Kroger Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
September 10, 2021

Key Takeaways

  • Identical sales ex‐fuel declined 0.6% year‐over‐year but rose 14% on a two‐year basis, with triple‐digit digital growth, driving confidence in delivering 8–11% total shareholder returns.
  • Customers seamlessly shifted between channels as part of Kroger’s seamless ecosystem, adding over 340,000 new digital households, cutting pickup wait times, and on track to launch 6 customer fulfillment centers by 2023.
  • Kroger led with fresh and private brands, recording positive comps in produce, floral, deli and bakery, while Simple Truth and Private Selection brands gained share through new innovations like GOES Kitchen and the Go Fresh & Local Supplier Accelerator.
  • Gross margin contracted 60 bps ex‐fuel due to price investments, shrink and supply chain costs, but Kroger tapped operational efficiencies to achieve a $1 billion cost savings goal and raised full‐year guidance despite higher inflation.
  • With almost 500,000 associates, Kroger advanced its ESG and human capital priorities—administering 6.7 million vaccine doses, winning a Gold Award for COVID‐19 response, and investing $350 million in hourly wage increases for 2021.
AI Generated. May Contain Errors.
Earnings Conference Call
Kroger Q2 2022
00:00 / 00:00

There are 10 speakers on the call.

Operator

Good day, and welcome to The Kroger Company Second Quarter Earnings Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Rob Klonft. Please go ahead.

Speaker 1

Thank you, Sarah. Good morning. Thank you for joining us for Kroger's Q2 2021 earnings call. I am excited to be here today and look forward to working with all of you in my new role as Head of Investor Relations. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen and Chief Financial Officer, Gary Millichip.

Speaker 1

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 Company 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.

Speaker 1

After our prepared remarks, we look forward to taking your questions. I will now turn the call over to Rodney.

Speaker 2

Thank you, Rob, and congratulations on your new role. I would also like to take a minute to thank Rebecca Manis for her service to the IR team. We wish her continued success In our new role as Head of New Geographies for our customer fulfillment centers. Finally, I would like to thank you all for joining us today. Our associates have done an incredible job operating our stores, pharmacies, supply chain and manufacturing facilities Through the COVID environment, their unending commitment to serving our customers and communities Continues to make a difference in Kroger's 2nd quarter identical sales without fuel, grew 14% on a 2 year stacked basis, Ahead of our internal expectations, we saw triple digit growth in digital over the same time period and continue to drive costs out of the business through cost saving initiatives and operational efficiencies.

Speaker 2

We remain confident in our positioning and our ability to deliver consistently attractive total shareholder returns of 8% to 11% over time. I'd like to spend the next few minutes discussing 3 key areas. 1st, Customer behavior and how our seamless ecosystem is working. 2nd, I'll share examples of how we are leading with fresh And accelerating with digital. And finally, I will highlight how we continue to live our purpose to feed the human spirit Through the associate experience and our work to advance Kroger's ESG commitments, Our strategic focus on leading with fresh and accelerating with digital continues to build momentum across our businesses.

Speaker 2

As we've operated through the pandemic, we've recognized that the structural shifts in our customers' eating and cooking habits, Customers are responding favorably to our value proposition and are enjoying the convenience of our seamless offerings. Early in the quarter, customers visited stores more frequently and many shifted from online to in store. This highlights the relevance and convenience of our easily accessible footprint. Towards the end of the quarter, as COVID-nineteen cases increased in many geographies, customers began shifting back to our digital solutions. This further demonstrates the strength of our seamless ecosystem.

Speaker 2

Customers can choose how they want to shop. Our job is to be available in every channel, so the customer does not have to compromise. Regardless of how they choose to shop, customers are eating more food at home because it's more affordable, Convenient and healthier than other options. While some food at home trends may be transitory, our research success, Those I highlighted are structural and Kroger is uniquely positioned to address them through our assortment of fresh products, World class digital platforms and innovative meal solutions, we will continue to elevate our position as a food authority So that when customers think food, they think Kroger. We continue to advance Our position is a leader in fresh during the Q2.

Speaker 2

We saw positive identical sales in produce and floral and deli bakery Even as we lapped elevated sales in 2020, our research shows how much our customers love our brands. Sales for both Simple Truth and Private Selection brands were strong as food at home trends remain sticky. We continue to innovate within Fresh. For example, our expanded partnerships with GOES Kitchen allow us to offer customers freshly prepared On Demand Restaurant Food. This is especially relevant at a time when many customers Are looking for inspiration and 70% of our customers say convenience is important when cooking.

Speaker 2

We also announced our 2021 Go Fresh and Local Supplier Accelerator cohort cohort and are already bringing innovative Locally and regionally sourced products to stores across the country and helping many small entrepreneurs achieve their dreams. Earlier this week, Kroger announced our new brand icon. The Freshcart icon brings together the Kroger family of companies Under one unifying visual and reinforces our brand promise fresh for everyone. We are very proud of our growth in digital, which increased 114% over the last 2 years, Similar to our Q1 growth, we remain on track to deliver against our 2023 digital growth And profitability targets introduced at our 2021 IR Day. While digital sales decreased 13% during the quarter, Almost all customers who reduced their online spend during the quarter continue to shop with us in store, Highlighting the power of our ecosystem and our ability to create a meaningful customer experience across all channels.

