Kroger Company (KR) — Q3 2022 Earnings Call Transcript

Good morning. Thank you for joining us for Kroger's Third Quarter 2021 Earnings Call. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen; and Chief Financial Officer, Gary Millerchip. 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. The Kroger Co. assumes no obligation to update that information. Our press release and supplemental information regarding the quarter can be found on our website at ir.kroger.com. After our prepared remarks, we look forward to taking your questions. I would also like to announce that we will be hosting a business update on March 4, 2022, in Florida with an opportunity to tour our recently opened Kroger delivery customer fulfillment center. We hope that you are able to join us. I will now turn the call over to Rodney.

Thank you for joining us today. We often say the holidays are our time to shine. And as we move through the holiday season, we feel great about our ability to deliver. I would like to say a huge thank you to our associates who remain engaged, energized, and focused on taking care of our customers. We are incredibly proud of our third quarter results and the underlying momentum in our business. We returned to positive identical sales without fuel for the quarter. We saw triple-digit digital sales growth on a 2-year stack, and we've increased our full year 2021 guidance. Our agility and the commitment from our amazing associates is allowing us to navigate current labor and supply chain conditions and provide the freshest food at affordable prices across our seamless ecosystem. Customers are demonstrating more back-to-normal behaviors, and at the same time, are eating more food at home because it's more affordable, convenient, and healthier than other options, plus you can do it as a family. This was evidenced by our Thanksgiving holiday shopping behavior. Customers engaged in larger celebrations with friends and family compared to last year. We also saw them continuing to cook at home, leading up to and during the holiday, and select more premium products to elevate the food experience. These are all reasons why we believe the food-at-home change is structural and not temporary. With most people consuming meals at home and grocery stores continuing to capture the majority share of stomach, it is more important than ever that we provide customers with flexibility on how they choose to shop with us. We have the right seamless ecosystem in place to meet our customers' evolving needs. Leading into Thanksgiving, 70% of consumers said that they would be doing more of their holiday shopping in the store this year. At the same time, 84% of consumers said that they will continue to shop online the same amount or more in the future. These seemingly contradictory behaviors are exactly what Kroger's seamless ecosystem was designed to accommodate. We know that inflation is having an impact on customers as well. 82% of consumers polled across the country are feeling the impact of inflation, and 1 in 4 consumers are not confident in their finances right now. We are leveraging our data and personalization to enable our customers to stretch their food dollars. We deliver value when customers need it the most with personalized promotions, big packs, and dynamic holiday offerings. Our brands also offer our customers flexibility within their spending without compromising, thanks to the wide variety of incredibly high-quality and innovative products at various price points. And while price continues to be top of mind, customers continue to desire the freshest food options, and we're there for them, leading with fresh. We grew sales in Natural & Organics as customers continue to gravitate toward better-for-you options. Our fresh departments outpaced total company identical sales without fuel during the quarter as well. We had a record quarter in our alternative farming offerings, which includes new approaches to growing produce, including vertical and indoor farm operations. These offerings expand customers' access to produce picked at the peak of freshness. We are very proud to share that Home Chef became a $1 billion brand on an annualized basis in the third quarter as mealtime shortcuts and solutions, as well as new product innovations, have clearly resonated with our customers. Kroger is focused on delivering a customer-centric, seamless experience that requires zero compromise no matter how customers choose to engage with us. We launched three new offerings during the quarter that support the plan to double digital sales and digital profitability by 2023. First, Boost by Kroger builds on our industry-leading loyalty program to deliver additional savings and personalized offers to our members. We are encouraged by the initial engagement in the program which is ahead of internal expectations. Second, we launched Kroger Delivery Now in partnership with Instacart. This unique convenience and immediacy offering positions us to win more trips with current customers and to bring new customers to the Kroger ecosystem by offering the largest selection of quality fresh products at affordable prices in 30 minutes. Here's what's so special about this offering. It was profitable on day one, contributing to our goal to double digital profitability by 2023 that was announced during our 2021 Investor Day. And third, we announced a strategic collaboration with Bed Bath & Beyond and buybuy Baby that will expand our current marketplace offering and provide Kroger shoppers easy access to essential home and baby products. This exclusive offering will be available through both Kroger.com and on a small-scale physical store pilot at select stores beginning in 2022. We continue to be pleased with the rollout of our customer fulfillment centers in Groveland, Florida; and Monroe, Ohio, which are exceeding internal expectations, and we are especially proud of our Net Promoter Scores driven by our teams, delivering a world-class experience for our customers, and we're really looking forward to hosting you in Groveland early next year. Turning now to our supply chain. We feel great about our ability to serve customer needs through the holidays and beyond. This is because our teams have done such a good job planning well ahead to maintain a full, fresh and friendly customer experience. In fact, our customers took action to prepare for today's supply chain constraints back in the spring. And a great example of leveraging learnings from operating during the pandemic, we kept the additional warehouses originally brought on to support business through COVID to ensure we were able to provide for customers throughout the holiday season as well. Because of our team's agility, we are better in stock today than we were a year ago, and we were able to serve customers through the Thanksgiving holiday with items they needed for their celebrations. In fact, we increased our year-over-year pickup fill rate by over 130 basis points during the week of Thanksgiving. We chose to incur significant costs in our supply chain during 2021, which has allowed us to provide our customers today and into 2022. We continue to deploy a wide array of tools, including our owned and operated fleet, and we're working closely with suppliers to mitigate pain points for the customer. We are eager to welcome thousands of new associates to our organization as we began an incredible holiday season. Our hybrid hiring event last month contributed to the hiring of over 64,000 new associates during the quarter. We continue to invest in our associates by expanding our industry-leading benefits, including continuing education and tuition reimbursement, training and development, health and wellness, and continued investments in associate wages. As we reflect on the one-year anniversary of our Framework for Action in response to racial injustice across the country and in the communities we serve, we are pleased to share our progress with you. Over 405,000 associates have completed diversity and inclusion training. We've increased our strategic hiring partnerships with Historically Black Colleges & Universities and Hispanic-serving institutions from 6 to 17. The Kroger Co. Foundation has awarded more than $3 million in grants to support innovative organizations focused on building more equitable and inclusive communities, and we increased Kroger's diverse supplier spend by 21% to $4.1 billion last year alone and remain on track toward our long-term goal to spend $10 billion annually with diverse suppliers by 2030. While we know that there is more work to be done, we are energized and look forward to keeping our stakeholders updated on our progress. One of Kroger's greatest strengths is our ability to manage our business successfully in every operating environment. We remain customer obsessed and focused on operational excellence to deliver for our customers, associates, communities, and shareholders. With that, I would like to turn it over to Gary to take you through our third quarter financials. Gary?

