Earnings Call Transcript - KR Q4 2024

Operator, Operator

Good morning, and welcome to The Kroger Co. Fourth Quarter and Full Year 2024 Earnings Conference Call. Please press star followed by one on your telephone keypad. If you'd like to remove it, you may press star followed by two. Please note this event is being recorded. I'd now like to turn the conference over to Rob Quast, Vice President, Investor Relations. Go ahead.

Rob Quast, Vice President, Investor Relations

Good morning. Thank you for joining us for The Kroger Co.'s fourth quarter and full year 2024 earnings call. I am joined today by The Kroger Co.'s chairman and chief executive officer, Rodney McMullen, and interim chief financial officer, Todd Foley. Before we begin, I want to remind you that today's discussions will include forward-looking statements. We want to caution you that such statements are predictions and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. The Kroger Co. assumes no obligation to update that information. After our prepared remarks, we look forward to taking your questions. In order to cover a broad range of topics from as many of you as we can, we ask that you please limit yourself to one question. I will now turn the call over to Rodney.

Rodney McMullen, Chairman and Interim CEO

Rob. Good morning, everybody. Thank you for joining our call today. Before we begin, I'd like to just share a few comments. The Kroger Co. has always been committed to its enduring values. This has been true for The Kroger Co. since my first job in the summer of 1974 working in the Fort Mitchell, Kentucky store. In many ways, I grew up at The Kroger Co., working summers in college, and then full time for ten years. Following business school, I've held various roles in stores and in manufacturing, human resources, marketing, strategy, and sales. The Kroger Co. has really been a special place throughout my career in retail. And I'm just as proud to be a Kroger associate today as I was then. I will be serving as the interim CEO as we search for a leader for our next phase of growth. The board has formed a search committee and has engaged a nationally recognized search firm. We look forward to updating you as we have more information. As a board member, I know The Kroger Co.'s strong leadership team well, and they support the unique culture that powers the company's long-term success. We care for people, and we love food. These are the most important elements of successful grocery retail. Today, The Kroger Co. operates from a position of strength. We delivered strong financial results in 2024 and have positive momentum in our business. We're confident in our plans for 2025, and our commitment to deliver total shareholder return of 8% to 11% over time. I will be especially focused on executing with speed and confidence, keeping our teams working toward the priorities that create long-term growth. We're delivering on our go-to-market strategy, providing families across America with fresh and affordable food. In my retail career, I understood that an outstanding customer experience comes from best-in-class store conditions, friendly associates, and great products at low prices. That's who The Kroger Co. is today. And that's who we will be tomorrow. I'll turn the call over to Todd to recap our 2024 performance, and how our value-creation model allows us to deliver on our goals. He will then recap our financial results for the fourth quarter and full year 2024, and then cover 2025 financial guidance. Todd?

