was approximately $0.261 compared to $0.249 from last year's third quarter. The average retail price of fuel was $2.81 compared to $2.46 in the same quarter last year. We expect our tax rate for 2018 to be approximately 23%. Excluding the 2018 adjustment items, Kroger expects a tax rate of about 21%. These rates reflect third quarter adjustments related to a regular IRS audit that resulted in a reduction in prior year tax deductions at pretax reform rates and future tax deductions at post-tax reform rates. Our financial strategy is to use free cash flow to drive growth while maintaining our investment grade debt rating and returning capital to shareholders. We continuously balance cash flow usage to achieve these goals. Over the last four quarters, we used cash to invest a total of $589 million in Ocado securities and Home Chef; contributed an additional $185 million pretax through a company-sponsored pension plan; paid $467 million to satisfy withdrawal obligations to the Central States Pension Fund; repurchased 91 million common shares for $2.3 billion, including $1.2 billion repurchased with after-tax proceeds from the sale of Kroger's convenience store business under an accelerated stock repurchase plan. We also paid $435 million in dividends and invested $3 billion in capital, excluding mergers, acquisitions, and purchases of leased facilities. At the end of the third quarter, we had approximately $546 million remaining under the current share repurchase authorization. We remain committed to generating $6.5 billion of Restock free cash flow by 2020 as part of our Restock Kroger Plan. We've incorporated working capital improvements into this guidance and have made a strong start with a $100 million improvement in net operating capital so far this year. Kroger's net total debt to adjusted EBITDA ratio on a 52-week basis stands at 2.72. Our target is a net total debt to adjusted EBITDA ratio of 2.3 to 2.5x, and we are committed to bringing the leverage ratio back into this target range. We are investing an additional $500 million in our associates for wages, training, and development over the next three years through Restock Kroger, alongside our ongoing efforts to rebalance pay and benefits, as well as focus on certifications, performance incentives, career opportunities, and training.

In March, we also announced investing a portion of our tax savings in our educational assistance program, Feed Your Future, and an increased 401(k) match for nonunion associates. The average hourly rate for our store associates is more than $18 per hour when you factor in our comprehensive benefits that many of our competitors don't offer. We recently ratified a new labor agreement with the UFCW covering more than 13,000 Kroger associates in Columbus, Ohio. The agreement raises starting wages and accelerates wage progressions after 1 year of service. We are currently negotiating with UFCW for contracts covering store associates at Smith's in Albuquerque and Fred Meyer in Portland. Our objective in every negotiation is to find a fair and reasonable balance between competitive costs and compensation packages that provide manageable wages, good quality affordable health care and retirement benefits for our associates. We continue to strive to make our overall benefits package relevant to today's associates. Our financial results continue to be pressured by inefficient healthcare and pension costs, which some of our competitors do not face. We continue to communicate with our local unions and the international unions, which represent many of our associates on the importance of growing our business in a profitable way, which will help us create more jobs and career opportunities and enhance job security for our associates. Turning now to guidance for the remainder of 2018. We continue to expect identical sales growth, excluding fuel, in the second half to be similar to the first half results. We updated our GAAP net earnings guidance to $3.80 to $3.95 per diluted share for 2018 from the previous range of $3.88 to $4.03. The change in GAAP guidance is due to the third quarter market value adjustment of $0.09 per diluted share for Kroger's investment in Ocado shares and does not reflect any future changes in the market value of those shares because those cannot be predicted. On an adjusted basis, we maintained our net operating earnings guidance range of $2.00 to $2.15 per diluted share for 2018, and keep in mind that fiscal 2017 included an extra week. We continue to expect capital investments, excluding mergers, acquisitions and purchases of leased facilities, to be approximately $3 billion for 2018. And now I'll turn it back to Rodney. Thanks, Mike. We're not quite through our first year of executing Restock Kroger, and we feel great about where we are. We are laser-focused on our customers and fulfilling their needs. We are clear on our vision to serve America through food inspiration and uplift. Our 2018 accomplishments and investments set us up well for 2019, and we are committed to delivering on our Restock Kroger financial targets by the end of 2020. We have a clear path through both redefining the customer experience and growing alternative profit streams. Now we look forward to your questions.

