Good morning, everyone, and welcome to The Kroger Co.'s First Quarter Earnings Conference Call. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to Ms. Kate Ward, Director of Investor Relations. Ma'am, please go ahead.

Thanks, Jamie. Good morning, and thank you for joining us. Before we begin, I want to remind you that today's discussion will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings, but Kroger assumes no obligation to update that information. Both our first quarter press release and our prepared remarks from this conference call will be available on our website at ir.kroger.com. After our prepared remarks, we look forward to taking your questions. [Operator Instructions] I will now turn the call over to Kroger's Chairman and Chief Executive Officer, Rodney McMullen W. McMullen: Thank you, Kate. Good morning, everyone, and thank you for joining us. With me to review Kroger's first quarter 2017 results is Executive Vice President and Chief Financial Officer, Mike Schlotman. As we all know, there is a lot of change in the food retail industry, both in terms of the operating environment and the competitive landscape. The best thing that we can do is to stay on the offense by continuing to focus on our customers, what they want and need today and what we anticipate they will want and need tomorrow, and executing our strategy. We continue to manage our business for the long term and to deliver earnings growth on a 3 to 5-year time horizon. We are making meaningful investments in our digital and online growth. We believe that customers of the future will want to shop with us for anything, anytime and anywhere. In the first quarter, we saw more than 30% growth in new digital customers and a more than 30% increase in digital visits, with faster growth in mobile compared to last year. We are also building on our personalization expertise to benefit our customers. An example of this is My Magazine, which delivers personalized content like recipes to loyal households based on their shopping behavior and interests. In fact, we delivered more than 6 million unique My Magazine offers in the first quarter alone. This also allows us to offer personalized lower prices to our loyal households in addition to low prices everyone can see. This is another example of how we leverage 84.51°'s expertise. We are investing in our people. We are improving customer service by both increasing labor hours in certain areas and increasing starting wages in certain markets. Taken together, these steps will improve the customer experience and improve retention. I share these examples to demonstrate that we are laser-focused on providing our customers with the right value proposition. This is our Customer 1st promise, our commitment to provide friendly service, fresh foods and low prices every day, and this is what we will continue to do regardless of the external factors because it's what our customers deserve, and we know, ultimately, that delivers shareholder value. These investments both maintain and enhance our position in our markets. And while it is still early in 2017, we are starting to see some traction. We are happy with the better identical sales trends in this first quarter compared to the fourth quarter, and we are pleased to see that our current identical sales trends is positive. The last 9 weeks of the first quarter were positive, and so are our second quarter to date. Our teams continue to innovate in new and exciting ways that reflect where our customers are going. Recognizing the demand for convenience, high quality and best value, Kroger's culinary development team watched an incredible collection of Prep + Pared meal kits that we are currently piloting in Cincinnati stores. We can hardly keep them on the shelves, and it's easy to see why as soon as you try them. Kroger’s Prep + Pared meal kits offer restaurant-quality meals that are easy to cook in about 20 minutes. We think customers will love knowing that they're available in their stores when they are wondering along about 2:00 in the afternoon what's for dinner. Our brands are one of the primary means we have to differentiate ourselves from our competitors. Last year, we commissioned an independent third party to conduct research that would give us an objective view of how our customers view our brands. This included blind taste tests with national brands and other private-label foods. Our research showed that the most loved brands sold in our stores are our brands, above even the national brands. And in the blind taste test, our brands outperformed competitive national brands and other private-label products almost 100% of the time. Our products in Private Selection, Simple Truth and Simple Truth Organic brands rated significantly above their respective competitive offerings. Of course, our journey is never done. So our customers will continue to see rising quality and better value on our brand products in the future. By having brands our customers love that are only available from us, we gain loyalty and advocacy from our customers. Our brands represented approximately 28% of total units sold and 25.6% of sales dollars, excluding fuel and pharmacy during the first quarter. Our customer needs are constantly changing. What doesn't change is the desire for welcoming customer experience with an abundant variety of food available when and how they want it all at a great value. That's why we regularly evolve the execution of our Customer 1st strategy, while the core strategy itself doesn't change. Too often, American consumers have to make a choice between low prices and a great experience, compromising one for the other. Kroger is uniquely situated to eliminate the need for the compromise, serving customers who are hungry for more than food, who want to be nourished in ways that help them live their lives best. Kroger's purpose is to Feed the Human Spirit, and we are more confident than ever that by living our purpose and delivering our Customer 1st promise, we'll deliver long-term shareholder value that you can count on. We remain committed to delivering our long-term net earnings per diluted share growth rate of 8% to 11% plus a growing dividend. And here is Mike to go into more details on our first quarter results. Mike? J. Schlotman: Thanks, Rodney, and good morning, everyone. Like Rodney said, we were glad to see the better results compared to the fourth quarter for identical food store sales, and for the second quarter to date, our ID sales are positive. Tonnage continued to be positive during the first quarter. We continue to focus on the areas of highest growth like natural and organic products as well as areas where we are serving -- saving customers time such as ready-to-eat and ready-to-eat meal solutions. Visits per household