Thanks, Rodney, and good morning, everyone. As Rodney shared this morning, Kroger delivered strong results in the third quarter, highlighting the flexibility of our business model in a dynamic operating environment. Our focus on execution, combined with our disciplined approach to balancing investments in our associates and customers with strong cost management and growth in our alternative profit business is positioning us well for the future. Over time, our model has proven to be resilient during different economic scenarios, and this was true again during the third quarter as we grew the top and bottom lines while navigating higher product cost inflation, a tight labor market, and supply chain constraints. Our identical sales without fuel in the quarter returned to positive, growing 3.1% as we delivered for our customers across our seamless ecosystem, and customers, again, signaled higher food-at-home consumption is here to stay. Adjusted FIFO operating profit and adjusted EPS both increased year-over-year and grew by compounded annual growth rates of 22% and 29%, respectively, versus 2019. Third quarter EPS was impacted by two unusual items that were excluded from our adjusted EPS result. First, we engaged in an annuity buyout and lump sum distribution transaction related to the company's consolidated retirement benefit plan which will reduce future administrative costs. This triggered a write-off of deferred losses and a nonrecurring noncash charge of $87 million on a pretax basis. This company pension plan is currently 100% funded as a result of previous action taken to freeze the plan and protect benefits for our associates. This transaction was fully funded by assets in the plan. The second unusual item was Kroger recording a nonrecurring benefit of $47 million or $0.07 per diluted share, primarily due to the favorable outcome of income tax audit examinations covering multiple years. This amount is also excluded from the company's adjusted net earnings per diluted share result for the third quarter. I'll now provide more detail on our operating results in the quarter. On a 2-year stack basis, our identical sales without fuel increased 14%. We also saw digital sales increase 103% on a 2-year stack. As we have previously shared, we do not expect digital growth to be linear, especially as we cycle last year's sales spike and customers become more comfortable shopping in-store again. The launch of several new digital offerings, which Rodney outlined earlier, in addition to the rollout of new customer fulfillment centers, gives us confidence in our ability to deliver against our growth targets for digital sales and profitability. We look forward to sharing more detail on our digital roadmap at the business update in March that Rob noted earlier in the call. With regard to digital profitability, we continue to make progress during the quarter and achieved our best cost to serve on record for pickup orders. Gross margin was 21.66% of sales for the third quarter. The FIFO gross margin rate, excluding fuel, decreased 41 basis points compared to the same period last year. This decrease primarily related to higher supply chain costs and continued price investments, partially offset by sourcing benefits. Our investment was in line with expectations and fully funded by cost savings and operational general administrative improvement. Recognizing recent inflation trends and our outlook for the rest of the year, we recorded a higher LIFO charge for the quarter of $93 million compared to $23 million in the prior year. This increase represents a $0.07 headwind to EPS in the quarter versus 2020. The operating, general, and administrative rates decreased 49 basis points, excluding fuel and adjustment items. This improvement was achieved even with continued investments in our associates and growth in our average hourly rate and reflects the outstanding work our associates are doing to execute cost-saving initiatives in a very dynamic environment. We remain on track to deliver $1 billion of cost savings during 2021. Our alternative profit business had a record third quarter and remains on track to deliver the high end of our expected range of $100 million to $150 million of incremental operating profit in 2021. We saw increased strength in Kroger Personal Finance results during the quarter, and Kroger Precision Marketing introduced a new programmatic advertising marketplace to unleash first-party targeting and measurement capabilities, further highlighting our ability to differentiate in the advertising space. Fuel is also an important part of our overall value proposition and a key offering to help customers stretch their dollars, especially in times when fuel prices are high. During the quarter, we saw a significant increase in the number of customers actively engaging in our fuel program. Gallons grew in the third quarter by 5%, outpacing market growth. The average retail price of fuel was $3.24 this quarter versus $2.15 in the same quarter last year. Our cents per gallon fuel margin was $0.42 compared to $0.37 in the same quarter in 2020. I'd now like to