The Kroger Co.

are followed by one on your telephone keypad. Please note, this event is being recorded. I would now like to turn the conference over to Robert Quast, Senior Director, Investment Relations. Please go ahead.

Good morning. Thank you for joining us for Kroger's third quarter 2023 earnings call. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen, and Chief Financial Officer, Gary Millichap. 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. 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 take a moment to outline our discussion topics this morning. I will begin by covering the current retail environment and how the strength of Kroger's value creation model is supporting earnings growth, and generating strong free cash flow. Then Gary will cover our financial results and guidance for the remainder of the year. Finally, I will conclude with an update on our proposed merger with Albertsons before we open it up for questions. Now turning to our third quarter. Kroger's third quarter results highlight the strength and diversity of our business model in a challenged operating environment. as strong fuel performance and growth in our alternative profit businesses supported continued adjusted net earnings per diluted share growth. As consumer spending tightens, we are focused on providing customers with exceptional value. By maintaining our long-term commitment to lower prices, personalized promotions, and rewards, we are growing households and increasing loyalty, positioning Kroger for sustainable future growth. Customers are managing many economic factors that are pressuring their spending, including higher interest rates, reduced savings, and fewer government benefits, including SNAP. Although inflation is decelerating, customers are still adjusting to the impacts from eight consecutive quarters of broad and significant inflation. During the quarter, Kroger grew higher income households once again, as our attractive mix of quality, value, and convenience continues to drive engagement. By buying larger packs, more fresh items, and more premium R brand products, these households are more profitable. As we've seen over recent quarters, our customers are actively looking for value, and our budget conscious customers are under more significant spending pressure. We are also looking for ways to support customers with additional value, including in-store displays with everyday staples at low price points. We've seen a great response from all customers to these offers. But engagement from our budget-conscious households has been especially strong. Customers purchasing these offer items are making more trips and buying more units. not only recognizing the value with these displays, but the value across the entire store. To help more customers manage their budget, we are only deepening our commitment to deliver exceptional value for our customers. Our personalized promotions are an increasingly critical way for customers to save on items that matter most to them. We are applying analytics to Kroger's unmatched purchase data to strike the right balance between the depth and breadth of promotions. To ensure customers were able to enjoy a memorable Thanksgiving, for example, we created a meal bundle that served a group of 10 for less than $5 per person, which represents a lower price than last year. We have a long history of delivering value to our customers by providing a broad assortment of fresh foods at low prices Through our unique omni-channel shopping experience, we achieved our 10th consecutive quarter of total household growth and increased loyal households even faster, positioning Kroger for sustainable future growth. Now I'll provide more details about how our go-to-market strategy is delivering for our customers, starting with Seamless. Our digital business delivered a strong third quarter With double-digit growth in both our pickup and delivery businesses, multiple tell-wins are driving our sales momentum, including growth in both households and visits. Our new two-hour pickup service, available in more than one-third of our stores, also contributed to our success in the quarter. To become the online food retailer of choice, we are focused on delivering best-in-class fulfillment. improved key customer experience metrics in pickup, increasing fill rates, and reducing wait times during the quarter. This resulted in improved net promoter scores. Our customer fulfillment centers again led our delivery growth, where we continue to rapidly increase households. Our delivery customers enjoy the convenience of on-time, refrigerated delivery directly to their doorstep. with zero compromise on freshness, quality, and value. Turning to personalization, investments in our personalized capabilities ensure we are meeting elevated customer demand for savings and enables us to deploy promotional dollars more effectively. Digital offers have increased compared to last year, and our personalization capabilities have resulted in even more significant increase in redemptions. driving loyalty and increasing digitally engaged households this quarter by 13%. Digitally engaged households are incredibly valuable to our model as they are more loyal, spend nearly three times more with us, and accelerate growth in our alternative profit businesses. Now I'd like to share more about how our diversified business model supported earnings growth this quarter and gives us confidence in our ability to navigate the environment ahead. Starting with our alternative profit businesses, growth in alternative profit businesses remains strong in the third quarter, with balanced growth across the portfolio. The strength of our seamless ecosystem and elevated digital engagement is having a flywheel effect, creating the traffic and the data needed to drive growth in Kroger Precision Marketing higher margin profit stream recently we celebrated the sixth anniversary of KPM this quarter KPM made an important step in its journey to become the most trusted and transparent media company by activating ad buying platforms we are offering more self-service solutions to meet clients where they are today providing advertisers more direct access to custom Kroger audiences. This first iteration has already launched and KPM expects to expand to other buying platforms in the future. These new innovative features will help accelerate KPM's impressive growth by allowing advertisers to reduce waste and enhance measurement tools. Kroger Health had a strong quarter that exceeded our internal expectations and helped drive sales and profit growth. Our decision to terminate our agreement with Express Scripts reflects our commitment to making decisions that we believe are in the best long-term interests of our customers and shareholders. Our teams have done an excellent job retaining patience, and utilizing our pharmacist's extra capacity to devote more time to patient care, including growing our number of vaccinations. Gary will provide more on the financial impact of this later. During the quarter, we continue to see rapid growth in GLP-1 drugs in our retail pharmacies. While the long-term impacts of these drugs on customer buying habits are unknown, Kroger's food as medicine philosophy positions as well to support our customers' health and wellness goals. Our comprehensive approach includes healthcare services, professional dietitians, and proprietary tools like our nutrition rating app, Opt-Up, which are all designed to support healthy living and to do so holistically. While we pride ourselves on data and insights, The patient data in our pharmacy operations is separate from our customer loyalty data and is protected by privacy laws. We are committed to using our data in an appropriate manner while not jeopardizing customers' trust. For now, we have not seen any major macro shifts in customer eating habits or spending behaviors. Food trends are constantly evolving, and we are committed to offering products that meet our customers' needs. For customers looking to adopt healthier habits with or without the help of these drugs, we are well positioned to provide important health care services and healthy food options. At Kroger, our purpose is to feed the human spirit. And I'm so impressed by the many ways our associates bring this to life every day and the ways they support our customers and each other. We know when associates are connected to our purpose they feel connected to Kroger. Our annual Kroger Wellness Festival is just one example of living our purpose. This festival is one of the nation's largest health and wellness events, showcasing more than 150 experiences and food offerings. Sponsors and celebrities joined Kroger and hundreds of thousands of visitors to share our vision for better physical, mental, and emotional health for families. It was wonderful to see the level of support and participation in this important mission. Also this quarter, we released our annual ESG report, which highlighted Kroger's significant progress on our Zero Hunger, Zero Waste journey to expand access to affordable, fresh and healthy food and to reduce waste, especially food waste, across our footprint. Since we launched Zero Hunger, Zero Waste in 2017, Kroger has donated more than 3 billion meals to feed hungry families, including more than 1.3 billion to fight food insecurity and nearly 600 million pounds of surplus food to our food bank partners. I am so proud of our teams and their efforts to reach these incredible milestones. Our associates are the driving force behind our success. by delivering an outstanding customer experience and helping make the holidays even more special for our customers. We facilitate this through our long-standing commitment to invest in associate wages and benefits and training tools to advance their career growth. Feed Your Future, our continuing education benefit, is one of the important ways we make Kroger a place where associates come for a job and discover a career. This benefit provides up to $21,000 lifetime and has helped almost 6,000 associates this year alone, with approximately 90% of these participants being hourly. Our focus on development is contributing to strong improvements in retention, which includes associate continuity and a more consistent customer experience. With that, I'll turn it over to Gary to take you through our financial results.