were flat in the first quarter. Basket size and price per unit were down, but those were offset by household growth. Loyal households grew 3.2% compared to last year's first quarter and our loyal households had positive ID sales growth in the first quarter. In the first quarter, our gross margin was down, operating costs were up and FIFO operating profit was down. While this is not representative of our typical expectations, it is important to keep in mind that we're making very deliberate and targeted investments in line with our Customer 1st Strategy. As Rodney outlined earlier, we have made conscious decisions to increase starting wages in certain markets to improve associate engagement and retention that will create a better experience for our customers. We continue to invest and grow our digital business. Our digital revenue more than doubled in the first quarter compared to last year. This includes revenue from ClickList, Harris Teeter's ExpressLane and Vitacost.com. As we continue to invest in price, we also remind you, Kroger's investment in price can be seen very clearly if you look at gross margins in the early 2000s compared to today. Kroger has invested more than $3.8 billion to lower prices for our customers over that time period. We have no intention of giving up the momentum we've gained on low prices. These investments enable us to connect with our customers in a deeper way and increase our market share over time. We are pleased that Kroger's market share, as traditionally calculated, was up in the first quarter. That said, we recognize there is no perfect metric for capturing market share. We are doing a lot of work to better define or perhaps redefine the market as a share of stomach rather than share among traditional grocery stores. We see food as a massive $1.5 trillion market and we have a substantial growth opportunity in that market. I also want to stress that we're committed to lowering costs as a rate of sales. Many of the things we are doing to pull costs out of the business today set us up for savings in the future. We will only further intensify our process improvement efforts. Now for an update on retail fuel. In the first quarter, our cents per gallon fuel margin was approximately $0.171 compared to $0.143 in the same quarter last year. The average retail price of fuel was $2.28 versus $1.92 in the same quarter last year. Our net total debt-to-adjusted EBITDA ratio increased to 2.33x compared to 2.12x during the same period last year. This resolve (sic) [ result ] is due to the merger with ModernHEALTH and the repurchase of shares. Over the last 4 quarters, Kroger has used free cash flow to repurchase $1.5 billion in common shares, paid $438 million in dividends, invest $3.4 billion in capital and merged with ModernHEALTH for approximately $390 million. The flexibility to return value to shareholders is a core strength of our financial strategy. We are committed to balancing the use of cash to maintain our current investment-grade rating. Return on invested capital for the first quarter on a rolling 4-quarters basis was 12.75%. On the labor relations front, we are currently negotiating agreements with the UFCW for store associates in Atlanta, Dallas and our Food 4 Less warehouse stores in Southern California. Our objective in every negotiation is to find a fair and reasonable balance between competitive cost and compensation packages that provide solid wages, good quality affordable health care and retirement benefits for our associates. Kroger's financial results continue to be pressured by rising health care and pension costs, which some of our competitors don't face. Kroger continues to communicate with our local unions, which represent many of our associates, the importance of growing Kroger's business and profitability, which will help us create more jobs, incur opportunities and enhance job security for our associates. Turning now to our guidance for fiscal 2017. We have previously indicated that the environment during the first half of this year would be similar to the back half of 2016, and that is what we are seeing. As Rodney said, there is a lot of change in the retail food industry. That, coupled with the transition from deflation to inflation, creates a challenging operating environment. The deflationary environment was less severe in the first quarter compared to the fourth quarter, coming in at 20 basis points deflationary without fuel. Grocery was essentially flat during the quarter, but had fluctuations up and down during it. Meat continued its deflationary trends. And produce, while deflationary for the quarter, showed inflation in the last 4 weeks of the quarter, and pharmacy was inflationary. As a result, we increased our expectations for LIFO to $80 million, a $55 million increase over our initial expectations. We have also made some incremental investments in price in certain markets that had very hot features on milk and eggs. While this affects gross margin in the short term, it is less expensive than regaining a customer's loyalty later on. These 2, plus the incremental investments in hours and wages, are the primary factors causing us to lower our guidance for the year. Our GAAP net earnings per diluted share guidance for 53 weeks is now $1.74 to $1.79. Our adjusted net earnings guidance range is $2 to $2.05. The previous adjusted net earnings guidance range was $2.21 to $2.25. See the Form 8-K we filed this morning for additional information on guidance. Because this is an unusual year, we're going to provide a quarterly cadence relative to last year rather than compare it to our long-term guidance rate as we've done in the past. For net earnings per diluted share, we expect the second quarter to be down compared to last year, the third quarter to be up slightly compared to last year and the fourth quarter to be flat excluding the 53rd week. We continue to expect identical supermarket sales, excluding fuel, to be flat to 1% growth for 2017, and we continue to expect capital investments excluding mergers, acquisitions and purchases of leased facilities, to be in the $3.2 billion to $3.5 billion range for 2017. Over the long term, we remain committed to achieving a net earnings per diluted share growth rate of 8% to 11% plus a growing dividend. Now I'll turn it back to Rodney. W. McMullen: Thanks, Mike. We are making the investments necessary to continue being the best food retailer in the country. We know there is a lot of upheaval in the food retail industry. Our strategy is to focus on our customers. As their wants and needs change, we'll be right there with them. We are confident that we will continue winning with our people, our food and the customer experience, and we will not lose on price. Now we look forward to your questions.

