Kroger Company (KR) — Q1 2024 Earnings Call Transcript

Good morning. Thank you for joining us for Kroger's first quarter 2024 earnings call. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen; and Interim Chief Financial Officer, Todd Foley. 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 material effect on our business on an ongoing basis is contained in our SEC filings. The Kroger company assumes no obligation to update that information. After our prepared remarks, we look forward to taking your questions. In order to cover a broad range of topics from as many of you as we can, we ask that you please limit yourself to one question and one follow-up question if necessary. I will now turn the call over to Rodney.

Thank you, Rob. Good morning, everyone, and thank you for joining us today. Before we begin, I'd like to provide an outline of our discussion topics this morning. I will start by sharing a recap of our first quarter performance and highlight how we continue to advance our go-to-market strategy, which powers our value creation model and drives long-term sustainable growth for our shareholders. Then Todd will cover our financial results for the first quarter. Finally, I will provide a few comments on our proposed merger with Albertsons before we open it up for questions. We're off to a solid start in 2024, reflecting the strength and diversity of our model. As better than expected performance from our Grocery business helped us manage Fuel and Health & Wellness results that were behind expectations, Kroger is providing exceptional value and a unique omnichannel experience, which combined with strong store execution, led to growth in households and an increase in customer visits. As inflation moderates, we expect customer sentiment to continue improving. But near term, many customers are managing economic uncertainty. While we expect Health & Wellness profitability pressures to continue into the second quarter, our recent improvement on store execution metrics and strong customer trends give us confidence that we are building momentum for a strong back half of the year and we are well-positioned to deliver on our full-year guidance. As we've seen over recent quarters, customers continue to seek value and are shopping with us differently based on their financial situations. Spending from premium and mainstream customers continue to be strong. Mainstream households drove our overall household growth and we improved our share of wallet with premium customers who are deepening their loyalty, spending more in our fresh departments and enjoying more premium products such as Private Selection. Within our most budget-conscious households, we are starting to see positive momentum and we grew households in this segment after experiencing declines last year. Historic multi-year inflation across the economy, high interest rates and reduced government benefits disproportionately affect these customers and are influencing their spending behaviors. Kroger's longstanding commitment to low prices and personalized promotions creates real value for our customers at a time when many of them need it more than ever. Food-at-home continues to be the most affordable meal option for customers while food inflation has impacted every meal occasion, inflation in food-away-from-home has been even higher than food-at-home inflation since 2019. We are committed to making sure our customers can enjoy a great meal experience with zero compromise on quality, selection, value and convenience. We see a significant growth opportunity to deliver convenient restaurant quality meals at an attractive value and we are expanding our Ready To Heat and Ready To Eat offerings. For example, after we revamped our fried chicken recipe, we created a meal bundle which feeds a family for $3.50 a person, a fraction of what it would cost to eat out at restaurants with quality that's difficult to beat. Every day we strive to provide an outstanding customer experience and we are focused on sharpening our store execution to do just that. This year, we raised the bar on our full, fresh and friendly customer experience metrics and we are very proud of our store teams who are delivering an even better shopping experience with service metrics at record highs. To continue the momentum in our Grocery business, we are committed to keeping prices low for customers and delivering a consistent experience while growing our pillars of Fresh, Our Brands, Seamless and Personalization. Leading with Fresh, our store team's primary goal this year is to drive a more consistent shopping experience and that begins with Fresh.

