Good morning, and welcome to The Kroger Co. Fourth Quarter and Full Year 2022 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Rob Quast, Senior Director of Investor Relations. Please go ahead.

Good morning. Thank you for joining us for Kroger's Fourth Quarter and Full Year 2022 Earnings Call. I am joined today by Kroger's Chairman and Chief Executive Officer, Rodney McMullen and Chief Financial Officer, Gary Millerchip. Before we begin, I want to remind you that today's discussions will include forward-looking statements. We want to caution you that such statements are predictions, and actual events or results can differ materially. A detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. The Kroger Company assumes no obligation to update that information. This morning, we released a presentation to accompany our call today, which can be found on our Investor Relations web page at ir.kroger.com. We encourage you to refer to these materials as Rodney and Gary will make references to the presentation throughout the call. During our prepared remarks, we will share our fourth quarter and full year results. We will update you on the progress our team has made since our Investor Day last year on our Leading With Fresh and Accelerating With Digital strategy. We look forward to returning to a full Investor Day in 2024, where we expect to share detailed plans for how we will achieve synergies and maximize shareholder value from our merger with Albertsons. 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 1 question and 1 follow-up question, if necessary. I will now turn the call over to Rodney.

Thank you, Rob. Good morning, everyone, and thank you for joining us today. I'd like to start by sharing how incredibly optimistic I am about Kroger's future. Our performance last year demonstrates how Kroger is consistently delivering for our customers, our associates and our communities and by doing so, creating value for our shareholders. Since announcing our Leading With Fresh and Accelerating With Digital strategy at our 2020 Investor Day, we have made tremendous progress against our commitments. As you will see from the chart on Slide 6 of the presentation deck Rob mentioned, we are delivering a fresh, affordable and seamless shopping experience for our customers with 0 compromise on value, quality, selection or convenience. We are advancing our purpose to feed the human spirit by significantly increasing associate wages and uplifting our communities. And we are delivering on our financial commitments through our strong resilient value creation model. With this strategy, we exceeded our financial goals and delivered attractive total shareholder returns during the past 2 years. In 2022, customer preferences shifted in response to inflation and macroeconomic uncertainty. Our customers were looking for more ways to stretch their budget. The gap between food at home and food away from home spending grew in the fourth quarter as more customers gravitated toward affordable meal solutions that restaurants simply can't provide. Our research shows that cooking at home is 3 to 4x less expensive than dining out. And as Kroger was there for our customers, innovating quickly to meet their needs and wants, our nimble and customer-focused approach helped us deliver strong results in 2022, leading to total household growth and enhanced customer loyalty. We saw an especially strong response in our higher income households as this segment grew by 1.1 million households, further illustrating the resiliency in our…

Thank you, Rodney, and good morning, everyone. Before jumping into our 2022 results and sharing our outlook for 2023, I'd like to take a step back and remind you how Kroger's value creation model is enabling the company to deliver sustainable value for our shareholders. We believe our value creation model has been a key to delivering consistently strong results over the past 4 years and is positioning Kroger for growth in years to come. The go-to-market strategy that Rodney outlined earlier is the foundation of our model. Over recent years, we have invested significantly in our people, our customers and technology to create a leading omnichannel position in food retail. By executing our go-to-market strategy, we win customers in our core supermarket business, including health and fuel and drive significant customer traffic and data into our ecosystem. This, in turn, allows us to deploy our investments in technology and 84.51° to deliver even greater value for customers and create new high-growth, high-margin alternative profit businesses. The value generated from these businesses enables us to reinvest back into our supermarkets and drive further store and digital traffic, creating a flywheel effect. We are evolving from a traditional food retailer into a more diverse food first business that we believe can deliver sustainable future growth and succeed in a variety of operating environments. As a reminder, since introducing this model in 2019, we have achieved consistent returns for our shareholders that have significantly exceeded our TSR commitment of 8% to 11%. As you can see in the table on Slide 19, over the past 3 years, Kroger has achieved more than 19% compounded annual growth rate in adjusted FIFO net operating profit and approximately 25% compounded annual growth rate in adjusted EPS. Over this same time period, we generated adjusted free…