Gary? Thank you, Rodney, and good morning, everyone. Kroger's third quarter results demonstrate the resilience of our value creation model. The investments we have made over recent years to strengthen and diversify our business are allowing Kroger to navigate a challenged environment characterized by tightening consumer spending and food at home disinflation. We achieved adjusted earnings per share growth of 8% this quarter, while also providing greater value for our customers, higher wages for our associates, and investing in strategic initiatives that will support future growth. This was made possible by our teams delivering strong performances across our margin expansion initiatives, fuel, alternative profit businesses, and health and wellness. Our year to date results keep us on track to achieve adjusted earnings per share growth in 2023, building on record results over the prior three years. I'll now provide more detail on our third quarter. Identical sales without fuel decreased 0.6%. Underlying growth would have been positive 1%, adjusting for the effect of our terminated agreement with Express Scripts. Similar to the first two quarters of the year, the terminated agreement with Express Scripts had a positive effect on our FIFO gross margin rate, excluding fuel. and a negative effect on the OG&E rate excluding fuel and adjustment items. The overall net effect on operating profit was slightly positive. As a reminder, we will begin to cycle the impact of express scripts at the start of the new calendar year. Turning back to identical sales without fuel, As Rodney shared earlier, our seamless ecosystem is a critical component of our growth strategy, building customer loyalty and fueling our alternative profit businesses. Digital sales were a highlight in the quarter, growing 11%. Our overall sales continue to be affected by industry-wide disinflation. Inflation ended quarter three in the low single digits. approximately 270 basis points lower than the second quarter. Towards the end of the quarter, we saw inflation decline at a slower pace, and we would expect this trend to continue in the fourth quarter with inflation remaining positive at the year end. Encouragingly, units have shown signs of improvement as inflation has decelerated, and we have sequentially improved units for four straight quarters. However, unit growth rates have lagged the rate of inflation decline and have not improved at the pace we would have expected. As a team, we are laser focused on returning to unit growth and expect improvement in volumes to continue for the balance of the year. Gross margin was 22% of sales and our FIFO gross margin rate, excluding fuel, increased three basis points compared to the same quarter last year. During the quarter, we increased investments in pricing and promotions to deliver greater value for customers, and we were able to successfully fund these investments by continuing to execute our long-term margin improvement plan, including our brand's optimization, sourcing efficiencies, and supply chain improvements. Shrink was a headwind to gross margin during the quarter. primarily due to the continued rise in industry-wide theft and organized retail crime. We are investing in initiatives to mitigate shrink and protect our associates and customers in our stores. Looking ahead, we would expect these same factors that influence gross margin in quarter three will drive a similar outcome for gross margin rate in the fourth quarter. During quarter three, we recorded a LIFO charge of $29 million compared to a charge of $152 million for the same quarter last year. This reduction was due to inflation returning to low single digits compared to double digit growth experienced last year. Kroger's OG&A rate increased 32 basis points, excluding fuel and adjustment items. The increase in OG&A rate was driven by planned investments in associate wages and benefits and the effect of our terminated agreement with ExpressGrips. During the quarter, we also made the decision to invest in a number of strategic initiatives that are expected to drive growth in 2024 and beyond. Investments were partially offset by execution of cost saving initiatives and lower incentive plan costs. We are confident in our ability to effectively manage costs and continue to deliver savings by eliminating waste in areas that do not affect the customer experience. We continue to identify incremental cost saving opportunities across the business and remain on track to deliver our sixth consecutive year of $1 billion in cost savings. In the fourth quarter, we would expect our OG&A rate to be relatively flat compared to last year. Kroger Health is an important component of our value creation model and is delivering profitable growth in 2023. During the quarter, the team exceeded our internal goal for the number of vaccinations administered and the higher profit margins associated with these vaccines helped offset the negative impact on margin rate from growth in GLP-1 drugs. As Rodney shared earlier, we are excited about the momentum in health and wellness. and see significant potential for future profitable growth in this area of our business. Fuel is also a key part of our strategy and through our rewards program is another way that we deliver value for customers and increase loyalty. Our fuel team did an outstanding job delivering results that were ahead of expectations in the third quarter. Our customers saved 14% more in rewards per fuel purchase compared to last year. which led to gallon sales outpacing the industry. The average retail price of fuel was $3.77 this quarter versus $3.84 last year. And our cents per gallon fuel margin was $0.57 this quarter versus $0.50 last year. I'd now like to provide a brief update on labor relations. Kroger has made substantial investments over the last five years in our associates, raising the average hourly wage by more than 33%. We remain committed to supporting our associates with sustainable investments in wages and comprehensive benefits that will at the same time allow us to continue to keep products affordable for the communities that we serve. During the third quarter, we ratified new labor agreements with the UFCW for fries, food and drug, Dallas Meat, and four stores in Roundies, in total covering more than 19,000 associates. We have now ratified all agreements that were scheduled for negotiation in 2023. Turning to liquidity and free cash flow, Kroger continues to generate strong free cash flow through consistent operating results and the disciplined approach to deploying capital, prioritizing the highest return opportunities that support our growth At the end of the third quarter, Kroger's net total debt to adjusted EBITDA ratio was 1.4, which remains well below our net total debt to adjusted EBITDA ratio target range of 2.3 to 2.5. This positions us well to execute our financing strategy to close the proposed merger with Albertsons early in 2024 and then quickly return to within our target leverage range post-merger. As I wrap up my comments on the quarter, let me provide additional color on our outlook for the remainder of the year. Today, we updated our four-year guidance to reflect the impact of near-term economic pressures and food at home disinflation. We now expect four-year identical sales without fuel to be in the range of 0.6% to 1% and adjusted FIFO net operating profit to be within a range of $4.9 to $5 billion. As a reminder, our sales guidance reflects the effect of Express Scripts, which is reducing our reported identical sales without fuel by approximately 150 basis points in 2023. Our latest sales trends would put us on track to achieve the midpoint of our updated annual sales guidance range. Importantly, we would expect to exit quarter four with a stronger sales trend than our overall results for the quarter, as we start to cycle the effective express scripts in January. We believe we are well positioned to navigate near-term headwinds, and the strength we are seeing in our alternative profit businesses, health and wellness, and fuel, combined with a lower expected LIFO charge, gives us the confidence to raise the lower end of our full-year adjusted net earnings per diluted share guidance range. We now expect adjusted EPS to be between $4.50 to $4.60. And looking forward, Kroger remains committed to delivering attractive and sustainable returns for our shareholders. I'll now turn the call back to Rodney.