Our ongoing work to differentiate and elevate our brands is driving higher profitability. We are identifying new supply sources using more effective promotions and improving product mix, which is contributing to further margin improvements. Now to Seamless. Delivery solutions led digital results again this quarter with an increase in both households and visits. Pickup also had solid growth and focus on delivering best-in-class fulfillment led to strong improvements in key customer experience metrics. This quarter, our teams improved fill rates to a new record high, reduced wait time and delivered a significant improvement in perfect orders compared to last year. Through the power of machine learning and AI, we are developing new ways to elevate the Pickup experience for customers and at the same time reduce costs. With dynamic batching of orders, these tools are providing associates the most effective pick routes, which is enabling us to dramatically reduce pick lead time in our highest volume stores. Our customers love the Kroger delivery experience with refrigerated products delivered directly to their doorstep. As a result, the Kroger delivery network has experienced remarkable growth with sales nearly doubling this quarter versus last year. As we focus on providing an incredible customer experience, we are learning and adjusting the delivery network. A good example of this is our decision in the first quarter to close three spoke locations to reallocate capacity closer to our automated fulfillment centers where we have higher customer density and better order level profitability. This decision does not impact Kroger's automated fulfillment centers or other spoke locations. We remain confident that our Kroger delivery network provides a differentiated customer experience and will continue to be a key pillar of our digital growth strategy. Turning to Personalization. The combination of seamless and our personalization capabilities generated another quarter of digital engagement growth, up 9% compared to the same quarter last year. Personalization enables us to balance the depth and breadth of our promotions more effectively and encourages customers to engage more with us by focusing on promotions that matter most to them. This led to an 18% increase in digital coupon clips compared to last year. Capturing more digital households is a key to our long-term growth model as these households are more loyal, spend nearly three times as much with us and drive our alternative profit businesses. By executing our go-to-market strategy, we create momentum in our Grocery business. In turn, this creates the data and traffic to accelerate growth in areas like Health & Wellness and our Alternative Profit businesses. Alternative Profit businesses had a strong quarter led by growth in Kroger Precision Marketing. KPM results were in-line with what we expected and keep us on track to meet our full-year expectations of more than 20% media growth. Yesterday, KPM continued to broaden its reach by offering its custom audiences and ad measurement capabilities to advertisers on the Meta social media platforms. This is another important step in KPM's growth, creating more opportunities for clients to reach relevant audiences in more places and providing better transparency to ad effectiveness. Health & Wellness grew its top line this quarter. However, profitability results were below expectations. We are optimistic about the potential of this area of our business. Our script adherence initiatives are on track and our teams are providing excellent care which helps patients live healthier lives. Additionally, our marketing plans and in-store activations designed to raise awareness and attract new patients are launching now to help drive growth in the back half of the year. Turning now to associates. Our associates are doing an excellent job elevating the customer experience and improving our full, fresh and friendly metrics this quarter. Team consistency leads to better execution and retention improved again this quarter. We are retaining more associates through a holistic approach which includes wage and benefit investments and also a focus on associates’ well-being and this work is being recognized. This quarter, Kroger received the 2024 Platinum Bell Seal for Workplace Mental Health. This is the third consecutive year that we've been recognized with the certification. And for the first time, we received the top distinction. This program recognized Kroger as an employer who creates a mentally healthy workplace for our associates through culture, benefits, compliance and wellness programs. We'll continue to invest in our associates. When our associates have a better experience, they provide a better experience to our customers. With that, I'll turn it over to Todd to take you through our first quarter financial results.