I just wanted to ask a bit further on the alternative revenue streams. Since your Investor Day, we, on the phone, of course, have been getting a lot of questions from investors as well around that. You called out today kind of the Kroger Personal Finance seeing nice results there, but can you just kind of give us a little bit more color on that specifically? And just kind of as a category alternative revenue streams, what are some of the puts and takes? We know it's one of the more important components of your EBIT guide.

In the October meeting, we discussed several topics. We highlighted Kroger Personal Finance because we wanted to show that we have a strong history of identifying new business opportunities and growing them significantly. One of our announcements last year was Kroger Precision Marketing, which leverages insights from 84.51°. These initiatives are based on the traffic from our stores and digital platforms, creating a seamless shopping experience for customers. Additionally, they enable our CPG partners and others to target specific consumers effectively. Over the past four years, we have seen a compounded annual growth in profitability of 16%. Looking ahead from 2018 to 2020, we anticipate that growth will accelerate to 28% annually. The progress made in 2018 supports our projected 16% based on historical data. Mike, do you have anything to add?

No. I think Rodney provided some insights on Kroger Precision Marketing. It's noteworthy that it's increased by 150% year-to-date, and the boosted search for a relatively new product generated 700 million product impressions just in this third quarter. Additionally, achieving click-to-conversion ratios that are two to three times higher than the industry average helps maintain that momentum and keeps third parties interested in continuing with the boosted search.

Okay. That's helpful information. As a follow-up, regarding the press release this morning about the price investment commentary, would you say it’s pretty much the usual cadence, nothing unusual? Or did you notice any specific changes in the competition or by category this quarter?

Yes. I would say it was just about executing the overall strategy that we began discussing at the start of the year, which we've been working on for several years. So I wouldn't characterize anything as unusual. As Mike mentioned in his prepared comments, last year's third quarter was higher than the trend line. Additionally, it's important to note that we had a couple of new warehouses starting up and a conversion of a warehouse that also negatively impacted the margins this quarter. These are one-time issues, but it will take a couple of quarters for them to be fully operational in the transition, and that also had a negative effect this quarter.

I would like to ask about the full year guidance and the implications for the fourth quarter. The range for Q4 is quite broad, from $0.38 to $0.53. Could you provide some insights on this and the factors affecting the operating margin? Additionally, could you comment on the guidance considering that gas margins have appeared strong so far this quarter? In the past, when gas margins were strong, you've tended to pull forward expenses into that quarter, so any insights on that would be appreciated.

Sure, Karen. We all agree that the range for the fourth quarter is quite wide, keeping it at $0.15. This is primarily driven by gasoline margins, which have been very volatile in recent weeks. While we've had a strong year, these margins can change quickly, both positively and negatively. To put it into perspective, a $0.01 change in margin per gallon can equate to almost $0.01 per share in earnings. This volatility led us to maintain a wider range. It does not reflect our outlook on how the business will perform in the fourth quarter; rather, it hinges on whether margins will remain strong or weaken in the coming weeks. Because it's difficult to predict these weekly margin fluctuations, we decided to keep the range broader based solely on the potential outcomes for gas margins in the fourth quarter.

Okay. So is it fair to think though if they remain strong, you'll pull expenses into the fourth quarter? Or it's just impossible to predict?

Yes. I wouldn't necessarily expect expenses to be pulled into the fourth quarter. Looking at our position in early December, our promotional activities and advertisements are well established for the upcoming holidays, New Year's, and even as we prepare for late January events like the college football playoffs and the Super Bowl. Those plans are solidified, and the supply chain is prepared for these activities. Therefore, making significant changes in the next eight to eight and a half weeks seems unlikely, and we feel confident about our current plans.

Okay. And then just a general question on the alternative revenue streams. I mean, presumably, those are high-gross margin and this quarter isn't really the quarter to see the flow-through, obviously, given the comparisons from last year, but gross margins were still a little lower than we were modeling. But any color on how to think about how alternative revenue streams will impact reported gross margin ex fuel going forward?

