Kroger Company (KR) — Q2 2020 Earnings Call Transcript

Thank you, Gary. 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 second 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. In addition, please save the date for our 2019 investor conference, which will be held in New York City on November 5. Further details will be shared soon, and we hope you can join us.

Thank you, Rebekah. Good morning, everyone, and thank you for joining us. With me today to review Kroger's second quarter 2019 results is Chief Financial Officer, Gary Millerchip. Kroger is focused on executing the second year of our Restock Kroger plan to generate shareholder value by serving America through food inspiration and uplift. Restock Kroger has four main drivers: redefining the grocery customer experience, partnering for customer value, developing talent, and living our purpose. Combined, these drivers come together to create shareholder value. We are halfway through the second year of our three-year plan. We continue making strategic investments to reposition the company for the future while also growing and delivering today. We started this conversation in the last two quarters by acknowledging we had our work cut out for us. As always, we are energized by that challenge. While we continually strive for improvement, there are several examples in our second quarter results that reflect the disciplined focus of the Restock Kroger blueprint paying off. Guided by our customer obsession, Kroger delivered our best identical sales results since launching our transformational plan. Our internal customer measures are improving even faster than our identical sales growth. There will always be a lag between enhancing the customer experience and when customers respond positively. Some other positive trends during the second quarter include stable FIFO operating margins in our supermarket business, excluding fuel and pharmacy. Fifteen of our divisions reported increasing supermarket identical sales without fuel compared to the first quarter. We are continuing to reduce costs and are on track to deliver $100 million in incremental operating profit through alternative profit stream growth. Additionally, we are making significant investments to redefine the grocery customer experience. We are building a platform of seamless experiences to serve customers anything they want, anytime they want, anywhere they want. We know that a seamless experience is essential to the customer experience, both today and tomorrow, which is why we continue investing heavily in our capabilities in this area. Kroger's digital sales grew by a solid 31% in the second quarter. Pickup and delivery sales growth continued to perform in the mid-30% range during the quarter. Going forward, we expect our digital sales growth rate to moderate year-over-year, primarily due to cycling Home Chef and as a result of our disciplined focus on growing the Ship customer from our other digital offerings like Vitacost. Vitacost remains an important part of our business, and our growth in Ship is partially due to the gains we've made from their platform and talent. We have also expanded our digital coverage area to reach 95% of our customers. This means that 95% of our customers who shop Kroger at our physical stores can also shop for pickup or delivery. Importantly, we are starting to see improving operating profit trends in our digital business. Our digital business is becoming less of a hindrance, which marks an important inflection point, and we continue to invest in new capabilities to support our transition to seamless. However, I want to emphasize that this is still a significant investment for the company. A great example of partnering for customer value is our ongoing rollout of Ocado sheds. In July, Kroger and Ocado announced plans for a new high-tech customer fulfillment center in Forest Park, Georgia. What is exciting about Ocado is that their model for delivery is significantly less costly than our existing model. So, the sheds will not only accelerate our ability to provide customers with a seamless experience, but they will also enable us to do so in a more cost-efficient manner. We understand that Ocado's value lies not just in its current capabilities but also in how quickly the company can innovate to serve a rapidly evolving online consumer market. Ocado's technology team of over 1,400 software engineers brings a vast depth of expertise and a long record of innovation to the growing opportunities in online grocery retail. We also announced an expansion of our relationship with Walgreens into a new test area in Knoxville, Tennessee. Starting this fall, 35 Walgreens stores in that area will feature a curated selection of Kroger's popular Our Brands products, including Simple Truth, America's largest natural organic brand, along with national brand products. Kroger's Our Brand sales increased by 3.1% this quarter. Retail and unit share growth led to the highest second quarter share in the history of Our Brands. We introduced 203 new Our Brand items during the second quarter. Our customers' favorite new items align with key food and flavor trends we predicted and shared with our investor community last year at Investor Day. Those new items generated more than $137 million in incremental sales during the second quarter, further supporting our supermarket business. We are pleased to announce that Kroger is leading the way with the widest assortment of plant-based protein among U.S. retailers through our Simple Truth brand. We continue to see progress in alternative profit streams, with Media and Kroger Personal Finance as the primary growth drivers. Gary will provide further commentary on the progress of our alternative profit streams in his section. Regarding talent development, we are proud that our average hourly wage exceeds $20 per hour, inclusive of comprehensive benefits that many of our competitors do not offer. As a result of our investments in talent development, we are significantly improving employee retention in one of the tightest labor markets in years. We continue to invest in our associates as part of Restock Kroger by offering various support, including wage increases, training, and development. Our Feed Your Future education assistance program is leading in the industry and continues to gain momentum. Among all participants, over 85% are hourly store associates. Since the program began last year, we have awarded 3,000 awards totaling $5.1 million in education assistance. In addition to developing talent internally, we continue to recruit external talent, particularly in the areas of digital, technology, and supermarkets. Increasingly, customers, associates, stakeholders, and U.S. investors are choosing partners based on purpose and values. We were pleased to see the business roundtable's recent announcement acknowledging that businesses have a responsibility to positively influence society. Kroger has always focused on being a trustworthy partner in communities and committed to social responsibility. In the second quarter, we were proud to publish our 2019 environmental, social, and governance report, reflecting our efforts to be environmentally responsible and a positive influence on society. The report highlighted our progress on Kroger's Zero Hunger | Zero Waste social impact plan as well as our 2020 sustainability goals. Other highlights included our 9% reduction in food waste generated by retail stores, as well as a 13% improvement in supermarket food waste diverted from landfills, increasing diversion from 27% in 2017 to 40% in 2018. We have reduced the amount of plastic resin in Our Brands packaging by 9.1 million pounds so far, well on track to achieve our goal of reducing 10 million pounds by 2020. I will now turn it over to Gary for more detail on our quarterly financials. Gary?