Thanks, Rodney, and good morning, everyone. Kroger's first quarter performance reflects the resiliency of our model, which enables us to manage a variety of economic cycles. The strength of our model combined with the momentum in our Grocery business gives us confidence to reaffirm our full-year guidance even as we continue to navigate an environment of economic uncertainty. I'll now take you through our first quarter financial results. We achieved identical sales without fuel growth of 0.5%. As Rodney mentioned earlier, our identical sales were driven by several positive customer metric trends, including increases in total and loyal households and increased customer visits. We continue to see sequential unit improvement and our teams remain focused on returning to positive units later this year. Inflation continues to moderate, which is consistent with our expectations at the start of the year, and towards the end of the first quarter, we began cycling the headwinds from the reduction in SNAP benefits. Digital sales grew by more than 8%, which was led by 17% growth in delivery solutions. Gross margin was 22.4% of sales and our FIFO gross margin rate, excluding fuel, decreased seven basis points. The decrease in rate was primarily attributable to lower pharmacy margins and increased price investments partially offset by favorable product mix reflecting Our Brands' margin performance. The slight decline in our FIFO gross margin rate was in line with our expectations. We expect our FIFO gross margin rate to improve beyond our first quarter result driven by the core components of our margin expansion initiatives. During the first quarter, we recorded a LIFO charge of $41 million compared to a charge of $99 million for the same quarter last year. The decreased charge for the quarter was due to lower inflation expectations for the current year compared to last year. The OG&A rate excluding fuel and adjustment items increased 22 basis points, driven by planned investments in associate wages and increased incentive plan costs partially offset by continued execution of cost savings initiatives. In the second quarter, we expect the factors identified in the first quarter to continue, leading to a similar to slightly higher OG&A rate. We expect our OG&A rate to improve in the second half of 2024. We continue to make progress on our digital profitability, delivering another quarter of improvement in our pickup cost to serve. It remains a long-term margin opportunity with runway to improve through increased volume and process enhancements. Our store associates played a key role in the cost to serve improvements and, as Rodney mentioned earlier, did so while they improved key customer experience metrics. Adjusted FIFO operating profit was $1.499 billion. Our adjusted EPS was $1.43 per diluted share, a decline of $0.05 compared to last year. Fuel continues to be a key driver of our strategy to build loyalty by providing compelling fuel rewards to customers. We continue to see more reward activity with 8% more redemptions contributing to gallon sales, which outpaced the industry this quarter. However, our fuel profitability was below expectations this quarter with our cents per gallon fuel margin down low single-digits compared to last year. I'd now like to provide a brief update on associates and labor relations. We continue to invest in our associates as part of our long-term strategy, resulting in an average hourly rate of $19 an hour and a rate of nearly $25, with comprehensive benefits factored in. During the first quarter, we ratified new labor agreements for our Houston Clerks and Meat, Mid-Atlantic Division stores in West Virginia, South Carolina stores in Columbia and Myrtle Beach and Portland Distribution Center and Drivers covering more than 21,000 associates. Turning to cash flow. Kroger continues to generate adjusted free cash flow, strong adjusted free cash flow through consistent operating results which is enabling us to continue deleveraging in anticipation of our merger with Albertsons. At the end of the quarter, Kroger's net debt to adjusted EBITDA ratio was 1.25 compared to our target range of 2.3 to 2.5. Our strengthened balance sheet provides ample opportunities for Kroger to pursue growth and enhance shareholder value. We continue to take a disciplined approach to deploying capital with a focus on projects that drive long-term sustainable net earnings growth while remaining committed to our investment grade debt rating, increasing our dividend over time subject to board approval and returning excess capital to shareholders when we are able to do so. As part of our capital investment plans for 2024, we shared last quarter our plans for approximately 30 major storing projects focused on higher growth geographies, where we have traditionally achieved a strong ROIC and operating profit growth. We've made good progress on our projects so far and remain on track with our plans. While early, we're happy with the results from projects completed in the first quarter. We are confident these new storing projects will help advance our omnichannel strategy and be an important component to our sales growth and TSR model going forward. During the first quarter, we announced we had entered an agreement for the sale of our Kroger Specialty Pharmacy business. As part of our regular and ongoing review of our portfolio, we determined that Specialty Pharmacy was not part of our core strategy going forward and a sale would enable us to focus on our Health & Wellness strategies that revolve around our retail pharmacies. Due to the sale, a non-recurring held for sale tax adjustment of $31 million was recognized in the quarter and it has been reflected as an adjustment item in our results. The sale of KSP is not expected to have an impact on our 2024 guidance. I'd now like to provide some additional color on our outlook for the rest of the year. Today, we reaffirmed our annual guidance reflecting both positive momentum we are seeing in our business along with a more cautious customer environment in the near term. In terms of quarterly cadence, we now expect a decline in adjusted EPS for the second quarter similar to the rate we observed in the first quarter as we expect pharmacy business profitability pressures to carry over into the second quarter. This reaffirms where we expected to be through both the first half of the year as well as the full fiscal 2024. In closing, our first quarter performance reflects the strength and resiliency of our model. We are strengthening our Grocery business, which drives the data and traffic to accelerate growth in our Alternative Profit businesses and we remain confident in our ability to drive attractive and sustainable returns for our shareholders. I'll now turn the call back to Rodney.