Speaker 2

As a short reminder, Kroger has doubled our e commerce household penetration, increasing the number of our brick and mortar customers that engage with our digital solutions since 2019. During the quarter, we added over 340,000 new customers To our digital platforms, we continue to expand capacity across our footprint and we reduced wait times for Kroger Pickup. As we look ahead, our seamless ecosystem will remain a competitive advantage as we offer what customers need and want In a way that fits into their life, whether it's shopping in our stores, picking it up at our stores, or getting it delivered or shipped directly to their homes. We continue to enhance our seamless ecosystem. As we've shared last quarter, We currently have 2 customer fulfillment centers open, which are expanding our capabilities in Ohio and allowing us to expand into the new geographies within Florida.

Speaker 2

We are happy with the performance thus far and are energized by the volume and growth in both sheds. In Ohio, our focus has been on involving the customer proposition to maximize opportunities alongside our existing digital solutions. In Florida, We launched Delivery Savings Pass offering customers unlimited deliveries for just $79 per year. We continue to see incredible Net Promoter Scores and our customers tell us they love our friendly, professionally trained drivers And the refrigerated delivery vans that bring the freshest food directly to their doorsteps. Looking ahead, we remain on track to open 6 customer fulfillment centers over 20222023, which will further expand our seamless ecosystem.

Speaker 2

Before I share some specifics On how we are using data and personalization to grow the business, I thought it would be helpful to remind you about how our rewards program and how it works. Our rewards program has been active for over 2 decades. It captures data from 60,000,000 households At 96% of our sales, customers clearly see the value of our program, which drives sales and builds loyalty. As an example, nearly 60% of all items in a digital basket were added through our personalization science. Highlighting our ability to make meaningful suggestions that surprise and delight customers.

Speaker 2

Furthermore, when we personalize recommendations for our customers, we can reduce their time to shop by nearly 70%. Overall, 1 in 3 people have noted that groceries have gotten more expensive in the past month. Kroger customers benefit from our personalization as we offer highly relevant savings at a household level allowing them to further stretch their food dollars. Our associates continue to deliver a full, fresh and friendly customer experience every day, every time, While also supporting our communities through the pandemic, we remain urgently focused on keeping people safe in our stores and facilities. Our teams were recently recognized with the Gold Award for Excellence in Human Capital Management From the Brandon Hall Group for our people centered COVID-nineteen response.

Speaker 2

Obviously, we're especially proud of that recognition. During the quarter, we introduced new technology to elevate our associate experience. Kroger launched FreshStart, A new personalized training program to foster greater associate engagement and retention. We also launched our Feed app, which provides associates easy access to company communications And resources from their smartphones. We are incredibly proud that during the quarter we saw an improvement in retention As we strive to be an employer where associates can come for a job and stay for a career.

Speaker 2

Now turning now to the Live Our Purpose. We continue to believe that customers, associates and investors Are increasingly choosing where to shop, where to work and where to invest in companies that are taking meaningful steps To improve our communities and work to build a more sustainable planet, we recently published our 2021 ESG g report on the krogercove.com. It outlines our progress over the last several years. It further outlines our aspiration to further integrate ESG performance into lines of business And our commitment to creating shared value that benefits all stakeholders. We imagine a world Where everyone is thriving together and Kroger is helping millions of people live healthier, more sustainable lifestyles, Protecting and restoring natural resources and contributing to more responsible and inclusive global systems.

Speaker 2

One of the many ways we bring our ESG vision to life is through our work that our Kroger Health team has been doing to serve and support our customers and communities through the pandemic. During the quarter, we worked with Lyft To provide rides to COVID-nineteen vaccine appointments, teamed up with local sports icon to drive awareness And access in the underserved communities and we concluded our community immunity giveaway. To date, we have provided over 6,700,000 doses of the vaccine and continue to drive availability and education. And yesterday, President Biden noted that Kroger is one of 3 national partners who have agreed to make the rapid COVID test Available to customers at cost for the next 100 days. Kroger is committed to helping people live healthier lives, While safeguarding the communities we serve.

Speaker 2

RESG goals are ambitious and with a team of almost 500,000 dedicated and Driven associates, they are also achievable. Since we first introduced our commitment to delivering strong Our teams have been laser focused on execution. This focus has resulted in tangible results, allowing us to deliver this quarter and for the long term. Now I would like to turn it over to Gary to discuss our Q2 financial results. Gary?

Speaker 3

Thanks, Rodney, and good morning, everyone. Kroger is delivering strong results and continues to build momentum as we execute on our priorities of leading with fresh and accelerating with digital. During the quarter, adjusted FIFO operating profit grew by a compounded annual growth rate of 23% over 2019 And adjusted EPS grew by a compounded annual growth rate of 35% over the same 2 year period. This reflects our disciplined approach to executing our strategy, balancing investments in our associates and customers With strong cost management and accelerating growth in our alternative profits business. It also provides a further I will now provide additional details on 2nd quarter results.

Speaker 3

Identical sales without fuel declined 0.6%. On a 2 year stack basis, Identical sales without fuel increased 14%. Each period during the quarter was stronger than the last, And I'm delighted to say we returned to positive identical sales without fuel during the final period of the quarter. Our digital platform remains a key strength in our model and we were pleased with the triple digit growth achieved over 2019. We remain on track with our plans to double our digital business by 2023 and would expect continued investments in the customer experience, Scaling of new fulfillment centers and several new innovations, which we will announce throughout the year to drive future growth.

Speaker 3

As shared last quarter, we would not expect future digital growth to be linear, especially as we cycle COVID in 2021. During the quarter, we also made further progress in improving digital profitability as we achieved a record low for the time taken to pick a digital order in store and continue to see growth in the media revenue generated on digital transactions. Gross margin was 21.4% Sales for the Q2. The FIFO gross margin rate excluding fuel decreased 60 basis points compared to the same period last year. This decrease was primarily related to price investments and higher shrink and supply chain costs, partially offset by sourcing benefits And growth in our alternative profit business.