I wouldn't say that we're in a position to provide detailed insights at this time. Your hypothesis is correct; the margins from our alternative profit streams are significantly higher than those of the core business, which is one of the reasons we want to highlight that. Additionally, it's essential to note that these areas are typically asset light. For example, with Kroger Personal Finance, we have a strong partnership with the bank, and the assets required to grow that business are quite modest. Similarly, Kroger Precision Marketing leverages insights and data to generate that revenue stream, making it easily scalable if we can deliver results for our customers. It's an exciting aspect, but I believe it's still too early to provide specifics.

Can we start with just IDs? Could you maybe talk about the cadence of the IDs throughout the quarter? What you're seeing so far in the current quarter? And any update on the optimization drag? I think, obviously, your guidance implies Q4 will be better. I'm just curious as to whether you're seeing some of that yet.

The cadence throughout the quarter was fairly consistent. So far this quarter, we are starting off at about the same level as we ended the third quarter. Considering space optimization and the holiday season, we have remained disciplined to avoid disruptions in stores during this busy time, and we expect those stores to start performing better as mentioned at the Investor Conference. We will begin space operations next year, with some stores launching in January after the holidays. The information I shared at the Investor Conference regarding space operations remains relevant, as the ID sales for those stores have not changed significantly since October.

All right. And then I wanted to ask you about SG&A. It was a positive surprise this quarter, for sure. Can you talk about your ability to drive 20 basis points of OpEx leverage this quarter? And you've been talking about cost discipline, right? Is this now starting to inflect into the P&L? And I'm just kind of curious as we think about things going forward, how we should be thinking about this line item? How important is it to your $400 million over time? Just any color there would be good in terms of like what this quarter means as to how we think about modeling going forward.

Yes. I think what it means is a lot of what you said, and when you look at the areas that I called out in the prepared comments, when you think about retention, and our retention getting significantly better than it has, it does multiple things. One, you don't spend the dollars you have to spend to hire somebody, just the actual hard cost of getting somebody into the system whether you do a background check or any kinds of other screenings on the individual, getting them through a training program and then getting them on to the sales floor, at a productivity level lower than someone who has 6 or 9 months experience. So when you have more and more people who have that 6 to 9 months experience and start to get to the 12 months experience, that helps the productivity inside the store. More people then wind up staying, particularly the part-time workforce, as they start to understand and appreciate, when they're here 6 months, they start to get the benefit of Feed Your Future where they can get $3,500 a year towards furthering their education. That cost, while it sounds expensive, actually will be offset by that person staying for another 12 or 18 months versus having that person turn a couple of times and having lower productivity and training. So you kind of create a virtuous cycle and better opening wage rates, more contemporary benefits, helping them with their college education or GED or English as a second language. We have a lot of folks here work for Kroger in management positions that have decided to go back and get their MBA and other advanced degree certification. So all of those together help with that. We continue to see improvements in our cost to filling our pharmacies. Our pharmacy business continues to be a very strong piece. Our script count on a 30-day adjusted basis continues to grow nicely. And as we leverage that and are able to leverage down our cost to fill prescriptions, that certainly helps.

I completely agree with everything Mike mentioned, and I believe the key takeaway from his comments is important. As we look ahead to 2020, you should anticipate seeing us reduce our operational costs. Mike provided several excellent examples, and our operations team is effectively collaborating with our stores and technology team on innovative ideas to enhance processes and reduce costs. All of these elements are working in unison. Therefore, over the course of 2020, you can expect us to improve our operational expenses.

In light of the fact that space optimization disruption should be a little less in the fourth quarter plus given the re-acceleration of your price investments, should we expect that IDs are going to meaningfully accelerate in the subsequent months over your fourth quarter?