Thanks, Todd. As you've heard from both of us, our Grocery business is performing well and we are building momentum across our business. Kroger is operating from a position of strength. We have the right strategy, which is resonating with customers, and we have the financial strength to pursue growth and enhance shareholder value. As we continue to prepare for our merger with Albertsons, I'd like to thank our associates for their incredible commitment. Since we announced the proposed merger back in October of 2022, our associates have done an exceptional job preparing for the integration with Albertsons while never once taking their eye off the ball of serving our customers, advancing our strategy, operating our business and driving results. Because of their efforts, we will be prepared to hit the ground running as a combined company ready to serve more customers from day one. A more general merger update, in April, we announced an expanded divestiture plan with C&S, which directly responds to the concerns raised by federal and state antitrust regulators regarding the original agreement. We believe the package, which includes a modified and expanded store set and more non-store assets, bolsters Kroger's position and regulatory challenges to the proposed merger. Including our upcoming court proceedings, it also positions C&S to be a strong and successful competitor. We are prepared to defend our merger because it will produce meaningful and measurable benefits for customers, for associates and for communities across the country. Customers will benefit from lower prices and more choices following the merger close. We have committed to investing $500 million to begin lowering prices day one following close, along with an additional $1.3 billion to improve Albertsons stores. Employees will benefit from Kroger's commitment to invest $1 billion to raise wages and comprehensive benefits, further building on our $2.4 billion and incremental investments since 2018. As union membership continues to decline nationwide, this merger will secure union jobs. And communities will benefit from the strength and the ability of the combined company to accelerate Kroger's commitment to ending hunger. As a combined company, Kroger has committed to donating 10 billion meals to families across the US by 2030. In closing, Kroger is off to a solid start to the year, positioning us well to deliver on our commitments. We continue to invest in associates and the associate experience because when they have a better experience, our customers do as well. Grocery results are off to a better-than-expected start, which provides the foundation for growth in Alternative Profit businesses and our model is generating strong free cash flow, which has strengthened our balance sheet and positions us for future growth. With that, Todd and I look forward to taking your questions. Because we are in litigation, we will not be taking questions on the merger this morning.

Good morning and thanks for taking my question.

Good morning.

So I wanted to dig deeper into the gross margin line, if you can maybe walk us through the puts and takes as you guys see it for the balance of the year, including how you think about the pharmacy margins in the back half of the year.

Yeah, thanks, Rupesh. Great question. We talked at the beginning of the year that our expectation was to have relatively flat year-over-year gross margin and that is still the expectation. As mentioned in my comments, we do expect results for the balance of the year to improve beyond our Q1 results and that's really reflective of some of the gross margin expansion efforts that we have going on. They're going actually really well. We alluded to our Our Brands performance. Our margins in Our Brands continue to do very well and as that business continues to grow, particularly in today's environment, we talked about the budget-conscious consumer and that continues to connect with them. And so the growth in that business helps drive the margins and we expect to see that as the year goes on. Fresh is another category where we've had meaningful growth. Fresh is doing really well. We've talked a lot about produce, our end-to-end Fresh and how that business is growing. And certainly, that comes with higher margins, which has a positive effect on our mix. And then when you look at Alternative Profits and in particular retail media, that business continues to grow well and especially in the second half of the year. We expect retail media to continue its momentum to achieve our growth of excess of 20% for the year. A lot going on in that space. And we went to a new platform a year ago and as we went and ramped up the platform a year ago, we'll be cycling that period of time with some of the momentum we have in that business. So all of those are where a lot of our confidence comes from when we talk about reaffirming our guidance for the year. And we alluded to some of the pharmacy headwinds. Even though we expect some of those to carry over into the second quarter, I think all of the results that we're seeing from our margin expansion efforts are going to continue to drive us so that we hit our expectations to improve the result relative to Q1.

I want to just add a couple of points on Todd's last point. We continue to have good success with value-add product and typically that product is something that the customer can eat almost immediately in the car or at home, and that's helping on margin. And then our sourcing teams continue to making progress in cost of goods, which helps as well.

Great. And then maybe just one quick follow-up question. In light of some of the competitor announcements of reducing prices on certain items, just wondering how you guys feel about your price gaps today.

Overall, Kroger has consistently focused on investing in pricing for many years, and 2024 is no exception. We are committed to helping customers manage their budgets, and we are confident in our relative price position. Notably, we have seen growth in our budget-conscious customer base for the first time in over a year. We are pleased with our current standing. It's also important to note that promotional offers significantly boost customer purchases, and we have a sophisticated rewards program with personalized offers that may not be visible to the public, alongside our fuel rewards. We feel optimistic about our position in relation to our competitors. Thank you, Rupesh.

Great, thank you. I'll pass it along.

Oh, hey, Rodney. I had just two follow-ups on the first question. Hey, just in terms of the price investments, and I know you guys always do them, but has anything changed with what your CPG partners are doing with Kroger to drive volumes? Because we know that they're looking to do that. And then also would love to just get further perspective on what Kroger is seeing competitively either the same or different sort of there's kind of Walmart and Target, but what are the regionals and independents doing competitively? Are they changing at all? What they're doing?