Speaker 3

On a 2 year basis, our FIFO gross margin rate excluding fuel Decreased 55 basis points compared to 2019. Consistent with many retailers, We experienced supply chain constraints and increased warehouse and transportation costs during the quarter. We are actively managing this risk within our business by securing increased capacity and augmenting associate retention programs within our own facilities. We expect supply chain costs to remain elevated in the second half of the year, and this is contemplated in our updated guidance. In the second half of the quarter, we also saw higher inflation in some categories.

Speaker 3

We are being disciplined in working with suppliers to manage these increases and are passing along higher cost to the customer where it makes sense to do so. While difficult to predict with precision, as we shared last quarter, We believe inflation for the full year will be higher than originally contemplated in our 2021 business plan. For the second half of twenty twenty one, our guidance now assumes inflation of between 2% 3%. Recognizing recent inflation trends and our outlook for the rest of the year, we recorded a higher LIFO charge for the quarter of $47,000,000 compared to $23,000,000 in the prior year. Kroger's strong operational execution allowed us to leverage operating, general and administrative expenses by 76 basis points excluding fuel and adjustment items in the Q2.

Speaker 3

This reflects lower COVID-nineteen related costs And savings captured through our cost saving initiatives. On a 2 year basis, our OG and A rate excluding fuel and adjustment items Decreased by 137 basis points compared to 2019. We continue to see opportunities to streamline processes And leverage technology and remain on track to deliver $1,000,000,000 in cost savings during 2021. The traffic and data generated by our seamless ecosystem continues to create a strong flywheel effect for our alternative profit business, Which again experienced significant profit growth in the quarter. Media and Kroger Personal Finance continue to lead the way And we remain on track to achieve the high end of our expected range of $100,000,000 to $150,000,000 of incremental operating profit in 2021.

Speaker 3

Fuel is also an important part of our overall value proposition for our customers. Gallons grew in the 2nd quarter by 7% And outpaced market growth. The average retail price of fuel was $3.13 this quarter versus $2.14 Our cents per gallon fuel margin was $0.39 compared to $0.37 in the same quarter in 2020 And fuel was a tailwind to operating profit of $33,000,000 compared to prior year. Turning now to our financial strategy. We continue to generate strong free cash flow and remain committed to investing in the business to drive sustainable growth, while also returning excess cash to shareholders.

Speaker 3

We are prioritizing capital investments that support our growth strategy, widen our competitive modes and deliver strong returns. Capital expenditures year to date were down compared to prior year as we carefully navigated the impact of higher project costs and longer project lead times due to a challenging labor market. As we confirmed in guidance today, we are maintaining our range for capital investments excluding mergers, acquisitions and purchases of lease facilities of between $3,400,000,000 $3,600,000,000 and would currently anticipate coming in at the low end of this range for the year. During the quarter, Kroger repurchased $349,000,000 of shares and year to date has repurchased $751,000,000 of shares. As of the end of the Q2, dollars 779,000,000 remains outstanding under the current Board authorization Announced on June 17, 2021.

Speaker 3

In June, Kroger also increased the dividend by 17%, Marking the 15th consecutive year of dividend increases. Our proactive approach Investing in our associates over recent years is helping us navigate a challenging labor market. Our strategy continues to focus on investing in compensation plans That reward our associates in ways that are meaningful to them. We are committing to investing $350,000,000 In hourly wage increases for our associates during 2021, in addition to the $800,000,000 we invested in associate wages between 2018 2020. Over the same period, we have also taken several opportunities to improve the security of our associates' pension benefits.

Speaker 3

Our average hourly rate is now in excess of $16 an hour and with comprehensive benefits factored in, we'll be approaching $21 by the end of 2021. We are committed to increasing retail hourly wages sustainably And our long term financial model fully contemplates continued investments in associate hourly rates. During the Q2, we ratified new labor agreements with the UFCW for associates in our Atlanta, Michigan, Food 4 Less and Mid Atlantic divisions, Covering over 34,000 associates. We continue to negotiate contracts with the UFCW for store associates in Houston, Little Rock, Memphis and Portland. Our financial results continue to be pressured by inefficiencies in healthcare and pension costs, which most of our competitors do not face.

Speaker 3

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. Turning now to our expectations for the second half of twenty twenty one. Driven by momentum in our results And sustained trends in Food at Home, we are raising our full year guidance. We have also narrowed the range of our guidance as we are further into the year and the trends in our business and the broader food at home market become clearer. We now expect identical sales without fuel in the second half of twenty twenty one to be flat to slightly positive, resulting in full year results Negative 1.5 percent to negative 1% and a 2 year identical sales stack of between 12.6% to 13.1%.

Speaker 3

We expect our adjusted FIFO operating profit to be in the range of $3,900,000,000 to $4,000,000,000 reflecting a 2 year compounded annual growth rate at between 14.1% 15.6%. In conclusion, we are emerging stronger through the pandemic I remain confident in our ability to deliver total shareholder return of 8% to 11% by sustainably growing earnings and using our resilient free cash flow to return excess cash to investors. And now I'll turn it back to Rodney.

Speaker 2

Thank you, Gary. The environment we operate in is dynamic And I am so proud of our associates' ability to meet the challenge and serve our customers while building for the future. Kroger's seamless ecosystem is working. This was evident during the quarter as we saw customers seamlessly shift between channels And we continue to see strong digital engagement. We are leveraging technology, innovation And our competitive moats to deliver against the total shareholder return model we introduced in 2019 and reaffirmed in 2021.