Yes. I believe that the only expectation for ID sales is aligned with our guidance, as we anticipate the second half to be similar to the first half. Our third quarter was nearly on par with the second quarter, and our first quarter performed slightly better than the second. We do have some ground to cover regarding that guidance, but we mentioned similar outcomes rather than exact equals. We are looking forward to a better fourth quarter and are making significant efforts to achieve that, with strong plans in place.

And Mike, what would be the offset to some of those benefits? Are there industry factors, consumer pressures? What are your thoughts there?

I don't know what you mean by offset.

Because you're going to see less disruption from space optimization and you should get a sales lift from the price investments that you've been making, so I'm just wondering if there's offsetting drags to those factors.

Yes. I wouldn't point to any particular offsetting drag as it relates to the top-line. Keep in mind, our fuel rewards program continues to be incredibly important to our customers and our associates when they think about the total value that we give them on a day-in, day-out basis. And that $0.10 a gallon they get off, keep in mind, we reduce reported IDs for that because you have to buy groceries to get the lower fuel discount. Not all of our competitors account for it that way. So as that continues to be popular and more and more people engage in that, we're selling more in the stores, but it actually slows how quickly ID sales grow just because of the way we do our accounting. So there are always puts and takes on that top line.

That's helpful. And my follow-up question is on Kroger Personal Finance. It's been seeing very healthy growth. What's been driving that? And how much of that is the private label credit card?

It's really all of the portfolio of products they offer. So in the last 2 or 3 years, we've done a couple of mergers with Roundy's and Harris Teeter, so there's good growth there. There's good growth in the existing business. And then the credit card business continues to be an incredible tie-in for loyalty for Kroger customers, so it's really all pieces of that business continues to grow. Obviously, credit write-offs are low as well, but that's a pretty small part of the overall impact on the profitability of that business.

In the past, around this time of year, you've provided some initial thoughts about the upcoming fiscal year, at least, on some occasions. Mike, at the Investor Day, you did say, I think, 2019 has to have some, I think, the word you used was decent operating profit margin dollars. I just wanted to see if you could elaborate a little bit on that in terms of what you're expecting next year? Or in general for next year, are there any unique tailwinds, headwinds we should be thinking about? Just opening up that topic if we can.

Yes. I won't go into too much detail about 2019, but if you look back to 2017 and the first quarter of this year, when we discussed bringing some investments from 2019 into 2018, it's clear that operating profit margin needs to increase in 2019 compared to 2018, setting us on a path to generate $400 million over the next three years under the Restock Kroger Plan. I anticipated that we would be asked about this, as we were much clearer during last year's call about our expectations for 2018. At that time, we had a wide range of estimates, ranging from the $1.40s to above $2.20, and we aimed to narrow that range as we approached the end of the year. We knew we would provide guidance in March and did not want such a broad range. I believe people now understand that we are committed to a three-year program. As we shift those investments from 2019 to 2018, we expect them to yield better results in 2019 and even more in 2020. Therefore, it's a three-year growth strategy to reach the $400 million target, and we see a clear path to achieving that.

The other point that I would add, and we talked about it in October, is if you look at digital, our overall digital business continues to be a significant investment for the future of the business. And we would expect for '19, that to become less of a headwind that it was in '18. And that is also an important part to remember as well.

If I examine your SG&A expenses, they decreased year-on-year when excluding the one-time pension contribution from last year and some extra weeks. This marks the first decline in at least 22 years according to my analysis. While I understand you are becoming more efficient with store associates and that Personal Finance is a variable SG&A item, I am still uncertain about why that decline was so abrupt. Your SG&A was $200 million lower than expectations from analysts. Can you provide some clarity on what caused this significant change in the quarter, or perhaps we miscalculated and overlooked something?

Yes. From a dollar standpoint, Ken, don't forget that last year would have had the C-stores in our OG&A rate and they're disposed of now in our dollars.

Yes. But last quarter, in the second quarter, you were still up year-on-year with SG&A, so it was a bit of a dramatic change. I can follow up offline if needed; I don't want to hold everyone up on the call.

Hold on one second.

Ken, they're pulling up stuff to talk.

I'm sorry, I didn't mean to do this.