Thanks, Gary. Before we open the floor to your questions, let me provide an update on our pending merger with Albertsons Companies. As of November 15, 2023, Kroger certified substantial compliance with the second request issued by the FTC. We continue to work cooperatively with the FTC in its review of the transaction. This step keeps us on track to close our proposed merger with Albertsons in early 2024. We are confident that we have fulfilled all the commitments we set out in the original merger agreement. including the comprehensive divestiture plan announced with CNS wholesale grocers. CNS is a well-qualified buyer who meets all the criteria necessary to complete our transaction and will ensure no stores will close as a result of the merger. Frontline associates will remain employed and existing collective bargaining agreements will continue. We have made a compelling case to both Kroger and Albertson stakeholders Our proposed merger with Albertsons creates meaningful and measurable benefits for our customers by lowering prices beginning on day one, extends our commitment to associates by increasing wages and benefits, and deepens trust with our communities by keeping stores open to assure America has access to fresh and affordable food. In terms of integration planning, we are progressing well. Our integration teams have made significant progress toward our first goal, which is to ensure continuity for associates and customers at closing. It is exciting to see the complementary strengths of both organizations and how we'll be able to learn from each other to provide customers with an even stronger food retail experience and compete even more effectively against larger non-union operators in the future. In closing, Kroger delivered another quarter of solid results. We are demonstrating our ability to manage through a more challenged environment and remain committed to balancing our investments in our associates and in lower prices for our customers, while continuing to generate attractive and sustainable returns for our shareholders. With that, Gary and I look forward to taking your questions.