Speaker 2

Gruber will continue to deliver for all stakeholders and position the business for long term success. Now we look forward to your questions.

Operator

We will now begin the question and answer session. At this time, we will pause momentarily to assemble our roster. Our first question comes from Greg Badishkanian with Wolfe Research. Please go ahead.

Speaker 4

Good morning. This is Spencer Hanus on for Greg. Can you guys talk about the comps that you're seeing quarter to date? Because I think the guidance does imply somewhat of a slowdown on a 2 year basis in the second half. And then Although it's early, how are you thinking about comps in 2022?

Speaker 4

Do you guys get back to your long term algo next year? Thanks.

Speaker 2

Yes. As Gary mentioned in his prepared remarks, the last period of the Q2 we returned the positive identicals. And so far in the Q3, we've continued to see the trend of positive identicals and our guidance for the balance of the year It's positive as well. So we're very pleased with where we are. We're pleased with The performance our teams are doing and we're making progress and substantially ahead of where we initially we thought we would be at this point in time On cycling the COVID peak from last year.

Speaker 2

As we look toward 2022, Gary, unless you want to get into more of the details, I think the key thing would be what we talked about at our Investor Day In 2021 and that's our commitment to a TSR model of 8% to 11% and that's driven by a combination of sales growth, Slight margin improvements and taking free cash flow and returning to our shareholders via dividend and stock buyback And the sum of those together is what will drive the 8 to 11 and we remain committed to that. And obviously since we put it in place in 2019, we've outperformed it. I don't know, Gary, if you want to add anything.

Speaker 3

The only thing I would add, I think you said it very well, Rodney, is we feel really good about the trends This is obviously as we shared on the prepared comments. As you look at the back half of the year, you asked some for additional color on How we're thinking about the trends that we're seeing there and the guidance, I would say we're obviously heading into the back half of the year, as Rodney mentioned, with momentum in the business. We did raise the guidance to now be in that sort of 0% to 1% for the back half of the year based on reversing into that from the year to date performance and the guidance We gave for the year. Overall, we're feeling really good about how we're executing in the business and seeing that sustained trend in food at home As consumers continue to gravitate towards some of the trends that Rodney talked about. And also, obviously, we are seeing some Return to previous behavior with the Delta variant currently prevalent in the U.

Speaker 3

S. As well. That being said, we do still think there are some knowns In the market, if you look at different countries, how long the impact of the Delta variant lasts, if you like, on consumer behavior. We are seeing some consumers return to normal behavior of returning to offices in some cases. And so while we feel really good about our trends and our ability To continue to win with the customer, the back half of the year would be more of an 11% to 12% 2 year stack based on still some of the Uncertainties and unknowns around those elements that we're still looking to see how they play out.

Speaker 3

I think the only other thing that I would Reinforce on Rodney's comment is that we do expect as we shared at our Investor Day at the beginning of the year that as we come through 2020 2021, we expect the overall Food at home trends in the market, but also specifically Kroger's overall sales to come out of 2021 in a much stronger position than we would have been had the pandemic not occurred. And so we believe that that will still certainly be true as we head towards 2022. And We look forward to sharing more details on 2022 when we get to towards the end of the year.

Speaker 4

Thanks. That's really helpful color. And then could you guys comment on how rational your peers have been at passing through inflation? And are you expecting any gross margin Headwinds from some of the elevated inflation in the perimeter of the store, any additional color there would be helpful.

Speaker 2

If you look at During the quarter, about half of the gross margin impact was from higher shrink and higher supply chain costs. And Gary in his Prepared remarks talked a little bit about both of those. But if you look at shrink, a lot of that about Half of the half or 25% of it is driven within the shrink component and that's heavily driven by organized crime At least it appears to be. And I know Congress and other groups are starting to spend more time on understanding What's driving that and what's behind it and what's the distribution channels for the stolen products as well and trying to manage that. And then on the supply chain costs, we are proactively investing there to minimize the effect.

Speaker 2

On both of those areas, the guidance that Gary shared for the balance of the year reflects the pressure in those areas. And from an inflationary standpoint, as you know, over time we've been successful in operating in Low or negative inflation and high inflation and we would see this no different. And Our business, the easiest place to operate is when inflation is between 3% or 4%, but you don't ever get what you It makes it the easiest, but so far, where costs are being passed through in an organized way for the most part and As we would expect and following our strategy.

Speaker 4

Great. Thank you so much.

Speaker 2

Thanks, Greg. Sorry.

Operator

Our next question comes from Michael Lasser with UBS. Please go ahead.

Speaker 5

Good morning. Thanks a lot for taking my questions. I wanted to drill down into your comments The consumer embracing eating at home coupled with targeting the total shareholder return formula for next year We're still largely in the midst of this pandemic. Many workers are still working from home. So is the strength this year just delaying The inevitable shift back to food away from home in calendar 2022.

Speaker 5

And if that's the case, you're guiding to a 3% Operating margin this year essentially. So how will you be able to maintain this operating margin rate In an environment where your sales are going to continue to be pressured particularly as you have reduced a lot of your OG and A expenses this year? Thank you.

Speaker 2

Thanks, Michael. I'll start and let Gary finish. If you look at all of our research on people eating at home, customers are telling us They enjoy eating at home and eating with their families, which we believe is structural and sustainable. They're also telling us That eating at home, they're able to eat healthier, stretch their budget significantly further because it's not nearly as expensive as eating in a restaurant. And they also like showing off their new skills on cooking.