spend a couple of minutes providing some additional perspective on how we are proactively managing inflation. We are currently operating in a more volatile inflationary environment. And during the third quarter, Kroger saw higher product cost inflation in most categories. We are being disciplined in managing these increases. Our teams are doing an excellent job working to minimize the effect on our customers and our financial model by using our data and working closely with our suppliers. We are passing along higher costs to the customer where it makes sense to do so. In some key areas, we are choosing not to pass through cost increases and continuing to invest in value for the customer. We are investing where it matters most, using our proprietary data to be strategic in our pricing and personalization with the objective of winning long-term customer loyalty. We also believe our brands is an even more important differentiator for Kroger in an inflationary environment, offering customers an unmatched combination of great value and great quality. Turning now to our financial strategy. Kroger is operating from a position of strength and continues to generate strong free cash flow as evidenced by our net debt-to-EBITDA ratio hitting an all-time low of 1.68 in the third quarter. While we continue to see attractive opportunities to invest in the business, to widen our competitive moat and drive sustainable revenue and earnings growth, our capital expenditures in 2021 are now expected to be below our original guidance range of $3.4 billion to $3.6 billion. This is because of delays in project implementations, primarily due to COVID-19-related supply challenges. Kroger continues to return cash to shareholders. During the quarter, we repurchased $297 million of shares, and year-to-date, have repurchased $1 billion of shares. Since 2000, we have now returned more than $20 billion to shareholders via share repurchases at an average price of $16.45 per share. As of the end of the third quarter, $511 million remains outstanding under the current Board authorization announced on June 17, 2021. We look forward to sharing more about our plans for future deployment of excess cash to drive sustainable growth and create value for our shareholders at our business update in March. As Rodney mentioned, we continue to invest meaningfully in our associates. In addition to the $350 million of hourly rate investment already planned this year, we have committed to further investments in the fourth quarter, which equates to an incremental $100 million on an annualized basis. During the third quarter, we ratified new labor agreements with the UFCW for associates in our Columbus and Mid-Atlantic divisions, covering over 4,500 associates. We continue to negotiate contracts with the UFCW for store associates in Houston, Lake Charles, Freeport, Dallas meat, Little Rock, Memphis, Portland, and Denver. Our financial results are pressured by inefficiencies in healthcare and pension costs, which most of our competitors do not face. We continue to communicate with our local and international unions, which represent many of our associates about 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. I'll now turn to our expectations for the remainder of 2021. Driven by the momentum in our third quarter results and sustained trends in food at home, we are raising our full-year guidance. We now expect identical sales without fuel for the full year to be between negative 0.4% and negative 0.2% and a 2-year identical sales stack of between 13.7% to 13.9%. There remain some uncertainties as we look ahead, and our guidance of positive id sales excluding fuel of between 1.5% to 2.5% in the fourth quarter reflects this. We expect adjusted net earnings per diluted share to be in the range of $3.40 to $3.50. We expect our adjusted FIFO operating profit to be in the range of $4.1 billion to $4.2 billion, reflecting a 2-year compounded annual growth rate of between 17% and 18.4%. The midpoint of our adjusted EPS range for 2021 now equates to full-year results, approximately in line with our 2020 results, despite cycling the unique COVID-19-related demand spike last year. Our guidance fully reflects the investments in our customers and associates I shared earlier, plus increased marketing to support the exciting new digital initiatives we launched in the third quarter. It also reflects the latest projection for LIFO. And because we recorded a LIFO credit in the fourth quarter last year, LIFO is now expected to be a $0.13 headwind to EPS in the fourth quarter. Overall, we are very proud of our results, which are projected to be significantly ahead of where we originally guided for the year. In conclusion, Kroger is executing against its key financial and operational initiatives and continues to invest in strategic priorities that will deliver attractive and sustainable total shareholder return of 8% to 11% over time. We believe our business is emerging stronger through the pandemic and through the investments we are making, is well-positioned to grow beyond 2021. I'll now turn it back to Rodney.

Thanks, Gary. Kroger's strong year-to-date results are the outcome of our customer obsession, our incredible associates who bring our vision and values to life and our commitment to bringing fresh, affordable food to everyone. The strength of our teams has never been more apparent. With every new challenge, they rose to the occasion, whether by implementing solutions to minimize supply chain disruptions, delivering the freshest produce to our customers or using our data to offer personalized promotions that surprise and delight. Our team is bringing our competitive moats to life. Now we look forward to your questions.

You've obviously done a very good job of passing on inflation to consumers while shielding that at the same time. Your gross profit dollars are up now. Can you talk a little bit about what drove that outperformance versus your expectations last quarter? Because last quarter, I think you were pretty cautious on gross margin. And then secondly, I think there's another big tranche of pricing coming in January from a lot of your vendors. How would you characterize that next tranche? Is it an unusually high acceleration? Or is it just kind of a continued acceleration similar to what you've seen so far? Maybe if you could even put it into context of CPI for us, it would be helpful.

Okay. Rob, I'll start, and I'll let Gary get into more of the details. First of all, I think it's important to remember what's allowing us to continue to invest in the customer and value is the great work our team is doing on cost reductions. And as Gary mentioned, we're on track to take $1 billion of cost out, and this is the fourth year in a row that we've been able to accomplish that, which really gives us the flexibility to be able to continue to invest in our customers. The other thing that our teams have done a nice job on, if you look at our procurement team, they've done a nice job of identifying opportunities to save money by working with our suppliers, and we continue to aggressively work in partnership with them. If you look at inflation during the quarter, it continued to increase throughout the quarter. As of right now, it's starting to stabilize but obviously at a pretty high rate. So it's something that we aggressively use our data to understand, and we aggressively try to make sure that the customer has alternatives to be able to stretch their budget as well. And that's — in some cases, that's switching to a cheaper price meat. In some cases, it's buying our brands, which has amazing quality as well.

Sure. Thanks, Rodney. Thanks for the question, Rob. Yes. I would say, Rob, obviously, when we guided at the second quarter, we said that the gross margin contraction could be similar to what we were seeing in Q2. And I would say the dynamics that are in place haven't changed dramatically. Obviously, it's a dynamic environment that we're managing, and our goal, as Rodney mentioned, is to continue to find sourcing benefits and savings to offset the cost increases where we see them and to pass on pricing where it makes sense but also to keep investing in the customer. And I'd say that we — in Q2, we were doing that. In Q3, we've continued to do that. Supply chain would have been a similar sort of headwind in Q2 and Q3. I would say we were successful in mitigating some of the cost increases in shrink during the quarter, which helped during the quarter, although we still think shrink is a dynamic metric to manage based on some of the organized crime that we see in shrink. But overall, we were pleased with the progress in shrink during the quarter. And I think for us, we kind of guided, while we never get into specific numbers on individual gross margin and operational general administrative metrics because, as Rodney mentioned there, our goal is to be dynamic in managing it, ensuring that we're delivering sustainably for our customers and growing loyalty while also being able to improve profitability over time by managing the different levers across selling growth rate, cost of goods savings, taking cost out of the business, and continuing to grow alternative profit streams. So I think it's a dynamic environment we continue to manage. I think somewhere between the Q2 and Q3 range is where we think that we're operating right now. We think Q4 would likely be similar to what we've seen in Q2 and Q3. And as I mentioned in my prepared comments, we are increasing some advertising in the fourth quarter to support the accelerated growth in some of those new initiatives. So I think, again, I wouldn't be guiding to a specific number, but in the range that you've seen in Q2 and Q3 is where we feel comfortable in managing the business and driving the right balance of sustainable growth for shareholders while continuing to win customer loyalty over time.

And just a quick follow-up. I think Rodney said that you're seeing your inflation kind of leveling off. Are you looking at like PPI inflation there? Because I would agree with you, it seems like in the low teens, it's leveling off. Is that what you're looking at?

Yes. We would be looking at more of our own costs in terms of what we're incurring and what we see coming forward. And one of the other things that I always think it's important to remind people, we manufacture a lot of our own products, so we also understand the raw materials themselves and what's going on there. And we would be looking at CPI and PPI both. But in terms of trying to estimate inflation, we would be looking at our actual cost increases that we're incurring.

Rodney, I'm glad you mentioned the fact that you make your own products because that's a good lead into one of my questions, which is we're still seeing, at least in the scanner data that we get, some pretty poor trends on top of last year's poor trends for store brands in general. I'm not talking about Kroger. I'm talking across the measured industry. And I'm just hoping for an update for what you're seeing there. I know you've talked about this a little bit in the past, but are there any signs of improvement from that? And again, I know you're somewhat agnostic, you'll make money either way. I'm just trying to get a sense for what the outlook is, what you're seeing, any updates from your side.

If you examine our brands, you'll notice that the trends in the third quarter were an improvement over those in the second quarter. Throughout the quarter, we saw continuous improvement. As Ken pointed out, our priority is to ensure we offer the products that customers desire. Therefore, a Kroger brand item must prove its worth on the shelf, just like any other brand. Nevertheless, this is key to our competitive advantage. As I stated in the prepared remarks and indicated in a press release earlier this quarter, we are pleased that Home Chef has become our fourth brand to exceed $1 billion in annual sales. Our brands are vital for connecting with our customers, providing exceptional value and quality. Simple Truth and Private Selection are both distinguished in the marketplace and continue to grow rapidly. Most items under Private Selection are exclusive, while Simple Truth makes it easy for customers to make healthy choices. Thus, we are seeing positive trends, and our brands are an essential component of our overall strategy and competitive edge.

And then quick follow-up. I think you mentioned that you're not passing on cost increases fully in either certain categories or certain products. Is it safe to assume that, like many of your peers, you're a little more hesitant to take pricing up on items that draw people into stores on a regular basis, things like milk and bread, et cetera? Or is it a little more strategic and nuanced than that? Just trying to get a sense for how you're thinking about which items to take pricing up on and which not.

Yes. We will use our historical data from the past several years on price elasticity by category and by products within those categories to decide what to pass through. For certain products, there’s an opportunity to build deeper loyalty, some of which is clear and some that is not. Additionally, some items that previously had wider household penetration may not have the same appeal now. This information is dynamic and reflects current market conditions. Our data also indicates that price elasticities can vary in different regions of the country. Gary, do you have anything to add?

No. I think you've covered it well.

This is Michael Kessler on for Simeon. Can you hear me?

Yes.

First, I wanted to ask about any initial thoughts, if you have any, on 2022, another good quarter in Q3. It looks like the full year is going to end up basically a retention or maybe slight growth off of 2021 on earnings. So I guess any more confidence or conviction that next year could be another, call it, algo type of year on both IDs and EBIT? And I guess any puts and takes as you're starting to think through that outlook?

That's a great question, and we appreciate it. We'll provide more detailed information at our March Investor Day, where we'll go into the specifics. Currently, we're in the process of developing our budgets and collaborating with our Board on our expectations for 2022. I can say that, as we mentioned during our Investor Day in 2019 and have continued to update, we anticipate an annualized total shareholder return of 8% to 11%, driven by earnings growth and free cash flow, along with returning cash to shareholders. Overall, we maintain a positive outlook. We are encouraged by our business momentum regarding customer connections and our efficient processes aimed at reducing costs, allowing us to invest some of those savings in employee wages and enhancing customer engagement. The business also continues to produce strong cash flow.

I think you expressed that well, Rodney. I would just add to your thoughts. While we won't be providing detailed guidance for 2022 until our meeting in March, we have been clear about our confidence in the long-term prospects of the business. We are focused on building the business from the foundation we established during COVID, with the aim to grow and meet the TSR commitment that Rodney mentioned. Specifically, we believe that some of the food-at-home trends we've discussed will be structural, leading to sustained trends in that area. Our performance over the last two years reflects our confidence in our value creation model and our ability to drive sustainable growth. Additionally, our alternative profit stream continues to grow at double-digit rates from a higher base. I fully support Rodney's comments about our long-term commitment to TSR, and we will provide more details on 2022 in March.

And it's Simeon for the follow-up. I thought maybe Michael might have a better shot at the '22 question than me. But my follow-up is on the puts and takes on IDs. It looks like it held pretty consistent, Q2 to Q3, and you talked about inflation lifting but leveling. Can you talk about anything, puts and takes sequentially got worse or better in terms of units, traffic, et cetera?

If you look at most pieces, the third quarter would have been better than the second quarter. When considering household trends, the basket size would have been somewhat smaller but not significantly. We continue to observe premiumization throughout the quarter, and we are seeing consumers purchase larger pack sizes in nearly every category. Therefore, when you analyze the various factors at play, there are numerous positives and negatives.

Certainly, Rodney. The trends were quite consistent throughout the third quarter, improving slightly as the period progressed. We are currently tracking at the top end of the guidance range we provided for the fourth quarter. The start of this quarter may have seemed a bit sluggish due to comparing it to a significant spike in consumer activity just before Thanksgiving last year. However, we were very happy with our results during the Thanksgiving week. As we consider potential uncertainties looking into Q4, it's challenging to predict the impact of government stimulus funds, especially at the state level, where it's difficult to gauge ongoing financial support in individual states. Additionally, we are aware of ongoing supply chain issues affecting product availability in certain categories, which are gradually improving but still present challenges. These factors will influence how strong Q4 will be for us.

Gary, I wanted to follow up on the sourcing benefits to gross margin. Can you remind us what strategies you're using to achieve sourcing benefits in this environment? You're also doing an excellent job with the cost savings initiatives, which are helping to offset labor and other cost pressures. Could you provide an update on that and share some insights on how sustainable these factors might be as we move into next year?

Thanks for the question, Robbie. We are truly proud of what our team has accomplished in these areas. It all began at the start of Restock Kroger, where we focused on seizing immediate opportunities, which has now become a fundamental strength of our organization in driving sustainable savings. On the sourcing front, our approach spans various aspects. Initially, it's about consolidating buying in the right areas to leverage data and experiences from commodity costs, especially since we manufacture many of our products. This has led us to become more intelligent and efficient in our purchasing strategies. We've also ventured into product and packaging design, ensuring we optimize value without compromising on customer quality. Our GPO partnership with Walgreens is an extension of this, as we explore how to consolidate opportunities and insights from that collaboration. The team is doing an excellent job at identifying ways to maximize savings, and we expect this trend to continue as we find new innovative methods to design for value and enhance efficiency. Moreover, on the operational administrative side, we are focused on numerous areas, including utilizing technology and automation to minimize shrink and waste. This would improve store operations, allowing our associates to devote more time to customer service by eliminating non-value-added tasks. We are automating our ordering and production planning processes, and a significant area for improvement this year that we anticipate will benefit us next year is reducing costs in our digital services. We've heavily invested in developing our digital ecosystem and expect continued growth. Enhancing efficiency in our $10 billion digital business will not only reduce costs for new sales but also improve savings on our existing operations. Finally, we've utilized insights gained from COVID to understand where we can work more efficiently and operate in a hybrid manner, which also helps reduce costs. I hope this provides you with a clearer view of how these practices have integrated into our business, and we expect them to support our overall growth model by freeing up funds for associate wage increases, pricing strategies, and ultimately growing shareholder returns.

Robbie, I would like to add to Gary's comments, which already imply this, that we have made significant changes to our personnel. We have recruited talent from both within the company and from outside the industry, bringing in skills that deviate from traditional methods. This has been instrumental in helping us to rethink our strategies and for our team to approach challenges in innovative ways.

That's great. That's really helpful. I have a quick follow-up question. With the changes you're making on the sourcing side and with your own brands, what is happening with total SKUs compared to national brands SKUs and owned brands SKUs in your stores? Are they shrinking or is some growing? Can you provide any details on that?

Before COVID, the number of SKUs was lower compared to now due to reduced change time and similar factors. In some cases, national brands have not reintroduced certain varieties, while we have added over 200 new SKUs this quarter and plan to maintain a strong pipeline moving forward. Overall, there is still growth in SKUs within natural organics and plant-based categories. However, for items like paper towels and paper goods, you will notice fewer SKUs since customers are opting for larger package sizes.