If you look at CPG partners, overall, we would be seeing more trade dollars than in the past, and I think some of that ties to the comment I made before on sourcing. As economists always say, all short statements are incorrect. There are some CPG partners that aren't worried as much about tonnage and wouldn't be as aggressive. But we are seeing an increased trend where CPG most CPG partners are starting to focus on tonnage again and then trying to partner with us more aggressively to help tonnage. If you look at regional competitors, really wouldn't see much difference there than the national competitors. And overall inflation is up slightly. You would see people raising slightly more prices than lowering. But nothing that's especially different there than what we would see. And as you know, there's a ton of great awesome regional competitors out there. Thanks, Robby.

Hi. This is Zach on for Simeon. Thanks for taking our questions. First, with respect to the Q1 performance, would you say that you set up the guidance with some conservatism or was it genuinely stronger than what you thought it would look like? And maybe as a follow-up, why shouldn't we extrapolate that level of upside for the full year? And was it driven primarily by price or units or some of both? Thank you.

In the first quarter, as Todd and I mentioned, we were pleased with our performance. It's early in the year, so it's unusual for us to make significant changes at this stage. We are happy with our customer growth across all segments and appreciate how our store team is enhancing the overall experience and stocking levels. One challenge we face is that our incentive plans will require higher accruals in the second quarter compared to last year, which will impact our results. However, we maintain a positive outlook for the year and feel good about our current position relative to our expectations, but it's still too early to implement many changes.

That's a good call, Rodney. The strength we observed in the first half of the business is closely linked to your comment about the incentive plan. A significant factor contributing to the strength in our Grocery business is our teams' performance in store execution and enhancing the shopping experience. Improvements in those metrics are a crucial aspect of our incentive plan this year, so those two ideas are connected.

Okay.

Hi. Thank you. I just wanted to clarify, are you still on track to see inflation increase as the year progresses? I think that was mentioned in the last quarter. I didn't hear any update on that rate of change. And then I don't think you provided, again, I may have missed it, gross profit dollars or pennies per gallon for fuel. Just trying to follow up on those two.

I'll let Todd address the second part. Regarding inflation for the year, the first quarter was aligned with our expectations. For the year, it remains consistent with what we anticipated. If I recall correctly, we mentioned it was slightly over 1% and we expect it to stay just above that. Some commodities will fluctuate, and as we move into the latter part of the year, those fluctuations will be influenced by factors like the corn crop yield. Overall, we expect inflation to be similar to last year's, and it appears to be stabilizing. We do not anticipate broad-based deflation, but it is stabilizing around that just over 1%.

Yeah, that's great. Regarding fuel, I mentioned that the cents per gallon margin was down in low single digits.

Okay. Thanks, Ken.

Hey, Rodney, I wanted to start with, when you think about delivery and pickup profitability, I mean, I know you're losing money in those areas. Do you have an idea in mind when you can begin to approach breakeven? I know it's going to take a while, but thought on that. And then if you had to pick a couple of key drivers, right, that would get you there, what do you think they are?

Our primary focus is to retain customers, and our second priority is to ensure we are profitable with each one. Currently, some of our divisions are either breaking even or showing slight profits. When we evaluate our performance on a per order basis across nearly all channels, we see incremental contributions. We expect that over time, these customers will become just as profitable as those in our physical stores. While I can't provide a specific timeline, that is our expectation. To achieve this, it's crucial that we maintain strong Net Promoter Scores, as they drive customer loyalty. Additionally, we aim for customers to add more items to their orders, and we will continue to leverage technology to improve our operational efficiency.

Okay. As a follow-up on pharmacy, where do you think the pressure is coming from? Is it just reimbursement or are there other factors? What are your thoughts on reimbursement in the long term? Do you anticipate seeing a decrease in capacity, particularly with many drugstores closing locations? With supermarkets exiting the pharmacy business, do you believe we will have significantly less capacity in three to five years, which could enhance profitability?

John, I'll talk to the headwinds a little bit. What we're seeing there was really a couple of items in product mix. One was around GLP-1. We've talked about that before. It's a high retail ring, but an extremely low margin and so that puts pressure on our margins. And coming into the year, if you recall the latter part of last year, we had supply constraints on GLP-1. And so some of those restraints were relieved in the first quarter. And frankly, our team did a really nice job with suppliers getting out there to get product to meet demand in our stores. And so our sales exceeded what we expected to see in the first quarter and that put a little bit of that unexpected pressure on margins. And then the second, there's another category of drugs as well, where we saw some regulatory restrictions that were unexpected that drove up the cost on those meds and put some pressure on the margin. So when we talked about some unexpected trends in Pharmacy, it was really around product mix in those couple of areas, and wanted to make sure we called it out, because we do see that carrying over into the second part of the year, it wasn't necessarily reimbursement related.