Speaker 2

And all of those things, Everything that our research would suggest are long term trends and structural trends. The other thing that Everybody on the call, your guess is as good as ours, but everything that we can tell, we believe that People will continue working from home more than the past. And many companies and I know certainly we are We're supporting people in terms of different jobs, what jobs can be worked from what location. And in all of those cases, what we're finding is People are eating more meals at home I. E.

Speaker 2

Breakfast and lunch. So everything that we can see A meaningful part of the trend change is really structural and sustainable and it's not Just a one time blip because of COVID. In terms of the margins and stuff, Gary, I'll let you Drill into some of that detail.

Speaker 3

Yes. I think all I would add Rodney is maybe just Mike will take you back to the journey we've been on for the last 3 years with our model and as you think about how we Teed it up at our Investor Days, we feel that over 2019, 2020 and now 2021, We're really demonstrating how we're able to manage the business more holistically, as we think about delivering on our TSR model. So you think about the Continued investments even through the pandemic that we are making our customers to ensure that they see the value we're delivering whether that's in the experience and some of the digital investments or through Continue to invest in price where it makes sense and personalization to make sure we're positioned well with the customer. The investments that we're making in Average hourly rate for our associates, to ensure that we're continuing to improve the experience there. And as you look at that and then think about The way in which we've managed costs, we're continuing to accelerate our alternative profit businesses and at the same time Continue to get stronger and more effective at sourcing and managing margins in that way.

Speaker 3

I think that gives us Confidence in our ability to continue to manage the business overall and drive a strong TSR in line with our commitments as you think about over time Our commitments are to our shareholders. So we'll obviously get into more specifics around how we think about 2022 later in the year. And at this point, I I wouldn't want to get into specific details about next year, but that's certainly how we think about our model and how we get confident in our ability to maintain The trajectory over time and supported by Rodney's comments on how we think about continuing to see the customer spend Dollars of Food at Home and how we can continue to grow our business within that context.

Speaker 2

Yes. As you look at costs, it's one of those things where we've been able Take costs out of the business without affecting the customer experience for years. And I know when we set out a goal, we always think that that's all we're going to find and then our great teams are able to find more areas for Process change and cost opportunities. And when I watch our operations team, Gary mentioned, the procurement team, Our technology team, but more importantly, how our stores and technology and operations team are working as one. They continue to identify things to make our associates' job easier to reduce the number of touches of product And be able to take costs out, which our customers then benefit and some of that cost reduction is shared with our customers, some of it is shared with our associates, But it's part of the overall flywheel that continues to accelerate and make our model sustainable.

Speaker 2

And Gary's point on alternative profit It's an important component of that as well.

Speaker 3

Actually, one other thing on the cost side, Michael, that I think is important too. We mentioned this again at our Investor Day, but this The plan that we have to double digital profitability, that's obviously very important to the long term strategy that Rodney outlined around how do we make sure that from a customer perspective, they're not having A compromise between store and digital experiences, but it's also important from a business model point of view to continue to improve the profitability of the channel so that from our perspective, We can be agnostic from whether the customer is buying online or buying in the store. As we grow that digital profitability rate, Important to remember that just doesn't affect the growth in the future. It affects the $10,000,000,000 business that we have today. So that's also Proving to be a tailwind in the financial modeling OG and A now, but also will continue to be a tailwind because we're only partway through that journey as we Take cost out of filling an order and continue to grow media revenue per transaction as well.

Speaker 5

And my follow-up is focusing on the media revenue per transaction. It Seems like that's the area where you're really supporting the profitability of your digital business And subsequently, the overall gross margin for Kroger, as a result, where are you from An advertising perspective from a large CPG company perspective versus getting more Advertisers on the platform, can you frame out how big this advertising opportunity can be? And as an unrelated side note, To what extent was there a vaccine distribution benefit within the gross margin, one of your large competitors talked about that within the quarter?

Speaker 2

Several questions there. I'll briefly talk about the media. We still see retail media as a significant opportunity And we shared at Investor Day, but Kroger's Retail Media team and our Retail Media offer In 5 different areas, we ranked number 1 among our competitors in 3 of the 5 And we were tied for number 1 and the other 2. So obviously the value CPGs get from our offer and our ability To use our data to make sure the right customers are seeing offers is substantial and significant. And we believe that it's a significant opportunity to continue to grow retail media.

Speaker 2

I won't get into specifics Other than we would say that we feel like we're just getting started.

Speaker 3

Yes. And then Michael, I'll just say on the health and wellness question, We would certainly have seen some benefit from COVID vaccines during the quarter. Having said that, we pivoted a lot of our efforts in the Pharmacy business, which as you know is a big part of our operation in our little clinics, I would say, net net, if you looked at the Health and Wellness business, I would think of it as largely being On plan and so I wouldn't think of it as a headwind or a tailwind during the quarter or for that matter being a headwind for the rest of the year either. I think we've got Fully contemplated within our guidance the expectations around the Health and Wellness business going forward.

Speaker 5

Thank you very much and good luck.

Speaker 3

Thank you.

Operator

Our next question comes from Chuck Cerankosky with Northcoast Research. Please go ahead.

Speaker 6

Good morning, everyone. Nice quarter. I want to talk a little bit about or ask a little bit about private label in this inflationary period. How do you see customers reacting to it? And is there a difference between A customer shopping in store and online?

Speaker 2

Yes, if you look at our brands, Simple truth and private selection continues to really gain share and grow. We're also finding big packs are growing significantly. If you look at for us We find our brands, if CPGs are passing through inflation that's not real, Every time when somebody does that our brands even gain incremental share. The other thing that I've been really proud of our team is the innovation they put behind the product and we've introduced over 140 new products in the quarter And we continue to expect that going forward. I don't we're not seeing behavior changes.