Yes. We experienced a slight increase in the second quarter. I would attribute this to the fact that in the prior year, we had some reductions in bonus accruals due to the direction the year was taking, which we did not see this year.

So as it was noted, you guys are doing quite well in OG&A but gross margins were a bit lower than what we were all expecting. Mike, can you just maybe help ballpark the impact on gross margins based on the noted items that you called out? And I know you don't necessarily like to guide to any one line item, but just given the particular strength in fuel margins that we're seeing quarter-to-date and how that plays into overall earnings, can you give us a sense of just how to think about gross margins ex fuel in Q4?

Yes. If you think about that margin rate in Q4, I'm more comfortable doing that than listing out the effects in any one quarter of some of those things because 1 quarter is not an indication of where they go long term. The one I did call out is Kroger Specialty Pharmacy. It's a very profitable business. It has a very low margin rate. But because of the individual cost of those prescriptions for the patients, it generates very strong gross margin dollars which is why we're in that business. And as that business continues to grow, it will be a headwind. That one alone was a double-digit basis point headwind, but I won't give the exact amount. When you think about the fourth quarter, you should probably think about the fourth quarter change in gross margin rate the way we talk about that basis point change being more similar to the second quarter than the third quarter.

Okay. That's helpful. And then just my follow-up. Over the last couple of weeks now, we've seen several sizable product recalls. And I think some of it was even specific to the Kroger brand in both meats and pet food. So I'm just curious on what Kroger has been doing of late or what it plans to do when it comes to supply chain and improving sourcing helping mitigate recall costs.

Well, if you look, food safety has been something that Kroger has been incredibly proud of for many, many years. And we have a team of folks here that, that is their only responsibility is to make sure that products are safe throughout the food channel. We will do routine audits of our suppliers as part of that process. One of the things that we are incredibly proud of is, in the unfortunate situation where there is a recall, we reach out to our customers and let them know that there's been a recall on products they bought so that we try to get that customer to get the product back to us as quickly as possible to make it easy on them and to let them know. It's something that we also review with our board on a regular basis. If you look at severity of incidents, we've actually, over the last 5 or 6 years, seen a decline in severe incidents. Now if you look at overall recalls, it continues to increase just because I think the overall food safety chain in the U.S. continues to improve.

Okay. And maybe just 2 quick housekeeping questions. What was inflation, deflation in the quarter? And was there any notable call-out from hurricane impacts on the comp or expenses in the quarter?

If you consider the impact of the hurricanes, it slightly affected ID sales. We didn't highlight it much because the effect wasn't dramatic—just a few basis points. It was significant enough, but not enough to drastically alter the overall outcome. Regarding your question on inflation and deflation, looking at my chart, which is formatted for clarity, we saw about 11 basis points of inflation when excluding fuel and pharmacy. Including pharmacy, the inflation figure rose to about 22 basis points. Overall, it was a mild environment, with some categories experiencing a bit of inflation and others showing considerable deflation.

So on capital allocation, I was curious how quickly you anticipate being back to that 2.3 to 2.5x leverage ratio. And then as we look out to next year, I know you have a $1 billion term loan coming due. So just curious if you have any initial thoughts in terms of whether you would pay that down or refinance that debt.

We actually have about $1.1 billion of long-term debt that is now classified as current and is due in the next 60 to 90 days. Some of it is due this month and some next month, and we expect to refinance that in the market. We have forward starting swaps for both types of debt we anticipate issuing at favorable rates. The 30-year hedge is nearly 100 basis points below the current 30-year rate, and the 10-year hedge is close to that but not quite as strong. We haven't finalized our decision regarding the term loan. Some of our banks have a positive view of the business, while others do not. However, we have enough capacity with commercial paper to pay off the term loan if we decide to. We will have a financial policy committee meeting with our board in January to discuss our flexibility. Rolling over the term loan would maintain more revolver capacity to manage daily fluctuations. We maintain ongoing communication with the rating agencies regarding our net total debt-to-EBITDA range. They are aware of our program, and we are executing it as described to them to sustain our ratings.