Thank you. If you would like to ask a question, please press star, fill it by one on your telephone keypad. If you would like to retract your question, please press star, fill it by two. When preparing to ask your question, please ensure your phone is unmuted locally. We ask you please unmute yourself to one question and one follow-up. Our first question goes to Dean Rosenblum of Bernstein. Dean, please go ahead, your line is open.

Hey, good morning, guys. Thank you so much for taking my question. Hey, my question is really about a debate regarding the gross profit and operating profit impact of increasing digital sales. I mean, online digital sales were up 11 this quarter on a total comp express grips of one, which says it's growing share. Can you help us understand? I know you think about it in terms of the whole digital ecosystem, including the alternative revenues, but in terms of the actual operating profit, contribution from digital relative to the stores. Can you help us understand how to think about that if that mix continues to increase?

If you look currently, digital would not be as profitable as stores. We do believe over time that will change, and we think that'll change by multiple things. The If you look at pickup, we continue to make significant progress on reducing the cost to serve a customer on pickup. If you look at our sheds, we continue to make progress on our sheds to get them to where – The profitability of the shed would be the same as a store. So, you know, if you if you just step back, kind of we view job one is make sure we don't lose the customer. And what we find is that customer over time will spend more with us when they're engaged with us through pickup, delivery and in store. And then, obviously, if you look at the incremental profitability, that is making meaningful progress. And we also, when you include media as well, that's making progress. So if you look initially, it is not as profitable, but we have every expectations over time that it will be.

Yeah, Rodney, maybe just to add, Dean, a couple of specific data points. Can you hear me okay? Yeah, please. I think we talked, Dean, before about we sort of bucket our digital business into two areas, the business prior to launching our CFCs, which will be pickup and delivery through our third-party providers, and then our customer fulfillment centers powered by Ocado. We've talked before about the pickup and delivery business sort of having a pass-through profitability rate on incremental sales of around 5% or mid-single-digit percent and the store being sort of north of 15%. And we talked a couple of years ago about being on a journey to improving that pass-through rate through some of the things that Rodney mentioned around improving mix, around improving media revenue per transaction, and then also lowering the cost to fill a digital order. We've made good progress on all three of those areas, and we would certainly see now sort of the digital pass-through profitability heading towards that double-digit rate, sort of on that journey towards getting towards parity in terms of overall profitability. And then the Ocado CFCs, we're really still very much in the early stages of that journey where the total investment is sort of starting to peak, and we're starting to see tailwinds in that profitability as we start to achieve more scale in those facilities.

That's great. So thanks so much, Gary. My follow-up question is, you mentioned certifying the second request substantial completion on November 15th. That would suggest that the FTC now has 30 days to either make a decision or to extend the period. Do you have any sense right now as to whether we might expect some sort of an FTC decision or that the FTC is more likely to extend the time for that decision?

Dean, it's a great question, and if you look in our prepared comments, we expect to close in early 2024, as we have all along. We continue to have a cooperative relationship with the FTC and other interested parties, and it's still too early in terms of specific dates. Thanks, Dean. Thank you.

Thank you. The next question goes to Simeon Gutman of Morgan Stanley. Simeon, please go ahead. Your line is open.

Hi there. This is Michael Kastner on for Simeon. Thanks, guys. Maybe starting with the question on your inflation or deflation outlook for 2024, what your current expectation is and what would need to happen in the backdrop for us to see either deflation or a return to more modest inflation? And in the event that we see deflation, is there a scenario in which you can hold or still expand margins, even in that kind of backdrop?

Yeah, thanks for the question. As you know, we'll certainly provide a lot more specific details of our outlook for 2024 when we get to our quarter four earnings in March. And we're continuing, as I'm sure many are in the market, to look at all the data points we see both internally and externally. And we're probably looking at some of the same data sources that you are from the likes of USDA and other published sources. I think our view right now, we recognize we don't have the perfect crystal ball and we'll continue to watch and evaluate how we see the outlook for next year. But overall, most of the data that we're seeing would tend to point towards more of a typical year next year for food at home with food at home inflation being in the low single digit range. We certainly think there are different scenarios that could play out. And of course, we'll look to adapt our model as we wouldn't need to if those were the case. But that would be the data that we're watching. And we'll certainly provide more color when we get to the March earnings and talk specifically about our 2024 views.

And one of the things that Gary always reminds me of, if you look over the last 50 years, there's only been two years out of the last 50 where it's been negative, where there's been actual deflation in a year. And as you know, we've been able to maintain and create strong business results in all environments, whether it's inflationary or deflationary, and you just manage accordingly.

Okay, great. And then a quick follow-up on the fuel business, which had higher than expected profitability. So you talk about what drove that change. And is there any interplay, I guess, between that business and the core supermarket business if there's any balancing of the profitability dynamics and what you're able to earn to kind of manage the P&L or this is being managed separately and it just happened to come in a little stronger in Q3?