Todd Foley, Interim Chief Financial Officer

Thank you, Rodney, and good morning, everyone. The Kroger Co. achieved solid results in 2024, demonstrating the strength and diversity of our value-creation model. Our performance improved as the year progressed, and our momentum positions us well for growth as we head into 2025. Offering fresh, high-quality products with personalized offers through a unique seamless shopping experience led to strong customer engagement trends, including growth in both households and loyalty. As a result, we are growing sales and generating traffic, which accelerates growth opportunities in other areas including alternative profit businesses. We are confident in our ability to build off this base from 2024 and deliver growth in 2025. Before we get to 2025, I'd like to start with a recap of last year. Beginning with our customers. We saw customers adjust their spending habits, responding to ongoing macroeconomic factors. The effects of multiyear inflation and higher interest rates pressured spending from budget-conscious households. Meanwhile, spending from less budget-conscious households was more resilient. Our most favorable household trends were driven by our core mainstream customers. Our go-to-market strategy positioned us well to meet our customers' needs, growing households and enhancing loyalty. We helped customers save in multiple ways, through fresh, affordable products and promotions, including loyalty discounts, personalized offers, and fuel rewards. And also through our brands' products, which are priced well below national brands at equal or greater quality. Our focus on operational excellence through our full fresh and friendly strategy brings our strategic pillars to life, meaning our customers can have value, selection, and convenience. We will continue to improve our customer experience to drive traffic and increase volumes because it powers our value-creation model and is critical to our long-term success. Fresh is one of the primary determinants of where customers shop, and we continue to invest to offer more days of freshness. In 2024, we reduced dwell time in our distribution centers, which meant most customers had extra days of freshness in their homes on key fresh items. As a result, we saw strong year-over-year identical produce sales improvement, above our total company identical sales without fuel results. Going forward, we see more opportunities to enhance our sourcing capabilities and supply chain to deliver additional days of freshness. Onto our brands: Our brands are an important differentiator for our business, providing The Kroger Co. the ability to offer unique and high-quality products at exceptional value. We expanded our multi-tiered brands product portfolio in 2024, resulting in more than 90% of customer households purchasing our brands' items last year. Over time, we built distinct brands that are customer favorites. We're always listening to our customers to understand how we can create more offerings to better meet their needs. Our proprietary customer insights drive our innovation and led to more than 900 new brands products released last year alone, including 370 fresh items. We look to create destination items that can only be found at The Kroger Co., differentiating ourselves from competitors and national brands. Last year, we introduced Field & Vine, a new brand offering regionally grown berries. We also began refreshing existing product lines and rolling out new packaging, which reinforces product quality and improves shoppability. Turning to Seamless: Digital sales were strong in 2024 with more than $13 billion in sales. As our digital business grows, so does its impact on our financial results. As a result, we're making improved profitability a key priority through automation, new technology, and improved density and volumes. We are encouraged by our fourth quarter results, which delivered the best digital profit improvement quarter we've seen yet. Seamless is an important growth accelerator in our business. Capturing more digital households is important to accelerating growth in our model, because these households are more loyal and spend nearly three times as much as non-digitally engaged households. The additional households and traffic in turn create more growth opportunities in our alternative profit and health and wellness businesses. The Kroger Co.'s alternative profit businesses are high growth and margin rich. Alternative profit businesses delivered solid results in 2024, generating $1.35 billion in operating profit driven by a 17% increase in media, excluding the 53rd week in 2023. While our pool of alternative profit businesses fell short of our initial growth expectations in 2024, in part due to slower growth in advertiser spend, we expect both near- and long-term growth to exceed our 2024 results. 2025 is off to a strong start, with increases in upfront commitments from both CPGs and agencies. KPM's mission is to be the most trusted and transparent media company by offering advertisers more effective ad spending through a compelling combination of custom audiences and ad effectiveness measurement. KPM continues to make strategic decisions designed to further this, such as their holistic brand-building approach with clients. We expect a long runway for growth, supported by continued innovation and growth in our digital sales. Health and wellness delivered solid sales results, gaining momentum in the second half of the year as strong vaccine performance in the second half helped offset margin pressures from growth in GLP-1 sales. Last month, we announced a new agreement with Express Scripts, which will provide ESI customers access to prescription medications and health services at The Kroger Co. pharmacies. While exiting this relationship in 2022 was a difficult decision, we are pleased to renew this relationship under a fair and more equitable contract, which enables