And it's important for us to get back into the range.

Okay. Great. And then switching topics on price investments, they clearly accelerated in the past quarter or two. So I'm curious whether the volume increase so far is meeting your expectations.

Yes. I wouldn't say that they clearly accelerated. If you look at each quarter this year, we mentioned at the end of the first quarter that we started making the pull forward investments in the fourth quarter. From that perspective, it's reasonable to say that we began those pull forward investments then. I don't view the third quarter as a significant increase in our price investment plans for the year. We're simply continuing to make price investments throughout the year, and it's more a matter of how we executed price investments last year, which was a bit more uneven than this year.

And are they meeting your volume expectations as far as the volume uptick...

We are pleased with the results of our plan, which involves multiple investments across various areas. As with any strategy that encompasses a broad spectrum of initiatives, some are performing better than anticipated while others may not meet expectations. While not every investment is flawless, we regularly review and evaluate the outcomes. In general, we are satisfied with our investments. I want to clarify that it's unrealistic to expect perfection from every single one, but collectively, we feel positive about the overall performance. For those initiatives that are successful, we plan to expand them, while for those that are underperforming, we will make adjustments or explore alternative options.

Just to follow up on the price investment first. Can you give us some insight into how internally the decisions are made around seeing better fuel profitability and kind of how quickly you can turn that into pulled forward price investment. And then how should we think about that pull forward? Does it actually offset investments that you may have made next year? Or since the environment is so competitive, is there just this race to the bottom with everybody?

I don't believe that when fuel profitability is high, it necessarily means we invest more in prices, which then reduces our gross margin. For this calendar year, we had a specific price program as part of Restock Kroger and we were clear about our investment strategy. The Tax Reform Act allowed us to reduce our cash taxes, and we decided to move some investments from 2019 to 2018 to clear that expense early on. The lower taxes are expected to enhance growth in those areas as we approach 2019. I wouldn't say we've made significant changes to pricing due to strong fuel margins; it's just how the situation has unfolded.

Yes. The other thing, I think it's always important to remember when we go to market, our fabulous associates in terms of the great experience they deliver in fresh products is also important. So for us, it's the overall shopping experience that we're trying to create for the customer. And we're aggressively investing in the Anything, Anytime, Anywhere so they can do it anyway they want to, whether that's digital, delivery, pickup or physically in a store and have the same great experience and great fresh product in all those together.

Okay. And then just a quick follow-up on the OG&A line. I would say, historically, your unionization was thought of as kind of a knock on the business. And today, I would say that the expansion into online and digital is seen as needing incremental investment in OG&A. But would you say we're at a point where the unionization may be helping you in some ways, given the tightness of the labor environment? And is there anything you can do to dispel online grocery necessarily adding meaningfully to SG&A or bringing down the margin there?

When examining our overall workforce, we acknowledge that Kroger is not entirely unionized. Comparing results in unionized and non-unionized markets reveals there isn't a significant difference in aspects like employee relations and satisfaction, especially regarding wages. We provide all associates with excellent healthcare options; those in unions typically are in a defined benefit plan, while some non-union associates might be in either a defined benefit or defined contribution plan, resulting in a varied benefits mix. Regarding home delivery and online services, there are substantial costs involved, which led us to partner with Ocado to establish fulfillment centers, the first of which is being built in Cincinnati. While some expenses will be added to the overall supply chain, other costs will be reduced thanks to greater efficiency from robotic picking, which completes a 50-item order much quicker than in-store processing. Our approach shifts the product journey from manufacturer to Ocado warehouse, then directly to customers, creating different efficiencies that we believe will help alleviate concerns over additional costs.

Could you speak to any additional color around your digital business? I know you mentioned up 60%. Just kind of what you're seeing out of Kroger Ship versus pickup and Home Chef. In addition, if you can maybe just speak to the new pilot with Walgreens.

