Albertsons Companies, Inc. (ACI) Q2 2022 Earnings Call Transcript

Welcome to the Albertsons Companies Second Quarter 2021 Earnings Conference Call, and thank you for joining us. This call is being recorded. I will now turn the call over to Melissa Plaisance, GVP of Treasury and Investor Relations. Please proceed.

Good morning, and thank you for joining us for the Albertsons Companies' Second Quarter 2021 Earnings Conference Call. With me today from the company are Vivek Sankaran, our CEO; and Sharon McCollam, our new President and CFO. Today, Vivek will share insights into our second quarter results as well as review our progress against our strategic priorities. Sharon will then go into the financial details of our second quarter as well as our updated full year 2021 outlook before handing it back over to Vivek for some closing remarks. After the prepared remarks, we will conduct a Q&A session. I would like to remind you that management may make statements during this call that are or could 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 differ materially from those anticipated. Additional information concerning factors that could cause actual results to differ materially from those in our forward-looking statements are and will be contained from time to time in our SEC filings, including on Forms 10-Q, 10-K and 8-K. 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'll hand the call over to Vivek.

Thanks, Melissa. Good morning, everyone, and thanks for joining us today. Before we get started, I would like to introduce Sharon McCollam to any of you that do not know her in a new role as President and CFO at Albertsons Companies. She will lead all areas of finance, IT, real estate, strategy, corporate development and supply chain. As many of you know, Sharon officially joined us on September 7, and now has just over 6 weeks under her belt. She came out of retirement to join us on our transformation journey, and her prior experience at Best Buy and with the digital transformation of William Sonoma will help us as we move forward. We are very excited that she has joined our team, and I look forward to working with her to accelerate our transformation. We also want to congratulate Bob Diamond on his retirement and thank him for his 7 years of service with Albertsons and especially for his contributions to our successful IPO last year. Let me now turn to our second quarter results. I'm pleased to report that our results for the quarter exceeded our internal plans across all key metrics, increasing our confidence in the business going forward. Our ID sales increased 1.5% in Q2 and 15.3% on a 2-year stack basis. We continue to gain market share in food on a 1- and 2-year basis. And in MULO, we are up on a 2-year basis and down only slightly on a 1-year basis. In addition, we achieved adjusted EBITDA of $965 million and adjusted EPS of $0.64 per share ahead of our expectations. Again, this quarter, against a backdrop of digital sales growth exceeding 200% in every quarter of 2020, the benefits of our digital and omnichannel investments continue to resonate with our customers. In the quarter, digital sales increased 5% year-over-year and increased 248% on a 2-year stack basis. Our Drive Up & Go and home delivery capabilities, reaching 95% of our customers increased omnichannel households by over 4x versus Q2 2019 and retention has been strong. Omnichannel household growth is a key initiative as these customers spend 3x more than any in-store-only shopper. We also continued to drive year-over-year growth in identified households, another key initiative that is foundational to better understanding our customers through data analytics and allowing us to improve our offerings to drive recurring and incremental spend. In our just for U loyalty program, ongoing benefit enhancements continue to accelerate membership growth, which increased 17% year-over-year to 27.5 million members. Within the program, the number of actively engaged members increased by almost 9%. Actively engaged members are those that are redeeming rewards such as fuel or grocery rewards in the current quarter. In addition, we had a 93% retention rate with actively engaged members in Q2. Remember that actively engaged members spend approximately 4x more with us. We also saw better-than-expected in-store results as traffic in our stores continues to increase versus Q2 2020. We believe the increased traffic is being driven by our ongoing efforts to protect the health and safety of our employees, customers and communities and the higher vaccination rates that are helping customers become more comfortable in returning to stores. These results reflect the momentum we are seeing through the execution of our transformation strategy across all channels. The consumer backdrop remains strong throughout the quarter. I will now take a few minutes to walk through the pillars of our transformation strategy that helped drive these results and provide you with an update on our progress. These pillars include in-store excellence, accelerating our digital and omnichannel capabilities, increasing productivity and strengthening our talent and culture. In-store excellence has been elevated by providing the right assortment in each local market using digital tools to enhance replenishment and in-stock conditions, encouraging friendly customer service and enhancing speed and ease of checkout through frictionless and contactless payments. I will briefly touch on recent progress on 2 elements of our assortment, fresh and Own Brands. In fresh, our efforts to differentiate our offerings have generated elevated demand with fresh growth outpacing center store by approximately 250 basis points year-over-year. Sales in each of our fresh categories remain ahead of pre-pandemic levels as customers continue to consume more meals at home. In Own Brands, the introduction of new products as well as the rollout of Own Brands into Albertsons legacy divisions has generated strong growth. Our Q2 sales penetration was 25.2%, up approximately 60 basis points from Q2 '20. During the quarter, we launched 85 new products, including ready-to-eat meals, refrigerated Signature Reserve pastas and several O Organics coffee items. Year-to-date, we have launched over 400 new Own Brands items and are on track to reach our goal of launching over 800 items this fiscal year. Finally, we continue to invest in stores. Through the first half of the year, we opened 7 new stores and completed 76 upgrade and remodel projects. Our next priority is the acceleration of our digital and omnichannel capabilities. Digital transformation is an imperative in our growth strategy, as we aim to provide an array of convenient shopping experiences for our customers. To this end, we have expanded our Drive Up & Go locations to over 1,900 and expect to reach approximately 2,000 locations by year-end. Underlying the rollout of our digital and omnichannel capabilities is our focus on delivering a superior customer experience as well as improving profitability over time. For example, in Drive Up & Go, our average wait time for pickup is now down to 3 minutes. In delivery, we continue to speed up delivery times while reducing delivery cost per order by expanding our third-party delivery store network, and we added DoorDash 1-hour delivery to all divisions with a catalog of 40,000-plus products. And we also announced DoubleDash allowing customers to combine delivery of a restaurant meal and a grocery delivery in 1 trip. In micro fulfillment centers, we are improving our productivity in our 3 existing MFCs, and we have plans for an additional 4 MFCs before the end of our fiscal year, bringing the total to 7. This is 2 less than previously estimated as the launch of 2 locations has moved into fiscal year '22, primarily as a result of delays in construction. In loyalty, our integrated loyalty and e-commerce app is now fully rolled out and offers a connected customer experience with redesigned rewards and other new features. To partially offset all of these investments and cost inflation, our third priority is driving productivity. During the quarter, we continued to eliminate waste and improve efficiencies to enhance promotional effectiveness, reductions in indirect spend, labor efficiencies and ongoing efforts to reduce shrink. We continue to expect to achieve the targeted $1.5 billion in annual gross savings by the end of fiscal year 2022. Our fourth priority is strengthening our talent and culture and supporting the communities we serve. We continue to add talent throughout the company at both the corporate and division level, including the recent appointment of Sharon, our outreach through job fairs for retail and distribution employees and the training we have put in place to assist in the success of our new employees and enhance retention. Our pharmacy team continues to serve our communities with an array of services, including the COVID and flu vaccines. To date, the pharmacy team has administered over 7.5 million COVID vaccine doses. In support of our associates that were impacted and the communities we serve, the Albertsons Companies donated $500,000 to help provide food to those impacted by Hurricane Ida and the California wildfires. We also continue to take actions related to ESG and sustainability. We recently published our fiscal 2020 ESG report, which is available on our company website. As the next step from our recently refreshed materiality assessment, we will soon release a comprehensive set of goals in areas, including climate action, diversity, equity and inclusion, waste reduction and circularity, and community stewardship. And now I will turn to Sharon to provide remarks and cover the details of our second quarter financial results and outlook.

Thank you, Vivek, and hello, everyone. I'm thrilled to be here today and couldn't be more excited to have joined this team at such a transformative time in the company's history. What I have found to be the most impressive since joining is the disciplined approach that the company is taking to leveraging the favorable backdrop that the industry is seeing today while at the same time, remaining deeply focused on the strategic priorities that Vivek just covered and are foundational to advancing the transformation's longer term. Consistent with these priorities, where I am currently spending the majority of my time is in the acceleration of our digital and technology initiatives, the strengthening of our omnichannel capabilities and the advancement of our productivity agenda, including identifying opportunities to further rationalize our cost structure, particularly in the technological enablement of our supply chains and our stores. I look forward to discussing all of these topics further, both today and in our meetings to come. But now we'll turn to the details of our second quarter results and provide an update on our fiscal '21 outlook. As Vivek said earlier, we were extremely pleased with our sales trends as we delivered Q2 2021 identical sales growth of 1.5% on top of 13.8% growth in Q2 2020 for a 2-year stack of 15.3%. Total sales in Q2 2021 were $16.5 billion compared to $15.8 billion last year and $14.2 billion in Q2 2019. Gross profit margin was 28.6% in Q2 2021 compared to 29% in Q2 2020 and 27.8% in Q2 2019. Excluding the impact of fuel, however, our gross profit margin was flat compared to Q2 2020 as higher product, supply chain and advertising costs were offset by productivity initiatives, favorable product mix and pharmacy margins related to COVID-19 vaccines. Compared to Q2 2019, gross margin increased 85 basis points, primarily driven by improvements in our productivity, shrink expense, sales leverage and improved pharmacy margins related to COVID-19 vaccines, partially offset by investments related to our growth in digital sales. Selling and administrative expenses as a percentage of sales were 25.6% during the second quarter of fiscal '21 compared to 25.6% in Q2 2020 and 26.8% in Q2 2019. Excluding the impact of fuel, selling and administrative expenses increased 55 basis points year-over-year. This increase was primarily driven by higher employee costs, appreciations and expenses related to the acceleration of our digital and omnichannel capabilities and other strategic priorities. These increases were partially offset by lower COVID-19-related expenses. As it relates to the year-over-year increase in employee costs, labor related to the reopening of certain fresh departments such as deli, bakery and prepared foods, market-driven wage rate increases and higher equity-based compensation expense contributed to this increase. On a 2-year basis, our selling and administrative expenses were down 120 basis points versus Q2 2019. This decrease was driven by strong sales leverage, partially offset by higher employee costs and expenses related to investments in our omnichannel and digital capabilities and other strategic priorities. As a result of opportunistic refinancing transactions as well as continued debt reduction Q2 2021 interest expense decreased by $20 million to $109 million versus Q2 2020. Adjusted EBITDA was $965 million in the second quarter of 2021 compared to $948 million in Q2 2020. This increase in adjusted EBITDA was primarily due to increased sales, partially offset by higher selling and administrative costs. Adjusted net income in Q2 '21 was $370 million or $0.64 per fully diluted share compared to $356 million or $0.60 per fully diluted share in the second quarter of fiscal 2020. I would now like to discuss free cash flow and capital allocation. During the second quarter and year-to-date, we have generated significant free cash flow driven by better-than-expected operating results as well as lower working capital. From an investment perspective, capital expenditures year-to-date were approximately $823 million as we continue to invest in our digital and technology platforms, completed 76 remodels and opened 7 stores. For the year, we continue to expect capital spending in the range of approximately $1.9 billion to $2 billion. Regarding debt reduction, subsequent to the end of the quarter, we provided notice of redemption of the remaining $200 million of Albertsons 5.75% unsecured notes, due in 2025, which will save us $11.5 million per annum in interest expense going forward. And finally, in regards to returning cash to shareholders, we announced today a 20% increase in our quarterly dividend from $0.10 to $0.12 per share based on our confidence in future cash flow generation and our strong operating performance. I will now turn to our updated outlook for fiscal year 2021. Given the outperformance in Q2 and recent trends, we have updated and raised our guidance for fiscal year 2021. We now expect identical sales in fiscal 2021 in the range of negative 2.5% to 3.5% compared to prior guidance of negative 5% to 6%, representing an updated 2-year stacked ID range of 13.4% to 14.4% compared to prior guidance of 10.9% to 11.9%. We expect adjusted EPS in the range of $2.50 to $2.60 per share, up $0.30 from our previous guidance range. We expect adjusted EBITDA in the range of $3.95 billion to $4.05 billion, up $250 million from our previous guidance range. We also expect our tax rate to be in the range of 23% to 24% compared to 25% previously. I will now turn the call back over to Vivek for some closing remarks.

Thank you, Sharon. In summary, I would like to reinforce a few messages. Our omnichannel strategy is working with our customers. We're adding customers to our franchise. They're spending more with us and engaging in more ways with us. We continue to gain market share in dollars and units, and our trends improved with each successive period in the quarter, and especially around holidays. Our digital initiatives continue to drive engagement and growth. We remain focused on elevating service, quality and speed. Our productivity initiatives are delivering, strengthening the middle of our P&L. We're also navigating the uncertainties of the times: inflation, product supply, labor challenges to name a few, with agility and creativity. Our strong performance year-to-date and continuing positive trends give us the confidence to raise our full year 2021 outlook for the ID sales, adjusted EBITDA and EPS. While we celebrate progress, we remind ourselves that we are still in the early innings of our transformation with significantly more potential to capture. Finally, none of this would be possible without the efforts of our 285,000 associates, who take care of our customers and the communities we serve day in and day out. I want to thank each and every one of them for their contributions to our ongoing success. We will now take your questions.

Our first question is from Simeon Gutman with Morgan Stanley.

My first question is on inflation, I guess just straight housekeeping. So can you talk about product cost inflation or retail price inflation to the customer? Where is it, and how is it trending sequentially? And trying to figure out what the benefit could have been during the quarter.

Thank you, Simeon. I'm going to turn that over to Vivek.

Yes, Simeon. The consumer price index inflation was approximately 2% in the quarter, while our cost inflation was around 3%. As I mentioned earlier, we anticipate that inflation will increase as the year progresses, but we still expect it to fall within the 3% to 5% range, which we consider quite manageable. You can see the effects of this in the quarter we just completed. We are confident in our ability to manage this, particularly given our strong customer base and our focus on productivity, allowing us to handle it effectively in our profit and loss statement.

Got it. That's helpful. My next question is for Sharon about the phrase "table stakes." I believe it was frequently mentioned at Best Buy and related to pricing and ensuring prices are aligned with those of major competitors. We've previously discussed this in relation to Albertsons, but I'm interested in your perspective as a customer of Albertsons and of the industry overall. What are your thoughts on where pricing should be? Where do you think we should operate? Do you have an opinion on where it would make sense and where it wouldn't to create a level playing field against other competitors?

Yes, Simeon, thank you for that. I think I'll let Vivek talk first about where we have been with pricing, and then I will follow up with my view as it relates to Albertsons in that comparison you spoke to. So Vivek, why don't you take the first part, and I'll take the second?

Yes. Simeon, I just want to be sure that I reinforce our approach to pricing, right? The first thing we look at is, are we gaining market share in dollars and units. Because to me, gaining market share units gives us a good indication that the value we are providing our customer across the mix of our portfolio, the fresh portfolio we have, our own brand portfolio and the branded portfolio resumes, and so that's the first thing. The second principle on pricing, I want to reinforce again is that we take an incredibly surgical approach to it. So every single quarter, you should know that we are investing in pricing. And we invested by price area in specific markets. And again, it's with the outcome that we care about, which is growth and market share gains in dollars and units. So please keep that philosophy. And then, Sharon, you might want to add to that?

Yes. So Simeon, I would say that interestingly enough, there are great similarities to what we were doing in my previous life. And I would say, overall, the company has a very surgical approach to pricing, and that is actually not new. We are definitely building capabilities in this area. I would say that they have moved their capabilities in this area materially over the last 12 months. And when I look at that, Lightning Rod Products, we might call them something different in the grocery space. But there are products that we offer in our store that, mentally, customers are consistently benchmarking. And to the extent that we see that, of course, we are going to be reacting because that is what is good for our customer. So it is different in every category.We have a much more expansive number of products that we offer. And I would say that you will continue to see us invest in surgical ways into pricing over time where it makes sense to do it.

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

I want to start with a follow-up and then ask a bigger picture question. On the inflation front, you mentioned last quarter that a rate of 3% to 4% is favorable for the business, and today you indicated a range of 3% to 5%. However, the Consumer Price Index is significantly higher, closer to the upper end of that range. I'm curious if you could elaborate on your strategic approach to managing this situation, what your competitors are doing, and how we should consider gross margins in the latter part of the year in this context.

Ed, I'll let Vivek take that.

Let me begin by addressing the gross margin question, as that is what we aim to manage effectively. We are focused on top line growth while ensuring it is accompanied by a healthy gross margin. Our company prioritizes the importance of gross margin tailwinds, which arise from better mix management, improved shrink management, smarter promotions, and benefits from supply chain and cost of goods. The first three have been ongoing programs for us, and we anticipate seeing more advantages from the latter two as we move into the second half of the year. Although we cannot predict future inflation trends, we are prepared to manage what is within our control. Regarding the CPI projections, they have risen to 3.5% for the year, and I expect a slight increase as we progress through this year and perhaps into the next. However, I believe we can manage this effectively, especially considering the current consumer environment. Additionally, a significant portion of inflation relates to proteins, which tends to fluctuate cyclically, so I expect some relief there. We have butchers in our stores who can help manage protein inflation, providing consumers with various options to fit their budgets.

Great. That's helpful. And then I just wanted to follow up related to the broader category of investments. So you're ramping investment in the business and in digital transformation. I'm curious, is this changing at all with Sharon joining? What I mean by that is, either in urgency or the size of the spend, kind of curious, Sharon, is that how you think about like the position of the company's stores or technology or supply chain, and how that could impact areas like CapEx going forward? We have seen companies sort of ramp CapEx into transformation. So I'm kind of curious as to how that may apply here.

Ed, they have implemented a very disciplined approach to their current capital investments. If we could expedite those investments, we certainly would. In my view, these investments yield gradual and incremental returns over time. The early phases of these transformations involve laying down the necessary foundations. The company is currently focused on replacing outdated systems and establishing platforms that allow for quick development. This is a common narrative among large retailers dealing with legacy systems. They have been addressing this for the past 18 to 24 months since Vivek's arrival. We are progressing in analytics related to these investments, and the direction for many projects is clear; now it's about execution. Our goal remains to speed up the rollout. A crucial step was transitioning to the cloud, which is a significant task, but the company is making substantial progress. We still have a journey ahead, yet we are advancing well in that area to enable faster movement in the future. Regarding your question, I believe the discipline and strategic focus surrounding this have been outstanding. There is always potential for acceleration, which I've mentioned in my prepared remarks and am keen on pursuing, both in technology and supply chain. As we look ahead and prepare our guidance for 2022, I've received this question repeatedly from many of you during our private discussions before today's call, and I will share further insights as we finalize our capital spending expectations and budget for 2022. They have adjusted their plans upward, so I am confident in our ability to follow through on the initiatives originally outlined.

Our next question is from the line of John Heinbockel with Guggenheim.

I wanted to start with omnichannel households. They are up four times, but I imagine that's still less than five percent of your total households. Is that correct? Looking ahead to the next two years, do you think you can double the number of omnichannel households to two times? What do you believe drives that growth? Is it mostly your marketing outreach that contributes to this growth, along with your organic capabilities?

I'm going to let Vivek take that.

John, we are currently behind our competitors in terms of our overall omnichannel mix, which we have acknowledged before, and we are actively working on improving it. While we are encouraged by the growth rate, we are also pleased with the quality and speed of our services. In response to your question, I believe we can maintain or even accelerate our growth rate. One key factor is ensuring we reach the entire market. For example, when we launched 2-hour delivery in our markets, we experienced additional growth because customers appreciate the speed. Our service coverage is nearly 60% of the market, and we plan to expand it further. Our goal is to continually offer more options for Drive Up & Go, which provides a 3-minute service when customers arrive at the parking lot. We want to enhance both delivery speed and options, and these strategies are helping us increase our omnichannel customer base. As you mentioned, we have not initiated a large marketing campaign yet; instead, we see many customers visiting our stores, and we convert them at that moment as they recognize the availability and engage with our services.

And John, I would add to that, that over time, this past year, we have been adding capabilities. The app that customers were buying online with has been upgraded materially. Again, all of these initiatives that we're working on in the e-commerce side of the business are gradual and incremental. You implement them, customers learn to use them. They see how much more efficient they are. They have a better experience, and then they use it more. So we've really soft launched the majority of these. We're also making similar progress in the loyalty area. We talked in Vivek's prepared comments about the fact that we are increasing our number of loyalty member. And as we enhance the benefits and enhance the efficiency and the experience the customer has in redeeming loyalty, et cetera, that will also be greatly helpful to advancing this.

As a follow-up, while I'm not sure if we will see a doubling of omnichannel customers, the demand is definitely expected to rise significantly. Could you talk about this? I understand the MFCs are related to this but it goes beyond that. How can we reduce the cost of picking items? Are you able to decrease the cost of picking for individual pieces compared to full orders? Is it possible to lower that cost by 25%, 30%, or even more?

Vivek?

Yes, John, reducing picking costs involves two steps. First, improving efficiency in stores through technology is essential. In some locations, we've established a ware room, allowing us to expedite the preparation of our fastest-moving items in a compact area. However, we will eventually reach physical limits. Therefore, our long-term approach will not rely solely on store picking. In certain areas, that has been necessary, but this is where the Micro Fulfillment Centers (MFC) come into play. I can share that our MFCs are approaching a cost-per-pick that is comparable to the labor cost associated with fulfilling an order in a store due to the productivity they offer. Eventually, customers will likely feel indifferent about whether their orders are picked by an automated system or by someone shopping in-store. That realization will significantly benefit us. The rollout of MFCs will take some time, as we've faced delays due to longer permitting and construction timelines in the current environment.

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

So just a question regarding guidance. So your comps guide has obviously improved. But when we look at the second half EBITDA dollars, they're kind of more or less in line with consensus. So I'm kind of wondering if you could give a little color there, meaning, you can obviously raise top line, but you didn't really change the second half EBITDA dollars. And then tying into that, you did say sales accelerated throughout the quarter, but the full year ID guide implies the deceleration in the 1- and 2-year ID. So some color on that? And then I had a bigger picture question.

Karen, on the bigger view for the back half, I'll let Vivek take that, and then I'll take more of the detailed financial side of the question.

Karen, I consider that we have around 2.5 points of additional ID growth, which translates to approximately $1.65 billion. With a 15% flow-through, this would add about $250 million for the year. This is how I perceive it, and keep in mind that the latter half of the year will rely significantly on our increased productivity. This is the model we've used for our full-year projections.

And then, Karen, looking at the second half of the year, if you do the math, it appears to be around flat in the midpoint. This will flow through, as Vivek mentioned. As we consider the second half, like many of you, I have read several reports. We are carefully evaluating the dynamics that will influence the second half, particularly regarding the stimulus changes that are coming, some of which have already occurred. I would note that there have been new developments. We transitioned from snap increases in the first part of the year to monthly payouts for childcare credits. From what we understand, the industry seems to be directing a significant amount of this towards grocery and everyday necessities. Therefore, we are mindful of the second half and the comparisons we will face.

That's helpful. Sharon, you mentioned that there are great similarities at Albertsons to some of your past experiences. You also said you are taking a very precise approach to pricing and have made significant progress in the last year. Can you provide an update on your current status regarding this and what we can expect moving forward?

As it relates to my comments on the pricing, the company is building a very strong pricing team. Considerable resources have been added to that. This is one of those investments that we continue to talk about on our strategic priorities. So again, this is all about data, Karen. And as you think about the time, the benefits of that are gradual and incremental. I hate to keep saying that, but it is true for just about every one of the underlying projects and the strategic priorities that Albertsons has. So as we think about pricing, again, what I said is the company has always been known for its deals. While the price that you see, customers are getting special pricing through loyalty. They are getting special pricing through deals. And actually, we have data that would tell you that people come to us for our deals. So it is interesting to see how well the company is managing that at this point. Now do I think we need to go further? I do. And there's no one here that doesn't think that you have to keep safe and keep pace with what others are doing in the industry. So I feel like we will continue to see benefit in pricing, and I think we will be looking at the guests, like we always have been looking at them and where we believe it is important, and it will create more stickiness with our customers. We will be adjusting that pricing.

Yes, Karen, I would like to add to that. We have discussed our national promotion tools that we are implementing. Although we are conducting fewer promotions, we are being more strategic with them by identifying which promotions effectively drive traffic and margins. Additionally, many of our promotions are transitioning to digital formats. From a promotional perspective, we have advanced significantly compared to a few years ago, leveraging data and technology more effectively. This will remain our guiding principle. Furthermore, as Sharon mentioned, we are making surgical adjustments to our everyday pricing across different market areas, with some segments of our franchise experiencing these adjustments on a regular basis. This ongoing combination is enhancing our capabilities, as we have the necessary data and tools to execute it effectively.

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

Sharon, you mentioned that one of your current priorities is the productivity agenda. We've observed that margins in the grocery sector have been declining for decades. I'm interested to know if you believe that focusing on productivity might ultimately lead to a reversal in this trend, allowing margins to increase over time. Or do you think the goal is simply to acquire additional tools to better manage the existing headwinds? I'm trying to understand your perspective on this, especially since there's a general belief that margins will keep declining indefinitely in this industry. How do you view the situation?

So Vivek had made some comments about this in the last conference call. I'll let Vivek take this first, and then I'll give you my view.

Yes, Ken. Our goal is to grow this business not just by increasing gross margins but by ensuring there is room for reinvestment in growth. We want to see positive movement in gross margins while focusing on productivity within Albertsons. We have plenty of opportunity to improve our performance because, although we completed the integration process in the past, we have yet to fully harness the benefits of operating at scale. Many of our current initiatives aim to enhance our cost structure through scale advantages. We also haven't adopted all the technologies that others in the industry have, which would boost our productivity. Therefore, our improvements are coming from strategies that, while common in the sector, are new to us, leading to better performance in our financials. It's important to consider this philosophy: we aim to manage gross margins through supportive moves and investments that enhance customer engagement and, in turn, drive revenue. By combining this with technology and scale-driven initiatives to improve our operations, we believe we can sustain growth while maintaining healthy margins.

I would like to add to what Vivek mentioned, emphasizing that there are additional strategies we believe will help mitigate some of the cost pressures. First, I want to state clearly that I firmly believe there will be ongoing cost pressures affecting all sectors of retail, whether it's grocery, consumer electronics, or home furnishings. These pressures are inevitable. Additionally, there are extra costs associated with expanding our online operations, which we're all aware of. To address this, growth must serve as the cornerstone of our strategy. We are making substantial progress in increasing our market share, which remains a primary focus for our organization. As Vivek noted, over the past two years, we've seen growth in both dollar value and unit sales. Another advantage we have, which other retailers in our industry have already leveraged, is the increased adoption of private label brands. Looking back to our IPO, we noted the potential for greater penetration of our own brands. Currently, we have a 25.2% penetration rate, but there is still considerable room for growth here, and we will continue to take advantage of that potential. Furthermore, we see another opportunity to alleviate some of these pressures through an increased focus on fresh produce. We are growing at a faster pace in the fresh category than in our core offerings, which is providing us with a margin benefit. Our goal is to enhance our customers' fresh experience, which not only fulfills their needs but also boosts our margins. These are just a few points I wanted to add to what Vivek discussed regarding the tailwinds that will help counterbalance the inevitable cost pressures we all recognize are on the horizon.

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

Curious about the categories where you're seeing the highest levels of inflation. And Vivek, I think, maybe mentioned protein earlier. And how you've chosen to passthrough or not passthrough those higher prices to the customer? What has been the customer reaction in terms of elasticity of demand? And how does that compare to what you had expected?

Vivek?

Yes, Paul, we are aware of that. Let me begin by saying we haven't observed any significant changes in customer behavior. This indicates the strength of our customers, who are still consuming a lot at home and enjoying activities like cooking. We see these trends persisting. In fact, our research with shoppers shows no major shifts in their intentions in the coming weeks and months. Furthermore, it's important to note that we continuously optimize for basket value. While we are aware of rising protein inflation, we focus on two main aspects. First, we aim to find the best way to manage inflation to keep baskets affordable while maintaining our desired gross margins. Second, we handle this on a local level, leveraging our divisions that understand their specific market dynamics and competitive landscape. By managing these two factors closely, we can effectively pass through costs while preserving sales and gross margin. Does that clarify things?

Can you provide details on the year-over-year changes in SG&A and which factors were significant? I'm also interested in the status of the productivity initiatives aimed at achieving $1.5 billion by 2022 and how that is progressing compared to your plans.

Yes, I’ll take that question, Paul. Regarding SG&A and the increases, there were a few factors at play during the quarter that we mentioned in the press release. First, we reopened many of our fresh departments, such as deli, bakery, and prepared foods, which impacted the mix within our stores and led to increased labor hours. This was one of the main contributors to the increases. Secondly, we noticed rising market wage rates. Although we have union contracts for the majority of our workforce, these contracts still include annual wage increases. Additionally, we are experiencing wage pressure across the company, similar to what other retailers are facing, spanning all positions from store employees to corporate staff. We also saw an increase in stock-based compensation this quarter, linked to a credit from last year. The magnitude of these items is detailed in the press release.

Got it. And just that $1.5 billion?

Yes. We have not disclosed our progress against that. However, we are progressing as you would expect them to progress. And we continue to be committed to delivering on that promise.

Our next question comes from the line of Rupesh Parikh with Oppenheimer.

I wanted to follow up on the gross margin line. I was wondering if you could provide more color on the puts and takes you see on the balance of the year. And I think last quarter, you guys indicated you could be close to flat with the prior year. So I just wanted to get a sense of what your updated expectation is for the full year.

Vivek, do you want to talk about the back half gross margins?

Yes, Rupesh, we view several initiatives as beneficial for gross margins in the latter half of the year. These include factors we've previously mentioned such as product mix, shrinkage, promotions, and increased penetration of our own brand. Additionally, we expect to see positive impacts from supply chain improvements and reductions in the cost of goods, both of which will utilize our scale effectively. We remain optimistic about the overall factors that will support our gross margins. We'll strategically apply these advantages to foster growth and make necessary investments. Therefore, there shouldn't be any significant changes to our outlook on gross margins, Rupesh, if that clarifies things.

And we don't guide by gross margin. We only guide adjusted EBITDA, just as a reminder.

Okay. Great. And then maybe just one follow-up. Just on the supply chain. Just curious where you guys are on the stock front right now?

Yes. So I'll let Vivek speak to that. He was just in a meeting on it.

Yes. It's surprising that we're still discussing the status of our stock levels. So let's talk about our management approach. We offer customers alternatives; if you visit, you may not find exactly what you want when you want it, but there will be options available. If you come another day, you'll likely find what you're looking for. This all comes down to execution—local execution, ensuring our stores are well-stocked, and making sure that items are available on the sales floor rather than in the backroom. I'm proud of our teams for striving to be slightly better than others in terms of what's available on the shelves.

And I'll just add to that, Rupesh, for the next 3 months, fourth quarter holiday, actions that you've seen that are being taken by many of the largest retailers, we have been all over this and have a list of probably 25 things that we are approaching differently this year than we have in the past in order to ensure that we offer our customers the best in stocks we can.

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

So I wanted to talk about something a little bit more short term, which Sharon, I think you always had the reputation of being pretty conservative on the guidance. Is that the philosophy you're going to bring to Albertsons? Should we assume kind of a continuation of that?

Yes. There would be no question that I believe that, especially in the environment that we're operating in today that, that would be appropriate. So I couldn't affirm more strongly that I believe that is a good strategy.

Okay. Great. And then I know it's a little early to think about '22, but we get a lot of questions on this. And I guess, as you think about it, is it going to be possible to grow earnings next year to a degree? Or is that something that's going to be just really hard given the cost pressures on the business, the union contracts and labor and other things going on.

Yes. Scott, we will not be talking about 2022 until we get closer to the end of this year. There is so much learning that needs to happen with the changes in the consumer and what's post-COVID. There is never going to be a post-COVID, but the next chapter of where this goes. So when we get into the fourth quarter, and we look at next year, we'll try to give you a lot more color on that. But I think this needs to unfold before we start talking about 2022.

Yes. The only thing I'd add, Scott, is that remember, cost on things are a controllable item. We can work that with productivity initiatives. I think the biggest unknown as Sharon points out is, where is the consumer? How is consumer behavior going to change? And as we've all seen, I don't know if we predicted what's happening now. So...

Perfect. Can I ask one last question about whether there will be a change in the philosophy regarding capital efficiency and ROIC, especially considering that we are entering a period of further investment?

Yes. Scott, I would say this. I think it is a philosophy of discipline, but it is a philosophy of 'do it as fast as you can.' Time is not your friend. And philosophically, that is very much how we will be moving forward. We have a lot of opportunity. Vivek mentioned earlier, we have brought together a lot of companies. And they've done a good job of getting them solidified onto a similar platform, a common platform. But as we move forward, we still have opportunities in better buying. We just consolidated some of that. So we have significant opportunities. But by the way, other retailers don't have in their tailwinds. So I think, yes, the diligence around those investments will be high, and we will continue to accelerate to the extent we can over the next 12 to 24 months.

Your next question will come in from line of Robbie Ohmes with Bank of America.

Vivek and Sharon, I have one question. The guidance seems to suggest lower ID sales in the second half. Can you provide more insight into the assumptions around traffic and transaction sizes? Also, what are you observing regarding customer behavior? Are trips remaining consolidated, or is that trend declining? I'm curious about what aspects of customer behavior are consistent versus those that are changing, particularly regarding transaction sizes compared to store visits.

Yes, Robbie, back in Q1, we noted a significant increase in in-store traffic. While digital traffic was higher, its growth rate was declining. Interestingly, over the past few periods, store traffic appears to have stabilized, showing healthy and consistent activity. Additionally, we've observed a resurgence in digital traffic. About three weeks into this quarter, we started noticing an increase in digital engagement coinciding with the launch of our new app and enhanced services. I anticipate that the stability in store traffic will continue as customers adapt to a new pattern. I'm not sure how Thanksgiving will impact this, but I hope this provides clarity on our outlook for the rest of the year.

Our next question is from the line of Michael Montani with Evercore ISI.

Just wanted to follow up, if I could, quickly Vivek and Sharon, on the competitive environment, and what you're seeing in terms of promotions throughout the quarter and then obviously to start this quarter and into year-end.

Yes. Vivek?

Yes, it’s been stable, Mike. We’re not observing any fundamental shifts. It seems that all the major players are increasingly utilizing digital promotions and adopting smarter strategies similar to ours. Additionally, we are facing supply challenges. Overall, there haven’t been any significant changes in the promotional landscape.

Our next question comes from the line of Chuck Cerankosky with Northcoast Research.

Great quarter. Could you provide some insights on how your prepared foods business developed during the quarter, particularly regarding the reopening of the older sections of fresh and your progress in Meal Solutions?

Yes. Chuck, we were very cautious as we brought those back in, and we saw different take rates in different markets on salad bars, hot bars and such. And the general sense I get now is that customers are back on the fresh side of the store, on the self-service side of the store, and certainly, you could see that in most markets. And then on the meals program, we are excited about what we're doing. It's a very difficult thing to pull off to develop the meals in store, manage and keep the shrink down, yet keep the offer really fresh. It's a difficult thing to do, and I'm delighted that the team seems to have cracked the code on that, and we've launched it in about 4 markets already. Our plan is to continue to drive that through. Chuck, the crazy thing is that the biggest challenge there is equipment. Because like everything else that too is constrained and how quickly you can get it.

Okay. Thank you, everyone. I'm sorry we weren't able to get to everyone today, but we ran a little bit over. We appreciate your interest. Cody and I will be available for the balance of the day for questions, and Sharon is going to join us on the follow-up call. So thank you very much, and we'll talk with you soon. Bye-bye.

Thank you.

Thank you, all.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.