Thanks, Gary. Before we open up the floor to your questions, let me provide an update on our pending merger with Albertsons. During the past few months, we've spent time getting to know Vivek and the Albertsons leadership team. We are incredibly impressed with their talent, culture and commitment to their customers and communities. We look forward to bringing together our 2 highly complementary organizations to provide customers with lower prices and more choices while realizing the long-term value we expect this merger will deliver. We are working cooperatively with regulators responding to the Federal Trade Commission's second request and in discussions about the transaction, while also working to identify potential buyers for the stores, we expect to divest to obtain clearance for the transaction. We are pleased with the level of interest received thus far, and we'll work towards finding a solution that benefits all stakeholders. We remain on track to close the transaction in early 2024. During the quarter, we launched our integration planning efforts with the goal of preparing for a seamless cultural and operational integration. We expect to create customer benefits beginning day 1 post close. The integration team is developing work streams with clear objectives and milestones to deliver value for our customers, associates, communities and shareholders. We are pleased with the progress we've made to date, and we'll continue to provide updates as we have them. We achieved exceptional results in 2022, building on our record years in 2020 and 2021, and we exceeded our commitments in our Leading with Fresh and Accelerating with Digital strategy. Our folks strategy is focusing on our customers, our associates and our communities is working. Our customers are telling us that we're doing a better job serving their needs. We continue to improve our associate wages and comprehensive benefits with a 34% increase in the last 5 years. And we are helping to create healthier thriving communities through our Zero Hunger | Zero Waste work. We believe our momentum is sustainable and will only accelerate upon the completion of our pending merger with Albertsons. With that, Gary and I look forward to taking your questions.

[Operator Instructions] Our first question for today comes from John Heinbockel of Guggenheim Partners.

Rodney, I wanted to start with since it's the beginning of a new year. As you guys think about your consumer deciles, quartiles, however you look at it, what's the wallet share opportunity right, maybe from the average consumer to your best, most loyal consumer. And where is the -- when you do sort of a gap analysis, where is the gap? Is it fresh? Where are the biggest pockets, right, where the average consumer is not spending as much as the most loyal.

And John, thanks. I love the question. And we always look at it slightly different because we look at the opportunity is all the business. And even in places where we over-index, there's still a lot of opportunity. Customers that are most loyal to us will still spend 30% to 50% of their spending somewhere other than Kroger. And that's an opportunity for us to improve our position. When you look at Fresh, we start off with a higher share of Fresh than we do in the other parts. But it's an area where we're meaningfully better than our competitors. So our ability and focus on growing our business is to really -- what we find is full Fresh and friendly resonates with all customer types, and we do it in a way where there's 0 compromise. So a customer on a budget can get great value from Our Brands. They can save 7% to 10% by buying Our Brands versus national brand. If you look at our Home Chef and products related to that, a customer can get a meal for 1/3 to 1/4 of what it costs going out. So it's really all of those together. And our opportunity -- our sweet spot is always the customer that likes a good value for the money and Fresh is incredibly important and friendly is incredibly important. That's our sweet spot where we connect the best and that is a growing area across the U.S., and we operate in many markets that are growing as well. So for us, that's really our sweet spot and our opportunity and our strategy is oriented around that. And then technology just provides the support for that make it easier for the customer.

Great. Maybe secondly, right, if you look at the Express Scripts impact, so how much of that is pharmacy versus none, right? And I know you guys have always said pharmacy customers among the most loyal customers. How do you think about losing trips, right, because of this and then maybe using right, your data, okay, we know who -- I think you know who the Express Scripts customers were. We can do incremental outreach to make sure we don't lose trips with those particular households.