[Operator Instructions] Our first question today comes from John Heinbockel from Guggenheim Securities.

So guys, just to start off, if you think -- is there any way to quantify, maybe directionally, the investments in labor, in SG&A versus the investments in price? Labor being some multiples of the investment in price or maybe it's equally split. And then when you think about the investments in price, is a lot of that proactive on your part? You talked about dairy. Or is that more reactive given what competition is doing? W. McMullen: I'll start, and Mike, just fill in. On the mix between labor and price as you look forward, I would think it's probably pretty close to 50-50, plus or minus 10%. In terms of price, there would be -- as you know, we would not be leading on price as a strategy, but we're not going to let somebody have price. Now if you look at some of the competitive changes and what we see going on in those situations, we would be proactive versus reactive. And then Mike, anything you want to add to both of those comments? J. Schlotman: No, I absolutely agree. And the whole trick here, John, is just how quickly the lines cross and our price investment create more gross profit margin dollars. And as we said in the prepared remarks, there's really 2 things relative to the labor. One is adding some hours to certain service departments, as well as increasing starting wages, which we believe over time will reduce our turnover, which has a great payback when we can have a higher retention of our associates who then are more productive and give a better shopping experience. So that one has a little bit longer runway relative to when we see the benefits of those investments.

And then as a follow-up, if you think about what's different versus March, is it primarily the cadence of reflation? And then as you think about -- because it does sound like you do expect higher inflation this year than you had before, you didn't reflect that in your comp. Is that just higher cost inflation offset by price investments gets you kind of to a 0 net impact from that? W. McMullen: Yes. The biggest thing, if you look in terms of anticipation of identical sales going forward and the improvement of that, we would expect that improvement will continue, but the improvement will be a little bit slower than what we had expected. From an inflation standpoint, Mike went into a little bit of detail on LIFO, but that would be a big chunk. Obviously, the change in LIFO affected, I think -- what, Mike, about $0.04 a share as well. J. Schlotman: Yes. Kind of around $0.035, $0.04, in that range. John, it's not necessarily that it's dramatically different today than we were expecting. But when we look forward based on the movements we're seeing in the underlying commodities, we do think there could be a little more inflation by the end of the year than we originally thought. But the accounting convention is whatever your year-end estimate is, you expense that ratably throughout the year. So it's really more reflective of where we think the end of the year is going to be, not necessarily what would happen in the first quarter, but we're required to ratably expense that over the year.

Our next question comes from Karen Short from Barclays.

A couple of questions. I guess in general, since you're taking the opportunity to lower guidance, I guess I have 2 questions. One is, why not take the opportunity to widen the range to give yourself a little more wiggle room? But I guess more importantly, why wouldn't you lower guidance more? Because if I look at your revised guidance, I still would say this seems pretty optimistic, especially given the competitive landscape has only really just begun to heat up. And within your guidance, originally, there was some assumption that there would be operating expense opportunities, and it now sounds like that's off the table, which makes me even more confused about how we get to the full year numbers. J. Schlotman: We talked about all of those in deciding exactly where to set the guidance range. We spent a lot of time taking where we are today, looking at forecasts for the rest of the year, trying to understand the gives and takes, and settled on the $2 to $2.05. A wider range, perhaps we could have done that. I don't -- other than -- the only answer I have to that is we decided that we feel good about the range we've put out there. We do feel good about the traction we're getting in ID sales that we think will help us support that ID guidance range. Relative to the operating cost reductions, I think that -- I don't have any concern that we aren't going to continue to get the operating cost reductions we're getting. We have made an independent decision to add some service hours to some departments, as well as in some markets, increase starting wages to try to reduce the turnover we have, which hurts the customer experience as well as creates its own cost and friction when you're constantly hiring and training people. We didn't do that across the country, it's in select markets. But it's not an inexpensive proposition. So we try to factor all those in. In fact, what we call enabler savings are actually pretty close to tracking to exactly what we expected in total to save on our cost-savings initiatives for the year. W. McMullen: A couple of other things, Karen, too, and Mike and I both mentioned it. Our identical sales continue to improve, and we would expect that trend to continue. If you look at quarter-to-date and realize it's only 3 weeks plus a few days, we would be at higher than the midpoint of the range that we gave for the year, and that's continued to improve over the first quarter, and the first quarter was an improvement over the fourth quarter and it improved during the quarter. And then Mike's point on expenses, there were some items where it's more of a onetime type of expense item. If you look at some of the changes and the logistics in some other places, we would expect, as we get throughout the year, that some of the investments we've made, it'll flip. So you won't have the start-up costs. And then if you look at digital, obviously, you have a lot of start-up costs initially when you turn on digital in a store. And if you look at the maturity of those stores, over time, that becomes a headwind versus -- a tailwind versus a headwind.