This is Spencer Hanus on for Greg. I just wanted to ask how you're thinking about the delta between retail and cost inflation in '22. And then what is the breadth and depth of promotions that you need to hit your long-term top line targets, just given the unique opportunity the industry has had to reset promos over the last 18-plus months here?

Sure. Yes. Thanks for the question, Spencer. As we mentioned, we're kind of not really providing sort of an outlook for 2022 at this point around how we think about sales and investments overall. We'll be doing that, for sure, as we get to the March meeting and sharing our Q4 results. I think, really, I would pivot back to some of the comments that we made earlier around we think very much of it from the perspective of in all operating environments, Kroger has been able to demonstrate our ability to navigate through those situations. And it really comes back to what we were talking about earlier around ensuring that we understand the customer better than anybody, using our data, our targeting, our promotional activity, and our personalized pricing, and of course, where the pricing structure of product starts to change, really ensuring that customers see the value in our own brand products because of the great quality and value that they offer in combination. And during times of high inflation and certainly in times of economic challenge, we found that Kroger has performed very well, and we've seen customers pivot to some of those opportunities based on the way we can communicate and connect customers with those strategies. So I think from our perspective, we're very much managing the business dynamically to ensure that we can deliver for the customer, but at the same time, deliver on our TSR commitments in the way that we talked about earlier in the conversation.

On promotions, we would always use our insights because different types of customers react differently to types of promotions. So we would aggressively use our insights to personalize promotions. A lot of that is one-on-one with a customer, either sending an old-fashioned mailing or electronically with e-mail or text or whatever. And it really depends on each customer and what do they test react to.

Got it. That's helpful. And then in the prepared remarks, I think you mentioned that the Ocado facility is performing better than expected, the one in Florida. But could you just provide some more details on the basket size and the repeat orders relative to your targets? And then how are you thinking about the need, longer term, to build or acquire stores in that market to provide a more complete omni experience down there?

Yes. On your second question, I'll answer it first, and you got to walk before you run. So right now, we're totally focused on making sure that the sheds open strongly, and we continue to maintain outstanding NPS scores, or net promoter scores, with our customers. And I am super proud of our team in Florida and Monroe, both in terms of how they continue to connect with the customer and continue to improve. If you look at basket size, the basket size continues to grow. And what we expected and what we believe is as the customers begin to trust the experience, begin to have good experiences, we get a higher share of their total spend. And that's what we're starting to see. And when you look at overall in Florida, one of the reasons why we announced the two additional facilities in Florida is obviously the connection and the growth that we are achieving. So far, we feel good about the opportunity in Florida. And as everybody knows, the population growth in Florida and the economic growth in Florida is just mind-boggling relative to an awful lot of the country. So it's an incredible opportunity for all grocery retailers in Florida. Obviously, the offering we have is unique in the market, and I'm very proud of what we're getting done there.

And the repeat usage, Rodney, is higher than we expected, right? than net promoter score.

Rodney, let me start by discussing how consumer behavior has changed over the past couple of years. Specifically, I'd like to know the percentage of purchases that are made at shelf price compared to promotional pricing and personalized promotions. How has this distribution shifted? Also, regarding personalized promotions, do you think they account for as much as 50% of purchases? Additionally, could you share how your efforts on price perception have trended from the early days of COVID to now?

If you look at customer behavior, I want to broaden it a little bit in relation to your question. We continue to see people focusing on health. Early in COVID, people were not as focused on health, but they are now definitely more engaged with it. Across the board, you can see a trend towards premiumization in consumer choices. Personally, I consider myself an enthusiastic shopper at Murray's Cheese. Growing up, I didn't have access to high-quality cheese, but once you experience really good cheese, it's difficult to go back to what you used to have. We're finding that when customers upgrade to higher-quality products, they discover they love it and become loyal to it. Looking at customer behavior regarding promotional purchases, it has remained fairly consistent throughout the pandemic. People adjust their budgets as needed or desired and will splurge in other areas, which is something we focus on in helping customers optimize their budgets for things that matter to them, allowing them to indulge in what they consider important.

Yes. Thanks, John. Obviously, we are really proud of the business performance, and it has demonstrated strength in the overall model and the position that we're in, as we said in the prepared comments. I would say our overall capital allocation strategy is unchanged, that we start with where are the opportunities to invest in capital in the business to drive sustainable growth. We're obviously in a great position around maintaining our investment-grade debt rating, and we've been able to make some good progress on chipping away at the pension funding from an overall sort of debt and potential liability there as well. This year, of course, we've been very committed to continuing to return cash to shareholders with the $1 billion, so far, on buybacks and the 17% increase in the dividend that we announced earlier in the year. So I think we've been very consistent with that plan so far. We do think that in the short term, it's important to maintain some flexibility, recognizing some of the uncertainty in the market that we've all talked about, that we're all navigating through at the moment. That being said, within those principles, we do think it's important, and we've been very committed, as you know, as a company, to being very disciplined with cash flow and deploying it to either grow the business or return to shareholders. So as we head towards 2022 and as we move towards the March planning meeting and the business update meeting that Rob shared, we'd certainly expect to share more color of how we're thinking about the excess cash and some of the opportunities we're exploring there.

And we would continue to look for things that are the right opportunity for things that add capabilities. So if you think about merging with Home Chef a couple of years ago, it was a capability that we didn't have on the direct-to-customer meal kits, and we've been able to partner with the team there to leverage it back within Kroger as well. And I always think it's important to remind people that we're not required to do any kind of mergers in order to achieve our TSR of 8% to 11% as well.

Great quarter. Rodney, I think you previously mentioned that you decided to incur some significant costs to strengthen the supply chain this quarter. Can you provide us with some details on that and whether these costs will continue into next year? I also have a follow-up related to this.

Yes. Our supply chain investments were quite similar to the second quarter. Our team has effectively begun identifying opportunities for improved efficiency. One significant area is our continued use of excess warehouse space, which we are utilizing. Over time, as conditions stabilize, we plan to undertake more permanent warehouse projects to enhance capacity instead of using space inefficiently. We expect to continue this in the fourth quarter. Looking ahead to next year, we are focused on remaining agile because circumstances are evolving rapidly, particularly concerning COVID and its variants. We are making decisions based on this agility, which is a key lesson we've learned early in the pandemic, and we will apply this approach to our supply chain as well.

Is there anything noteworthy regarding labor? Also, when discussing supply chain issues and product outages, are we referring to branded versus private label, fresh versus shelf-stable, or edible versus nonedible products? Where are you allocating the most funds and management resources to ensure shareholder satisfaction?

Yes. If you look at labor, we certainly have partnered with outside companies to supplement our labor resources, especially on the supply chain. If you look at in-stocks, they would be more affected on center store. If you look in the fresh departments, we would be in much better shape in most of the fresh departments in terms of in-stock.

This is Mark Carden on for Michael today. As a follow-up to some of the earlier inflation questions, where do price gaps stand today? And what's the posture on further investments from here? And have competitors been acting as rationally, given just the heightened inflation this time around?

As everyone knows, we approach the market as a high/low merchant. Therefore, we are proactive with promotions. We are also confident in our position regarding price gaps. Our strategy has always focused on neutralizing price while excelling in our fresh offerings and fostering strong connections between our associates and customers. This approach continues to be effective, and we feel positive about our standing in relation to the various gaps.

Great. That's helpful. And then on Ocado, how integrated is the GFC today with your Cincinnati operations? Has it been integrated in click and collect yet? And then in Florida, who do you think you're taking the most share from?

If you look at Florida, the market growth is so strong that we're all benefiting from it. I don’t see it as taking market share from others because the overall market is expanding significantly. Regarding your first question about Monroe, we are continually integrating it within our store network. Every week, we make further progress to ensure a seamless experience for our customers.

Thanks for your questions, and that will end our question-and-answer session.

Thank you for your interest in Kroger. Many of our associates own stock, and we take this opportunity to communicate directly with them. As we enter the holiday season, it’s a time for reflection as we enjoy special meals with our loved ones. I am incredibly proud of our associates across the Kroger Family of Companies and what we have accomplished this year as a team. Every associate is helping to make the holidays brighter and fresher for our customers and their families. Whether it’s the Kroger Health team administering 8.5 million doses of the COVID-19 vaccine or individuals like Donna Greer, a cashier at our store in Collierville, Tennessee, whose unwavering positivity has inspired many, including her recognition as Collierville Woman of the Year, we have remarkable people bringing our vision and values to life every day. Our associates are exceptional and continue to serve and uplift our communities and customers. That wraps up our call for today. We wish everyone a happy holiday season, Merry Christmas, and encourage you to stay safe. Thank you for your interest in Kroger.