Speaker 2

If you go back to prior times when you had inflation, the customer a lot of times would trade over to Our brands as part of their stretching their budget, we're not seeing budget changes on our brands happening at this point, But I'm sure if inflation continued, our customers are telling us they still feel pretty good where they are financially And for the most part people are still saving at record levels and things like that. Now at some point if If budgets got more constrained, you would probably start seeing some of that behavior. But the business we're gaining right now It is really being created because of the innovation in our product and the quality of the product and it's really standing on its own.

Speaker 6

And then secondly, Rodney, are you seeing regional differences in the shifts in the way people moved in and out of E commerce over the course of the quarter?

Speaker 2

Yes, we would and it's really wherever COVID is higher, You would see the shift to more online and that's delivery and pickup. And as it moves north, you would see that within the company. And as I mentioned in my prepared remarks, the thing that we're especially proud of is almost every customer that we're Shopping with us digitally early in the quarter that started that stopped shopping digitally, they started shopping in the stores. And for us that's really important as part of our overall strategy for Seamless because what we find is After the 1st year, an online shopper actually comes into the store more often than they did before they became an online shopper.

Speaker 6

And have you quantified what your total e commerce did to the operating earnings during the quarter? Is there way to put a number on that whether smaller loss or is it trending towards a positive number?

Speaker 2

Well, Gary, I'll talk a little bit. If you look at within the quarter, obviously, we had the start up costs of Our sheds in Florida and Monroe, so that created a headwind. Obviously, that was reflected in our guidance That we gave for the year and our updated guidance. I don't know Gary if there's any additional?

Speaker 3

Well, I think we talked about, Chuck, the profitability of digital in different ways. When we add in all the fixed costs, we're more on the journey towards profitability as you were alluding to. We generally focus though on what's the pass through rate on the transactions as we're growing customers because what we find with digital as you know is the customer becomes more loyal overall to Kroger and we see about 50% or so incrementality as the customer engages digitally. As we've talked about previously, we've kind of When you think back to last year, we're at mid single digit pass through rate compared to a pass through rate that will be closer to mid to high teens on a store transaction. And we're on the path to improving that profitability to drive towards doubling the profit rate on the digital transaction and ultimately targeting to get to parity.

Speaker 3

I would say we're making good progress on that journey. As I mentioned on my prepared comments, we continue to make solid improvements In the efficiency of picking a digital order and over time we'd expect Ocado to play a role in that as well of course with the automation they provide. And with media revenue continuing to grow rapidly, that's also creating a tailwind. So I'd say we're seeing good momentum and on track with where we expected to be with that journey in the quarter.

Speaker 6

Thank you very much. Good luck for the rest of the year.

Speaker 2

Thanks, Chuck.

Operator

Our next question comes from Edward Kelly with Wells Fargo. Please go ahead.

Speaker 7

Yes. Hi, guys. Good

Speaker 3

morning. Good morning.

Speaker 7

I wanted to ask about share repo and the Cash balance, so you ended the quarter with a lot of cash again. You're well below your leverage target. Thoughts on the buyback, Is the stock attractive here? I guess it's a straightforward question. And what are your thoughts on taking out additional debt to buy back stock?

Speaker 7

Because With the dry powder that's here, I mean, it seems like you could probably take out north of 10% of the shares. Is this a bigger part of delivering 8% to 11% next year? Just kind of Curious as to how we should be thinking about all this.

Speaker 3

Yes. Thanks for the question, Ed. I would say overall, We're not changing our overall financial strategy. As we think about our free cash flow, we continue to start with how can we invest in the business To grow it profitably and sustain growth, and we still think there's lots of opportunity to accelerate the model. I think we alluded to a little bit of this at our last Investor Day.

Speaker 3

Our goal over time Would be to be stretching our top line growth and our overall earnings growth. So the focus for excess free cash flow is certainly looking for where are the opportunities as we We can continue to lead with fresh and accelerate with digital to drive that growth. We're certainly going to look at any of those incremental investments against the bar of saying, Is that going to drive a stronger return for investors versus buying back incremental stock? But within our overall framework today, As we obviously continue to invest in the business to grow, we are committed to continuing to return cash to shareholders at the level that we've shared in our current TSR model. As you heard us say, we increased the dividend by 17% to reflect really our confidence that we expect to come out of COVID at a Higher position from an operating profit perspective as we leave 2021.

Speaker 3

And we continue to buy back During the quarter and would expect to continue to buy back stock at the current price. We do leverage a grid. I think I've referred to this before. So Think about it as depending on where the share price is, if the share price is lower, it buys back more stock during the quarter. If the share price is higher, it buys back Let's stop because we're not trying to time anything in the market.

Speaker 3

We're really trying to make sure that we're maximizing the return on the dollars as we go through the year To take advantage of fluctuations in the prices as it happens during a typical trading period. But we certainly remain committed to returning cash to investors. We start with the excess cash from a point of view of saying where could we accelerate our growth and ultimately we'll share more on that as we Identify those opportunities and we'll continue to flex if we believe that there aren't those opportunities then obviously we'll look to make sure we are dynamic in making sure we're Deploying excess

Speaker 4

cash. Okay, great. And just

Speaker 7

a quick follow-up on the gross margin. Is the 2 year number for Q2, is that a good way to think about the back half or with inflation accelerating and Supply chain, does that headwind grow a little bit in the back half? Just curious as how we should be thinking about that?