Okay. But just so I understand, in terms of the operating expenses reductions that you've identified, that -- we did not see any of that really in this quarter, but we will see more in the second, third and fourth? J. Schlotman: I would say we saw some in this quarter. And our -- what we have saved in the quarter and the runway -- run rate we have for the year is right in line with what our original expectation and our business plan is. There were other, as I said, the hours and the dollars investment in starting wages were something that was incremental to the plan, but we think it's proven to do that. We try to run the business dynamically and not sit back and say, "Well, it's not in the plan. So even though we think it's good, we're not going to do it." And sometimes, those are pluses, and sometimes, those are minuses. The investments we made in milk and eggs did not lose the customers to people trying to draw our customers into the store. It was -- that, by itself, if milk and eggs were normal kinds of retails, then we probably would've had positive IDs in the first quarter, not negative, which also affected gross margins in the first quarter. So there's always gives and takes. But the thing we're trying to get across is we've made some conscious decisions to make incremental investments in our Customer 1st Strategy, plus the effect of a $0.04 higher LIFO charge.

Our next question comes from Zach Fadem from Wells Fargo.

Is there any color you can provide on the ID sales impact from digital orders at this point? I believe you mentioned you doubled your digital sales. So when looking at your data, how are you thinking about what's incremental versus what might be coming at the expense of in-store volumes? W. McMullen: It's a great question, Zach, and it's one of those that's always hard to answer because you don't know what a customer would have done. The best we can tell, if you would give a range of between 40% to 60%, you're probably within that range. But it is a hard, hard number to guesstimate because you really don't know for sure. J. Schlotman: [ 60%. ] W. McMullen: Incremental or you would have gotten anyway, either way.

40% to 60% incremental, you said? J. Schlotman: Yes. It is clear that those ClickList customers spend incremental dollars with us. To put your finger in the exact number, would they have grown their loyalty with us without ClickList? Perhaps. But you try to take the household trends as a whole and see where they've been going and where they are today.

And is it large enough to say that it's having a meaningful impact on the ID sales line yet? W. McMullen: Not when you look at the total. The cost of the start-up would be a lot more painful than the tailwind from it. But if -- as you know, when we merged with Harris Teeter, Harris Teeter had been doing it for 10 years. And when you look at the maturity that we're having with the Kroger versus the maturity that Harris Teeter had, the maturity would be very similar, but it's a headwind for a while.

Okay. And I also wanted to address the headlines around Aldi and Lidl. Conceptually, how do you think about the role of the hard discounters in the U.S. and how that compares relative to the U.K? And in your mind, what are the structural differences between the 2 markets that you'd call out? And given that, do you think that those guys would have the same competitive advantages here versus the U.K. market? Any thoughts on that? W. McMullen: Yes, Zach, I love the question. A couple of things, for sure. One, just obviously the sheer size of the countries are different. I think the biggest structural, I guess, 2 big structural differences, if you look at the cost that it takes to operate a supermarket in the U.S, it's meaningfully less than the U.K. If you look at the price spreads that they're able to achieve in the U.K. versus the U.S., the price spread isn't as much either. So you have, both from a cost standpoint and a retail advantage for the customer standpoint, not as big a spread. Also if you look at the base experience of a supermarket in the U.S, we would typically offer more services in terms of every store would have a butcher that's there, ready to help. The produce would be much more variety, fresher. So there's a lot of aspects from the experience standpoint that would be different in the U.S. than the U.K. as well.

Our next question comes from Ken Goldman from JPMorgan.

Rodney, one of the first things you said, and I'll paraphrase, was that the environment for food retail has changed. So I guess, I'm curious. Why was it surprising, given that, to see these hot promotional prices on milk and eggs? Shouldn't that have been sort of expected given that the environment has changed? Or maybe you were talking about something different, which is why I'm asking the question. And I guess for my follow-up, I'm curious what is in your guidance in terms of what you're assuming for competitive pricing as we look ahead? Because if things do get worse, and as Karen Short was pointing out, they likely will in terms of competition, I just want to understand what you guys are thinking and how much that's factored into your numbers at this point. W. McMullen: Okay. In terms of the environment is changing, I wouldn't tie it directly to milk and eggs. To me, that's just one example. But as you know, people change -- are changing the way they eat, and we could -- and we're committed and we will support the customer in changing the way they eat. So if you think about the comments on Prep + Pared, if you think about the comments on digital and using where a customer can engage with us digitally or in-store, what we find is a customer does both. So it's all of those things together when I talk about the way customers are eating is changing. And we intend to be there and take care of the customer the way they change. In terms of guidance, Mike, I'll let you... J. Schlotman: Yes. Again, in response to Karen's question, you never know when somebody in select markets is going to run some hot feature and you have to make independent decisions as those features hit the street, because if somebody just run an ad for a couple of weeks trying to get some business in the store or they're going to do something longer term. And when those kinds of ads stay there for a little bit longer, particularly when it's 2 important commodities like milk and eggs, ultimately, we're going to react and not allow our customers to think they have to go somewhere else to get the best value for those kinds of products. It just so happens those 2 commodities are big, big commodities and it's expensive when hot features hit versus some other commodities. And to say we do or don't have something exactly built onto our business plan, that's difficult to say. But we did make the decision to react to those prices and to keep the customers inside of our stores. W. McMullen: It's our best guess in terms of what we see happening going forward in terms of at this point in time.