And as we look longer term, three years or five years, we definitely think there'll be less capacity. And as you noted, there's a significant number of closures by the other three players in that space. And there's a lot of work that's being done from a governmental standpoint around PBMs. The thing that I get super excited about, our pharmacies and our Health & Wellness teams, they continue to do a great job of improving the experience. And I think it's amazing that a third of our customers don't even realize we have a pharmacy. And we're obviously working incredibly hard to make sure that third of our customers that don't even realize we have a custom that we have a pharmacy to get them to convert and become a patient of our pharmacy because our teams do an amazing job on service. We have incredibly quick lines and things like that and it's one less trip that somebody has to make. So thanks, John, for the question.

Good morning. Thank you so much for taking my question.

Good morning.

Rodney, there seems to be a perception that the food retail industry is becoming more competitive, potentially impacting profitability in the latter half of the year. Can you discuss the current promotional intensity compared to the past, particularly during disruptive periods? Additionally, how significant was your price investment in attracting more price-sensitive customers and lower-income consumers this quarter?

Overall, promotional activity now resembles pre-COVID levels, and for the first time, it truly feels like those times again. As I mentioned earlier, we observed an increase in prices overall, with more prices going up than down when examining individual SKUs. I am confident about our position and our teams' capability to continue serving our customers well. Regarding our valued customers, much of this is influenced by our new brand initiatives like Smart Way, which helps customers understand they can shop with us without compromising on freshness, quality, or their overall experience. Overall, this aligns well with our expectations, and I believe it reflects the moderating inflation, although we still anticipate some inflation moving forward.

I think you're right. Our model is to drive 2% to 4% ID sales. We discussed last quarter the dynamics of inflation and the rapid disinflation we observed last year. This year, we anticipate a more normal inflation environment, which Rodney mentioned, as we start to cycle through the heavy disinflation. We expect to approach the high end of our sales guidance by the second half of the year, which aligns with the range our long-term model is based on, 2% to 4%.

It's a great question, and while I can't provide a specific date, I can assure you our team is working diligently to achieve our goals. We continuously strive to improve, and our capital investments will support that growth. We're also increasing the number of stores we open, and the maturity and remodeling of those stores will contribute positively to comparable sales over time, which we fully anticipate. As Todd mentioned, we are in the early stages of increased capital spending for new stores and expansions, and we are pleased with the initial results. Thank you, Michael.

Hey, thanks for taking the question. I wanted to ask if you could discuss the ID sales cadence through the quarter and then in the month of June. How should we think about ID sales for 2Q? And then I had a follow-up.

Yeah, the first quarter was a little choppy because we had a Easter mismatch relative to the calendar. But the general trend throughout the quarter was that we saw IDs increase steadily as we went through the quarter on average. And then as we look to Q2 to date, so far, we're right on plan relative to our expectations for Q2 results in the guidance that we've given.

We expect IDs to improve throughout the year, and so far, we are seeing that trend continue.

Got it. That's helpful. And if I could just wanted to try to better get the arms around some of the pharmacy pressures, is there anything that you could point to in the back half of the year, whether it be comparison-based or otherwise, that would help to alleviate some of those pressures or perhaps other sources of profit, whether it be media or fuel that could offset somewhat?

I will make a few comments, and Todd can add to them. As we approach the third quarter and early fourth quarter, one key factor is vaccines. Last year, our teams did an excellent job increasing the number of vaccines administered, and we have gained valuable insights that will help us replicate that success this year. When considering the pharmacy business, this will be a significant aspect. We also expect that supply issues will become more normalized, and regarding the generics Todd mentioned, historically, their emergence has led to improved profitability. We anticipate that these developments will occur in the latter part of the year. Todd, I'll let you take it from here.

You're right on with what I was going to say on pharmacy, Rodney, and just overall with the business. I alluded to earlier, the margin expansion efforts that we're seeing, and those are all factored into the guidance for the rest of the year. And even given those pharmacy headwinds, we expect the pharmacy or the margin expansion, the gross margin expansion initiatives that we have blended with the pharmacy headwinds that we called out should enable us to achieve gross profit results beyond what we saw in the first quarter.