Thank you, Rodney, and good morning, everyone. Our second quarter results show our ability to deliver for shareholders while we transform the company for the future with Restock Kroger. For the quarter, we achieved an adjusted EPS of $0.44 per diluted share. I want to highlight a few areas of our business that performed particularly well. Our Brands played a significant role as both a sales driver and a profit leader. The entire Kroger team effectively controlled costs during the second quarter and executed our Restock Kroger savings plans. The alternative profit businesses met budget, positioning us to achieve our additional operating profit target for 2019. Additionally, our fuel performance was strong, helping to offset challenges from pharmacy gross margin, LIFO, and taxes this quarter. The LIFO charge for the quarter was $30 million compared to $12 million during the same period last year, largely due to higher-than-anticipated inflation in dry grocery, pharmacy, and dairy. Our adjusted corporate tax rate for the quarter was 23.9% compared to 18% in the prior year. These two factors combined resulted in a $0.05 per diluted share headwind compared to last year. As Rodney noted, Kroger reported identical sales growth without fuel of 2.2% during the second quarter, marking our most successful quarter since we initiated our transformation plan. Several departments exceeded company performance in the quarter, including key beverage categories, produce, and natural foods. We were also pleased with the sales momentum in our pharmacy business, which saw a mid-single-digit increase in script counts. Overall, we are satisfied with our sales progress this quarter and will continue to build on this momentum in the second half of the year. Adjusted FIFO operating profit for the second quarter was $626 million, a 10.6% increase compared to the second quarter of 2018. Gross margin was 21.9% of sales for the second quarter. FIFO gross margin, excluding fuel, decreased by 29 basis points from the same period last year, mainly due to industry-wide lower gross margins in pharmacy and continued growth in our specialty pharmacy business. Retail supermarkets, excluding fuel and retail pharmacy, experienced a gross margin investment of 12 basis points. We are focused on balancing margin investments and capturing savings from cost of goods and operational efficiencies to offset these investments. A great example of this focus is our associates successfully managing shrink, which improved in the second quarter compared to last year, marking the eighth consecutive quarter of year-over-year shrink rate improvement. OG&A costs as a percentage of sales, excluding fuel and adjustments, decreased by 14 basis points. This reduction was achieved through our efforts to execute Restock Kroger initiatives that enhance administrative efficiencies, store productivity, and sourcing cost reductions. We consistently seek opportunities to enhance free cash flow and ROIC, which are critical metrics for Kroger shareholders. During the quarter, we accepted a substantial offer to sell an unused warehouse that had been on the market for some time. Kroger applied the profit from this sale to contribute a similar amount to the UFCW company pension plan, thereby helping to stabilize associates' future benefits. The net effect of these transactions on EPS growth was neutral. Fuel remains an essential part of our strategy to engage customers, and our loyal customers continue to enjoy hundreds of millions of dollars in fuel rewards annually through price discounts at the pump. The average retail price of fuel was $2.71 this quarter, compared to $2.85 during the same quarter last year. Retail fuel profit exceeded our expectations for the quarter. Our cents-per-gallon fuel margin in the second quarter was $0.35, up from $0.26 in the same quarter last year. Fuel exemplifies how Kroger's sourcing teams have improved buying practices, allowing us to enhance fuel cost of goods during the second quarter. We now anticipate that fuel will be less of a headwind in the second half of the year than we initially expected. Alternative profit streams are on track to generate an additional $100 million in operating profit in 2019, with media and Kroger Personal Finance being the main growth drivers this year. Kroger Precision Marketing continued to gain momentum in the quarter, engaging over 300 consumer packaged goods companies and achieving a 90% retention rate, along with significantly higher spending. Kroger Personal Finance also grew in line with our expectations, successfully expanding the customer base and increasing utilization frequency. Now, for an update on labor relations. We ratified a new labor agreement with the UFCW covering associates in Fort Wayne, Indiana; Louisville, Kentucky; and Nashville, Tennessee, during the second quarter. We also reached a tentative agreement with the UFCW for 17,000 associates in our Ralphs division in Southern California earlier this week. Currently, we are negotiating with the UFCW for contracts covering store associates in Las Vegas, Memphis, Portland, and Seattle. Our goal in every negotiation is to find a fair balance between competitive costs and compensation packages that offer solid wages, quality health care, and retirement benefits for our associates. We strive to make our overall benefit package relevant to today's workforce. Our financial results continue to face pressure from inefficient health care and pension costs, which some of our competitors do not experience. We maintain communication with our local unions and the international unions representing many of our associates about the importance of growing our business profitably. This approach will help us create more jobs, career opportunities, and enhance job security for our associates. Our financial strategy emphasizes using our strong free cash flow to drive growth while also sustaining our investment-grade debt rating and returning capital to shareholders. We actively balance cash flow usage to achieve these objectives. We are committed to prioritizing free cash flow to bring our company's net total debt to adjusted EBITDA ratio within our target range of 2.3 to 2.5. Over the past 12 months, we have reduced net total debt by $1.3 billion, and Kroger's net total debt to adjusted EBITDA ratio stands at 2.46 for the second quarter of 2019, compared to 2.59 a year ago. We are committed to reaching our target net total debt to adjusted EBITDA range, and as we consistently operate within that range, we will consider options for returning additional capital to shareholders. Earlier this year, Kroger raised the dividend by 14%, marking the 13th consecutive year of dividend increases. Now, regarding our guidance for 2019. We expect identical sales growth, excluding fuel, to be between 2% and 2.25% for 2019. We also expect adjusted net earnings to be in the range of $2.15 to $2.25 per diluted share and adjusted FIFO operating profit to be between $2.9 billion and $3 billion for 2019. We are pleased with our progress in the second quarter and are maintaining our full-year guidance. However, with ongoing pharmacy gross headwinds anticipated in the second half of 2019 and as we compare to particularly strong OG&A performance in the third quarter of 2018, we now expect EPS to be flat in the third quarter of 2019. For the fourth quarter, we anticipate double-digit EPS growth as we compare to unique items from the previous year and continue to gain strong momentum with our alternative profit streams.