Speaker 3

Yes. I think actually Q2 is It's a pretty good sort of overall I'm going to get we don't go into specific numbers, but I think directionally it's a helpful way to think about the back half of the year. As you think about overall earnings, we would think gross margin continue to be a headwind, part of that being warehouse and transportation, part of it being shrink. We're also continuing to invest in the business where we think it makes sense and give value to customers. OG and A will continue to be a tailwind, but we will see less COVID cycling, if you like, in the back half of the year.

Speaker 3

So that's why the overall impact on operating profit won't be as strong in the back half of the year. If you think about Q2 in general outside of that cycling of extra COVID costs last year in the first half of the year, I think it's a pretty good way to think about the back half of the year, Ed. Great. Thank you.

Speaker 2

Thanks, Ed.

Operator

Our next question comes from Michael Montani with Evercore ISI. Please go ahead.

Speaker 5

Great. Thank you for taking the question. I was just hoping to get a little bit of incremental color around the ID sales. Has the transaction count Turn positive at this point. And then secondly, if you could provide some incremental color around how much inflation You were able to kind of pass through to consumers visavis what you saw in COGS just because at times in the past you have given some helpful context

Speaker 2

If you look at transaction count, we would continue to have Slightly declining or kind of flat transaction count. It really depends on if you're looking at versus prior year or 2 years. If you look at basket size per purchase, it's significantly increased in terms of When customers come into the store they buy significantly more or if you look at our online shop That customer's basket size is significantly higher than a basket when somebody comes into a store. So Both from a digital standpoint and individual transaction standpoint customers are significantly buying more And it's really three things. 1, they're buying more.

Speaker 2

They're also buying premiumization of product where they've upgraded The products they buy and they also are buying bigger sized products as well. So if you think about toilet paper, Very few customers now can or will even buy a 4 pack of toilet paper where most customers now are buying 24 pack or even bigger in some cases. In terms of the inflation, Gary, I'll let you answer

Speaker 3

Thanks for the question, Michael. Yes, we've laid out before I know on the call, we have a very robust process for how we manage When we see inflationary costs flowing through from suppliers and first of all we challenge to make sure that we feel confident they're legitimate because obviously we want to make sure That they truly are structural cost changes and then if they are, we absolutely have a process for passing them on to the customer. I would say that generally we've been very comfortable with our ability to pass on the increases that we've seen at this point and we would expect that to It continued to be the case looking into the back half of the year. As you saw during the quarter, we are continuing to invest in price where we think it makes sense. Sometimes That might be in areas where we're seeing inflation.

Speaker 3

Sometimes it might be where we're investing because we believe it's the right thing to do to grow customer Long term loyalty in other places through our personalization strategies. So overall, we feel good about the way in which we're able To manage the inflation within the business, at the same time we are continuing to invest because we believe that's going to be important to grow share over the long term as well.

Speaker 5

Got it. Thank you.

Speaker 3

Thank you.

Operator

Our next question comes from Karen Short with Barclays. Please go ahead.

Speaker 2

Aaron, are you there?

Speaker 8

Sorry, can you hear me now? Yes. Sorry about that. Yes, so I had a couple of questions just related to guidance. Gary, you mentioned that the vaccine admin fee Kind

Operator

of netted

Speaker 8

out with respect to other initiatives that you had in, I guess, health and wellness in general. Just wondering if you could give a little more color on that because it was very sizable and one of your competitors in terms of basis point contribution to gross margin. And then other model questions that I just wanted to clarify were what your actual LIFO expectations are for the year because that's Obviously relevant for EPS. And then what your COVID costs were in the quarter and what your expectations for COVID costs will be For the rest of the year? And then I had one other bigger picture question.

Speaker 3

Sure. Thanks, Karen. On the pharmacy side of things, yes, so essentially, as you know, we operate little clinics as well in a number of our stores, multiple hundreds of stores have little clinic facilities. And in our pharmacy core business, we continue to support the COVID vaccines. So my comment earlier was When you look at the total health and wellness business as we pivoted resources to do more COVID vaccinations and as we provided that support whether it be through Off-site locations or through our own facilities and you look at the total impact of the pharmacy business as customers Shifted to more COVID vaccines and less of the newer prescriptions, if you like, even though we grew script count overall during the quarter and continue to grow script count.

Speaker 3

If I look at the total impact on the health and wellness business for the quarter and the year to date, there wouldn't be a material overall outside of business plan performance. Although certainly if you look to The COVID vaccines in isolation, they would have created an incremental value to the health and wellness business, but it was offset by Lower revenue or lower margin impact on other parts of that business. So netting out to being on plan if you like. And as we look at the back half of the year, Wouldn't expect it to be a reason that we have an incremental headwind in margin because of having less COVID vaccinations In the back half of the year as things start to return, certainly we expect some vaccines in the back half of the year, but things start to return a little bit more to normal and less of a spike in vaccine Compared to what we saw in the first half of the year. From a LIFO perspective, as you I think you probably know, It's not really an easy thing to predict because LIFO is a charge is one data point at the end of the year.

Speaker 3

As we looked at the data point so far this year, we're seeing an inflation. We We use those spots to predict where it would be. I think the best guidance we could give you is if you take the year to date performance in LIFO that we've charged for the P and L and then Growth that up effectively for the full year, that would be essentially our full year expectation based on the data points that we've seen To this point in the year in our outlook, but FIFO sorry, LIFO, I beg your pardon, is notoriously difficult to predict. So we're giving you our best estimate, but at the end of the day, it will be Driven by accounting rules and a data point towards the end of the year, but I think the best indication we can give you at this point is to use the Year to date performance and growth are up for the year is our best estimate.