Yeah, Gary mentioned it, but we're super proud of our fuel team and the partnership with all the divisions. We had a significant increase in the amount of fuel rewards that were issued. So we really look at leveraging both of the businesses to support each other. The other thing that the fuel team has done a nice job on is, is making sure from an efficiency standpoint on deliveries, on procurement, and all the ingredients as well. So really proud of what they've done, but it really is we leverage both sides of the business to support each other and feel really good about where that business turned out. Thank you. Thank you.

Thank you. The next question goes to Michael Montani of Evercore ISI. Michael, please go ahead. Your line is open.

Hey, good morning. Thanks for taking the question. I wanted to ask on two fronts. One was just if you could discuss the overall competitive backdrop. And then secondly, we've heard a fair amount that promotions could uptick into next year. And I guess the question on that would be, what do you see in terms of vendor support versus you all having to fund that yourselves? And then the follow-up was just OG&A dollar growth. Is there still potential for a billion cost out into 24? And what kind of dollar growth should we look for underlying in the fourth quarter?

Yeah, I'll answer the competitive backdrop and promotions. And if Gary wants to add anything, he can. And then I'll let Gary ask about or answer the OG&A. If you look at overall from a competitive standpoint, the market feels very similar than what it has been for a long time. If you look at the promotional activity, CPGs are increasing their funding on promotional. And, you know, I think there's two things driving that. One is CPGs not being satisfied with their tonnage, so they're increasing the amount of support. The other thing for everyone is the supply chain conditions. constraints that would have been in place a year ago and two years ago is really getting back to normal. So people are beginning to feel comfortable in promoting again, where the worst thing that could have happened is for us or for a CPG to promote something and then not have adequate supply. So it really is behaviors getting back to pre-COVID. And even if you look at shopping during Thanksgiving, it was really more last minute. which really reflected, if you go back and look at pre-COVID, it's kind of what it was. And it's people getting comfortable. There'll be products there when they go to buy it. So both great questions, but that's really what we're seeing right now. And Gary- on OG&A?

Yeah thanks Rodney. So in OG&A I'll just maybe take a step back as well and just mention a couple of points that I talked about in the third quarter. You know as we looked at the third quarter going into it we would have expected OG&A to be a little bit lower as a rate. The things that were in the plan would have been the investments in average hourly rates and chain network and also the impact of ESI. And they were very much in line with what we expected. The real differences in the third quarter were that we did make some decisions during the quarter to make some strategic investments that we believe will help set up 2024 and beyond in terms of continued revenue growth, but also additional cost savings. So as we look at the fourth quarter, we actually believe that the trends in average hourly rate will continue. And of course, express scripts will continue to be a factor. But outside of that, we'd expect OG&A to be relatively flat during the fourth quarter. As we look at 2024, as I mentioned in my prepared remarks, we still see both a sort of tailwind from initiatives that we've launched this year that will have a run rate benefit into next year. And we still see good line of sight to continued cost savings by leveraging technology technology and improving efficiency, driving continued improvement in cost to serve in digital and a number of areas of the business. So we would remain confident that we see a good line of sight to continue to find that sort of three to five percent productivity improvements that we target to make sure we can continue to invest in our customers and continue to invest in our associates. Thanks. Thanks, Michael.

Thank you. The next question goes to John Heinbuckle of Guggenheim Partners. John, please go ahead. Your line is open.

So, Rodney, I want to start with, can you talk to, if you think about the promotional basket, proactive versus reactive on your end, right? And, you know, kind of, you know, is it, would you say, you know, I don't know, 80% proactive, 20% reactive? I don't know how you think about that. And then on the reactive side, it would seem that those without a loyalty program would be at a disadvantage to you in that you can see what's going on in the market and possibly respond, where yours is more stealth. Is that even remotely how you run the business, where you can respond to others based on what you see out there?

Thanks, John, for the question. By far, the majority, and when I say majority, would be almost all would be proactive versus reactive. Now, all our teams will check prices every single week, and there'll be adjustments based on that. But by far, the majority of our discounts are proactive. And some of that is what you can see in an ad. A lot of that is is the things that you mentioned in terms of direct to individual household offers. It's one of the things that we believe the reason why our loyal households continue to grow and some of those aspects is once you become a Kroger shopper, you're getting those loyal customer mailings, which will allow you to stretch your budget more. And there's also personalized offers that you can go to look at coupons and download those. and there's significant increase in those. So when you shop with us, obviously we are a promotional merchant, but when you look at the rewards that we offer between fuel rewards and other rewards and our loyal customer mailings, our basket price overall is within less than cents of our biggest competitor. It's just we go to market and offer a little different way. It is the reason why loyal shoppers are so important to us because that's the shopper that really gets the full value equation from us.

Rodney, maybe the one thing I would add to John's question too, the second part would be, I think, John, it's one of the reasons why we do have additional confidence in how we can navigate through the environment is that I think as a combination of our reward program and more customers engaging digitally post-COVID, it really does create the ability to channel the dollars in a way that give the customer the the most impact and most value, while also being able to target it rather than having to sort of peanut butter spread it across in different directions. And I think it's a different dynamic now compared to maybe five, 10 years ago in the way that we're able to personalize that value and go to market.