Thanks, Gary. As Rebekah said earlier, our Annual Kroger Investor Day is coming up in New York on November 5. As Gary just mentioned, we reconfirmed our 2019 guidance for identical sales, excluding fuel, adjusted EPS, and adjusted FIFO operating profit as well as reconfirmed that we are on track to deliver $100 million in incremental operating profit through alternative profit stream growth. We want to be clear on today's call that we are not reconfirming the 3-year $400 million in incremental operating profit expectation. In November, we will give detailed 2020 annual guidance. I do want to highlight that we do expect to deliver FIFO operating profit growth in 2020 over 2019 confirmed guidance. We have outlined a handful of key goals for our Investor Day and would like to use this opportunity to provide you with a preview. At Investor Day, we plan to reinforce our commitment to the overall framework of our Restock Kroger transformation plan, sharing what has worked well and what has not worked well thus far. We intend to do a deep dive into our supermarket business, which underpins the redefining grocery customer experience pillar of Restock Kroger. November 5 is the appropriate forum to be deliberate and to allow the experts on our team to spend the proper amount of time with our financial stakeholders to explain how we are thinking about Kroger's business model and how to measure the shareholder value created by Restock Kroger. Several of our senior executives will give detailed updates on our progress against the key metrics in our supermarket business and our momentum as well as how we think about it going forward. We will reiterate the ongoing successful results behind our asset-light, margin-rich alternative profit businesses. We will also talk about the continued strength in free cash flow since the announcement of Restock Kroger, which enabled us to get back to within our net total debt to adjusted EBITDA range earlier than expected. In addition, we will share our views on the business as we look further out beyond 2020 where growth is expected to continue. I've said it many times before. Transformation is incredibly difficult, and that's the journey we are on with Restock Kroger. As we reflect on this journey, we want to be transparent about what went according to plan and what didn't go as anticipated. Some things are coming to fruition as we expected but just later than we thought such as identical sales momentum. Some things were unanticipated such as the lower gross profit margin in the pharmacy business that the entire industry is experiencing. Things we did expect and that are going even better than we thought include productivity improvements and cost savings. Over the course of the 3-year plan and today's retail environment, there are lots of puts and takes. That said, I want to reiterate that Kroger is committed to FIFO operating profit growth in 2020 over 2019 confirmed guidance. The Restock Kroger transformation journey sets the company up for long-term growth looking forward. And the benefits we have seen thus far have helped Kroger in our transformation from grocer to growth company. We have the right overall strategy and framework for this business and look forward to telling you more about it in November. Now Gary and I will take your questions.