Speaker 2

In essence, annualized is divided by 7 times, times, exactly, yes.

Speaker 8

Great. And then just COVID?

Speaker 2

For the quarter and Oh, yes. So, as

Speaker 3

I mentioned earlier, we certainly saw significantly greater cost in the first half of last year As a company, we adapted and learned how to operate more efficiently. We would certainly see continued COVID costs in the back half of this year, But cycling less cost from last year, we would expect it to be south of $100,000,000 a quarter, but certainly we're still Seeing incremental costs and some of the areas that you would probably expect when you think about how we're continuing to operate through COVID, we still have Masks costs during the quarters, we still have cleaning costs, we still have extended leave of absence for any associates that Are identified as having the COVID virus and been diagnosed as a positive COVID case. So those will be the kind of costs that we would see and we'd expect it to be a little bit less than $100,000,000 a year sorry, a quarter, I beg your pardon, as we look at the back half of the year I'm still being a slight tailwind year over year, but nothing like what we've seen in the first half of twenty twenty.

Speaker 8

Okay. And then just my bigger picture question is on Florida. So with Respect to Ocado. Curious, Rodney, on your early learnings from Florida and whether you think that you may want to emphasize opening Sheds in markets where you actually don't have physical retail locations or any thoughts on where you're at on that Philosophy in terms of markets where you have a high market share, markets where you have middle market share, markets where you have no presence Based on what you know so far?

Speaker 2

Rodney McMullen:] Yes, it's a great question, but we're still early in the process of Answering that. And if you look in Florida, we are tracking ahead of where we thought we would be at this point. And the thing that I'm especially proud of our teams in Florida is our net promoter scores Are incredibly strong, I mean mind boggling strong and made up in the neighborhood of best in class Across all industries and as you know food retail usually struggles with having Net Promoter Scores that are up in the Apple neighborhood and things like that. So I'm incredibly proud of what our teams Are doing in terms of creating the experience for the customer. And I appreciate and like your question.

Speaker 2

I would say we're Still early in the process and we continue to learn every day on our ability to ramp up a facility in a new market. Certainly, it's easier communicating to the customer in new markets or markets where our share isn't as high. And that was one of the reasons why we picked Florida and picked Monroe here outside of Cincinnati Was to learn how to integrate it within our existing infrastructure and then having something from the ground up. And I would expect over time we'll learn how to do both of them and we'll be really happy with the results.

Speaker 8

Great. Thanks very much. That's helpful.

Operator

Our last question comes from rupesh Prior to Rick with Oppenheimer. Please go ahead.

Speaker 9

Good morning. Thanks for taking my question and fitting me in. So I guess just going back to the gross margin headwinds during the quarter that you saw, 2 that you called out shrink in supply chain, it sounds like that maybe half the pressure that you saw during the quarter. I was curious if you see those headwinds on the shrink in supply chain at all transitory?

Speaker 2

I think incrementally yes, but if you look at shrink, I think shrink will remain higher. Now we will go through and do all kinds of process changes to try to minimize shrink, but we are being more aggressive And Christine Wheatley, who is our General Counsel is also working with some trade associations to try to Start working on it in a broader group, not just Kroger specific when you look at organized crime. And I know I was reading Home Depot's earnings call and they talked about the same thing. So We do believe it will be important to partner with the government and the way products are able to be sold in the marketplace. So I do think there's things we will do to improve, but some of it will be a headwind until we're able to address that.

Speaker 2

On Supply chain, I think an awful lot of that will be transitory, but you still have to manage through it.

Speaker 9

Okay, great. And then maybe just one follow-up question. We're hearing more and more from suppliers lately of challenges in the supply chain and being able to fill all the So I was just curious how your out of stocks right now trending versus what you've seen in recent months?

Speaker 2

Rodney McMullen:] Yes. I would say that we were slightly higher. Now our teams had going in been continuing to aggressively forward by inventory. Originally, it was because of the inflation pressures. It's ended up because of some of the supply chain issues.

Speaker 2

It's also one of the benefits of a lot of our own brands and we manufacture a lot of our own brands. So our plants are aggressively pushing capacity. So I would say that it is a headwind. It's Slightly worse than it was, but we continue to work on minimizing and maximizing the in stocks.

Speaker 9

Okay, great. Thank you.

Speaker 2

Thank you. Appreciate it. Before we conclude today's call, I'd like to take a moment to remember the tragic events that took place nearly 20 years ago, 20 years ago tomorrow And to honor the lives lost on September 11, 2001. And as always, I would like to Thank you for delivering an outstanding performance this quarter And continuing to support our communities through the pandemic. As the number of COVID-nineteen cases continue to rise due to the rapid Spread of the Delta variant.

Speaker 2

I want to affirm that health and safety of our associates and customers remain our top priority. We are doing everything we can do to make sure that the vaccine is accessible and available to you and our customers wherever they are. I am so proud of our Kroger Health team who have already administrated 6,700,000 doses of the COVID Thank you to our talented healthcare professionals for being there for our communities And for addressing questions for our customers about the vaccine and about getting the vaccine. I'm often reminded of the impact our associates have on the lives of our customers. Recently one of our pharmacy managers Atlanta saved the life of a customer who was having allergic reaction in one of our stores.

Speaker 2

This is just one of the many examples that in extraordinary ways our associates care for those around them. Thank you for inspiring me every day and thank you for all you do every day to be there for our customers, Our communities and each other. That concludes today's call.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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