If you look the numbers that Gary provided by far, the majority of that's pharmacy. Our teams are doing great work on using our discount cards to be able to help customers identify other alternatives. And in fact, in many cases, they're saving money. We're also going directly with some other companies to provide the benefit rather than going through a PBM. So by far, the majority of the estimate that Gary provided is pharmacy. And we're using the things that you said to make sure that we don't lose that customer connection and we don't lose the trip to the grocery store. I don't know, Gary, anything you want to add to that?

I think you said it well, Rodney. I think that John described it, but work the team has done around using our data and personalization to make sure we're protecting the customer. We think it's working.

Our next question comes from Ed Kelly of Wells Fargo.

Thanks for all the color. A question for you to start. Rodney, just kind of big picture. We're coming off of an inflationary cycle that really none of us have ever sort of seen before. And obviously, there are a lot of implications associated with that. But as you look forward into '23 and sort of thought about providing guidance, how do you think the industry is going to evolve off of the heels of that? Meaning what's the level of inflation that you've embedded within your ID guidance of 2.5% to 3.5% ex Express. How do you think about like the promotional backdrop and how that changes? Are you happy with your underlying tonnage for instance or volume given what's happened with pricing and what we've seen with comps at some like value players like Walmart, et cetera. Just kind of curious, is that how all of that played into the way you're thinking about guidance?

Yes. If you look at inflation overall, we would expect inflation to be higher in the first half of the year than the second half of the year and the quarterly insights that Gary provided really reflected that. If you look at the thing that we feel really good about, and I shared specifics on the prepared comments, the higher income customer is really resonating with our value proposition, and we're having meaningful increases there in terms of that customer. And one of the things I always think it's important for people to realize is the profitability of that customer is higher as well because they shop for the full mix of our stores and they would be buying more produce in Fresh departments and Deli bakery, which is driving some of that profitability shift. So when you look at overall, we feel really good on how we're connecting with our customers. We feel really good at how we're improving on Fresh. And when you look at the share that we're getting with the customer that really focuses on that, we feel good about. When you look at it overall, we're always striving to do better. And I feel good about the progress we're making. We're excited about the opportunities we have in front of us, and we still think we can continue to do better. In terms of specifics on inflation, Gary, I'll let you share the specific inflation assumption because it's pretty -- during the year, it's obviously pretty wide range.

Sure. Yes. Thanks, Rodney. Thanks for the question, Ed. From an inflation perspective, what we're seeing at the moment is that we've seen in the last couple of quarters, inflation has really sort of stabilized. And what we're starting to see is in the Fresh categories, sort of deceleration of inflation, but grocery is -- has remained pretty stubborn in terms of the levels there. So we're assuming, as Rodney mentioned, in the first half of the year that a gradual decline, probably grocery remaining fairly stubborn where it is today, but some of the Fresh categories continuing to show some deceleration. And then we're expecting sort of towards the end of the year that we get to sort of between low and mid-single-digit inflation level rates about sort of 4% to 5% would be our assumption around where we think inflation starts to come down to in the way that we build our assumptions for the year. And obviously, Our Brand...

Okay, just a quick followup...

Go ahead, Ed.

Got you. Just a quick follow-up, Gary. The FIFO gross margin outlook for '23. I think there is a decent -- I mean, it seems like there's a decent impact associated with Express, given there's no P&L impact of losing the comp. Just how are you thinking about FIFO gross margin ex fuel in '23?

Yes. As you know, we generally don't get into a ton of specific guidance. But I would say, in general, we're thinking and the way we built our model is very much in balance and consistent with what we delivered in 2022 in terms of -- when you think about gross margin, we'll be continuing to invest in the customer in key areas of value whatever important to them, whether that's pricing, promotions continuing to roll out Boost, which creates a short-term headwind as you build the loyalty of the customer and get the incremental value over a longer period of time. We believe that there'll be some continued meaningful tailwinds in our gross margin rate as we continue to execute on our go-to-market strategy. So thinking about alternative profit streams. The work I mentioned in my prepared remarks about continuing to see improvement in Our Brands penetration, which is helpful to gross margin. And so we overall, think it's going to be a pretty balanced year. There's an awful lot going in there as we're investing in the customer, investing in the experience. But as our model is now kind of reaching more of a rhythm and maturity of delivering on those gross margin improvements that we're able to balance those things. I would say from an Express Scripts point of view and some of the other work that we've done around Kroger Specialty Pharmacy are making sure that we're really focusing on profitable growth in our health and wellness business that those probably create a call it, a sort of 10 basis point tailwind in gross margin, but a 10 basis point headwind in OG&A. It's kind of net, net neutral in terms of the operating profit impact, as I mentioned in my prepared remarks, but it will change the optics a bit just because the sort of pulling those sales numbers out of our overall business model.

Our next question comes from Simeon Gutman from Morgan Stanley.

My first question, it's a little similar to Ed's question. If you look at the FIFO EBIT guided for 2023, essentially, call it, flattish. I'm just rounding relative to '22. If you divide the business up into core, I don't know alternative and maybe gas as profit pools, and I don't know if those would be the right 3, the big ones to focus on. Can you give us a sense of the movement within getting to that flat -- roughly flat for EBIT year-over-year?

Yes. I think what I'd probably say, Simeon, as I think about it, the sort of 3 bigger picture moving parts that I tried to sort of tee up the overall guidance with as well. So I think about it as the 53rd week adding, call it, $0.15 of earnings per share. So that's helping with -- think of $0.01 of about $9 million to $10 million. So I think if it's like $150 million tailwind from the 53rd week. I think of gas, so fuel being a headwind of -- in the sort of $200 million to $250 million range. And then I would think of the sort of core supermarket business is really sort of continuing to grow year-over-year. So the gap is more than offsetting the impact of the 53rd week. The core supermarket business sort of executing on our value creation model, as I mentioned. So underlying sales growth in that 2.5% to 3.5% growth because the Express Scripts business really hasn't contribute to the bottom line, continuing to invest in the customer, continuing to execute on our plans around driving cost out of the business and improving mix and those things net overall getting us to a slight improvement. And I'll probably -- we won't get into the specifics obviously of breaking down the individual pieces, but we really categorize all profit as part of the overall ecosystem because we don't have media revenue unless we're driving the digital supermarket business. So we very much look at it as a total ecosystem.

Right. And then as a follow-up on the backdrop regarding pricing inflation, it seems like the backdrop is maybe more oligopolistic than one would have thought, not that it's not competitive out there, but in terms of price and wondering what that's a function of and maybe what could disrupt it? Is that a fair assessment?

We would certainly describe it and look at it different than that. And we've invested in pricing -- I'm trying to remember for the last 20 years or so every single year and would expect to continue to do that. And we fund that through process change, identifying other things to get costs out. And an awful lot of our promotions are much more directed personalized to the customer. So it's not what you see when you go to a store to look on a shelf because we provide a significant higher percentage of our value to our customers through fuel rewards and personalized offers that are connected one-on-one from -- in using technology and digital so that each person is individual. So we would certainly not describe it that way. And we view it -- every year is incredibly competitive, and everybody is working hard to do a better job and the customer gets the benefit of that.

Our next question comes from Michael Lasser of UBS.

Between the comments that you had indicated at the early start of the call, where you're working on the profitability of your digital business, along with what it sounds like a slowdown in the rollout of your Ocado shed this year, have you evolved your thinking on the long-term profitability of digital sales for Kroger because you had previously indicated that you expected the incremental margin on an incremental dollar of sales to be at or above an in-store dollar of incremental sales.

When you look at our digital business long term, we wouldn't see the profitability be any difference in this supermarket when you look at it over a longer period of time. And if you look, what we find is a customer when they move online, they actually after a year engage with us more in store than before. So what we're really focused on is having an ecosystem where the customer thinks food, they think Kroger. And what we're finding is the customer routinely moves back and forth between the different channels. If you look at each piece of it, every single day, you're working to figure out ways to improve processes and take costs out. And then on top of it, obviously, retail media is an important part of the driver. So when you look at it long term, we really see no change in the opportunity and potential. We're incredibly excited and everything that we see, we think it will be more important in 3 years, 5 years, 10 years to have where the customer engage with us through multiple ways. And the digital channel is a critical part of that, and we find the customer engages with us digitally, even when they don't shop digitally. So for us, we see it as exciting as we did before. We don't see the long-term profitability being different. And we're working continually in terms of both internally and with our partners on how to improve processes.

Maybe just to add, Rodney -- Michael, to the sort of short-term answer to Rodney's long-term perspective, I would say that we are seeing the benefits flow through in the profitability that we talked about on prior investor meetings. So if you think about our existing digital business today, pick up through the store delivery, what we're seeing is the cost to serve. We had our best ever quarter for the cost to serve a digital order in the Q4 of 2022. Rodney mentioned media, the amount of media revenue we generate per digital transaction continues to grow. So those are 2 of the big drivers that we expect to drive digital profitability, and we continue to see improvements in '22, and we expect improvements in '23 that were actually part of the tailwind in the financial model I described earlier. So we remain on that path and we are making good progress.

And Gary, just to clarify that, then why slow the rollout of the Ocado sheds? And my second question just at this time. To get to the slightly below the low end of the range for ID sales by the end of the year with still low to mid-single-digit inflation, do you assume that there's going to be a unit erosion by the end of the year as -- I don't need to tell you guys, groceries are expensive and in a tough economic environment that may get worse by the end of the year. The consumer may be pulling back even further, and we just want to make sure that you factored in some conservatism into your outlook.

Sure. Thanks, Mike. I'll try and be brief on those 2. So I think just to clarify on the first part of the question, I was describing the majority of our digital business today. So think about pickup through the stores, think about the work that we're doing in delivery to customers today. And when we share that doubling our digital profitability, that was based on those metrics. And so how do we improve the cost to serve, how do we improve digital media revenue. On the customer fulfillment centers, we're very much in the middle of that journey right now of sort of 18 months or so into those first 2 facilities, really kind of fully understanding the scale of demand to how the customers behave and how you optimize that model. So I'd say more to come on that as we continue to understand that sort of key phase of those first 2 facilities really seeing the progress there on profitability. But from a customer demand, the customer experience, we're seeing all the sort of things we have hoped to have seen around customer engagement.

And we are actively looking for sites for some preannounced locations too on those and finding the sites ended up being a little bit more difficult than what we would have expected.

And I think just very brief on your second question, Michael. But for us, it's about maintaining flexibility. We believe we built our model to be able to adapt and to deliver value for our customers. We gave directional numbers just because I think it's helpful on inflation because of the LIFO calculation. But our expectation is our goal will be to continue to deliver more value for customers and over time grow our share and obviously make sure we meet the customer where they are and we expect the second half of the year to have some -- definitely some things that we don't know how to perfectly plan for. We need to make sure we're nimble and agile to be adapt to that because there's clearly going to be changed in the second half of the year.

And we feel good about our overall model being able to adapt in any situation in any market because we give a great value for the customer regardless. Thanks for the question, Michael.

Our next question comes from Kenneth Goldman of JPMorgan.

You mentioned that one of the reasons why working capital was higher than usual in the fourth quarter is that you were buying a little bit ahead to protect margins, I assume as inflation rises. Two underlying questions here. First, was this mainly in the grocery department. You talked about grocery being particularly tough in terms of inflation. And then maybe more importantly, I'm just curious, is there going to be an offset to this in the first quarter, maybe as you run through that higher-than-usual inventory, I guess I'm really just trying to ascertain if you're going to buy less than usual from some of your grocery vendors next quarter or this quarter.

Yes. Thanks for the question, Ken. From our perspective, the main forward buying would be in pharmacy and some in grocery, that will be the 2 key areas that we looked at and felt there was a good opportunity to protect margins, as I mentioned in the prepared comments. From our perspective on working capital, certainly, some of the year-over-year variance would be things that we would expect to maintain because we are seeing continued higher inflation on inventory. And as we called out, we're expecting as we improve in-stock levels as we have that some of that will be sticky. We would look at some of the payables and receivables timing impact and would expect that to be coming back. In fact, if we look at our cash at the end of the first period, the first month of the new year, it was actually up by $1 billion and back in line with the prior year, which obviously wasn't the case at the year-end. So we do think some of it was timing and will flow through. But obviously, we have strong plans for the year in terms of continuing to grow with our partners. And I would focus more on -- from our perspective, how we make sure we're continuing to drive free cash flow, and we feel good about our ability to do that.

And the forward buying is really driven by the economics at any given day in terms of what's available in the marketplace. If it's a good return, we'll invest the money there. If the return is not good, then you'll see the flow of benefiting working capital.

We didn't give exact numbers. I would also say, Ken, the forward buying would be a smaller part of the number, the timing of payments would be a bigger part of that than the actual forward buying.

Got it. And then a quick follow-up. Implied operating cash flow. It's one of the questions I'm getting from investors. You gave a CapEx number, so we can back into it, obviously. Just curious why given the strong EBIT growth this year, given some of the working capital reversals, why would it not be a little bit better than what guidance is suggesting. I know you talked a little bit about this. I just wanted to get a little bit more detail on some of the underlying factors there if possible.

Yes. I think I would say we try to guide to what we think is a more normalized year in 2023, Ken. Part of it, I would say we probably are being a little bit conservative because of -- we want to see how this unwind of COVID exactly plays out. A couple of examples would be if inflation does remain at high levels, obviously, that could impact inventory but also as we kind of unwind accruals on things like incentive payments, assuming we're more going to be more like an on-target incentive payment than significantly higher than on-target payout, those things can create some 1-year adjustments, too. So there's a few areas that just kind of create a few wrinkles. And candidly, we're trying to be conservative to make sure we can see the flow-through of the catch-up from 2022 as well. So we feel we tried -- what we tried to do is take a conservative view of a normalized environment, but there is still some, I would say, unwinding that we wanted to make sure we understood as we reported out in 2023.

And our incentive plan is designed -- our long-term incentive plan is designed such that we are incentivized to do better than the guidance we've given.

Yes, I think it'd be fair to say our internal goal would be higher than what we shared because we do believe it's one opportunity, but we thought it was appropriate to be conservative in the circumstances.

Our next question comes from Rupesh Parikh from Oppenheimer.

Also congrats on a great quarter. So I just want to touch on market share. Just curious if you look at Kroger's performance in Q4, I'm not even sure if you have the full year data, just curious how your market share is performing versus your expectations? Because if I recall last quarter, you were starting to see improvement in the market share.

Yes. We're continuing to see improvement and if you look at internally, if you were at one of our meetings, you'd hear us continually focus on how to even continue to improve. Our objective and expectations of ourselves is to grow market share. And if you look at the higher-income shopper, in those customer segments, we did a great job gaining share in Fresh. We're doing a good job of gaining share. And I would say we're pleased with the progress, but we still are not satisfied.

Okay. Great. And then maybe just one quick follow-up question. Just quarter-to-date. Any color you can provide in terms of what you're seeing just throughout the quarter?

Yes. As you know, we always get it. We always provide some insight. If you look so far, we're consistent with our expectations and Gary outlined a little bit about what we would expect quarterly between quarters to be. If you look at the first period, the first 4 weeks of the year, it's trending a little bit better than [indiscernible] but both of those were lower than the fourth quarter actual. And I want to remind you that ESI -- Express Scripts, I should say, is about 1.5%. And then I always hate to talk about weather, but weather was more friendly to us a year ago than it is this year and I don't ever want to use weather as an excuse, but it is an insight if you look at the current trends, but the key point is we are trending where we expect it to be.

Our next question comes from Spencer Hanus from Wolfe Research. Please go ahead.

On Our Brands, you saw that outperform the overall comp again this quarter. Are you seeing CPGs get more willing to offer trade spend just given the share losses that they're seeing? And do you think the trade down that we've seen over the last few quarters accelerate as we move through '23?

Yes. If you look at a 5-year trend or a 10-year trend, Our Brands has picked up share on almost every year. And the only exception to that was a little bit of time during COVID where people had much more money in their pocket. If you look, I would say, all short statements and economics are wrong, but we still have several CPGs that are passed or trying to pass through costs more than probably their inflation. We would still see that they're more focused on profit and tonnage. And when that is true, that's when Our Brand continues to gain share. And that's the reason why Our Brand is performing so strongly. And if you look at historical cycles, eventually, that what you outlined will happen, but it hasn't started happening yet.

Got it. That's helpful. And then on fuel margins, you called out $0.51 during the prepared remarks, which is up more than 50% versus what it was in 2019. So just curious how you're thinking about the sustainability of fuel margins and where those will ultimately be baseline as it just becomes a bigger part of your overall operating profit today?

Yes. Thanks, Spencer. So I think as we mentioned in our prepared comments, we do believe that fuel margins will be sustained at a higher level than the historical averages. We think there's been some structural changes in that industry as you look at the last 5 years that would cause us to think that margins will be maintained at a higher level than historical levels. All that being said though, we do think -- I think I mentioned it in one of the questions earlier that we would think that fuel profitability somewhere between $200 million to $250 million headwind in 2023, largely not because we don't think that there's a continued sort of sustainability in fuel margins. But if you remember last year, when the war in Ukraine was announced, there were some real volatility in prices. And we think some of those shocks that happened around those times generally don't get repeated and cycle. So it's really allowing some of those sort of onetime unusual spikes in pricing or changes in pricing. But fundamentally, we believe fuel will be sustained at high levels.

The other thing just to add to Gary's point. When retail fuel prices are high, customers engage in our fuel rewards a lot more and we provide significant discounts to customers through our fuel rewards. If prices come down, usually our reward costs will go down there as well. So you have to look at all the pieces together.

Our next question comes from Kate McShane of Goldman Sachs. Please go ahead.

This is Leah Jordan. You called out sourcing again as a tailwind this quarter. How are you managing that differently today? How much of an opportunity do you still see there? And is there anything assumed within the cost savings guidance as well?

I'll let Gary get into the details. But in sourcing, it's an area where several years ago, we really didn't have a separate department and didn't have professionals that manage that organization. And a couple of leaders and now reports to Gary, they've done a great job of finding talent that understands how to source product, understands the cost of the ingredients and all the pieces. And it's really turned it into a professional organization, and it's under the leadership of Mike Donnelly and Erin Sharp and a few people that have retired and now it's under Gary's leadership. And I just think that team has done a great job of bringing professionalism to the area. In terms of the specifics, now I'll let Gary get into the details.

Sure. Thanks, Rodney. Thanks for the question, [ Kate ]. Yes, we certainly believe that we -- it's a bit like our overall approach to taking cost out of the business. We started out saying, how do we make sure we're as efficient as we can be and then really become, I think, part of the culture and part of the capability in the organization and the team is working together, I'd say it's across merchandising, operations, supply chain and sourcing, all kind of collaborating on how do we design for value. So whether that be, as Rodney mentioned, continuing to make sure we understand the cost that makes the product and build the product and get the product to our stores in a way that we're able to make sure we're being dynamic in negotiating and managing those costs effectively where they change, but it's also about optimizing product design. It's looking at product end-to-end and improving, whether it's packaging or product design and optimizing with customer demand alongside how we can then really match the customer expectations with how we're actually designing the products to really drive the maximum value. And I'd say a bit like the productivity savings, one of those things where every year, we see a road map to additional savings, additional opportunities. And I think that will continue to be the case based on our experience so far.

Great. And I have one quick follow-up on SNAP. Just giving any -- the potential changes there. How did you think about that with your guidance. And also, given you have such a diverse footprint, is there any color you could provide on the stores where states they've already had that extra allotment roll off?

If you look at SNAP, we've assumed that it's a meaningful headwind for the balance of the year. We're hopeful that everybody will work together to continue or find additional money because, as you know, because of inflation, there's a lot of people whose budget is under strain, but we have assumed that, that was a meaningful headwind both in the quarter and for the balance of the year. I don't know, Gary, anything you want to add?

No, I think it ties to the point about there is still uncertainty, so we're making sure that we're allowing for that in our guidance for the year. I would say historically, and you probably or say this before that it's actually very difficult to find a correlation between SNAP in the market and spend on food at home because typically, it tends to impact more discretionary spend. But I think our view was that we've never really had a point in time where we've had so much SNAP dollars in the market. So we believe most of the models that we've looked at for the last 30 years are kind of difficult to say, well, they hold true in this environment. So we felt it was important to be conservative given that we are in a unique time.

Our final question for today comes from Kelly Bania from BMO Capital Markets. Please go ahead.

Rodney and Gary. I wanted to ask just about what your guidance assumes regarding the broader promotional environment. And I guess particularly thinking about the back half when maybe inflation is at a little bit of a lower level, do you expect competition and promotional activity to heat up? This seems to be one of the key investor concerns as we head into next year.

Yes. Thanks for the question, Kelly. I think from our perspective, we feel that we have to be agile, and we're certainly shooting in our guidance that we'll be continuing to invest in value for the customer. I think one of the things that we believe has changed somewhat during the COVID environment is the situation of how the customer shops and engages with you is different. And what I mean by that is many more customers are engaged digitally, which gives us the ability to truly be able to personalize and bring together all the different pieces. So it's less about just what you see when you enter the store, it's about the fuel rewards that we can target for that customer. It's the personalized digital coupons. It's the Our Brands offers that, as Rodney mentioned earlier, can save the customer 10% on an equivalent basket if they decide to shift to some of those products. So we believe we've learned a lot through the pandemic of how do you really channel those dollars in the most effective way, and that's what gives us the confidence that as we think about the rest of the year. We'll continue to invest in value for the customer, but that we can do that even more effectively than the past to make sure that we stretch those dollars further to deliver value for our customers.

And one of the things that I think is always important to make sure a lot customers also decide where to shop based on how the freshness of product and the friendliness of associates, and that's part of the overall value equation. So when you look at how we go to market, we have personalized offers, we have promotions, we have fuel rewards. And the customer will engage in those to manage their budget and then they win by having incredibly fresh product and incredibly friendly associates. And that's how somebody decides where to shop. So I really think it's important for you to look at all those together.

Okay. Great. And just to follow up on the discussion of units and inflation. I think as we look at this year comps, 5% to 6% range with inflation, I believe, in the double-digit range. So maybe would imply units or tonnage down high single digit. And for next year, 2.5% to 3.5% maybe seems to assume a pretty meaningful acceleration in units. So just maybe correct me where I'm wrong on that math? Or just help us understand what would maybe drive a better unit or tonnage backdrop for Kroger in '23?

The unit change wouldn't be as much as you said because remember also, people are switching to Our Brands and other things, where the ring per item is less, but we sell more units. So when you look at overall, and if you look overall, we also look at share and if when you look at units in total, they're declining as well. So we would expect to continue to make progress in improving our share and the flow-through of units would come from that. I don't know, Gary, anything...

No...

Thanks, Kelly, for the question. With that, obviously, thanks to everyone for all your questions. And as always, before we close, I'd like to share a few comments directly with our associates listening in. We invite our associates to come to Kroger for a job and discover a career. And I can't think of a better example of this than an associate at our Cincinnati, Dayton division, [indiscernible] came to the United States from Togo. After a few weeks as a bagger, his store manager, Brian asked him if he'd be interested in leading the dairy department in his store. Because of the dedication, determination and great job that he's done, [indiscernible] is now the center store specialist, and I can't wait to see what's next for this amazing young man. I'm inspired every day by the amazing work each of you do and could not be more humbled to be part of this world-class team as we enter the next year. Thank you for making Kroger the incredible place that it is. Thank you, everyone, for joining us. That concludes today's call.

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