Congrats on a good quarter. So first, I guess on the comp acceleration, I was curious if you can give some more color in terms of whether you saw improvement in traffic or ticket. And also, what do you believe contributed to the comp acceleration during the quarter?

Yes. As I mentioned in the call, in the prepared remarks, it was broad-based across most divisions. The area that we saw the biggest year-on-year improvement is average spend per item. Customers continue to go upscale and buy bigger product sizes. We also saw continued improvement in loyal households in terms of the numbers and the frequency of their visits. The other pieces to me that I was especially proud of our team is it's broad-based and it's really using our data to connect with customers one on one.

Rodney, I'd like to add a few points. As Rodney mentioned earlier, we are noticing many of the factors we outlined at the beginning of the year regarding the accelerators we anticipated would enhance ID sales, and these are now becoming evident in the metrics we track. As you may remember, we discussed that as we start to reflect on the larger price investments from last year and the space optimization changes made primarily in Q2 and early Q3 last year, we are observing improvements in the customer metrics we monitor internally, which are beginning to reflect a positive trend in sales performance. Although, as we noted on the call and in the press release, the absolute growth in digital sales was at a lower rate due to the adjustment for the Home Chef acquisition from a year ago, ClickList and home delivery are still performing reliably well and contributing to significant growth. We anticipate these elements will continue to strengthen, which aligns with our expectations for Q2, Q3, and beyond. We are seeing many of the factors we expected begin to materialize in our results.

Great. And a quick follow-up question. Any color you can provide in quarter-to-date trends?

Looking at the current quarter, it’s clear that a year ago, a hurricane significantly impacted a couple of our divisions. Excluding those two divisions, we would be slightly ahead of our results from quarter 2, though it's just a marginal improvement. I've decided to exclude those divisions since it’s challenging to predict our overall position until we fully cycle through the effects. However, we are making continued progress.

So Rodney, curious, your take on the pharmacy business, right, where it sits today. Obviously, it looks like a fair bit of pressure on EBIT margin. How transitory do you think that is? And when you think about that business long term, I know you've always wanted to kind of own that customer because of the loyalty factor. Do you think about ways to do something with that business, right, to alleviate the pressure on the P&L?

One point you made is incredibly important. The pharmacy customer is very loyal to Kroger, and their total spend makes them a fantastic customer to have. Overall, the pharmacy business remains highly profitable relative to the invested assets. There are year-on-year headwinds, but the business continues to show strength. Additionally, our pharmacy team has done an excellent job identifying opportunities for growth, which brings benefits and has led to significant cost reductions. While these cost-saving measures have helped alleviate some of the gross pressures, there is still more work to be done in terms of cost reduction and process improvements. Overall, I am very excited about the progress we're making, and looking ahead, I believe the pharmacy business will remain a critical component of our overall strategy.

Okay. And then secondly, when you think about the Ocado rollout, right, one, much pressure on 2020. I know they won't open until '21 and probably a little pressure on '20. But then secondly, do you yet have sort of an ideal budget for the Ocado progression, right? From day 1 it opens, the shed is unprofitable by some amount and the time to profitability is x number of months or quarters. I know it's theoretical, but have you been able to get your arms around that?

We have some estimates regarding expectations that vary between existing and new markets. In a new market, it typically takes longer to reach profitability compared to an existing market where you can transition volume right from day one. Our projections are based on Ocado's experience in their ramp-ups in England, adjusted for U.S. store traffic patterns, customer locations, and labor costs. Until we open a facility, we can't confirm if our assumptions are correct. Generally, we anticipate that a facility will reach profitability sometime between the second and third year. However, only time will reveal the accuracy of these estimates, which are informed by Ocado's past experiences. Additionally, we hope to see improvements in ramp-up time with each new facility Ocado opens. We also have the advantage of learning from Ocado's upcoming facility in Canada, which is not currently accounted for in our budget, highlighting their trend of improving performance over time.

We are gaining valuable insights as we witness the digital evolution of our customers and their engagement with us. We have a clear framework for our expectations, but this framework is continuously adapting as we observe changes in customer behavior regarding home delivery and in-store pickup. We are committed to optimizing our efficiency and innovation with Ocado to support the entire digital ecosystem. This remains an exciting area as we consider how customer behavior will evolve and how Ocado can address these future needs.

Yes. And Gary just implied and I talked about it in the prepared remarks, Ocado is significantly more efficient than the way we're doing it today.

Rodney, I wanted to ask you about 2020. I know you mentioned that you anticipate growing FIFO operating profit. While you didn't want to go into too much detail, I was hoping you could share some additional insights on the key drivers behind that. I also wanted to address the fact that you've pulled guidance, which is understandable since expectations were low. However, this has created uncertainty for investors as we are unclear on your outlook. Is there at least a minimum expectation you could share today to give us a better understanding of your thoughts on 2020 and the direction of the business?

Yes. A couple of comments. And as you mentioned, we'll get to a whole lot more detail in November on all the pieces, and we'll also talk about 2020 and beyond. If you look at the key drivers, it would continue to be identical sales growth. Obviously, managing our gross profit margin. We continue to find a lot of cost opportunities, everything from process changes to cost of goods to goods not for resale. And in fact, one of the things that we're identifying there is there's a longer stream of opportunities than what we had even originally expected as part of Restock Kroger. On the guidance for 2020, that was the reason that I made the comment that we did want to be clear that we expect 2020 operating profit dollars to grow over 2019 provided guidance, just to make sure that people understood that we do expect a growth. We're in the middle of the process, and it's a process normally we wouldn't finish until March of next year when we would give this next year guidance. We are accelerating it until November because we think it's incredibly important to do that, but we are in the process on specifics. But we did want to make sure that everybody understood that we do expect growth.

Can we expect your gross margin, excluding fuel and pharmacy, to continue flattening out over time? Additionally, historically, you have been effective in returning cash to shareholders, especially through share buybacks when your stock is viewed as undervalued. Could this become a bigger focus next year?

