Albertsons Companies, Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, welcome to the Albertsons Companies First Quarter 2020 Conference Call, and thank you for being with us. This call is being recorded. I would like to turn the call over to Melissa Plaisance, GVP of Treasury and Investor Relations. Thank you. You may begin.

Good morning, and thank you for joining us for the Albertsons Companies First Quarter 2020 Earnings Conference Call. With me today from the company are Vivek Sankaran, our President and CEO; and Bob Dimond, our CFO. Today, Vivek will start with some opening remarks, share insight into our strong first quarter 2020 results and outline recent progress against our strategic priorities. Bob will then provide the financial details of our first quarter before handing it back over to Vivek for some closing remarks. After management comments, we will conduct a question-and-answer session. I would like to remind you that management may make statements during this call that include forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are not limited to historical facts but contain information about future operating or financial performance. Forward-looking statements are based on our current expectations and assumptions and involve risks and uncertainties that could cause actual results or events to be materially different from those anticipated. These risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements include those related to the COVID-19 pandemic, about which there are still many unknowns, including the duration of the pandemic and the extent of its impact. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are and will be contained from time to time in our SEC filings, including on Form 10-K, 10-Q, 8-K and our prospectus dated June 25, 2020, and filed pursuant to Rule 424B1. Any forward-looking statements we make today are only as of today's date, and we undertake no obligation to update or revise any such statements as a result of new information, future events or otherwise. Please keep in mind that included in the financial statements and management's prepared remarks are certain non-GAAP measures. And the historical financial information includes a reconciliation of net income to adjusted net income and adjusted EBITDA. And with that, I will hand the call over to Vivek.

Thank you, Melissa. Good morning, everyone, and thanks for joining us today. As you all know, Albertsons Companies went public just over a month ago, and I'm very pleased to welcome the equity investment community to this call. This is an important new chapter for us. So before we discuss our strong Q1 results, I'd like to first share some brief comments about our journey, especially for those on the call who may not be as familiar with the Albertsons story. Following the successful completion of the Safeway integration in 2019, we began the next phase of our transformation. We studied the competitive environment and secular trends and formulated a clear strategy that enhances our focus on the customer, leverages our strength as a leader in attractive markets and further strengthens our capabilities to efficiently meet the changing needs and preferences of our customers by modernizing all aspects of our company. We sought out and put the best talent from inside and outside the company into pivotal positions and pushed ourselves to set new expectations that better reflect the full sustainable growth and earnings power of this business. Our results in 2019 were solid, with steady improvement in performance with each successive quarter. We were primed for even stronger performance in 2020. And while no one expected the impact of COVID-19, we moved swiftly to adapt our business in response. Our stores remain the foundation of our business. When combined with our growing suite of digital and eCommerce offerings and loyalty programs, we are well positioned to respond quickly and effectively to changing consumer behaviors. Let me now turn to our priorities in this new chapter, along with some key highlights from the quarter and disciplined actions we have taken to navigate the pandemic over the past few months. Our strategy is predicated on leveraging our operational expertise as well as building deep and lasting relationships with customers that result in long-term growth and lifetime value. We celebrate local ownership in how we run our stores and support them with our national scale, which we believe makes us unique. In fact, everyone at Albertsons is guided by a common goal: to be locally great and nationally strong. I'm pleased to report that we had a record quarter by all measures, with 26.5% identical sales growth that drove adjusted EBITDA of $1.7 billion. This represents an increase in adjusted EBITDA of over 90% versus the same period last year and flow-through of approximately 20% on incremental sales. Our performance is the direct result of the steadfast commitment of all our associates to serve customers and support our communities through the challenges they have endured over the last few months and support each other in these very difficult and uncertain times. I'm so proud of them and thank them for all they do. I'm also pleased to note that we gained market share across our footprint and did even better in markets where we are not the market share leader. We are very focused on retaining our new customers and retaining the incremental spend of our current customers. Our rapidly growing loyalty program is a key enabler that will allow us to increase retention of customers. In addition to our efforts to enhance our in-store execution, breadth of offerings and omnichannel capabilities, which I will touch on in a moment, we offer fuel rewards, grocery rewards and hundreds of millions of personalized deals to our customers. We have expanded our pool of loyal customers, broadened their engagement with us and retained their business. For example, in Q1, we saw a 27% increase in the number of households that signed up for our loyalty program to 22.5 million driven by the expansion of the program in key geographies. The number of members in our program who redeemed digital deals and coupons was also up 32% year-on-year, with the average weekly spend being twice that of customers who are not engaged in the digital deals and coupons. Members who redeem rewards drive an average weekly spend 3.8 times that of customers who are not engaged in rewards. Sales from households that are redeeming in our loyalty program, just for U, digital deals, coupons and rewards, are up 28% versus their spend last year. Our retention rates were the highest in years among our loyal households during Q1, with over 40% of our existing shoppers moving up the loyalty ladder as customers were rewarded with more personalized deals and expanded the number of categories they shop with us. Going forward, we are focused on expanding our enrollment in geographies that have historically not had it and working towards strengthening engagement in geographies with high enrollment. Overall, the customer is at the center of everything we do. And picking the right priorities and putting resources and energy behind them will help us deliver value both for our customers and our stockholders. You've heard us talk about a framework that revolves around a few key themes: growth, productivity, technology, talent and culture. With that in mind, I wanted to spend the next few minutes providing insight into our strategic priorities within that framework. Our first strategic priority is driving growth through in-store excellence across our fleet of stores throughout the country. We fulfill this commitment in several different ways. So let me share a few examples. We are providing a compelling breadth of services and assortment, especially through our fresh offerings, which has proven to be very important as customers eat more at home, which is driving sales. Over the years, we have invested in relationships with farmers on a global, national and local basis and in our broader supply chain to give our customers the best quality and availability of fresh food. Those investments are paying off as we saw our fresh market share increase, with meat driving the highest sales and share gains in Q1. Part of this increase was also driven by promotions for Memorial Day when we featured some grilling items to support holiday weekend needs such as signature farms, pork back ribs, as well as sausages and hot dogs that achieved record sales. We have constantly focused on innovation and continuing to grow our Own Brands portfolio, which is another advantage for us. This portfolio includes 9 brands, over 12,000 products and was a $13 billion business in 2019, growing faster than our branded business and on average, contributing a 1,000 basis point advantage in gross margin versus national brands. Own Brands have been growing steadily as a proportion of our overall sales in recent years, and we intend to increase Own Brands penetration from 25.4% in 2019 to 30% in the next few years. During the pandemic, our Own Brands continue to be a source of growth. O Organics and Open Nature grew faster than our overall business with 31% and 28% growth, respectively. In Q1, we introduced over 400 new items in our Own Brands portfolio. This includes many exciting additions to our ice cream lines in both traditional and nondairy, plant-based options such as Signature SELECT cinnamon churro ice cream and Open Nature oat nondairy blueberry oatmeal crumble. We are seeing growing interest from our customers in plant-based offerings. So we're focused on expanding our efforts in this area as we look to accommodate all lifestyle needs and customer preferences. We also continue to invest in our stores, completing 46 store remodels during Q1, which are a proven driver of identical sales. Our second strategic priority is supercharging our digital and eCommerce offerings. As we began transforming the business last year, we prioritized eCommerce as an area for improvement and have allocated a lot of resources and attention to doing so. We brought new leaders and fresh thinking into the company, significantly stepped up our digital investments to enhance our customer experience, formulated an omnichannel strategy that leverages our stores' central locations in communities offering Drive Up and Go and delivery and piloted micro fulfillment centers to enhance productivity. We are seeing the benefits of our investments. During Q1, we saw a significant step change in our eCommerce business, with an increase of 276% in digital sales compared to the first quarter last year. Growth was driven by accelerated expansion of our Drive Up and Go curbside service, which is now available in 731 stores, up from 600 at the beginning of the fiscal year, a testament to how quickly the team was able to adapt and execute. We also now have our own delivery offerings in nearly 65% of our stores as well as third-party delivery, which, in total, covers over 90% of our stores. We see significant growth potential in eCommerce and plan to expand our Drive Up and Go offerings to nearly 1,400 stores by the end of this fiscal year, on our way to achieve our target of over 1,600 stores within 2 years. While the trend towards omnichannel is already occurring, the pandemic has dramatically accelerated this trend. And we have positioned ourselves to support our customers with the solutions they want and need right now. We're committed to supporting this expansion with the full resources of our organization. As we approach this work, we are balancing the need to expand our capability quickly with the knowledge that we have to provide an exceptional experience every time for our customers. It is the only way to build on the strength of our great stores and keep the customers who are testing our new capabilities. This requires us to move deliberately and also prioritize building a profitable and scalable omnichannel model for the long term. I'm certain that we will expand our capabilities to the vast majority of our stores over time, but we will do so in a way that does not compromise our competitive differentiators or our business model. Going forward, we will continue to build on and refine our capabilities and invest in the digital and physical experience of our customers, including experimenting with new delivery assets while implementing new technologies to drive productivity and working with our partners to streamline the omnichannel supply chain. Our third strategic priority is driving productivity. We're intensely focused on delivering operational efficiencies to help offset cost inflation and fuel reinvestment in the business. This includes leveraging the national scale of our organization to maximize efficiencies in our supply chain and drive operational leverage. While we sustained momentum on initiatives such as strategic sourcing, we took a brief pause in the first half of the quarter on others, especially those that require travel and contact between associates. However, we reactivated these efforts towards the end of the quarter and expect them to be a benefit going forward. Furthermore, a crucial enabler of our productivity initiatives is our focus on technology and automation. In the first quarter, we accelerated our technology agenda to scale our eCommerce business, transition many of our teams to work from home and monetize our technology stack to drive enhancements for our customers, store operations, merchandising and supply chain. We're pleased with the progress we've made in modernizing the data and technology platforms, leveraging the public cloud, software-defined network and upgrading core applications to be more agile, scalable and secure. We're also making good progress on ramping up automation in our stores, including the deployment of self-checkout as well as our automated forecast and replenishment system, FAR, and VisionPro, our production planning tool. Both use AI to manage our in-stock position and reduce our shrink. To give you an example, we launched VisionPro company-wide in produce and have seen reductions in shrink of over 40 basis points. Our FAR automated replenishment system has helped us reduce excess inventory in one of our divisions by over 7 pallets per store, and we are experiencing similar results as it launches company-wide. We've also leveraged technology to deliver training for these great tools virtually and creating a safer environment while also reducing the cost of travel. We believe these productivity initiatives will drive tangible improvements in customer satisfaction and will be a key driver in increasing customer loyalty, a key differentiator for us as I mentioned earlier. We are confident that we will achieve our $1 billion of productivity over the next 3 years. Our fourth strategic priority is to build on the unique culture that we have created, which marries our local focus with the advantages of our national scale. This is a critical differentiator for us as deep knowledge of the local needs of our customers helps us remain relevant and build loyalty, maximizing the lifetime value of the relationship we have with each and every one of our customers. This approach is proving itself to be more important in this time of heightened need, where our teams are working tirelessly to ensure the safety and well-being of our people and our customers while supporting the communities in which we operate. In support of this priority, this quarter, we spent nearly $300 million in appreciation pay and extended sick pay for associates, including a final lump sum reward payment to our teams totaling nearly $40 million at the end of the quarter. We implemented safety measures, including plexiglass barriers in every check lane and enhanced health screenings for all of our teams to help ensure our associates, customers and communities were afforded a safe, secure shopping experience. We also recently announced that we now require customers across all of our locations to wear face coverings when shopping for the protection of our customers and associates. We contributed $53 million in cash towards COVID-19-related hunger relief and another $5 million to support social justice. To further strengthen our culture, we are also continuing to build out our team and have made several key hires over the past few months. Our formal General Counsel, Bob Gordon, retired in mid-June, and Juliette Pryor was named Executive Vice President and General Counsel. She joins us from Cox Enterprises where she served as General Counsel and Corporate Secretary. Prior to that, she was at U.S. Foods where she served as General Counsel and Chief Compliance Officer, among other roles, over time. I thank Bob for his service and welcome Juliette to the company and the team. At the same time, we hired more than 80,000 associates to date since the pandemic began to support the surge in demand in eCommerce, our stores and our distribution centers. As we look forward, we remain focused on balancing the opportunity we have to leverage our national scale for efficiencies without compromising our commitment to empower store-level decision-makers to take care of the unique needs of our customers across the markets where we do business. This will further align the interest of those who directly manage our customer relationships on a daily basis with our commitment to creating value for all our stakeholders, including our stockholders. I'll come back with some closing thoughts in a few minutes, but now I will turn the call over to Bob to cover our first quarter results. Bob?

Thanks, Vivek, and hello, everyone. As Vivek noted, we delivered strong performance in the first quarter driven by continued successful execution against our priorities and an unprecedented increase in demand driven by the COVID-19 pandemic. Total sales were $22.8 billion during the first quarter compared to $18.7 billion during the first quarter last year. Our increase in sales was primarily driven by our 26.5% increase in identical sales. Identical growth was 47% in March, 21% in both April and May, and 17% in June as lockdowns and stockpiling behavior were followed by initial reopenings across the country. We are continuing to see elevated identical sales in the mid-teens since the end of the first quarter. While it isn't our practice to give monthly identical sales, we thought it would be helpful in this environment. Our gross profit margin increased to 29.8% during the first quarter of fiscal 2020 compared to 28% in Q1 2019. Excluding the impact of fuel, our gross profit margin increased 80 basis points. The increase was primarily attributable to lower shrink expense as a result of the significantly higher-than-normal sales volumes. During late May and June, we increased our promotions as supply levels improved, and we focused on blending the Memorial Day and Father's Day holidays. As Vivek mentioned earlier, we believe this increased promotional activity contributed to our strong identical sales. Turning to selling and administrative expenses. We saw significant sales leverage throughout the first quarter as our selling and administrative expense rate decreased to 25.4% of sales compared to 26.4% of sales for the first quarter of fiscal 2019. Excluding the impact of fuel, selling and administrative expenses as a percentage of sales were 190 basis points lower than the prior year. Overall, the improved sales leverage, including strong cost control, more than offset incremental COVID-19 costs totaling approximately $615 million, including approximately $400 million in one-time or nonrecurring expenses. As we continue to optimize our procedures and procurement of PPE and cleaning supplies, we expect to incur less ongoing COVID-related expenses during the second quarter. As I just mentioned, we are seeing continued strong identical sales growth and believe that these expenses will more than be offset by the increased revenue. Interest expense was $180.6 million during the first quarter of fiscal 2020 compared to $225.2 million during the same quarter last year. The decrease in interest expense is primarily attributable to lower average outstanding borrowings compared to the first quarter of fiscal 2019 and lower average interest rates. The weighted average interest rate during the first quarter of fiscal 2020 was 6% compared to 6.5% in the first quarter of fiscal 2019. Adjusted EBITDA was $1.7 billion during the first quarter of fiscal 2020 compared to $877 million during the first quarter of fiscal 2019. The increase in adjusted EBITDA primarily reflects our record identical sales and improved gross margin and lower selling and administrative expense rate. Adjusted net income for the quarter was $801 million, and adjusted EPS was $1.35 per share using our fully diluted shares outstanding compared to $177 million or $0.30 per share during the first quarter last year. From a capital expenditure perspective, we spent approximately $400 million during the first quarter. As Vivek mentioned, we completed 46 remodels in Q1 and also accelerated technology-related investments, including those in digital and eCommerce. For the full year, we expect to spend approximately $1.6 billion in total capital expenditures. We generated record free cash flow during the quarter driven by the strong identical sales and adjusted EBITDA, in addition to improved working capital trends driven by the increased volumes. As a result, we finished the quarter with over $2 billion in cash. And our net debt to adjusted EBITDA improved to 1.8 times on a last-twelve-month basis or 2.4 times our 2019 adjusted EBITDA. Looking forward, as we disclosed in our prospectus, we expect our Board of Directors will be authorizing an annual dividend of $0.40 per share payable quarterly, with the first declaration and payment dates occurring during our third quarter of fiscal 2020. As many of you saw last week, we announced a tentative agreement with the UFCW local unions regarding pension benefits for 5,100 of our associates in the Union-Industry Pension Fund, which is referred to as the National Fund. Upon ratification of the agreement by 9 local UFCW unions, we expect to incur a pretax charge of approximately $286 million, or $213 million after tax, to record the withdrawal liability likely in the third quarter of fiscal 2020. This charge will not affect adjusted EBITDA and adjusted net income for fiscal 2020. The payments into the National Fund will be made in 3 or 4 installments over the next 3 years. We will also be establishing a variable annuity pension plan to provide future benefits for our employees, and we'll be making a payment of $8 million to $9 million into this new plan within 30 days of its establishment. And now Vivek will provide some closing remarks.

Thank you, Bob. These last few months have been unprecedented in our company, our industry and our country. We have dealt with the challenges posed by a global pandemic and faced tragic racism, which, in turn, led to civil unrest. Our team really stepped up, and their perseverance and dedication to serve our customers and our communities is demonstrated in our record results, with identical sales growth and adjusted EBITDA growth of 26.5% and more than 90%, respectively. I could not be more proud of our associates all around the country. We're also pleased to see that our success is being recognized, with Supermarket News naming Albertsons its Retailer of the Year. We feel good about how the business has been performing. We are progressing towards our goals and are very focused on retaining our new customers through the variety of ways you heard me address earlier, including our loyalty program, an excellent shopping experience in our stores and our digital and eCommerce offerings. It is clear that we will remain in a period of heightened volatility related to the pandemic for some time, and its impact will continue to be felt in varying degrees across the markets in which we operate. As a result, we will not be providing guidance for fiscal year '20 at this time. To give some context for how we are thinking about the balance of the year, given our strong performance in the first quarter and our plan for the remainder of the year, we would expect to meet or exceed $3.7 billion of adjusted EBITDA for the year. With the recent flare-ups of COVID-19 in several parts of the U.S., including states where we have many stores like California and Texas, the magnitude of increases week by week has been closely correlated with the level of consumer concern about the virus. We have continued to see strong customer demand this month and estimate the July identical sales growth will be in the mid-teens. Given the current dynamics, we expect demand levels to remain elevated as customers are likely to continue to eat at home for an extended period. Looking at our history, we know that the types of changes to consumer behavior that we are currently seeing tend to have long duration when they do occur. This is why it is so important to focus on both strong execution in this moment of heightened need while also prioritizing the strategic work that we are doing to build on our competitive strengths. We will continue to invest in our people, our capabilities, our technology and our stores. It will ensure that we sustain the momentum that we currently have and build a lasting change in preference with our customers. When I step back and look at where we are, I have great confidence that our well-located stores, broad assortment with a focus on high-quality fresh products, strong loyalty program and rapidly expanding omnichannel offerings position us well to build these lasting relationships with customers and sustain the market share gains we have generated. We have the financial engine to support this ambition as we are operating from a position of strength and liquidity and generating strong free cash flow. We have a disciplined approach to assess and prioritize the opportunities to reinvest our cash in areas with the highest returns, a broad range of productivity projects that create additional fuel for reinvestment while maintaining our commitment to return of capital to stockholders through our dividend and continued reduction of debt over time. We expect this combination of strong execution and strategic reinvestment by a fully aligned and talented organization will drive long-term growth, enhance our profitability and support double-digit stockholder returns well beyond the period of heightened COVID-19-related demand. I will now turn the call back to the operator for questions.

The first question comes from Robby Ohmes with Bank of America.

It was a strong quarter. Vivek, my question is about your performance in markets where you're not the leader in market share. You've mentioned doing even better in those areas. Can you elaborate on that? Is it mainly because you're being more promotional than your competitors, or are there other strategies at play? Also, could you discuss the market share gains in the meat sector? Are those primarily driven by promotions, or is there more to it? Lastly, could you provide some insight on how the performance of your fresh food segment compares to the rest of the store?

Yes. Robby, I want to emphasize that in this kind of environment, execution is key. It’s about having the right supply and effectively managing our stores. This has been crucial in driving our share gains, and I believe we have outperformed many competitors in certain markets. Specifically regarding meat share gains, I was referencing the period around the Memorial Day holiday, which marked the first major holiday of the year leading into summer. We ran promotions during that time, contributing to meat share gains alongside the usual week-on-week growth we experienced throughout the quarter. Our fresh business is continuing to expand, with produce recovering quickly, and as the meat supply has begun to stabilize, we are building significant momentum in that category. Overall, our entire fresh business is performing very well. In fact, it has become the more stable and predictable aspect of our growth, as customers are returning weekly to replenish their supplies.

Can you provide any insights on the ticket versus traffic pattern? Were there any changes observed in July?

The traffic shows that people are still visiting less frequently but are making larger purchases. This trend has persisted over the last several months, and we have not observed any significant change in this traffic pattern.

Our next question comes from John Hencobob with Guggenheim.

I want to ask you 2 things on digital. It looks like you're pulling forward the Drive Up and Go expansion by a full year, right? I think you said to get to 1,400 by the end of this year. Is that right? And how do you think about staging that and managing that? That's a lot of installations, right? I assume you're going to try to get a lot of that done before Thanksgiving. And then where are you on MFCs, all right? I know we're 2 now. What's the timetable on expansion at this point?

Yes, John. So one, yes, we are pulling it forward. We are excited about Drive Up and Go. It is the fastest-growing in our portfolio, and so we're pulling it forward. The biggest constraint is less so the capital and the technology and such. It's always about getting the right people and embedding it in the team the right way. And the team has been working on that. And you saw we added about 130 or so in the first few months. And so we now have a formula on how best to expand that. With micro fulfillment centers, we're excited about the 2 that we have. And now we are looking at multiple ways. So as we talk, we're talking about expanding into different markets, one, doing it the way we did, which is putting it as part of a store, but we're also exploring other options where it doesn't have to be part of a store. So that will be the next phase, to think about various models in which we can implement a micro fulfillment center. And when we get comfortable about that, we'll accelerate the expansion. But it's another critical part of our productivity journey, let me put it that way, in eCommerce.

Okay. And then maybe for Bob, do you think that when you consider the incremental margin on a double-digit comp moving forward, is it still likely to be close to 20%? Or due to some of these investments, could it end up being less than that?

Yes, I believe our gross margin rate will remain relatively stable compared to previous levels. We don't expect significant deviations in that regard. Our strategy isn't focused on increasing the margin rate; instead, as we grow our fresh offerings and private label products, our margins will naturally increase unless we invest those gains into expanding our top line, which is something we aim for each year while maintaining a good balance. You can see the flow-through, as there's leverage in the profit and loss statement. With increased volume through our stores and distribution centers, that adds up significantly.

Our next question comes from the line of Ken Goldman with JPMorgan.

Vivek, I wanted to ask about what you're seeing from your competitors in terms of pricing and promotions right now. You talked about maybe in some categories where supply has gotten a little bit better, maybe taking your promotions back a little bit, which makes some sense. But I'm just curious, what are you seeing from some of your major competitors along these same lines? Are you seeing anyone restore promotions that were taken away in the center store, for example? I just kind of wanted to pick your brain a little bit about the more broad-based kind of environment out there.

Yes, Ken, I would say that no one has returned to the level of promotions seen before the crisis due to ongoing supply challenges. However, I believe you will observe consistent promotional activity during key holidays to ensure we keep our current customers and prevent them from shopping elsewhere. There are certain categories where I think promotions will remain limited until supply improves or demand significantly shifts. This includes items like sanitizers and some baked goods, especially as we approach the fall when baked goods tend to see higher demand. Promoting these items may be more difficult due to supply issues. Overall, we haven't noticed any major competitors significantly changing their promotional strategies from what I've shared.

Okay. No, that's helpful. And then my follow-up, thank you for the quarter-to-date identical sales number or the range. I realize you're not providing a full outlook today. But in light of sort of the June gross margin, how should we think about modeling, just broadly, your gross margin or your merchandising margin in the second quarter? Is it fair to assume it will potentially look a little more similar to the last month of your quarter than the first few months? Any commentary you can provide there would be helpful.

Yes. Ken, I'll start out here. I think what you need to look at is kind of look at the total quarter. We did have the period that had essentially 2 holidays in it, right? That the promotional activity pulled it down a little bit, but there's not any quarter where you have that in every period. And when you balance it out, I would think that the second quarter is going to be back to kind of our normal average.

Our next question comes from the line of Kate McShane with Goldman Sachs.

The loyalty statistics you cited were very helpful. But we were wondering how many new customers do you think you acquired during this period and how you're trying to retain them.

We acquired several million new customers, a significant number of whom are shopping both in our store and online. A large portion of these customers engaged with our eCommerce platform, which is exciting for us because it represents completely new business. We feel optimistic about retaining these customers based on our recent experiences over the past few weeks. We are enthusiastic about our loyalty program, which I believe is particularly relevant to those who are frequent shoppers, just as airline loyalty programs matter to regular travelers. Our loyalty program is proving to be effective as more people shop for groceries at home.

Okay. That's helpful. And if I can ask one follow-up unrelated question. Just wondering how you're thinking about fuel for the remainder of the year. Have fuel margins now returned to a more normal level versus history?

Yes, that's a great question, Kate. As we consider the situation, last year presented significant fluctuations. For instance, the second quarter was quite strong last year, which leads us to expect some modest challenges when comparing year-over-year. However, it's important to note that fuel does not significantly impact our business compared to others that rely heavily on fuel.

Our next question comes from the line of Edward Kelly with Wells Fargo.

Vivek and Bob, I want to revisit the gross margin. Could you discuss your promotional strategy in more detail? In Q1, the gross margin was quite strong until about the last 4 to 5 weeks, after which it seems to have declined year-over-year. There are concerns that this might indicate some underlying issues with your promotional strategy or competition as we approach the second quarter. However, you appear to be guiding for reasonably stable gross margins in Q2, aside from fuel. It’s possible that a 4-week period does not signify a trend. Could you explain that for us and reassure us about the gross margin outlook for the second quarter?

Yes, that's a good question. Let me explain. We recognized the summer season was crucial for our company, and it was essential to keep our shoppers from feeling the need to go elsewhere during the major holiday periods. In the fourth period, Memorial Day and Father's Day were closely timed, prompting us to engage in promotions, particularly for meat, which is significant for Memorial Day. During this time, we faced considerable inflation in meat prices, but we made a strategic decision to remain competitive on pricing to retain our shoppers and keep them loyal to our brand. This created a unique situation in the fourth period, as it's uncommon to promote while also dealing with inflation. This is why Bob commented on our outlook for the rest of the year.

Great. And then I wanted to follow up just to ask you on costs related to COVID. Can you just talk about what you're sort of expecting from here? Obviously, we've had a resurgence of the virus, and we've had some reopening issues in some states. How does that impact what the costs will be, particularly from a labor standpoint in terms of like what you paid to the people in Q1, what you think you're going to be doing in Q2?

Yes, we continue to make improvements due to efficiencies. When considering ongoing costs, we've already addressed many one-time expenses like plexiglass. The main ongoing costs are cleaning labor and cleaning chemicals. Additionally, if someone shows symptoms or has been in close contact, we put them in quarantine and make sure they are supported during that time. Despite these costs, we are focused on driving efficiencies. It's important to understand that as long as the virus is present, we will prioritize safety in our stores for both associates and customers. We will remain productive and adhere to CDC guidelines, ensuring safety comes first. I believe that as long as the virus remains a concern, we should also experience higher business volumes, and I see these two factors as connected.

Our next question comes from the line of Scott Mushkin with R5 Capital.

So the first one I wanted to ask you about was just omnichannel. I know, Vivek, you touched on this. I was wondering if you could talk us through the profitability and how you see that currently and how you expect it to trend. And then I had a follow-up.

Yes. So Scott, it is less profitable than the core business. Ultimately, we are doing the customers' work, and we're happy to do so. When considering profitability, it's important to look at it from two perspectives. From a customer perspective, we're excited that those who engage with us on eCommerce are increasing their involvement, which we can monitor through our various loyalty programs. Customers who were previously less engaged are becoming much more active now that eCommerce is available. This leads to additional business from a customer standpoint, which enhances profit without needing new assets beyond our stores, which support our eCommerce venture. Alternatively, when assessing profitability on a per-order basis for eCommerce, we are reaching a level of scale per store. This is beneficial because it allows us to optimize the entire store operation rather than just focusing on eCommerce alone. Hence, we are optimistic about the future of eCommerce and its potential to yield solid margins. Additionally, the micro fulfillment centers contribute to increased productivity within the stores.

I appreciate that. My follow-up question is about the uses of capital moving forward. You've mentioned the dividend of $0.40 and your success in M&A. I would like to hear your thoughts on future investments.

Yes. Let me provide a bit of context. We were planning to invest $1.6 billion, but we've adjusted that to $1.5 billion and added $100 million. In this environment, there are areas that need immediate investment, such as eCommerce and technology platforms, which we've decided to accelerate. It's the right timing, as many sectors in the technology supply community are not fully operational, and we have considerable work available. We're also prioritizing some merchandising areas that show promise, particularly in meals. Additionally, we constantly explore potential mergers and acquisitions, although it's not our main strategic focus. However, these opportunities could enhance our network and growth priorities. Scott, could you and Bob discuss other capital uses compared to dividend and debt?

Yes, Scott. So outside of reinvesting back into the business that Vivek just talked about, obviously, a piece of our total shareholder return is paying down or reducing some debt each year, and we're committed to that, as well as returning cash to shareholders via dividends. So those are kind of the 3 components.

Our next question comes from the line of Karen Short with Barclays.

I have a couple of housekeeping points to start with. Regarding the COVID expenses, I'm still a bit unclear. You mentioned $400 million in nonrecurring expenses out of a total of $615 million. Is the correct way to interpret this for Q2 that $215 million is recurring? Because it seems like you're suggesting a much lower figure for recurring expenses.

When we began the quarter, we focused heavily on safety, which is reflected in the efforts we made. Now, we are in a much more optimized situation and will continue to improve that figure. Additionally, this is based on a 16-week period instead of a 12-week one. Even if we consider a 12-week perspective, you'll notice significant optimization is happening while we also adhere to CDC guidelines.

Okay. But we should look at that $215 million on a 16-week basis and think about that on a 12-week basis going forward. Is that the right way to think about it?

But also recognize that, that in that 16-week, it was not the optimized number, right? And we continue to improve on that, Karen.

Okay. And then I just was wondering, I know in terms of your results, you added back the $53 million and the $36.9 million to both EPS and EBITDA. Maybe just why those 2 tranches specifically were the ones that you added back?

Yes, Karen, I'll take that. So I guess as we look at that is that we saw those as kind of discretionary categories that we had out there, the $53 million of charitable contributions that we made to the communities for hunger relief. And then when you think of the final reward payment of about $37 million, we saw that as being incremental to the base rate that we have been paying throughout the quarter. And that was kind of a one-time kind of payment, somewhat duplicative if you would have just had it lumped in with the rest.

Okay. That's helpful. Regarding eCommerce, I estimate that it accounts for about 9% of our food sales this quarter. Is that the right figure to consider? Additionally, could you discuss whether you have reinstated the pickup fee that was waived during the peak of the pandemic? What was the impact on gross margin of eliminating that fee?

We have not reintroduced a pickup fee or a service fee; the only fee we have is a delivery fee. Our goal at this time is to focus on growth and usage, and while this has had some impact on the overall margin, our priority is to drive scale. Once we achieve that scale, we can optimize other aspects. Therefore, I prefer to avoid optimizing any single order with a service fee. We don't disclose business size, but I can say that our eCommerce business, which has been almost tripling period-over-period, is growing significantly. We are excited about the direction the business is heading and have made substantial progress in its size.

Our next question comes from the line of Greg Badishkanian with Wolfe Research.

This is Spencer Hanus on for Greg. I guess if we could take a step back, can you talk about what you expect the new normal in food retail to look like? And then how are you thinking about 2021 and sort of cycling the strong performance you guys are on track for in 2020?

Yes. Looking ahead to 2021, analyzing ID sales will be crucial, particularly in terms of revenue and customer retention. That will be the key metric we need to focus on. From my viewpoint, the outcome largely hinges on people's ongoing concerns about personal safety and their readiness to go out for dining or attending events. As long as personal safety remains a priority, I believe we'll see sustained in-home consumption. There’s also the question of how work habits will evolve post-COVID. If more people continue to work from home, it could lead to breakfast or lunch being consumed at home instead of on the go, potentially increasing in-home consumption. We'll need to observe how this develops. Historically, out-of-home consumption tends to change only gradually, increasing slowly each year, even under the best conditions.

Our next question comes from the line of Paul Trussell with Deutsche Bank.

Yes. To start, you had very good relative performance in the first quarter. I would like to hear your thoughts on your relative performance so far this quarter and discuss in more detail the efforts and factors that will help you continue to gain market share for the rest of the year.

Yes, Paul, in this environment, it's important to consider relative performance. I'm pleased to share that we continue to gain market share, and we've observed positive trends in recent weeks. This momentum is largely due to two key advantages we offer. First, for those eating at home, we provide a high-quality fresh product selection. Additionally, for customers shopping less frequently, we enable them to complete their grocery needs in one visit. We also support this with our eCommerce capabilities and a loyalty program. Secondly, our loyalty program allows us to precisely target customers with relevant offerings. We're also enhancing programs like our meal options to provide customers with great choices, particularly for those who prefer not to cook. These initiatives, along with our ongoing investment in eCommerce, are essential for customer retention and growth.

And just a follow-up, you made some comments earlier about the pension plan. Maybe just give a little bit more detail on what we should keep in mind. And also in that, Bob, maybe touch on how we should be thinking about your position on leverage and debt overall.

Okay, great, Paul. To address the pension plan from which we announced a withdrawal, this was due to very unique circumstances, and we do not expect to withdraw from any other multi-employer plans. You may wonder why this decision was made. We believe it helps us avoid the risk of potential increases in contributions in the future. Actuaries conducted an analysis indicating that there could be significant increases in this specific plan going forward. We determined that withdrawing now is the best strategy to mitigate our future funding obligations. However, we do have a preferred approach regarding these multi-employer plans, which involves restructuring them by freezing the plans and then implementing either a 401(k) or a variable annuity plan.

Talk about leverage, too.

Yes. Finally, regarding leverage, our net leverage has decreased significantly by the end of the first quarter. We believe we can bring it down to the 2 times range once sales or EBITDA normalize, and we expect to achieve this within the next year or two.

Our next question comes from the line of Kelly Bania with BMO Capital.

It's Kelly Bania from BMO Capital. Vivek and Bob, I wanted to ask about incremental margins. Did you provide guidance on where you think that landed for the quarter on an ex-fuel basis and possibly into June? Additionally, how does digital impact that as you ramp up Drive Up and Go over the next few years?

Yes. I'll start, and then maybe Vivek can fill it in. There's obviously a lot of puts and takes in here. But I would say that one of the things that we disclosed is that we continue to execute very well on shrink. We've had some of our new technology implementations focus on ways that we can reduce our shrink, plus I think with the elevated sales, that also helped our turns, which also reduced that to some degree. But at the same time, we had some other items that probably grew our margin a little bit, but then we invested that as in things such as our growth in eComm and have balanced things out.

Yes, Kelly, I encourage you to consider all aspects of our margins as a business. We have positive influences on our margins, including our fresh portfolio and meals, as well as the Own Brands program, which contribute to margin growth. However, eCommerce, as I mentioned earlier, operates at lower margins compared to our core business, which impacts overall margins. It's important to also acknowledge our strong productivity program, which enhances the effectiveness and efficiency of our promotions and improves labor management in our stores and distribution centers, as well as in the goods we purchase. This productivity initiative acts as another positive factor and how we utilize it can vary. Overall, when considering our margins, you may notice fluctuations in specific areas, but they tend to balance out in the grand scheme of things.

Can you help us understand what to expect for July regarding the volatile inflation you mentioned in June, especially in relation to the promotional activities? Also, do you have any insights into the inflation or deflation outlook for the rest of the year?

Overall, there is a general trend of inflation associated with the increased demand we are experiencing, so it would be unexpected to see it shift in the opposite direction. However, the inflation levels we observed in meats, for instance, have decreased since July, especially after Memorial Day.

Our next question comes from the line of Simeon Gutman with Morgan Stanley.

This is Michael Kessler. It's actually Mike on for Simeon. I have a question about eCommerce. You've made several investments and accelerated your hiring in that area. How do you anticipate that normalizing as eCommerce demand stabilizes? Additionally, are there any changes to your strategy regarding in-house eCommerce? Do you aspire to have a fully in-house delivery operation given that you're currently at about 65%?

We are developing our in-house business and maintain a strong partnership with Instacart to provide consumers with choices. Even within our in-house business, customers can drive and pick up their orders, which we deliver using our own trucks. There are many options available, and we aim to keep offering customers choices. A significant part of our focus is on enhancing our in-house business. What was the second part of your question? Sorry, Mike, you had a...

Yes, it seems you have made several hires for the eCommerce team. Do you feel that this will become a regular part of your eCommerce offering to support demand, or do you anticipate it normalizing at all? What is your outlook on this?

Oh, the overall eCommerce demand. I don't have a definitive answer, but there is a higher level of demand, and some customers are deeply engaged. I believe this will become a normal part of their lives. The better the experience we provide, the more exciting it becomes for them, which is beneficial for our stores and eCommerce as they continue to engage with us. I can't predict exactly where it will land, but forecasts suggest it may decrease slightly as things normalize. However, it should remain at a higher level than before the crisis. Depending on various analyses, it might stabilize at twice the level it was prior to the crisis, but we will have to see how this unfolds. Our goal is to continue enhancing our offerings to ensure it's an excellent choice for our customers.

Our next question comes from the line of Paul Lejuez with Citi.

Can you maybe talk about the margins in fresh relative to the rest of the store? And where did you see larger improvements during the first quarter on a year-over-year basis, fresh versus the rest of the store? And then secondly, just coming back to the pension agreement with the withdrawal from the National Fund. You guys are paying, I think, $286 million. I'm curious what was the estimated liability tied to this specific multi-employer plan in your disclosures.

Yes. Fresh margins tend to be higher for us, especially since a significant portion of our fresh offerings is value-added items like cut fruit and custom cakes. Earlier in the quarter, we noticed a shift as customers purchased more from the center store alongside fresh items, but that balance has since stabilized. Fresh margins represent an attractive and growing section of our portfolio. Bob, could you address the pension question?

Yes. Paul, I think it's kind of a complicated analysis there. So I can't give you an exact dollar figure. As you know, the annual number we put in our SEC filing is as of a snapshot in time. And we have actuaries who are looking at this on an ongoing basis, who have estimated that had we done nothing, we would have seen some increases in this particular plan. And so after looking at where discount rates end up, there's lots of different things that affect those totals, as you probably know. So we'll have to wait and see what the underfunding balance is as we get closer to the end of the year for our overall share of that underfunding status anyway.

Okay. Thank you, everyone. We appreciate you participating in the call today. And Cody and I will be available over the balance of the week for follow-up calls and so forth. And thanks for your interest in Albertsons.

Thank you all.

Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.