Thanks, Michael.

Hi. Good morning, everyone.

Good morning.

I wanted to start with two questions. The first question is about the second quarter guidance. In Q1, you exceeded expectations despite lower fuel margins and pharmacy performance. However, the guidance for Q2 is down. Is this reduction solely due to pharmacy and incentive compensation, or are there other factors at play? I'm trying to understand the level of caution reflected in the Q2 guidance considering your performance in Q2 against these challenges.

Yeah, no, you're right. And it is primarily based on pharmacy and incentive. You are correct. From a fuel perspective, that's so volatile. It's really week to week. It's part of what we keep our eye on as we go forward. So far it has been closer to our expectations for the quarter, but that's one that we truly monitor daily and weekly to understand the impact it's having on the business.

All right. Then I guess a quick follow-up is just on leverage. So you continue to reiterate your leverage target. You are well below that at this point. Taking a step back, are there any advantages that you see to the business to running below the target long-term? Is this a metric that you think you would reassess post the Albertsons decision? Just curious as to how you're thinking about that.

I think long-term, our targets at 2.3 to 2.5 are in the right place. That is one of our key objectives is to maintain our investment grade rating and over time, it's proven that is the range that enables us to be able to do that. So I think we long-term continue to look to operate within that range, with or without the merger, frankly. And the beauty with where we're at here, you're right, we do have a lot of capacity there. Obviously, we're firmly focused on closing the merger and being able to use that capacity relative to the merger and come out the other end. But I think in any scenario, the capital allocation approach that we've taken over time, we've got a long track record on what that is and how we do it. And I would expect this to execute under that framework on a go-forward basis.

We really view our lowest cost of capital is a BBB rating. And if you look at it historically, it's like 80% of the time that would be the lowest cost of capital. And as you look at the markets going forward, we don't see anything that would cause that to change. So that gives you the financial flexibility to do things like merging with Albertsons. It also creates the lowest cost of capital. And the reason we always reiterate that 2.3 to 2.5 is that really is the point that we believe creates a solid BBB rating. And the thing that, as Todd and I both mentioned, the business continues to be incredibly strong from a free cash flow standpoint and the anticipation going forward. So it gives us the opportunity to continue to invest in the business, continue to grow the business, and we can't wait to be able to merge with Albertsons so we can do that at even a scale a little bit bigger. So thanks, Ed, for the questions.

Hi. Good morning. This is Kelly Bania from BMO.

Good morning.

Just wanted to ask about the volume and the tonnage outlook. I think you mentioned some positive momentum with the budget consumers and maybe an increasing customer count there. But how are volumes and tonnage trending year-over-year within your different customer cohorts? And how is that impacting your outlook for the full year in terms of tonnage and volume overall?

If you look, the tonnage trends are all trying to think if there's any exception to this, they're all in the right direction and they're improving. If you look at historically, part of that, we believe, is because of the moderating inflation, part of it is because of doing a better job on in-stock and the customer experience and connecting better with each customer segment. So we feel good about those trends for multiple of reasons. Was there a follow-up question or?

Thank you for your comments. I wanted to ask another question about the promotional and competitive environment. It seems like you're suggesting it's returning to normal. Can you explain what's different about Kroger's gross margin profile, especially since it appears to be more stable and possibly increasing in the coming quarters compared to a few years ago? How much of that stability is due to Alternative Profit and its ongoing growth versus any changes in the gross margin of the core business?

Yeah, Kelly, you touched on part of it. I believe it's not just about Alternative Profit. We currently have more options than we did in the past to enhance our value through margin expansion. This includes Alternative Profit and retail media, as well as the efforts of our merchants. We've discussed our brands and their contribution to margin expansion, along with Fresh. All these areas play a role. Additionally, our ongoing process improvements, whether in the supply chain or reducing shrink, are also significant. It’s the combination of these margin improvement initiatives that sets us apart from what we experienced a few years ago, as we have multiple sources of value to support our investments in customers and associates.

Our teams are making good progress in managing warehouse and transportation costs by reducing empty miles and handling more of the transportation. Over the past five to ten years, we've worked hard to diversify our business model and create value. This includes finding ways to monetize the traffic generated by our core business, which customers find valuable.

Hi. Good morning, and thanks for taking the question. I wanted to ask about the store execution plan that you implemented with the daily scoring system. Now you're really addressing some of the underperforming stores relative to the chain average. So one is what has been the biggest opportunity for some of the store-level improvements you're seeing? Just how much are they contributing to the traffic gains that you are also seeing? And just how best to think about further upside with both your budget-conscious customers but also the mainstream and the premium customers?