Thank you for the follow-up questions. This is Gary. I'll address them in the order you asked. Regarding gross margins, we are continuing to invest in pricing. As Rodney mentioned, there are substantial offsets in the investments we are making and how we manage our cost of goods. Over time, as we’ve indicated with the reclassification of alternative profit, we expect this to also provide support for our margins. While we believe that pricing investments are a critical part of our strategy, we anticipate it will look different from the investments in 2018 and 2017 when considering 2019 and the rest of the year. We leverage our data and insights to understand what matters to our customers, ensuring we are pricing products appropriately, especially those most important to them, both through everyday pricing and personalized offers, with 96% of our data connected to loyalty cards. However, customer insights tell us it’s not solely about price; customers choose to shop at Kroger for value, product quality, personalization through our data, freshness, and overall experience. We are confident in our plan for the remainder of the year and into 2020 regarding how we will manage these factors. Concerning free cash flow, to address your second question, I want to reinforce a few comments from our prepared remarks. You should expect Kroger to continue focusing on maximizing free cash flow for our shareholders. We are now within the target range, and it is important to us to consistently maintain this range, especially given the inherent volatility of retail. Now that we are there and anticipate generating free cash flow, we will closely evaluate the best ways to return capital to shareholders.

It's also a follow-up on 2020. You mentioned that your cost takeouts and your productivity initiatives are doing better than what you previously expected. But obviously, for you to back off some of your prior target, there are things that are not going as well as you anticipated. So can you give us more detail whether it's your ID sales growth, the market being tougher than you expected, the alternative profit stream. On each of those different levers, can you give us more detail on what's not going as well as you expected?

Sure. A couple of those points relate back to what we've discussed previously. The pharmacy aspect is obviously performing at a different level than we anticipated based on the structural changes in the market that have impacted everyone in the industry. Identical sales are progressing, but it's taking longer than we had expected. On the other hand, alternative profit is exceeding our forecasts and is growing robustly. We will provide more details in November. Additionally, we continue to identify significant opportunities for productivity improvements and cost reductions, even more than we initially projected. Just to reiterate, we are eliminating over $1 billion a year in operational costs.

My follow-up question, Rodney, is regarding the assumptions you made about the competitive landscape when you created this plan, considering both traditional retailers and the growing digital competition. How does the current market environment compare to your expectations? Since you are adjusting some of these targets, it seems like the situation is more challenging than you initially thought. Is that correct?

When assessing the overall competitive environment, it remains quite similar to our initial expectations, with the exception of the pharmacy sector that I previously mentioned. We anticipated that new operators would continue to play a significant role. Since merging with Harris Teeter, we have been proactive in ensuring a seamless customer experience and a robust digital offering. My top priority is to retain our customers; our secondary goal is to find profitability. We are neutral regarding whether customers prefer to shop online or in-store. Furthermore, this quarter, we observed a reduced headwind in digital performance compared to the same quarter last year. Overall, our expectations have largely been met, although the pharmacy sector requires a different approach, and we recognized the need for a transitional phase to transform the company, which is the motivation behind our Restock Kroger commitments.

Maybe just a couple more follow-ups. I think like Ed said, it's not a big surprise that the guides pulled. Can you clarify if it's just the operating profit piece that's pulled? Is the free cash flow guide still intact? Or is everything gone?

Thanks for the question. So as Rodney mentioned, we really plan to give you far more detail in November. And we felt it was really important that we committed to doing that in 6 or 7 weeks from now to be able to provide all the color. We still have obviously huge confidence in the level of free cash flow that we're generating within the company and continues to be a strength in this year. I do think we would want to provide additional guidance on that alongside, as Rodney mentioned, our future financial strategy and how we create value for shareholders at the November meeting.

Okay. That certainly makes sense. And kind of in terms of what hasn't gone right versus what has, I would imagine that this quarter gives you more confidence in kind of the go-forward process. ID is above 2%, gross margin ex fuel and the pharmacy down in the low double-digit range. Is part of the, I would say, pulling or pushing out operating profit dollar growth to perhaps beyond 2020, is part of that getting back to a more normalized supermarket operating environment and delivery of supermarket operating income growth? And can we expect that kind of this quarter and the guidance for the next couple quarters is indicative of what you think a normalized level is?

We'll provide more details in November. However, I want to add a couple of comments related to your points, which I previously mentioned during the first quarter earnings call. When we analyze the feedback from customers regarding their experiences with us, we notice a consistent delay between sales performance and customer perceptions of improvement. In the second quarter, we felt that this was evident and we are committed to enhancing the customer experience. I believe it would be more beneficial to discuss this in detail come November when we can go through everything thoroughly. It's also important for everyone to realize that we anticipate operating profit growth in 2020, compared to our confirmed commitment in 2019.

Could you provide some insights on market share for the quarter compared to your market share trends from previous quarters? Achieving 2.2% is significantly higher than industry scanner data.

Yes. If you look at market share overall, we would say it’s essentially flat. It might be slightly up or down, but we are not satisfied and believe it is heading in the right direction.

I have two questions. Rodney or Gary, regarding the ongoing rollout of delivery and pickup, could you help us understand how that will affect your EBITDA margin? Will there be a point later this year or next year where you start to see alleviation from the pressures associated with that rollout? Any insights on this would be appreciated. Additionally, I'd like to follow up on the dry grocery inflation commentary. Is that trend gaining momentum? Is it driven by pressure from CPG companies? Could this be a tailwind for IDs in the latter half of this year and possibly into next year? That information would be helpful as well.

Thanks, Robby.

We are very excited about how customers are engaging with us as they become more seamless in their interactions, whether through delivery to home or ship to home. The way customers engage more deeply with us demonstrates the value of our overall relationship across both store and digital channels. We've noted that when customers fill their first basket, it tends to be significantly larger, with a considerable portion of that spending being incremental. Over time, we've observed that customer visits to our stores also increase, further building their loyalty. This reflects a maturation process that we monitor for every store as they launch pickup and delivery services. By the second or third year of customer engagement in these stores, we see a more agnostic approach to how they shop with us, thanks to the incrementality in their behavior. This is what Rodney referenced when he mentioned that digital is becoming less of a financial burden in the second quarter and into the second half of this year, as we witness the maturation of that business. We anticipate that growth to continue, and we are committed to enhancing customer engagement through digital. We were pleased to see our digital household engagement increase during the quarter, which remains a key focus for us. As we progress beyond the maturation point, it still requires investment. Additionally, we are excited about the potential technology partnership with Ocado to automate backend operations, as it could significantly accelerate profitability given the seamless shopping experience we provide.

So would you say, Gary, that the peak EBITDA margin pressure from the rollout of pickup and delivery has been passed and we just passed it this quarter?

That's essentially what we're seeing overall within the way we look at our digital business and the way you look at that customer maturation. That's right. But that's kind of what Rodney was referring to.

I agree with Gary's point, and we also continue to invest in Ship and some of the other components as well. That has a high start-up cost, which is also reflected in the numbers that Gary mentioned.

Sure. Obviously, we deal with the question of CPG partners addressing price increases all the time. It's something that we deal with on a case-by-case basis, and we feel we're in a particularly strong position to really understand what's happening there because of our own brand products and the way in which we can have those conversations to make sure that the price increases are legitimate cost increases coming through to us. Certainly, as we shared, we are seeing our range for the year on inflation which we were assuming it would be somewhere between 0 to 1% and what we're actually seeing in a couple of those categories that I mentioned in the prepared comments that we're slightly ahead of that range. We continue to obviously manage to try and mitigate those through cost of goods opportunities and certainly where we do see the price increases coming through. And we believe they're legitimate, we are looking to pass them on to customers where it makes sense in light of the competitive environment.

The other thing I want to add is that it's important to remind our CPG partners that if they raise costs more than the market is increasing, our own brands tend to gain market share. We offer high-quality products that have been a staple for Kroger for many years. We are also continuing to innovate and expand our own brand lines like Private Selection and Simple Truth. So whenever a CPG adjusts their costs in relation to market changes in raw materials, our brands typically benefit, and I think it's essential to highlight this.

I'm curious about the 2020 goals. You provided a detailed explanation about the challenges, particularly with pharmacy and the timeline with ID. However, it's clear that fuel has been a significant advantage for you. That aspect hasn't changed and remains a supportive factor. I'm wondering what has shifted since the first quarter when you reaffirmed the $3.5 billion target to now.

Thank you for the question, Karen. To address the first part regarding fuel, you are indeed correct. Overall, we believe the fuel segment has continued to show strong performance this year, highlighting the value in the diverse portfolio we now have. The foundation of our business is built on food, which enhances customer engagement and loyalty. When we consider food in conjunction with health care, the margins we are achieving in our alternative profit streams make us confident in our ability to navigate external changes, particularly the pharmacy challenges we mentioned earlier. As Rodney pointed out, we intend to provide more details at the November meeting about our growth outlook. Rodney has already touched on some areas where we've gained insights, and as you mentioned, we've been transparent about our significant transformation journey, which includes enhancing store experiences, digital initiatives, and establishing new businesses around alternative profit streams while reducing costs. We've been analyzing how these elements converge and the pace at which they will yield the expected benefits for Restock Kroger. We want to emphasize that we believe we will achieve growth next year and exceed our operating profit guidance for 2019. In November, we aim to thoroughly discuss what has been successful, areas for improvement, and our projections for 2020.

And 2020 and beyond as well.

Okay. That is fair. Looking at the results this quarter, we see strong fuel performance, but the core is down around 30 to 31% in the second quarter. It's reasonable to say that some of this is outside your control due to pharmacy-related issues. Could you provide more insight into whether this number aligns with your expectations? Additionally, it would be helpful if you could clarify the impact of both specialty and regular pharmacy on the core performance.

I think that the best guidance we can give, kind of if we just refer back to a few of the points that we shared in the release and some of the comments that we made, Rodney mentioned it, from a supermarket perspective, when you take out fuel and retail pharmacy, essentially, the operating margins are relatively stable. And the pharmacy and the Kroger specialty pharmacy business were obviously a meaningful headwind during the quarter because of some of the industry headwinds that we see overall. But when you look at the investment in gross margin of 12 basis points that we shared around the supermarket business, excluding retail, pharmacy and fuel, and then the 14 basis points of OG&A benefit that we saw in the quarter, that's kind of really where I think is the best kind of data we would point you to, to give you a sense of what's going on in the business. And obviously, the gross margin, excluding fuel gross margin, investment was 29 basis points. And you get a sense of the disconnect, if you like, between what the health business impact to the quarter versus what the core retail gross margin investment was excluding pharmacy.

It's Tom Palmer filling in for Ken. I have a quick question for you. Last year, you mentioned hurricanes as a positive factor for the third quarter. Do you expect any offset in the southeast considering the potential stockpiling for Dorian?

Dorian had some impact, but not as significant as the hurricanes that affected the center last year. In the next few days, the situation will change because when a hurricane strikes, stores close and customers cannot access our locations. As we know, the timing of hurricanes is unpredictable. We always strive to be ready in advance for our customers. We support our associates and are prepared to reopen our stores as soon as it is safe. Our associates will go to any store they can access to work, rather than just their home store. We are committed to being there for the community as soon as conditions allow, recognizing our essential role in supporting them.

And then you've alluded to kind of the ability to look towards share repurchases again. Is that contemplated in your guidance for this year? Or would that essentially be upside if you go that direction?

At this point, we really haven't made any decision on repurchases for the remainder of the year. If we did consider it, it would be extremely modest. As you know, we just recently got back into the range. As Gary mentioned, we want to ensure that we're careful and monitor our cash flow as it's generated and balance all the aspects. So at this moment, I think it's a bit early to say. Gary, do you have anything to add to that?

I think that's right, Rodney. Certainly, we're actively looking and making sure that we're maximizing free cash flow. But at this point, we want to make sure we're consistent within the range and as soon as we feel we're in that position, but it's certainly not contemplated currently in the guidance that we provided for 2019.

Thanks, everyone, for all the questions. So as always, before we end today's call, I'd like to share a few final comments directed toward our associates who listen in and how we all live our purpose every day. To our associates, thank you for your hard work. I am fortunate to meet so many of you across the company and hear the incredible stories of what you do every day for each other and the communities. From our stores to plants and distribution centers and our corporate and division teams, you inspire me beyond my ability to express in words. Your passion for and focus on our customers is just incredible. More importantly, I am so proud of how you support each other and come together as a team. We are 460,000 strong, and we are Kroger proud. September is a special month for us as it marks the second anniversary of Kroger's social impact plan, Zero Hunger | Zero Waste. We know we can't achieve this goal alone. And recently, the Kroger Co. Zero Hunger | Zero Waste Foundation announced its inaugural cohort of 7 innovators who will join us in achieving our bold goal. Thank you to all of our customers, associates, and suppliers who make our business successful every day of the year. That completes our call today. Thanks for joining, and we look forward to seeing you in November.