There are many questions to address, so I will try to organize my thoughts clearly. As mentioned, our digital business grew over 60%. Every part of the digital business is continuing to expand. The primary factors driving this growth are our ongoing efforts to increase locations for customer pickup and delivery. From an online perspective, the stores that had these options last year are still experiencing growth, along with Home Chef, which is performing exactly as we expected from a growth perspective. If we look at Ship and other areas, it's still quite early in development. We had substantial initial costs to set up systems rather than focusing solely on sales, but we anticipate that over time it will shift toward being more sales-driven as it matures. Our relationship with Walgreens excites both companies, but we recognize the need to start small and learn from this collaboration. Our priority is to take gradual steps and find solutions that benefit both Walgreens and Kroger customers, allowing us both to grow and profit. What excites me most is the enthusiasm and collaboration between our teams as we seek out opportunities that are beneficial for our customers. However, it is still too soon to provide more specific details.

I appreciate the color. And then just to quickly circle back on inflation or lack thereof. It's clearly a benign environment in terms of the impact to your third quarter results. I just wanted to just circle back on your outlook as you think about what's to come over the next few months. Any change in your outlook on inflation, deflation impact to your results?

I don't see much in the market right now. There’s a lot of talk about CPG companies raising prices, but we’ll wait to see how that plays out and how others respond. When discussing inflation and deflation, it's important to remember that it relates to Kroger specifically, not the broader market. We're comparing our current cost of goods to last year's. A crucial factor in generating the $400 million of operating profit over the next three years is improving our cost of goods. Some of the deflation we’re seeing is a result of our efforts to secure better pricing at Kroger, which may not be mirrored elsewhere.

The other thing, I think it's always important to remember is I always think it's a dangerous thing for CPGs to raise their cost more than what the economic cost of something increasing. And what we find, over time, when somebody does that, our own brands will pick up a disproportionate amount of share whenever somebody does that. So to me, it's a fine balance that we're all doing to try to find what's that optimal price point.

I have a couple of quick questions. Mike, could you provide us with the traffic versus ticket data for the quarter? Rodney, could you share your thoughts on the customer sentiment during the quarter? Did you notice any differences? Are you seeing customers upgrading their purchases? Also, sorry if I missed this, but is the number of loyal households still growing in the third quarter like it has in previous quarters?

When you look at, overall, the basket value grew a little bit in the quarter, and that's primarily a result of the mix of what's going inside the basket. When you look at transactions in the quarter, when you add in all of the entities, it was up a little bit in the quarter as well.

The tone of the customer continues to reflect a positive sentiment about the economy. People are still buying wine and anything that enhances their lives, showing a willingness to spend. Additionally, we experienced slight growth in households. We have strong confidence in the future of Kroger, particularly with Restock Kroger. An exciting aspect of our earnings call is that many of our associates participate to gain a better understanding and insights into our business. Many of our associates are also shareholders. Therefore, before concluding today's call, I'd like to share a few final comments addressed to them. Last week, we celebrated Giving Tuesday. In conjunction with our partner, Feeding America, we set a goal to raise enough money to provide 4 million meals to those in need during this holiday season. Together with our customers, we raised enough to serve almost 6 million meals, helping us move closer to our Zero Hunger | Zero Waste goal of eliminating hunger in our communities. Last Friday, a major earthquake rattled Alaska. We operate 7 Fred Meyer Stores that were affected. And thankfully, all of our associates and customers inside our stores were safe. I'm so proud of the awesome job that Fred Meyer and Kroger team did. Under the leadership of Joe Grieshaber and our teams, everybody worked together to get all our stores opened within 1 day. Each holiday season, I'm reminded of our privilege to serve more than 9 million customers who shop with us every day. Every celebration or tradition is as unique as the customer who walks through our door. Among the hustle and bustle of the season, you welcome our customers and help to make their celebrations brighter. We lift our customers' spirits and they uplift our spirits as well. These are just a few examples of what it means to live our purpose to Feed the Human Spirit. It's an amazing thing of what we can do together. Thank you for all you do for our customers, communities and each other. Merry Christmas, Happy Holidays and Happy New Year to you and your family and all those listening in. That completes our call today. Thanks for joining.