Can I just sneak one quick one in to make sure I understand? Is the message then that -- and Mike and Rodney, that is helpful. But is the message that you can't really predict it, so you're not necessarily factoring in, as a general rule, more competitive prices? Or is the message maybe that you are, but it's harder to be that specific about it? J. Schlotman: I think we all believe that the industry's going to continue to get more competitive, because every year, it does get more competitive. I think the price investments that we've made so far, from our original pricing plan, are taking good hold and good effect. And we always build dollars in and -- to try to allow us to react to competitive pressures. So I don't -- I think the guidance, where we've lowered it to, certainly has some of both in it. Does it [ encompass ] everything that may happen? As Rodney said, it's our best guess at this point in time.

Our next question comes from Rupesh Parikh from Oppenheimer.

This is actually Erica Eiler on for Rupesh. So I guess, should the environment remain challenging from here, can you maybe just talk about your flexibility to further reduce CapEx and perhaps redeploy the buybacks or other avenues to increase shareholder value? W. McMullen: As you know, from a capital investment standpoint, we continue to adjust, and over the last year, we've reduced the amount that we invest in store, increasingly invest, increase the amount we're spending from a digital standpoint and an infrastructure standpoint. We will always want to keep our stores up-to-date and fresh in terms of the 4 walls themselves. What we find is what the customer wants and needs are it's constantly changing. So some of the things that I talked about, we'll need to make changes in the store to support that. If we -- we would believe that we can continue to reduce the amount of capital we're spending if we're not getting a return on that capital. We would still be looking like -- looking at it like a hawk. In terms of every dollar we spend, are we getting a return for that dollar that we're spending? And over time, does that create value? If for some reason it doesn't, we would reduce -- we have continued to increase the focus on the infrastructure, digital and some of the other parts and deemphasized stores in terms of net new stores. I don't know Mike, anything you want to... J. Schlotman: I absolutely agree with that.

Okay, that's helpful. And then just switching gears to private label. You talked quite a bit about private label in your prepared remarks. It seems that a lot of groceries out there are increasingly pushing private label lately. Some cases, select players are even lowering prices on private label. So are you at all seeing step-up efforts from the leading CPG players to support their products, whether it's through more promotional dollars or through other avenues? It just seems that there would be much more of a sense of urgency at this point, given what seems to be this increased retailer focus on private label. W. McMullen: Well, as you know, our brands has been incredibly important to Kroger since the founding of the company. And the research that we did last year, we wanted to make sure that we weren't just biased because we're so close to it, and we did the research with our customers. And our customers gave us glowing feedback on how strong our brands were, how great the products were in a blind panel. So they didn't know it was us. If you look at our Private Selection and Simple Truth and Simple Truth Organic, we just crushed the competitors in that space. So for us, our brand has always been massively important, and we will have a world-class our brand approach. And it's important for our customers. It's important in terms of being able to make money as well. So we don't look at it in terms of trying to do something versus a CPG. We really look at it as our brand and building our brand and doing the things the customer wants.

Our next question comes from Stephen Tanal from Goldman Sachs.

In sort of thinking through the cut to the guide, I'm curious to know how you're planning food margins for the balance of the year relative to Q1. Do you think the year-on-year gross margin pressure's bottomed? Or are you planning for that to get worse? J. Schlotman: Yes. I would say that when we look at gross margins overall, there's a variety of factors that wind up going into that. I think you'll continue to see us over time reduce gross margins. If you think about my prepared comments, over the last 12 or 14 years, we've taken $3.8 billion -- we've invested $3.8 billion in price by the drop we've made in gross margin. And I think over time, you'll continue to see it go down. It's typically what happens in any segment of retailing, to get laser focused on one particular year or one particular quarter. I probably wouldn't get that specific. But certainly, when you look at it over time, we built our business model assuming that gross margins will go down. We need stronger IDs than we've had the last few quarters. And we need to get back into the productivity loop of allowing our operating costs to come down as a rate of sales to grow that operating profit margin. Obviously, as I said in my prepared remarks, these aren't representative of the results we expect to deliver over time. But every once in a while, you run through cycles where you have to step back and adjust many of the metrics inside the company, and we feel that we've done a good job of reacting offensively and proactively to the environment around us, both from a labor standpoint, from a price investment standpoint and what makes sense to grow the business for the long term.

I guess 2 related sort of follow-up questions. The first would be the milk and eggs example. How widespread is that issue? And the second would be maybe qualitatively, as you think about the guidance and passing through the cost inflation that you're seeing, what's generally built in? Like how long are you sort of guiding so that you can hold the line on price longer than you think others will? Or is that a little different for any reason? J. Schlotman: Well, as Rodney said in response to an earlier question, we typically don't lead our market down on price, except in categories where it's one of our strategic investments we're making. You typically won't see us anymore -- maybe in the '90s, we did this, but you won't see the kind of reaction where we have very, very hot features that, in the end, don't drive any kind of loyalty in your store and just tries to drive foot traffic and get them to buy other things. Will we react to those types of things and make investments so that they don't attract any of our customers to their stores? Absolutely, we will. But I think if you look over time, we'll continue to be proactive on how we make the investments.