You know, you've been, you've followed us for a long time and you would have heard us use the word cherry pickers. And really what it is trying to make sure we do is to give value to customers that are loyal to us, as opposed to somebody that's just shopping a discounted item that we're not making any money on.

And then maybe as a follow-up, the, um, So it sounds like a volume is slightly is negative, right? I don't know if it's negative one or, or a little more than that, but volume is negative. Is that fair? Um, low single digit. When do you think that returns to positive territory? And is that solely driven? If you looked at the budget conscious customers, cause I know a couple of quarters ago, you broke that out. Is that negativity largely driven by that cohort?

Yeah, if you look, volume would be slightly negative. If you look, our trends have improved for four quarters in a row from a trend standpoint. That would be largely driven by the value shopper or customers on a budget. And, you know, the half full and half empty, the half empty is obviously that's being driven by that customer. Some of that's driven because of the impact from inflation. Part of it's where Snap is down about 30 percent. The full part is the customers that are loyal. We're continuing to grow with that customer. And that customer's profitability is meaningfully better than the value shopper. Thanks, John.

Thank you. The next question goes to Christina Katai of Deutsche Bank. Christina, please go ahead. Your line is open.

Hi, good morning. So, Rodney, I wanted to ask you just a conceptual question on the grocery sector and the level of competition, right? Because if we're thinking about it, why wouldn't the sector be more competitive as we head into 2024? The consumer remains under pressure. Some of the low end is under increased pressure. CPGs are raising their support, volumes continue to lag. So that is question one, just conceptually, why wouldn't that be the case? And secondly, how is Kroger positioned in a potentially no inflation to even deflationary backdrop relative to the base case of a normal food at home year of low single digit inflation?

If you look at one of the things that makes this industry a lot of fun is we always assume that the business will continue to be more competitive. And if you look at our fundamental business model over the last five years or 10 years or 15 years, every year we assume that it's going to be more competitive and We work really hard to identify process changes and cost reductions so that we can continue to fund wage increases and invest in lowering prices for the customer. So when we look at 2024, and obviously we'll go into a lot more detail early next year when we give guidance, but right now we don't see that environment any different than what we we would have felt for the last five years or 10 years or 15 years. And the positive is customers get a better value every year and they get a better experience every year. And, you know, when you look at for us, one of the things that we think is important for the customers, the customer doesn't have to compromise. So they get amazing fresh product that will last a long time when they get at home with amazing friendly associates. with a smile and support that everything in their basket, plus a little bit, you know, an extra piece of cheese or something, they've engaged with Murray's. So and not have to compromise from a pricing standpoint. So when you look overall, we feel very good in terms of how we're positioned with the customers that really appreciate what we offer.

Maybe, Rodney, one thing I would just add too, Christina, specific to 2024, you know, a couple of things for Kroger that we think are helpful as we look into next year. One is, of course, that we're cycling the impact of express scripts when we get to January, and we'll start to see that flow through in the early periods of the year. And then secondly, one of the things that we've seen as we look at 2023, many states, as you know, reduced the amount of snap dollars that were available in the market. And those happened sort of around the middle part of our Q1 last year, or this year, I should say. What we've seen in one or two markets where we're cycling those earlier markets where they reduced the snap dollars, it certainly starts to create a bit of a different trend in the growth in those markets too. So we do think for the industry and specifically for the markets that we operate in. As you start to cycle the impact of those snap dollars, which perhaps had a bit more of an impact than we were originally thinking they might across the industry, that starts to create some, I think, tailwind in the industry towards next year's growth as well.

Thanks, Christina.

Thank you. The next question goes to Ed Kelly of Wells Fargo. Ed, please, your headline is open.

Hi, morning everyone. Thanks for taking my question. Good morning. Gary, I wanted to ask you about the gross margin. I think you said that the Q4 gross margin you expect to be flattish. You know, if you could just confirm that. And then, you know, looking out, is the base case for 24 that that flattish trend would continue? And then within that context, I'm curious about shrink. you know, maybe just educate us a little bit on, you know, when you do your counts, the visibility you have on where you stand and shrink, and do you believe it's peak?

Sure. Thanks, Ed. So the first part of the question, yes, you're essentially right that I said on my prepared comments that we would expect Q4 to look very similar to Q3. The way that I sort of would break that down is that we've been equally as pleased with the progress that we've seen in the margin improvement plan initiatives that we saw in the earlier part of the year as well. Strong benefits from sourcing health and wellness, of course, with Express Scripts is a tailwind this year to gross margin and supply chain and alternative profits. All those areas continue to generate tailwinds in our gross margin rate. What we did in the third quarter is we did invest more in gross margin. increased pricing and promotion, as Rodney mentioned earlier. And we did also increase advertising costs during the quarter as well. So those would have been the differences quarter over quarter in terms of what we saw and what we would expect to continue to be a similar pattern as we think about the fourth quarter. I'd say as we look into beyond 2023, We certainly still see a lot of potential for the tailwinds that I mentioned around our brands sourcing these areas where we believe that we're on a multi-year path to continue to drive improvement and drive growth. And of course, alternative profit streams continues to grow at a double digit pace off a bigger base as well. So I think we still have a lot of confidence in those levers. And what we're doing is making sure we're balancing the business to set ourselves up for continued sustained growth in the future. From a shrink perspective, we would still see shrink as a headwind, as I mentioned in the prepared comments. I would say it's probably somewhat less dramatic for us than maybe some of our peer group, because while we have a general merchandise business that's impacted, it's less impacted than probably some of the big box retailers, but it would still be a headwind. the third quarter on a year over year basis. That headwind actually would have been less than it was in the second quarter, not dramatically, but it would have eased somewhat. So it's still something that we have to work through and continue to offset. But we are seeing at least the trend in terms of year-over-year growth decelerate, but it would still be a headwind today because of the crime and organized retail crime factors I mentioned earlier.

The other thing I think is important to remember is a lot of our shrink is in our fresh departments and our Fresh departments actually, a lot of that is you can manage it by changing processes and using technology. And our teams have done a great job actually on improving shrink in the fresh departments because of our store teams, partnering with warehouse teams on processes and leveraging technology as well. And I think that's a big chunk of the trend, slight trend improvements that Gary mentioned. Great point. Thanks, Ed.

Thank you. The next question goes to Chuck Tarankoski of North Coast Research. Chuck, please go ahead. Your line is open.

Good morning, everyone. Good morning. Rodney, can you talk a little bit about the economy's effect in inflation? on your digital business, and I'm thinking particularly about customers' willingness to spend money on any delivery fees or membership fees, and also how the economy might be impacting delivery volumes and digital order volumes.

Thanks, Chuck. If you look at overall, inflation is definitely stabilizing overall. And, you know, it's from a customer standpoint, they appreciate the stabilization. They also know the fact that if you look at over the last two years, they've had to endure a lot of inflation. And if you look at some of the fresh departments, some of that is actually returned back to normal. But if you look at on the process side, you wouldn't see that. So if you look at like eggs, for an example, eggs are significantly deflationary. And we'll all be happy when we get to the point where we're cycling that early next year or next year. If you look at customer behavior, it's fascinating. Customers do a lot of work to save where they want to save or feel like they need to save. you know, in pack size, if you look at moving to our brands versus some of the national brands. But if you look at membership fees and delivery fees and things like that, that business continues to grow strongly. And in fact, it was up double digits, and that's what drew over the 11%. I'm sure part of that, and anytime I talk to a politician, I always remind them, if you look at customers on a budget, they're under a lot of strain and they're doing a lot of behavior changes. If you look at customers that are not as focused on price because inflation hasn't affected them as much, that customer's behavior is still very strong and they are still continuing to buy big packs, continuing to buy nicer wines, Murray's Cheese, Starbucks, things like that. So we over-index with our membership program on customer mainstream and upscale. So I'm sure that's part of the reason why we're not seeing the behavior change.

Okay. Thanks for that. And just real quick, you're exiting the ghost kitchen business. Any particular reason for that?

Yeah, great question. Appreciate it. You know, we test a lot of different things, and we'll move on to the next version of it. We still think food away from home is a huge growth opportunity for us, and we'll continue to focus on it. The Ghost Kitchen, the few customers that used it loved it, but it just wasn't enough. So it's one of those things where you move on. So thanks, Chuck.

Thank you. The next question goes to Rupesh Parikh of Oppenheimer. Rupesh, please go ahead. Your line is open.

Good morning, and thanks for taking my question. Just going back to Kroger's digital performance, another quarter of double-digit growth, did anything surprise you on the digital front? And just any more color in terms of what you guys are seeing, delivery versus pickup?

Yeah, I'll start and let Gary finish. I wouldn't call it a surprise, but it's great to see that the MPS scores, both in terms of our year on year from a pickup standpoint and a delivery standpoint, is very strong. If you look at our shed delivery business, the repeat rate continues to be strong. So it really is. The customers really appreciate that white glove experience. So I don't want to make it sound like we're surprised by it, but it's nice to see what we thought play out. Gary, I'll let you finish.

Yeah, I think you said it well, Rodney. I think the only thing I would add, Rupesh, is that we've said before, we believe that digital is a growth engine for the company. And I think everything we continue to see gives us that belief. It will continue to be an opportunity to drive deeper customer engagement and growth. And I mentioned it in a comment earlier, but the thing we didn't talk about in the script was we are seeing continued improvement in profitability. So it's helping customers. through technology and continuing to see media revenue grow. So that's the only piece I think that I would reinforce.

Thanks, Rupesh.

Thank you. The next question goes to Kenneth Goldman of JP Morgan. Kenneth, please go ahead. Your line is open.

Hi, thank you. I'll take a shot here on next year. I know you're not in a position to really give numbers, and I wouldn't ask about that now, but You did talk about hopefully having low single digit sort of normal inflation next year. You highlighted a healthy amount of productivity you expected or expecting, but you also mentioned that maybe your unit growth right now is a little bit disappointing and you'll surely be lapping some challenging fuel margins that I imagine you won't assume will recur. So I'm just trying to get a sense if you have maybe sluggish units, fuel comps are tough. To get to your earnings growth algo for next year, do you theoretically have to find other drivers that are better than their algo to offset those headwinds? I just want to kind of get a sense of how to think about at least some initial headwinds and tailwinds into next year, if that all makes sense.