When you look at upside, I think our whole team feels incredibly good. If you were in one of our meetings, you would hear us talk about all the things that we can get better at, and it's things that matter to our associates and matter to our customers. So we're incredibly excited about the continued opportunity we have on getting better. On the store execution, obviously, they always say retail is detail and it literally is working with every single store. As we mentioned in our prepared remarks, turnover continue to improve. When turnover is lower, when retention is better, it helps on the experience, it helps on the execution in the store, on in-stocks and other things. Our teams are doing a very good job on Fresh and that's everything from our supply chain to our folks ordering product to using AI to make sure the right stores get the right product, to the stores getting it out on the shelf and helping the customer have a couple more days of freshness at home. So it's really all of those things together that we think it's what's driving the increased traffic and increased in connection with our customers. So it's obviously super proud of the whole team and excited about the opportunities going in front of us.

Great. And just a quick follow-up. I hate to beat this, but just on the promo backdrop, just how should we think about your promotional basket? How much of that is proactive versus reactive that you are doing in the current environment? And I think you said that it's pretty much back to pre-COVID levels. Is it fair to assume that your vendor funding is also in line with pre-COVID levels or do you anticipate that to continue to ramp as your vendors are focusing on driving volumes? Thank you.

Yeah. If you look at vendor funding, we would expect it to continue to increase because you know that CPGs are trying to move tonnage. If you look at overall, we would, I think, feel like it's pretty much backed up pre-COVID but at a higher level. Some CPGs have increased their margins without, so they're just making flat-out more profit. So we think they actually have room to even further invest in trade dollars.

In response to your comment about being reactive versus proactive, we developed our annual plan and guidance, including our pricing strategy, and we are currently implementing that strategy. Customers are responding very positively to our approach. We are sticking to the plan we established and executing our playbook. As Rodney mentioned earlier, this is what we have been doing for 15 to 20 years, and we believe it resonates well with our customers.

Yeah, there isn't things that are going on out there that I would say that's causing us to be reactive. You always pay attention and I spend as much time getting to the competitors' store as I do our own stores. But when I look at overall, we're running our plan and we're using our data and insights to make sure that we're taking care of our customers and associates. So I feel really good about where we are overall on that. So thanks for the questions.

Good morning, everyone.

Good morning, Chuck.

I was cut off for a while, but it sounded like you said, Rodney, that your delivery sales doubled year-over-year in the first quarter. What's driving that? Is it just your execution or the customer demand? And when you look at customer demand for delivered groceries, how does it break down between budget-conscious customers and more affluent customers?

Yes, the delivery business nearly doubled compared to last year, and this growth is across all customer segments. It's important to note that our technology has improved, allowing us to better accept SNAP and similar payments compared to a year ago. Our teams are doing a great job ensuring a positive experience for customers. For instance, in Florida, our customers receive ice cream that remains frozen and chocolate that doesn't melt thanks to our delivery trucks. While we're pleased with this progress, we recognize that there is still significant work to do to ensure we are satisfied with our profitability.

Are there any CPG promotions or monies made available to help get that customer to make the first delivery order?

Yes. The short answer is yes. And there's, as you know, online and with our data and personalization, there's all kinds of things that you're learning in terms of different customers find it attractive at different times. So the short answer is absolutely yes. The other thing is, obviously online really supports the Alternative Profit business as well from a media standpoint. Thanks, Chuck. Thank you for all the questions, as always. As you know, I always like to share a few comments with our associates listening in. Today I'd like to take a moment to celebrate Alex Spurlock. Alex is a store leader at QFC store 860 in Redmond, Washington, and recently was named the 2024 Food Industry Association Store Leader of the Year. Obviously, this is a huge honor and we are so impressed by the amazing work that Alex does at her store. With more than a decade in the grocery business, Alex understands the industry. She has a gentle spirit and a fierce attention to detail that clearly earned her this recognition. What's most impressive is Alex's passion for her associates. She is always ready to coach her team and celebrate their success in meaningful ways. Thank you and congratulations, Alex, for everything you do for our customers and your fellow associates. And congratulations on this amazing honor. And thank you to all of our teams for all the work they do every day to take care of each other and our associates and thank you for everyone for joining us today.