Okay, fair enough. And just lastly on meal kits. I know it was about 4 stores some weeks ago. How fast is that being rolled out? How fast can it be rolled out? And if you'd give us a feel for how incremental the sales are, maybe how you're pricing it versus kind of the group of ingredients in those kits, that would be helpful as well. W. McMullen: Yes. A great question that I won't get into all the specifics, because obviously, competitors would appreciate that knowledge as well. What we're finding is the quality of that meal is the same as going to a restaurant and getting a meal, but people like to prepare something at home, and they find it easy and they love the variety that we offer. So a lot of the price comparisons is what the price is versus going to a restaurant, but being able to do it at home. And when it takes you 20 minutes, it's just as fast as picking it up at Kroger's than it's going to a restaurant and going through all that hassle when you're at a restaurant. And we're getting great feedback. We'll continue to roll it out based on the ability for the facilities to handle the volume. And so far, it's been very good, and we appreciate, and looking forward to where it goes.

Our next question comes from Scott Mushkin from Wolfe Research.

I just wanted to kind of like broaden it out a little bit and try to understand kind of where you guys think your business is. And I heard Mike talking about gross margin pressure. As we look at the market, it seems like it's almost like the headline would be more Amazon moving into consumables, more Walmart price investments, more Walmart click-and-collect, more Aldi, more Lidl. And so with this natural pressure on gross margins, there's also seemingly a natural pressure on cost. And so as you look forward, I know you guys kind of reiterated your 11 -- 8% to 11% EPS growth rate. I'm just trying to understand over a number of years, how that's going to be possible in this environment? And do you need to make more aggressive, more offensive moves here with the business given this environment? W. McMullen: It's really making sure that we're using the advantages we have. Obviously, the data that we have, our average customer only has to drive a mile to get to one of our stores. So it's using that personalization to connect with the customer directly on a one-on-one basis and having where they can engage with us any way they want to. So if they want to pick up their groceries, if they want it delivered or if they want to shop and go the old-fashioned way, for lack of a better word, we continue to add services. And all of those services is part of the model in terms of making it an easy place to stop. So if you think about fuel and some of the others. So it's really the sum of all those pieces together that we're offering, and we're doing it in a seamless way. So it's -- I don't disagree with the more, more, more, but there's also things that are a huge advantage for us. And when you look at all those things, when a customer comes into our stores, we still give them a great experience on a friendly face, we have incredibly fresh product, and it's important for us to continue to improve on those aspects because that's what will be a point of difference.

So then my follow-up question would be regarding scale. Does Kroger have enough scale, in your minds, to compete in this environment against the likes of Walmart and Amazon, which are just -- produce tremendous amounts of cash, both companies. So I was wondering, as you look at the business, obviously, you're a large company, but a lot of investments need to be made. Do you need more scale? W. McMullen: Yes. From everything, from our perspective, we would have plenty of scale. And certainly $115 billion revenue company, we would have the scale. The other thing is if you look at like our own brands, the strength of our own brands and the strength of the experience the customers enjoy. All those things, obviously, add to that scale as well.

Our next question comes from Andrew Wolf from Loop Capital Markets.

So I just want to clarify. You did say tonnage was positive, but if you just take out the inflation or the deflation rate, it looks like it might've slowed sequentially. J. Schlotman: I didn't catch the first part of your question. The what was... W. McMullen: Tonnage.

Your tonnage. I just want to know if the tonnage has slowed. And if so -- tonnage growth. You said tonnage growth is positive. But just given the numbers you provide us, it looks as if it slowed sequentially. Just want to confirm that? And then ask you... J. Schlotman: I'm not going to get into -- we typically don't give exact tonnage numbers. And if you look at ID sales compared to inflation, deflation, you get really skewed results when you try to add those 2 numbers together because of the mix of product that wind up being inside of those categories. When you have inflation in certain categories and deflation in other categories, it's not necessarily an apples-to-apples comparison. Just stepping back from exact tonnage and things like that, when you have the number of loyal households we have and you add 3.2% growth on the loyal households and your ID sales with your loyal households is on a positive trend, those are all great signs of health for our business over time. Without giving the -- we're very happy with our unit growth in the first quarter, let's just stay with that.

Okay, great. Last quarter, you said whatever -- the market share growth, at least as you've given it out annually, was a little less than '16 than it had been in prior years. What I'm really trying to get to is in the last quarter, you said it was more store-based -- your traditional store base competitors running better stores. And meanwhile, you're talking more about a changing environment. So I just want to check in with you. Is that still what mainly you see as creating a heightened competitive environment here? Or is it starting to be, as Scott was alluding to, what's going on digitally, whether it's Amazon or other offers? W. McMullen: Estimating market share, as you know, is always difficult. But the -- our growth in the first quarter, certainly on the analysis, would indicate that our market share growth in the first quarter was better than the fourth quarter. And as Mike said, we're pleased with what our unit growth was, we're pleased with our improvement in trend and we're pleased with the improvement in market share trends as well. J. Schlotman: And the loyal household growth.