us to operate on a sustainable basis and keep prices low for customers. As our teams begin to welcome these patients back into our stores, we know it will take time to build the ESI business back up. As a result, our 2025 guidance does not assume any benefit from our recently signed agreement with ESI. Improving productivity is a core competency for The Kroger Co., essential to our value-creation model. Our focus on productivity initiatives preserves and enhances both the customer and associate experience. For example, we introduced a virtual AI-powered assistant for associates last year. Today, almost 70,000 associates engage with this tool for more than 70 use cases. It provides personalized service to associates for common HR and associate interactions including training and onboarding. It also provides leaders real-time and convenient access to labor data, ensuring fully staffed stores. Our efforts to improve shrink provide another example where productivity improvements directly connect to our strategy and improve customer experience. Last year, we launched a new generative AI-powered sell-through tool that uses real-time sales and shipment data that empowers associates to better manage fresh and center-store inventory. As a result, our products are fresher, we prioritize sell-through, and that optimizes both sales and margins. I'll now walk through our financial results. Beginning with the fourth quarter. We achieved identical sales without fuel growth of 2.4%. These results reflect positive momentum in our grocery business, along with strong pharmacy and digital sales growth. Our brands had another strong quarter, with sales outpacing national brands, led by growth in our most premium brand, Private Selection. Encouragingly, our positive sales trends were broad-based across many of our food categories. The FIFO gross margin rate excluding rent, depreciation, and amortization, fuel, and the 53rd week of 2023 increased four basis points in the fourth quarter compared to the same period last year. The improvement in rate was primarily attributable to the sale of The Kroger Co. Specialty Pharmacy and lower shrink, partially offset by lower pharmacy margins. The operating, general and administrative rate, excluding fuel and adjustment items and the 53rd week, increased 16 basis points in the fourth quarter compared to the same period last year. The increase in rate was primarily attributable to the sale of The Kroger Co. Specialty Pharmacy, increased incentive plan costs, and investment in associate wages, partially offset by the continued execution of cost savings initiatives. After adjusting for the effect from the sale of The Kroger Co. Specialty Pharmacy, our OG&A rate improved this quarter, demonstrating our ability to leverage expenses when achieving our long-term sales algorithm. Our adjusted FIFO operating profit was $1.2 billion. We had a LIFO charge for the quarter of $30 million compared to a credit of $18 million for the same period last year. Adjusted EPS was $1.14, which is flat compared to the same period last year, excluding the 53rd week. I'll then walk through our full year 2024 results. The Kroger Co. achieved identical sales without fuel growth of 1.5%. Digital sales grew 10% compared to last year, excluding the 53rd week, and delivery solutions led sales growth with an 18% increase. Demand across our delivery network continued to be strong, with an increase in both households and traffic. Customers enjoy the premium experience of our delivery service, reflected by consistently strong net promoter scores. Health and wellness was also a strong driver of sales this year, led by growth in GLP-1s. The FIFO gross margin rate excluding rent, depreciation, amortization, fuel, and the 53rd week of 2023 increased 32 basis points. The improvement in rate was primarily attributable to the sale of The Kroger Co. Specialty Pharmacy, our brands' performance, and lower shrink, partially offset by lower pharmacy margins. The improvement in FIFO gross margin rate reflects progress on our long-term margin enhancement strategies. Going forward, we continue to see more opportunity for improvement through our brands growth, alternative profits, utilizing technology through our supply chain, enhancing our product mix through fresh, and improving digital profitability. The OG&A rate excluding fuel and adjustment items in the 53rd week of 2023 increased 31 basis points. The increase in rate was driven by the sale of The Kroger Co. Specialty Pharmacy, increased incentive plan costs, an increase in cost due to severity of general liability claims, and investments in associate wages, partially offset by the continued execution of cost savings initiatives. Our adjusted FIFO operating profit was $4.7 billion. Our LIFO charge for the full year was $95 million compared to a LIFO charge of $113 million last year. Adjusted EPS was $4.47 per diluted share. Excluding the 53rd week in 2023, EPS declined 2%. Fuel is an important part of The Kroger Co.'s strategy and offers an important way to build loyalty with customers through the fuel rewards on our Kroger Plus program. Fuel sales were lower this quarter compared to last year, attributable to fewer gallons sold and lower average retail price per gallon. Fuel profitability was also behind the same period last year as a result of fewer gallons sold and lower cents-per-gallon margin. On both the fourth quarter and full year basis, fuel was a headwind to our results. I want to provide a brief update on our inflation expectations. Inflation in 2024 increased throughout the year and was in line with our expectation. As we look ahead to 2025, we expect inflation to be 1.5% to 2% which does not include the effects from tariffs announced earlier this week. External factors continue to pressure certain fresh commodities, including eggs. Notably, the avian flu resulted in egg inflation of approximately 70% during the quarter. Inflationary