Yeah, thanks, Ken. As you mentioned, we'll definitely share a lot more colour, as you might expect, when we get to March. I think, you know, as we think about the model, and just taking a bigger picture step back, we certainly believe that we've, over the last few years, built a more diverse ecosystem as a company. So, of course, food at home is an important part of the sort of, it drives the flywheel. But as you know, we've been continuing to grow, our fuel business continues to grow, health and wellness this year, even with the impact of So we look at it more as a journey. And we do believe that as we're building the strength in that ecosystem, it creates a new way to generate value for our shareholders over time, as we've talked about at previous investor meetings. I mean, I think some of the points you've raised would certainly be the areas where we'll be focusing on. I don't think it's a different strategy. for Kroger is how do we continue to drive that flywheel as we think about taking cost out of our business so that we can invest more in customers and associates, continuing to drive traffic so we can continue to grow the alternative profit businesses. And we do think there's opportunity for margin improvement to continue beyond 2023 because of the initiatives we're driving around sourcing supply chain, alternative profit streams, etc. So I think from our perspective, certainly if you were in a period where you weren't seeing sales growth for a sustained period of time, because our model is built on sales growth, we'd have to look at our cost base and we'll look at our cost base in certain areas to be more productive. But we still believe that will normalize in the typical pattern that we see of that sort of 1% to 2% inflation over time and sort of 2% to 3% food at home growth. And we think our model is really well set up to be able to drive growth within that framework.

Thanks, Ken. The only other thing I would add to Gary's comment is if you look at our seamless business, we would expect that to continue to make progress as well, as I mentioned earlier. Thanks again.

Thank you. The next question goes to Michael Lasser of UBS. Michael, please, your headline is open.

Good morning. Thank you so much for taking my question. As you talk to your processed food and CPG partners, what are they telling you about their desire to further raise prices into next year? given your expectation that there could be typical inflation across the assortment, that would necessitate that center of the store prices go up. And this is against the backdrop where volumes continue to go down. They're providing more support. Why are they not rolling back prices to try and drive volume? And as part of that, given that you used your P&L to fund promotions a bit more in the third quarter, Is that a sign that you are running into the limitations of the vendors willing to provide support for you to do these promotions? Thank you very much.

Thanks, Michael. If you look at overall, they say in economics all short statements are wrong, and you have CPGs that are all over the board in terms of their approach. Some CPGs are very willing to give up tonnage, and if they are, our brands will be there for a customer to give them incredible value. And what we find is when a customer tries our brand, our repeat rate is incredibly high because of the quality and the value for the money. If you look in the quarter, in terms of funding, it was really done by CPGs and us. And as I mentioned earlier, CPGs were more aggressive in funding. and would expect that to continue. We are seeing more CPGs worrying about their tonnage growth. And I think that's part of what's driving that willingness too. So appreciate the question. And thanks, Michael.

Thank you. Our last question goes to Kelly Bania of BMO. Kelly, please, your headline is open.

Good morning, Rodney and Gary. Thanks for taking our questions. I wanted to go back to the comment about building the more diverse ecosystem and talk a little bit more about alternative profit growth. I think there was a comment that that is still growing double Maryann D' digits, which I think would mean around 150 to 200 million in incremental year over year profit, but maybe just wanted to give you the opportunity to comment on that if that's right ballpark and how many more years, can this business continue to grow and double digit rate. Maryann D' into the coming years.

Yeah, I don't know that Gary and I will want to give the specifics for 24 on the alt profit since we're still going through the process. But we would expect alt profit to be a meaningful contributor of growth next year. And that's really driven by two things. One is our continued growth in our digital business, which is supporting our media business growth. And we think we're just getting started on that. If you look... You know, in the media world, your competitors are Google and Amazon and Meta and Walmart and then a lot of other players. And one of the things that we think transparency is so important in being able to give people good data is we think that transparency is incredibly helpful relative to the Googles and Metas and others. So we see a long-term opportunity to continue to grow the business there. And the specifics, I don't know that we want to get there either. And if you look at some of the other alternative profit businesses, some of those, we have wide variants of performance within the company. So part of that growth is It's just driven by taking best in class within our own company and growing that as well. So, Kelly, appreciate the question. And thanks, everyone, for all the questions. And as always, I'd like to take a few moments to share some comments with our associates listening in. To start, I'd like to say a huge thank you for all the hard work that you've done to make the holidays be so memorable for our customers and what you will do for the following, you know, the rest of the holiday season to make it equally as memorable for customers. As you know, food plays an important part in any celebration, and it provides an opportunity for people to connect and people that we love, especially with them and sharing special moments. If you had a chance to see our holiday film, you saw that idea come to life. And if you haven't seen our holiday film, you can go to YouTube to look at the full film. And it really does recognize that food connects us all. And whether that's honoring family traditions or creating new family ones, I've just been so inspired to see how our associates and our customers on sharing their videos and the unique ways they celebrate the holidays. As I said before, thank you for everything you do to create special memories for our customers every single day. And thank you, everyone, for joining us. We wish everyone a happy holiday season. Merry Christmas and Happy New Year.