Great. Well, that's encouraging. Do you want to comment on whether -- where you're seeing competitive -- it's obvious, new entrants coming into market, but some of them are store-based folks like Lidl and Aldi, and some are online like Amazon. So just in terms of what you're reacting to and so forth, or how you see things in the future, where do you -- what is your perspective? Is it still going to be a store-based competitive landscape? Or do you see being digital, including perhaps home delivery with certain click and collect, more of Kroger's future, really what you're stepping up to. W. McMullen: Yes. If you look, we really see the customer -- all our strategies and things are where do we anticipate the customer going. Everything that we could see and see, and doing what we're building our infrastructure for is to be able to serve the customer the way they want to be served. And everything that we can see, we find that the customer likes the combination of everything versus just one approach. And we continue to partner with third-party on doing deliveries. We have that in a couple of markets and we continue to expand that. We continue to expand the number of items that are offered. And obviously, we continue to expand the number of ClickList ExpressLane stores we have. But everything that we can see, the customer wants to shop on their terms the way they want to, but they still, for certain items, like to come into a physical store because they like to interact with people. And we think it's incredibly important to continue to have a strong physical presence, but it's the sum of all parts rather than just each one individually.

I just want to follow up, if I could, on the regional price, the hot pricing in dairy. Could you tell us what regions? Is that more in the East where -- is it proactive to Lidl's entry more so than not? And just generally, how widespread that is. J. Schlotman: Yes, I won't to comment on exactly where we sell those, other than it was not concentrated only there.

Our next question comes from Vincent Sinisi from Morgan Stanley.

Wanted to just go back to the pricing philosophy. Obviously, it'd been talked about a lot, but I think warranted given the fact that for investors today, probably the line that jumped out most within the release was, we will not lose on price. So you talked about obviously being certainly a part of that is proactive. I'm sure some of it in given markets is reactive. But can you just give us a little bit better sense on kind of the true kind of philosophy around balancing that kind of strict price versus, obviously, a lot of the other factors that Kroger has going for it and kind of who that may be kind of most aimed after, that'd be great. W. McMullen: Yes. I think it's important for people not to overplay the price comment. As you know, we do a ton of work on understanding where the customer wants and needs are, and we're incredibly focused on differentiating our experience versus our competitors in terms of the service our associates provide, the products and the quality of the products; the quality, especially in the fresh areas, in produce and meat and seafood and our deli; and the shopping experience itself. So how long did it take me to get into the store? How long did it take me to get through the checkout line? What type of experience? Those are the things that we're focused on and that we will differentiate ourselves. We're increasingly differentiating ourselves in terms of the ability to do -- engage with us any way you want. Price, we're just making sure we don't lose customers because of price. So it's really those pieces together is where we're focused on and focused on delivering for the customer.

Okay. And maybe just a follow-up to that, maybe more on the promotional environment, and obviously a big, kind of more theoretical question for everyone on the call is how much of this is more kind of permanent shifts in pricing versus more of just kind of the weekly blockbuster promotions, kind of like what you mentioned? So I guess, how do you think about, particularly in the second half of this year with the commodity costs showing signs of improvement, how much of kind of -- maybe some of those weekly promotions do you expect on your side to kind of moderate versus how much of this may just be more kind of permanent in nature? J. Schlotman: Yes. When you look at how people are going to promote and what weekly features are going to be, I wouldn't have enough time to step back and think about how our merchants develop their marketing plan. They're well out -- they're multiple weeks out. We certainly make assumptions about how customers or how other competitors react around holidays, how they may react in weeks during the summer when there's a lot of vacations going on and maybe fewer people at home shopping and what kind of promotions they may do. But to be able to sit here and say, this is exactly what we're expecting from a promotional standpoint, would be very difficult to say I have X, Y or Z built into the plan, other than we know there's always going to be markets and there always are markets where there are a lot of hot features going on. There's other markets that are kind of in the middle. There's high, low kind of activity kind of normal traditional grocery store pricing. And then there's other markets that are relatively benign, where you go about your daily life. Now fortunately for us, we have the number of markets we're in and the breadth of those markets, that not every market is hyper competitive at the same time. And some of the ones that aren't quite as competitive help offset that. So to sit here and try to project what the competitive environment, or more specifically, the promotional environment may be, would probably not be significantly prudent.

And our next question comes from Kelly Bania from BMO Capital Markets.