pressures are not new to our business, and we're confident in our ability to navigate any inflationary environment. We will remain focused on keeping prices low for our customers. I'd like to take a moment to talk about our associates. We respect and reward our associates because their success enables the success of the company. Ensuring they are successful means improving wages and benefits, focusing on associate well-being, and developing talent to create fulfilling careers. This approach improved retention as our store and enterprise retention rates reached record levels. Creating a better associate experience has benefits for our business. When associates stay longer, they're better operators and deliver a better customer experience. In 2024, we raised the bar on our customer experience metrics and our associates exceeded those higher expectations to deliver an exceptional customer experience that drove sales growth. These associate investments include associate wage increases in 2024, resulting in an average hourly rate of more than $19 an hour, and a rate of more than $25 with comprehensive benefits factored in. Over the last seven years, The Kroger Co. has increased wages by 38%. The Kroger Co. remains committed to supporting our associates with investments in wages and comprehensive benefits that are sustainable and will allow us to keep prices low for our customers. Similar investments in associates are incorporated in our 2025 guidance and long-term growth model. During the fourth quarter, we ratified several new labor agreements, including our Fred Meyer Alaska stores with the UFCW. I'd like to now turn to capital allocation and financial strategy. Our strong balance sheet and free cash flow provide significant financial flexibility to invest in our business and drive returns for our shareholders. At the end of the fourth quarter, The Kroger Co.'s net total debt to adjusted EBITDA ratio was 1.79, compared to our net total debt to adjusted EBITDA target ratio range of 2.3 to 2.5. Our capital allocation priorities remain consistent and are designed to accelerate our value-creation model to deliver on total shareholder return of 8% to 11% over time. We are focused on investing in projects that will maximize return on invested capital over time while remaining committed to maintaining our current investment grade rating, growing our dividend over time subject to board approval, and returning excess capital to shareholders. In 2024, we announced our plans to significantly increase our investment in major storing projects, including new stores to accelerate sales growth and improve share, while supporting our long-term growth model. We delivered on that commitment in 2024, completing 29 major storing projects focused in higher-growth geographies that have a track record for generating strong cash flows and returns. We expect to complete 30 major storing projects in 2025. We also expect new storing to continue to be a meaningful contributor to our long-term growth model and would expect new store openings to accelerate beyond 2025. In December, we delivered on our commitment to return excess capital to our shareholders as we announced a new $7.5 billion repurchase authorization. Under this authorization, The Kroger Co. entered into an accelerated share repurchase program for $5 billion of common stock. During the fourth quarter, The Kroger Co. initially purchased 65.6 million shares as part of the ASR. The ASR program is expected to be completed by no later than the third quarter of The Kroger Co.'s fiscal 2025. After completion of the ASR, we expect to resume open market share repurchases under the remaining $2.5 billion authorization that will further enhance shareholder value. Last year, The Kroger Co. issued $10.5 billion in new debt financing, of which $4.7 billion was redeemed when the merger terminated, leaving The Kroger Co. with $5.8 billion of new debt. Given this higher debt load, we expect interest expense to increase in 2025. Assuming current interest rates, we expect full year net interest expense to be between $650 million and $675 million. The net impact of our financing and the share reduction from the ASR created one cent of accretion to adjusted net earnings per diluted share in the fourth quarter. Turning now to 2025 guidance. We expect to achieve identical sales without fuel of 2% to 3%, adjusted FIFO operating profit of between $4.7 billion and $4.9 billion, and adjusted net earnings per diluted share of $4.60 to $4.80. We expect the LIFO charge to be approximately $130 million assuming inflation is in line with current expectations. In terms of quarterly cadence, we expect identical sales without fuel to be consistent throughout the year, building slightly as the year progresses as we continue to improve our volumes. We expect first quarter adjusted net earnings per diluted share to be similar to last year, and we expect quarters two through four to be consistently above each quarter compared to the same periods of last year. In terms of margin rates, we expect FIFO gross margin and OG&A rates excluding fuel and adjustment items to be relatively flat on a year-over-year basis after excluding the effects of our sale of The Kroger Co. Specialty Pharmacy business. In closing, we're happy to deliver another year of solid results, which reflect the strength of our model. Investments made to diversify our model have strengthened The Kroger Co. and positioned us well to deliver now and invest in the future. We're a more diverse business, and we are excited about the opportunities across our business to deliver future growth. The strength of our model and the momentum in our business support our confidence in achieving our 2025 guidance and our ability to continue delivering for our customers, investing in our associates, and generating attractive and sustainable returns for our shareholders. I will now turn it back to Rodney.

Rodney McMullen, Chairman and Interim CEO

Thanks, Todd. As you heard from us today, The Kroger Co. operates from a position of strength, and I'm very optimistic about our future. We delivered solid results in 2024, and our performance improved throughout the year. Looking to 2025, we have aggressive plans to build more stores and improve our share results, attract new households, and increase loyalty which will accelerate growth and create shareholder value. We continue to have a strong balance sheet, which positions us well for the future, allowing us to invest in our business for growth while remaining disciplined on returning cash to shareholders. Given our ongoing search for a CEO, The Kroger Co. has postponed its planned Investor Day in April of 2025. We will update investors at a later date; it has been rescheduled. In the interim, The Kroger Co. remains committed as always to being accessible and updating you on our strategic priorities. Before we open up for any questions, I want to take a moment to welcome David Kennerly. He'll be joining us next week and will succeed Todd as chief financial officer on April 3rd. David is joining us from PepsiCo Europe and brings broad and extensive financial experience. We're confident that David's expertise and leadership will help us to continue to deliver on our strategic and financial priorities. Now open it up for questions. As you might imagine, Todd will handle questions related to strategy and results.

Todd Foley, Interim Chief Financial Officer

Thank you.

Operator, Operator

Please limit yourself to just one question at a time. Thank you.

Simeon Gutman, Analyst (Morgan Stanley)

Thanks. Good morning, everyone. My question is at the highest level: if you look at the 2025 guidance, it looks like EBIT is expected to grow in the low single digits, 2% to 3%. Within that, can you share how much is coming from the core business versus alternative profit? And then one follow-up: I don't know if we're able to ask Rodney questions, but good to hear from you, Rodney. As you and the board approach the succession of CEO, you're obviously sitting on a treasure trove of great operators within the organization. How are you looking at an outside perspective? Because the traditional supermarket channel, not just The Kroger Co., has had mixed market share results over time and it's becoming more complex and the stakes are growing. So thinking about outside talent versus the internal candidates.

Todd Foley, Interim Chief Financial Officer

Thanks, Simeon. I'll talk about the guide first, then turn it over to Rodney for the CEO succession question. Our operating profit growth estimates, looking at the middle of the range, are probably in the 3% range. We see growth both from the core business and from our alternative profit business. As I mentioned on the call, we didn't quite hit our expectations for alternative profit in 2024, but we expect that to contribute more in 2025. Rodney alluded to momentum in the core business as well. We expect solid growth in operating profit to come from core parts of the business across the store—both center store and pharmacy—and we expect alternative profit to contribute as well. I'll turn it over to Rodney.

Rodney McMullen, Chairman and Interim CEO

Hey, Simeon. Great to work with you again. I'll tackle the succession planning question. The board updates our specifications for CEO every year as part of our annual succession planning process because our business and the environment we operate in change every year. We are in the process of updating that now. The board has formed a search committee and we have begun the search process with a nationally recognized firm. We will look at both internal and external candidates. Most importantly, we're focused on identifying the right leader to drive The Kroger Co.'s growth and enhance shareholder value. I am proud to serve in this role for as long as needed, but I am confident our board will select the right next CEO whether from inside the company or outside.

Simeon Gutman, Analyst (Morgan Stanley)

Thanks, everyone. Good luck.

Operator, Operator

Thank you. Our next question comes from Leah Jordan of Goldman Sachs. Line is now open. Please go ahead.

Leah Jordan, Analyst (Goldman Sachs)

Good morning. Thank you for taking my question. I just wanted to dig into digital a little bit. It sounds like it continues to be a strong channel for you and profitability improved notably this quarter. Looking longer term over the next couple of years, can you provide more detail on the path of improvement from here? And how much more can lower costs and retail media growth offset other ongoing investments you're making, like price investments in the channel?

Todd Foley, Interim Chief Financial Officer

Thanks, Leah. We were pleased to see the sequential improvement in digital profitability in the fourth quarter. We saw improvement in pickup as we continue to make progress improving our cost to serve within stores, and we also saw improvements in the delivery channel. We've talked about work we are doing inside our sheds and in the last mile in conjunction with Ocado to improve that performance. We are not where we want to be yet, but the green shoots we saw prior to the quarter and the progress during the quarter puts us on a trajectory that, if maintained across a few consistent quarters, will help get us where we want to be over the long term. So we are encouraged and we think we're on the right path. On the other question about how we generate value to continue to invest: we have many levers—margin enhancement initiatives, alternative profit, our brands, and productivity across the business including supply chain, DCs, and transportation. Those levers are essential to our model and allow us to invest in price and associates. Our level of investment in prices and associates for 2025 is consistent with prior years because those commitments are essential to delivering value and great experiences to customers.

Leah Jordan, Analyst (Goldman Sachs)

Great. Thank you.

Operator, Operator

Thank you. Our next question comes from Michael Lasser of UBS. Line is now open. Please go ahead.

Michael Lasser, Analyst (UBS)

Good morning. Been too long. If we look at your identical sales guidance for this year, you're basically assuming that volumes are flat to probably even down given your inflation expectation along with likely outperformance from health and wellness driven by GLP-1s. Why is that? And Rodney, is there anything you can do now that you're in the CEO seat to address some shortcomings of the business you observed as a board member? Quick logistical question for Todd: is driving EPS to be flat year over year in the first quarter the plan?

Todd Foley, Interim Chief Financial Officer

Michael, let me touch on those pieces. On the identical sales guide, your framing is right: with our inflation expectations and volumes, for the full year we expect flat to maybe slightly up volumes, and we expect to flip to positive as the year progresses given sequential improvement. When you layer pharmacy onto the business, that puts us into the middle of the range for the guide. Regarding the first quarter flat EPS, it was driven by a few items, the biggest being the year-over-year comp from last year's union pension relief where we had little or no required contribution early last year. We're back to a more normal cadence of union pension expenses, which affects the Q1 comparison. If you do an apples-to-apples comp, first quarter growth would be similar to what we expect for the rest of the year.

Rodney McMullen, Chairman and Interim CEO

Michael, great to talk with you. Our 2025 plans are nailed down and have been approved by the board. We spent a lot of time in January reviewing strategy. Our go-to-market strategy remains unchanged. I will focus on making sure our experienced management team executes with clarity, speed, and consistency on those strategic objectives. I do not plan to be a status quo CEO, but our plans for 2025 are solid and I'm looking forward to being a part of that.

Michael Lasser, Analyst (UBS)

Thank you very much, and good luck.

Operator, Operator

Thank you. Our next question comes from John Heinbockel of Guggenheim. Your line is now open. Please go ahead.

John Heinbockel, Analyst (Guggenheim)

Todd, a couple of things on digital. When you think about growth going forward, particularly in 2025, do you think it will be very similar to 2024 in total and in delivery? And when you think about improving losses, what are the biggest buckets—throughput through the sheds versus delivery density? Lastly, when do you expect to reaccelerate shed openings from a profit standpoint?

Todd Foley, Interim Chief Financial Officer

Great questions, John. For 2025, we expect continued improvement, and the fourth quarter performance gives us momentum going into the year. The improvement is not from one single factor; it's from many pieces—throughput in the sheds, delivery density, cost to serve in stores, and last mile improvements. Every piece of the puzzle has incrementally improved and contributed. As for sheds, we will reopen shed expansion when we reach the profitability targets we expect and can start new sheds at volume levels that allow them to hit the ground running. We have to be confident in scalable profitability and initial volume before accelerating openings. It won't be immediate, but we have momentum toward that point.

John Heinbockel, Analyst (Guggenheim)

Thank you.

Operator, Operator

Thank you. Our next question comes from Michael Montani of Evercore ISI. Line is now open. Please go ahead.

Michael Montani, Analyst (Evercore ISI)

Hi. Good morning. Can you unpack identical sales in terms of traffic versus ticket in the quarter? What kind of inflation did you have in the quarter? And how much impact did GLP-1s have on identical sales?

Todd Foley, Interim Chief Financial Officer

Great. For Q4 we had contributions from both ticket and traffic, skewing a bit toward ticket. We did see a small uptick in inflation. We haven't quantified GLP-1 impact specifically, but our experience has been similar to industry commentary: GLP-1s have contributed to health and wellness growth and had some impact on sales and category dynamics. For 2025 overall inflation, we expect 1.5% to 2.5% on a slightly broader view and the vast majority of our portfolio remains steady. A few outlier categories like eggs—and some proteins—are driving outsized inflation, but the core portfolio should see only a modest tick higher into 2025.

Operator, Operator

Thank you. Our next question comes from Rupesh Parikh of Oppenheimer. Your line is now open. Please go ahead.

Rupesh Parikh, Analyst (Oppenheimer)

Morning. Thanks. On the tariff front: I know your inflation guidance does not include the impacts of tariffs. Since tariffs are starting up now, what's your exposure? I'm guessing produce has some exposure to Mexico, but any color would help. Thank you.

Todd Foley, Interim Chief Financial Officer

Great question. As a domestic retailer, we have less exposure to international tariffs than some peers. Our exposure to products from China is very small. Produce is one area with some exposure, particularly items sourced from Mexico or Canada, but that exposure is mid-single-digit in most cases—not massive. We are monitoring this closely and our merchandising and sourcing teams are proactively evaluating supplier diversification to mitigate tariff impacts and keep prices low in our stores.

Operator, Operator

Thank you. Our next question comes from Ed Kelly of Wells Fargo. Your line is now open.

Ed Kelly, Analyst (Wells Fargo)

Hi. Good morning, everyone. Rodney, it's good to hear from you. A couple questions: First, related to share repurchase and the balance sheet—given your prior comments that there is no good business reason to run below your leverage target ratio, do you still agree with that? Second, for guidance this year, Todd, what specifically is included for share repurchases? And finally, what exposure do you have to SNAP and what have you seen historically when there are cuts?

Todd Foley, Interim Chief Financial Officer

Ed, I'll handle that. Regarding the guide and share repurchase, we expect to finalize the accelerated share repurchase (ASR) in the third quarter. We also have the remaining $2.5 billion authorization, which we expect to use primarily in the back half of the year depending on volumes. Our leverage ratio is around 1.8 after the borrowings, giving us some flexibility versus our target range of 2.3 to 2.5. We do have business uses for cash, including the $2.5 billion of repurchase authorization and some debt refinancing. On SNAP exposure, when we saw SNAP-related pullbacks a few years ago, customers prioritized essentials like food and reduced discretionary spend. We monitor SNAP developments closely and will lean on our experience to absorb impacts. Right now it's early to project any specific changes.

Operator, Operator

Thank you. Our next question comes from Ken Goldman of JPMorgan. Your line is now open. Please go ahead.

Ken Goldman, Analyst (JPMorgan)

Hi. I appreciate the guidance on inflation. Broadly, looking at food-at-home, retail and wholesale pricing trends, it seems some in the industry may be holding back on passing through wholesale inflation. What are you seeing in terms of the competitive environment and peers' price investments, and how does that inform your decisions to pass along inflation this year?

Todd Foley, Interim Chief Financial Officer

Good question. With most suppliers, we are not yet seeing a large wave of price increases, aside from selective price increases in a few fresh categories like eggs and some proteins. That's reflected in our inflation guidance. Competitive pricing remains important; we assume competition will be strong and monitor where our pricing stands versus competitors. We improved our price gaps in the fourth quarter and continue to invest in price to narrow those gaps. Maintaining value for customers is a core focus.

Operator, Operator

Thank you. Our next question comes from Karen Short of Melius Research. Your line is now open. Please go ahead.

Karen Short, Analyst (Melius Research)

Hi. Thanks. On price gaps: where do you think your price gaps are now versus ten years ago? Historically you were within 5% to 8% of the largest big box competitor on like items. Second, when you look at operating profit, how do you think about four-wall operating profit versus alternative profit, given the increasing overlap?

Todd Foley, Interim Chief Financial Officer

We measure price gaps at multiple levels, including visible shelf-tag level and an all-in level that includes promotions, loyalty offerings, and fuel rewards. On an all-in basis, we're favorable to the 5% to 8% range you referenced historically. We're working to make our value more visible to customers by simplifying promotions so customers clearly see the value and give us credit for it. On operating profit, four-wall and alternative profit are intertwined in our model. We expect growth in both and see them contributing in a reasonably similar way to overall operating profit growth for 2025.

Operator, Operator

Thank you. Our next question comes from Chuck Cerankosky of Northcoast Research.

Chuck Cerankosky, Analyst (Northcoast Research)

Good morning. Can you talk about accelerating new store openings? The conventional retail food industry has lost market share in recent years, but The Kroger Co. seems more aggressive. Can you talk about the strategic thoughts behind that?

Todd Foley, Interim Chief Financial Officer

Great point, Chuck. A few years ago we invested incremental capital into building out digital capabilities. Now that those capabilities are at a mature stage, we are redeploying incremental capital back into store growth. Building the physical footprint is a lever to drive share, especially because our most loyal and profitable customers engage with us both digitally and in-store. Reinvesting in stores is an opportunity to grow share and drive long-term returns, and that's why we're accelerating major storing projects now.

Operator, Operator

Thank you. Our next question comes from Krisztina Katai of Deutsche Bank. Your line is now open. Please go ahead.

Krisztina Katai, Analyst (Deutsche Bank)

Hi. Congrats on a good quarter. On our brands: you launched more than 900 new items in 2024. What is the plan for our brands in 2025? How much newness should we anticipate, distribution across opening price points versus premium items, and how will they contribute to gross margin in 2025?

Todd Foley, Interim Chief Financial Officer

Great question. Our brands deliver quality, value, and margin enhancement. The 900 new items in 2024 was consistent with our ongoing innovation cadence and not an unusual year. We expect continued innovation in 2025. Decisions about whether new items are opening price points or premium items are made on a category-by-category basis, and we've been doing deep dives to understand substitutability and opportunities. We're maybe a third to forty percent through those deep dives and expect them to continue through 2025. Brands will remain an important pillar for growth and margin enhancement.

Operator, Operator

Thank you. Our next question comes from Joe Feldman of Telsey Advisory Group. Your line is now open. Please go ahead.

Joe Feldman, Analyst (Telsey Advisory Group)

Thanks. You mentioned the pension in Q1. Can you share more color on that for the rest of the year? Are there any other big pension contributions this year we should be aware of?

Todd Foley, Interim Chief Financial Officer

Joe, I wouldn't call it a pension issue—last year we benefited from a temporary reduction in required contributions due to prior contributions. This year we're back to a more normal contribution cadence, which creates the Q1 comp effect. It's an opportunity from last year rather than a concern. We don't anticipate this to be an ongoing issue beyond normal required contributions.

Operator, Operator

Thank you. Our next question comes from Kelly Bania of BMO. Your line is now open. Please go ahead.

Kelly Bania, Analyst (BMO)

Hi. Thanks. On core underlying gross margin, you've shown solid expansion in recent years and this quarter came in ahead of plan, but you sounded like gross margin is planned to be flat this year. What is different this year versus the last couple of years? And how are you thinking about alternative profit growth for this year?

Todd Foley, Interim Chief Financial Officer

Good question. Net of Specialty Pharmacy, we were about thirteen basis points ahead in the quarter. A big contributor this year was improved shrink performance, supported by initiatives like organized retail crime counters and technology-driven sell-through tools. We still have some runway in shrink improvement, but we'll begin to cycle those gains in the middle of the year. We continue to invest in price and associates and will use margin expansion opportunities to support those investments. On alternative profit growth, we expect dollar growth in 2025 to be better than 2024, but we don't guide specifically to an alternative profit line.

Operator, Operator

Thank you. At this time, we'll take no further questions. I'll hand back to Rodney for any further remarks.

Rodney McMullen, Chairman and Interim CEO

Thank you, Alex. Thanks for all your questions this morning; they're much appreciated and it's great for me personally to reconnect with some old friends. Before we conclude, I'd like to speak to our associates who are listening. A message of encouragement to all of our associates: as CEO, I will keep our company focused on retail fundamentals—running great stores and online delivery while taking great care of our customers. The Kroger Co. is steady because of you. The work you do every day matters and keeps customers coming back; it makes The Kroger Co. the place they trust. The Kroger Co. is strong, and we have great momentum going into 2025. Thanks, everybody, for joining us today. It's great to be back home, and I look forward to our future together.

Operator, Operator

Thank you all for joining today's call. You may now disconnect your lines.