Just some more questions on margins and the price investments. I guess it seems fair to ask where these hot ads are? Are these traditional supermarkets? Are there any different kind of behavior that you would expect to get better over the next coming quarters from these competitors with these hot ads? And I guess, as you respond to them, how much of your response in terms of price investments is going in personalized efforts, personalized discounts versus your everyday pricing? And are you seeing any different changes in terms of what you would expect in terms of elasticity to those price investments that you are making? J. Schlotman: I'm not sure exactly where to start on all those questions. At the end of the day, we always assume this industry is going to get more competitive, quarter in, quarter out; year in, year out. And unfortunately, I guess, we're rarely disappointed with the result of our expectation, and that's that it's always a competitive market, it's always been a competitive industry. In our view, it's going to continue to be competitive. There are bursts of time where things heat up, and then there are bursts of times where it cool down. And we know over time that if somebody runs a hot feature over the course of a weekend, that's one thing. If somebody appears to be trying to put a stake in the ground on big volume important commodities to drive volume into their stores, the best thing we can do to counteract that is, as Rodney say, not lose on price on that commodity because that takes the advantage away from them and it doesn't cause any -- it doesn't get any of our loyal customers or any of our customers any reason to go anywhere else to shop. And you have to make judgments throughout the course of 1.25 years of is this a short-term thing somebody is doing that you can -- not necessarily this way, but by and large, ignore? Or is this something you need to react to? How do you balance that with planned price promotions you have? How do -- nobody on the call can see the advantage we create with our loyal households, with the My Magazines Rodney talked about where there were 6 million individualized offers in the first quarter alone that offered those households a different price than anybody sees on our shelf edge. We do that without creating any kind of price impression amongst our competitors because they don't know we're doing it. But that's the way to be able to reward and give a better price to our most loyal customers without putting it on the front page of an ad and perhaps us causing something like that happen. So we're constantly using those kind of advantages we have, primarily through 84.51°, to figure out how to reward our most loyal customers the best. W. McMullen: And the only other thing I would add, Kelly, to Mike's point, is if you look, typically, you'll have consolidation, and consolidation happens in spurts. And everything that we can see, we're probably at the front end of the next phase of consolidation. You're starting to see some competitors fall out, and it's one of the things that we think is incredibly important, to have the scale that we have and the diversity across the whole country that we have, because it allows us to continue to do what's right for our customers. We'll continue to work on improving the basic operation. And by doing those things, the shareholders continue to get a great return over time as well.

Great. I guess my follow-up to that would be just in this environment, are you thinking about M&A any differently given what you just said? J. Schlotman: I wouldn't say we're thinking about M&A any differently at all. I do agree with Rodney's assessment of consolidation, and I think you'll continue to see us have the opportunity to increase our footprint in markets we're already in by the consolidation of competitors who are going by the wayside. You saw the news reports from earlier in the week in Vienna. And I think there'll be further opportunities like that going throughout the course of the next few years. It's one of the reasons why Rodney's comment on reducing our capital expenditure, on increasing our footprint. It doesn't worry me too much over the next few years because I think I can lower my CapEx, invest it in things that are going to drive sales and reduce operating costs and increase my footprint at prices below what it would cost me to build from the ground up. And when they get into those kinds of situations, it says you really want [ to fit great ] rather than buying an entire chain and trying to do something with that. So I feel really good about that part of what's going on around us.

And our final question today will come from Chuck Cerankosky from Northcoast Research.

Rodney, could you talk a little bit about how prepared foods did just as a category, all the forms in which you sell in market prepared foods did versus a year ago? W. McMullen: It continued to grow nicely versus a year ago. It would be one of the strongest departments. And it's one of those things, as you know, we think it's -- more and more customers will go in that direction. And as you know, we went to the outside to hire some talent there, and we really feel good about the opportunity in terms of the growth opportunities, and we love the progress we're making.

Is that an area that is going to get more capital dollars when Mike spoke earlier of infrastructure spending? W. McMullen: Yes, it'll get more capital dollars. But more importantly, it'll get more attention and just the discretionary efforts of organization, we will -- it's not as capital-intensive to make the changes we need to make there. The key thing is changing -- keeping the menus fresh and up-to-date and the attention that we spend in that area.

And then switching to some of the offsets. Mike hinted about operating cost, projects to reduce operating expenses. That might be overshadowed this year by some of the wage investments. But could you highlight some of the projects that are going on, please? J. Schlotman: Yes. I wouldn't get too specific. One of the bigger areas that is always -- particularly of late, we have a lot of projects going on in and around shrink, some tests going on in a handful of markets trying to reduce the trends on shrink. It's early on those handful of markets, but early signs are the tests we're doing seem to be encouraging. And hopefully, as we get to the end of the year, it starts to be end of the year and into next year, something that becomes a little bit of a tailwind instead of a headwind.

By headwind, you mean the wage investments this year are going to cover up a lot of the other expense reduction efforts? J. Schlotman: Or just shrink not being exactly where we want it and these projects being able to turn the trend on shrink. W. McMullen: Before we end today's call, I just want make a couple of comments. First of all, the changes that we talked about today and the direction we're headed in, we're making those changes proactively, and it's really based on where we see the customer is going. And we think it's incredibly important to do those changes in advance. And we're massively excited about the growth opportunities for the business going forward. We feel really good about our team in terms of the opportunities and taking advantage of those. So I wanted to make that. And then I also, as you know, I always like to share some comments with our associates who are listening in. As you've heard us describe during this call, we're focused on executing our Customer 1st Strategy and living our company's purpose, to Feed the Human Spirit. Feed the Human Spirit is our purpose because both our customers and you, our associates, told us it resonates powerfully with you. And also because it's authentic to Kroger, it's who we are. We've been living our purpose in large ways and small for more than 134 years, whether it's through providing over 1 billion meals to feed hungry families in our neighborhoods over the last 4 years, committing to be a Zero Waste company by 2020, or simply extending a smile or a helping hand to the customer, we and you make the world a better place one associate, one customer, one community at a time. Thank you for all you do every day for our customers and each other. That completes our call today. Thanks for joining.

Ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect.