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Kroger Co. (NYSE:KR)

October 16, 2012 11:00 am ET

Executives

Cindy Holmes - Director of Investor Relations

David B. Dillon - Chairman, Chief Executive Officer and Member of Proxy Committee

J. Michael Schlotman - Chief Financial Officer and Senior Vice President

W. Rodney McMullen - President, Chief Operating Officer and Director

Jeffrey D. Burt - Group Vice President of Perishables Merchandising and Procurement

Michael J. Donnelly - Senior Vice President of Merchandising

Robert Kaufelt

Analysts

Jason DeRise - UBS Investment Bank, Research Division

Mark Wiltamuth - Morgan Stanley, Research Division

Deborah L. Weinswig - Citigroup Inc, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

Andrew P. Wolf - BB&T Capital Markets, Research Division

Edward J. Kelly - Crédit Suisse AG, Research Division

Meredith Adler - Barclays Capital, Research Division

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

Charles Edward Cerankosky - Northcoast Research

Michael Ellmann

Joseph I. Feldman - Telsey Advisory Group LLC

Colin Guheen - Cowen and Company, LLC, Research Division

Charles X. Grom - Deutsche Bank AG, Research Division

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Kelly A. Bania - BofA Merrill Lynch, Research Division

John Harris

Cindy Holmes

Good morning. I would like to introduce myself to those of you who don't know me. I'm Cindy Holmes, Director of Investor Relations at Kroger, and I'd like to welcome you to the 2012 Investor Relations Conference. We're glad that there's so many of you taking time out of your busy day to join us today. We also welcome those of you listening in via the webcast.

Before we begin, I'd like to make a few housekeeping -- address a few housekeeping items. The wireless network here is Network NY-2 [ph], and if you need the passcode and stuff, there's cards out at your table with the password and username on them. The restrooms are found back down the hall the way that you came in, and please be sure that your phones and BlackBerrys are in silent mode.

A quick look at our agenda today. Dave is going to open, then we'll have presentations from Dave and Mike. Then we will break for lunch around 12:30. After lunch, we'll have presentations from Rodney McMullen, Mike Donnelly and Jeff Burt. Then we will have a break. And then at the end of the day, we'll host an extended open Q&A session, then Dave will close it, and then we will end with a little -- some comments from Murray's Cheese.

Earlier this year, we conducted a perception study, and several of you took the time to participate that -- in that, and I want to thank you for your candid and honest feedback. We really took your responses to heart. We considered them as we put together today's program. I hope that you will notice the impact of this in today's message and know that you were a part of its development.

Before we begin, let me remind you that today's presentation will include forward-looking statements. We want to caution you that such statements are predictions and that 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. Kroger assumes no obligation to update that information.

Now I would like to briefly introduce the Kroger folks who are here with us today. Please just stand and stick your hand in the air when I call your name: Dave Dillon, Chairman and Chief Executive Officer; Rodney McMullen, President and Chief Operating Officer; Mike Schlotman, Senior Vice President and Chief Financial Officer; Mike Donnelly, Senior Vice President, Merchandising; Jeff Burt, Group Vice President, Perishables Merchandising and Procurement; Margaret McClure, Vice President, Deli Bakery Merchandising; Christine Wheatley, Senior Counsel; Keith Dailey, Director of Corporate Communications; and Julie Lacalameto, Executive Assistant to Mike and myself. And I'd like to take this opportunity to thank her for all that she has done to coordinate this conference, prepare slides, and all of the support she's given to me in my IR conference. Believe it or not, we've had a few belly laughs in the last couple of days. Thanks, Julie.

And now I would like to introduce Dave Dillon, Chairman and Chief Executive Officer of Kroger. Dave has been with this organization for 36 years serving in a wide variety of roles throughout the years. He grew up in the food retailing industry. His great grandfather first opened the grocery store in Hutchinson, Kansas in 1913. Dave is a graduate of the University of Kansas, holds a law degree from Southern Methodist University and sits on several boards. Please welcome Dave Dillon.

David B. Dillon

Thank you, Cindy. And got the clicker. Well, this is an inspiring room, and we appreciate you all joining us here. But because it's so inspiring, it may be daunting to make it as relaxed as we'd like to do. So feel free to come on in. There's plenty of spots over here on this side, more here than over here. I know we have some transportation issues, so there's going to be a number of people coming in late, and we welcome you to come in at any point. Restrooms out here, go out as you need. There's coffee in the back. We're going to serve lunch here in just a little bit, and it will be served right here at the back of this room, and we'll eat at the tables where we are now. So you can see it's going be informal, we hope.

So, Cindy, thanks. And like I said, welcome to all of you. Thank you for joining us today. We intend to make it worth your time and address topics of interest to you.

In a moment, I'll turn it over to Mike Schlotman, our CFO, but I first want to set the themes for today. Today is all about growing Kroger. You will hear how we are committed to produce higher earnings growth, a higher return to shareholders through dividend and stock buyback in addition to the higher earnings, and how this growth will be resilient and sustainable for the long term.

So now that I've gotten your attention, I first want to turn it over, then, to Mike Schlotman to give you a little bit of background and foundation. Mike?

J. Michael Schlotman

Thanks, Dave. And I want to echo Cindy's comments and thank Julie, as well as welcome you to the stock exchange. As you know, this is only the second time that Rodney and I can remember that we've done an Analyst Meeting in New York City. The last one was some 20 years ago or so. And I want to thank everybody for coming down. Hopefully, we'll have more people come in as the day goes on.

Before I begin into the -- my presentation is going to be the journey. I'm going to take us on a little bit of a trip down memory lane and go backwards a little bit to help you understand and just refreshen everybody's mind the journey we've been on the last 7 or 8 years. Before we do that, I want to start with some housekeeping items. And first off, I want to talk about where we are so far this quarter. Sales in tonnage for the third quarter are slightly better than when we updated you at the time of our second quarter earnings release, which was September 7. So both of those have shown some slight improvement from the levels we talked about a little over a month ago. This level of sales was contemplated when we raised our earnings per share guidance at that same time. And as a result, we reconfirmed our ID sales guidance of 3% to 3.5% and our earnings per share guidance of $2.35 to $2.42 a share, and we remain committed to maintaining the leverage ratio to support our BBB flat credit rating.

As I said, I'm going to go on a journey. I'm going to go all the way back to 2000 when we first, as a company and as a management team, started talking about how we were going to continue to be a viable food retailer in an ever-changing environment. And if you go back to 2000, basically, all grocers at that time continued to raise prices to increase earnings. It put many of us, including us, in an uncompetitive position against many of the new retailers out there that were coming out of that point in time, particularly Walmart. And we realized at that point in time that fixing price was an imperative. We really didn't have any choice at that point in time in our judgment if we wanted to be a viable retailer going forward. So on December 11, 2001, we announced significant price investments. As you all remember, our stock took a fairly dramatic drop that day because it came at the expense of earnings per share and gross profit margins.

In 2003, the significance of the Kroger Plus Card there is -- and that's one of the loyalty cards we have, was we formed a joint venture with dunnhumby, and called dunnhumbyUSA, and it has helped us understand where and how to make price investments that continue to be meaningful to customers, and Mike will go into more in-depth discussion on this in his section. And it allowed us to begin collecting customer habits on how they shop.

If you look at the time frame from 2004 to 2007, in 2004 is really when we first started talking about the Customer 1st strategy. We began investing in all 4 keys, not just price, but also products, people and shopping experience, because all 4 of them remain relevant, and we believe if we can compete and win on all 4 of those elements, we'll become a very difficult competitor for people to compete against.

Price has always gotten the most attention. We heard that loud and clear in the survey Cindy referenced that we did this summer. But the primary reason for that is we have, frankly, had the most work to do in price. So it shouldn't be surprising when you look back to that time frame that price has been the one everybody talks about because we were furthest away from where we wanted to be on that metric and on price checks.

To do that funding in price, we've been focused on sustainable cost reductions that don't affect customer service. I'm going to go through where we are in the 4 keys of our strategy in a second. But customers continue to give us credit even while we reduce operating cost for outstanding customer service. We look for process changes and things that don't affect the customer on a day-to-day basis, and we take those savings to reinvest back in 1 of the 4 keys.

2008 is called out by itself on the slide because, at that point in time, 2008 was actually our record EBITDA year. The strategy really was clicking quite well. If you look back at that point in time, the cost savings reduction we had over the period almost exactly matched the price investments we made in the reduction in gross margins.

Then the recession hit in 2009, and we call it through 2011. We made the conscious decision at that point in time to continue to play the game that had gotten us to where we were. We could've taken a different path. We felt that there was an opportunity to continue to gain market share as other competitors did different things to try -- play their game. Our ID sales remained strong. Our loyal household growth remained strong, but our earnings did drop somewhat in 2009 and 2010. Last year wound up being a record year again. And this year, we're in for another record year as well.

We emerged in a stronger position. We believe we have emerged in a stronger position than many of our competitors, whether you want to put us in the traditional food retailing category or you want to put us in wherever you want to wind up putting us. We believe that what we have done has set us a great foundation to continue to build from, and we are pleased with the results that we've had over this journey of about 8 years since we began the Customer 1st strategy. We think it has been the fundamental reason that we continue to post the results we have.

I want to -- as I said, I was going to talk about the 4 keys process. So here we are in 2012. Mike will have some more details as far as numbers on this, but we get a lot of feedback from our customers. We do this every quarter, and we track our progress in all 4 keys. If you think about where this is, just to set everybody's mindset, the base year in this chart is 2004. So everything is compared back to where our customers and how they said we were performing on a set of questions we asked in 2004 and the progress we've made so far.

So the blue section of this graph is where the progress we had made 2 years ago through 2010 when we last had a big Investor Conference in Cincinnati, Ohio. At that point in time, we were about 47% of the way to our goals. We called it about halfway there. If you fast-forward 2 more years, we're now on average a little over 60% of the way towards our goals. So we've continued to make steady progress towards our goals. And I want everybody to keep in mind what this is. This is not a graph of investments we have to make in these particular keys, so I don't want people to think, Oh, they've only invested 60% of what they need to in price. This is what customers tell us about how they think about our price position relative to our competitors.

So we're about 60% of the way to the reference point that we want our customers to tell us how we're performing. This is a lagging indicator. It takes a long time for perceptions on any of these 4 elements to change. And we're very pleased with the progress we've made so far.

Today, we're also going to commit to some metrics that we're going to report out to you on a quarterly basis. The first of those metrics we've done for a very long time, and it's ID sales, excluding fuel. If you look at this over time, obviously, this is a number that we've been very proud of, 35 consecutive quarters of positive ID fuel sales -- of ID sales without fuel. I don't think there's anybody else in all of food retailing, and we really consider the broad spectrum of food retail and when you do this, there's a lot of different competitors on here, not just what everybody wants to call traditional competitors. We look at the industry as food retailing industry, not just traditional supermarket industries. I think this speaks volumes to the connections we've made and continue to make with our customers.

The second one is FIFO operating margin excluding fuel. This is, obviously -- this is not a new metric either. But this is a metric that if you'd listen to the comments we've made about it, we are committed to growing this slightly over time on a rolling 4 quarters basis. If you look at the progress over time, just us by ourselves, it has come down. You can see it has flattened out. And recently, it -- you can't really tell at the end of that side, but it has started to tick up. And we remain committed to growing this metric on a rolling 4 quarters basis over time. And when we say growing, we mean slightly. It's not going to double, it's not going to go up 100 basis points in any particular year, slightly is slightly. I won't define slightly, but we want that end of that graph to start tipping up on a rolling 4 quarters basis. We think it's very important.

The next key metric that we're going to do, which is something we haven't talked about for quite a while, is return on invested capital. We're going to talk about this on a quarterly basis. We'll report out our calculation of this. It's going to be more of a textbook calculation. In the past, we've had different return metrics that were created internally that's caused some confusion. We stopped talking about ERONOA. This isn't really that different than ERONOA, but we're actually going to show those calculation on a quarterly basis on our earnings report, and we expect to grow this over time.

Now keep in mind, as you start looking at a return invested capital metric, and if you look at the slide for this, you can see that we're the bold red line in the middle, so we're kind of in the middle of the pack, not really stellar, not horrible. But we need -- we believe we need to grow that above the level that, that currently is. This won't change on a dime. As you know, the denominator of this is a huge number. It will take some time to have this grow, but we are committed to the fact and understand the fact that if we're going to get the permission to continue to invest the capital that we plan to invest, that we have to grow this metric to reward you all in the proper way.

The fourth is we're going to continue to report market share. The market share numbers we report are based on Nielsen Homescan Data. It's a very broad base. We are the dark blue chart, and you can see there on 2011, we're kind of cut out of the pie chart. This talks about the different segments of people who sell the products that we sell. So if you look at this, in 2007, our share in the total overall food industry was 19.7% -- or 19.1%. It is now 21.1%. So over this time frame, we've grown our market share 200 basis points. And you can see what the other folks that sell food and do what we do, what has happened to their market shares over time. We're very proud of our position in this. You can see in the red slice of that pie, yes, traditional food retailers define the way many people define them has gone down. But when we look at our share, not just in that group, but overall food retailing, our share continues to grow.

The important thing, I think, that we want to -- the other important point we want to make in this slide is there are winners and losers in every one of these segments. The conventional wisdom out there is that the traditional food retailing is going to go by the Wayside, and it's going to go to one of the other slices of the pie. Our belief is this slide refutes that. And if you look at some of the other slices of this pie, there've been winners and losers in virtually every one of the segments of this slide.

So if you look at traditional food retailers, there's those out there that are having their own lows right now. If you look at more of the upscale retailers, the natural and organics, while those, obviously, a few years ago sold themselves out to Whole Foods. And even if you look at the hard discounters, the segment that on all these Save A Lot would be in. The first time Save A Lot numbers were put out publicly, it was not a stellar number. So our view is that there are winners and losers in every segment. We can -- we expect to continue to be -- this is some of the informal nature of this, as I get some water to get that frog out of my throat. Thanks, Julie, I owe you. And Rodney, too, because I saw you go get it. People in the webcast are wondering right now what the heck is going on.

There are winners and losers in every segment of this. We firmly believe that there will be a space for a company that does what we do and how we go to market to interact with our customers on a day-in, day-out basis. We know our customers better than anybody. We've grown our sales better than anybody. And our market share is growing in a way most of our competitors can't match. And that's an important thing that we want you all to think about, is that it's not just traditional food retailing where there's losers, there's really been losers in every one of these segments.

Another point on Kroger that we don't get a lot of credit for sometimes is innovation. There's a lot of different items on this slide. We believe we're one of the most innovative companies in the food retailing business. We're actually a huge science lab, if you think about it. And since my section here is the journey, I'm actually going to go back a little further in time, all the way back to 1995 when we introduced our first U-Scan on a store in Louisville, Kentucky. It was kind of unheard of at the time that you're going to put a machine in a store that people would go up to and interact with rather than a human being, which was always one of the things that people thought about that was important part of customer service in our industry. Well, if you -- at that point in time as we were rolling this out at the beginning of this in 1995, utilization was around the 15% category. If you look at it today, we have over -- we have almost 11,400 robots in almost 2,000 of our different stores and our enterprise average utilization is in the low 40% rate.

Most people don't even remember that we were the first retailer, certainly in the food retailing industry, to even introduced U-Scan. And now it's almost news if somebody doesn't have a U-Scan in their stores because of the successes this has had. Some of the other items on here, you're going to hear more about later. The dunnhumby and some of the Simple Truth in the organic products that we've introduced, you're going to hear more about those over time. Have all these worked? Not all of them have worked as fast as the U-Scan has worked. Some of them are still in that science lab as we try to refine that process. But we keep trying, and you don't have to have that many of these that wind up being a huge success to be able to pay for the ones that you still continue to test.

Obviously, one of the reasons we're here today is this next slide. We get a lot of questions about this. We often get as confused to some of the questions that I get about why our stock hasn't performed. Sometimes I answer that with almost a rhetorical response, that if I knew, I ought to be let go because I should've been doing it if I had that magic bullet to change the results of this slide. We really do believe we built a solid foundation. And the biggest explanation I can -- I have for this is the fact people don't believe we have a future, because this doesn't even give us credit for flat performance from where we are in today's multiple. It just doesn't make sense in our stock performance. That's one of the reasons that we continue to invest dollars in our own buyback program. We've been very aggressive, as you know, over the last several years of buying in our own stock, because we do believe the stock is undervalued. Hopefully, you all will come to that conclusion. One of our goals for today is to drive that element home. And when you leave here, you leave here with expectation that our stock is undervalued today, the same way we view that.

So in summary, we built a very stable foundation, and Dave kind of gave a teaser at the beginning of this, and I'm now going to bring Dave back up to go through the metrics that we want to announce today. And off of this foundation, we intend to grow over the next several years. Thank you. And Dave?

David B. Dillon

Well, Mike, thank you. I'm going to bring my own water up here. I don't know about that. Mike, thanks. As you can see from what Mike established, he talked a little bit our foundation, trying to give you a sense of the journey and its importance. I'd like to glance at that journey through the eyes of all the constituents that we deal with.

First, from the point of view of the customer. I think it will not be a surprise you that our customers feel like they have won these last 10 years at Kroger. You can see it in our metrics. You see it in our identical sales. You can see it -- in addition to identical sales, you can see in our tracker results. Identical sales, by the way, Mike mentioned it, but 35 quarters in a row, all the way through the recession and well before the recession, we've had positive identical sales. That tells me that we have connected with customers, and that's essential.

In addition, the customer tracker results, that Mike also showed, have improved over the last several years as well. That shows that connection. So the customers have won in this journey. Our associates have similarly won. Our associates have won -- one way to measure that is our associates survey that we do every year. It measures the engagement of our associates. We call that -- refer to that as our engagement score. The engagement score is real important to us. And we just got the results for this year's survey, and we went up substantially. At a time when it's hard for businesses to improve engagement of their associates, we were able to improve it. We see that as a really positive result and believe that it's a strong result for our associates.

Then the constituents for the shareholder, all of you. Well, certainly, our dividend has improved, that's a good sign, but our stock price has not. And on that metric, we're not particularly happy, just as you're not happy. Go back one here. Here we go. Good. Just as you're not happy. And the shareholder results have not been strong for a variety of reasons, but we think they do not adequately reflect the growth we've had in our earnings. I've got my own theories. You might have yours. My 2 favorite are that publicly-owned supermarkets are out-of-favor; and second is that many of you have told us that at Kroger, our long-term earnings growth is not aggressive enough. And I will be happy to discuss those during Q&A, but we want to start by addressing some of these issues, and we have identified new targets to reflect our confidence in the future.

The first of which is on the screen here now. It's the new long-term earnings per share guidance growth rate of 8% to 11% rather than the 6% to 8% that we previously had been using. Second is a new higher dividend, which we announced in September of 30%. And each year, our intention is to review the dividend. But also to that, we add stock repurchase, and we are reloading today. Our board acted today to reload our stock purchase authority up to $500 million. We had not completely use the previous authority. I think we've used about -- we had about $340 million left, I think, in that ballpark. But it's reloaded effective today at $500 million.

We are investing to grow our business by increasing our capital expenditures. We are targeting to spend an additional $200 million per year in a very targeted way. There's $200 million in 2013, another $200 million in addition to that in 2014 and so on. And then we are adding some key metrics to measure our success. Mike went through some of those, but I'll talk a little bit more about those as well.

So let me give you a few more details. First, these new higher earnings targets and guidance are the reflection of the confidence that we have in the foundation that we've laid. We think that's very important. That's why we had Mike go first to help give you a little bit of that history. That foundation is quite important.

But second, and that's not all, we've stood back from our business and said to ourselves, Where do you want to plan and how do we want to win and how we shape the outcome intentionally? And we've identified several big tactical steps that we plan to take, which I'll describe now, and we can talk more in Q&A, and you'll hear a little bit more about them in some of the presentations.

We plan to take some of the targeted capital expenditures, and we plan to look at fill-in markets, places where we have the opportunity to grow, places that we don't have the market share that we might have in some other fully developed markets. And, frankly, as you'll see, even in fully developed markets, we still have room to grow. In fact, plenty of room to grow. But in these markets that are not as fully developed now, we see big opportunity, and we plan to invest in some of those markets to grow our earnings.

Second, we plan to identify new markets, not something you've heard us talk about much in the past, but we plan -- we're not going to identify which markets, certainly not today, but our intention is to identify new markets and to make plans and to expand the footprint of the company.

Third is our customers tell us that they love the communications that we have used, particularly in the personalization area. We've been doing that for years. But our customers are moving more and more into the digital arena, and so we are targeting to spend greater energy and some CapEx in the digital area. We'll actually have some demonstrations on that in just a little while.

Fourth, we're paying attention to the growth in the value-conscious customer. We've seen in the U.S. society that the customers are changing and the value-conscious customer is growing. And we think that, that's a long-term directional trend and not something just the result of the recession. We're quite good in that arena. Our data helps us there. We think it's important for us to pay attention there, and so many of our tactical steps will take that into account.

And fifth, and this is important to note, too, as we talk about the journey, we plan to have continued improvements in our core business. And that may sound a little boring, and it may actually be boring, not to the customers, not to the customers, to you, but it produces results. It is what grew our earnings these last 3 years. We've grown our earnings per share, our cash flow, our EBITDA, all of that, and identical sales, of course, have grown, and market share has all grown. We did that by doing the basics really well. It was our core that produced that. So don't discount the core at all but also consider the 4 items that I listed before this that are quite important to our success and to our growth.

Well, Mike talked about some of the key metrics, and I want to talk briefly about those, too. These key metrics will help drive shareholder value. That's the intention, to hold us accountable for shareholder value to clearly see where we're going. These metrics are interesting because if you look at the list of the peer group that Mike listed up there as the comparison, it wasn't our standard peer group. It wasn't even your standard peer group. We intentionally upgraded the peer group to reflect the people who are winning today at food retailing, including Kroger. And we believe that we should be held accountable to those kinds of the results.

So as we walk through those, we look at the identical sales and, of course, we have terrific results there, particularly the fact there's 35 quarters in a row. And that -- I believe that's the most important metric for any good retailer. I believe that because it is the most clear measure of relevancy to customers. And any retailer that loses that relevancy loses in the long-term. They may not lose in the short-term, but they will lose in the long-term.

The second metric that Mike identified was FIFO operating profit margin growth without fuel. That number, we haven't always talked about because, as you know, you've heard me often say that I don't get too hung up on margins. And yet, we went through a recession, and our margins on operating profit went down too low. And we recognize that, that has to rise. And so we're going to take that seriously. We're making that as one of our long-term commitments and one of the key metrics that we will follow regularly with you.

Return on invested capital. That replaces ERONOA. We concluded that a measure that everyone typically follows, rather than one that we developed, even if we think ours is a better indication of success or lack of success even, we think that this is a metric that you all follow, understand, and we're adopting it as a result. And frankly, when we looked at our own metrics and the chart that Mike showed, we weren't particularly happy with being just kind of in the middle of the pack. Now on ROIC, the objective isn't to be at the top of the heap either. What you want is a good, steady, solid return. But we're not happy with where we are, and we expect that number to grow.

Market share. That's a number we regularly have talked about and we'll keeping talk about because for Kroger, at least, it's a very important metric as we -- as you'll see in some of the later presentations, as we increase market share, we generally have improved our relative performance. It's not just -- it's a rather geometric progression rather than arithmetic progression. So that's an important one, too.

So in closing, before we go, we have lunch in a little while, we're going to take some Q&A first. And after each presentation, we plan to take time for Q&A. And since Mike didn't actually take time for that, I'm going to invite Mike to answer some of the questions that you all have for me and for him. We'll do that. I'll recap briefly the objectives that I've just listed, and then I'm going to show you a very brief video on sustainability, and then we'll go to lunch. So we have about 30 minutes or so for Q&A before we get to that.

So let's take your questions starting over here. Yes? Yes. I'm going to step out here so I can see a little better.

J. Michael Schlotman

Is there a microphone, Cindy? Do we have a mic? We're going to bring a microphone out, so hold on just one second, so the questions get over the webcast.

David B. Dillon

Now forget about -- with webcast, you got to make sure the mic is on, or I can walk up and have you taking to mine, if you want. Okay. Here she comes, so we got them.

Question-and-Answer Session

Jason DeRise - UBS Investment Bank, Research Division

It's Jason DeRise of UBS. Could you talk about a little bit more color about the drivers of the 8% to 11% EPS growth? Is that, basically, what you were doing before but now adding square footage from the CapEx spend, or is it a combination of...

David B. Dillon

Actually, it's a combination of 2 big elements. First is that we think our base business, the core business, will produce -- particularly the successes we've had in the last several years, will produce better results. That by itself produces an improved overall long-term result. And then secondly, as we stood back from our business and identified some specific areas that we can grow our business, for instance, spending additional capital and targeting it, and it won't be just the additional $200 million that produces this, it will be making sure we keep targeting as we have actually the other capital that we spent, so we have the base capital that actually is producing a result, and that achieves part of the increase. And then targeting on fill-in markets and expanding into new markets we think helps give us the assurance of the long-term success. It's an indication, too, of the confidence that we have and the things that we pull together, both the new specific things that we're identifying today but also the openings that we've been working on for some time that they will produce a better improving result. It is not just wishing and hoping. It's not just setting a new higher target. It's an intentional plan to improve our overall growth performance. Some will continue to be driven by stock buyback, and Mike, you may want to comment on stock buyback but some, of course, will be driven by that. And you saw we increased the dividend, which takes some money away from the stock buyback.

J. Michael Schlotman

Yes, the -- Dave's commented the board reloaded that buyback authority to $500 million. You may wonder that -- in fact, Dave even asked me this question yesterday, we're only down to $340 million or $350 million, in that range, why would we want to reload only up to $500 million. And the biggest reason in my mind is the fact that demonstrates the board's commitment and view that share buyback will be an important part going forward, and it will play some role in that earnings growth target. It probably won't be as aggressive as it's been over the last 18 months. As Dave said, as we use more dollars for the dividend and invest more dollars in growth capital and then the fill-in markets and new markets, obviously, you have to balance that, but we did want to have the commitment out there and demonstrate that share buybacks will continue to be an important part of our playbook.

Jason DeRise - UBS Investment Bank, Research Division

Can I just follow-up? Growing the base, does that -- in terms of the gross margin progression that you've had over these years and generating the absolute gross profit dollar leverage over SG&A, is that part of the equation changing a little bit? Are you going to be less aggressive on that?

David B. Dillon

On the price?

Jason DeRise - UBS Investment Bank, Research Division

On the price, because you've done all the work over the last 10 years, or is it...

David B. Dillon

Well, actually, you shouldn't read that into it exactly. What you should read into it is that, as Mike said in the journey, when we first started on here, we had the most work to do on price, and it was, frankly, a very serious issue. In our view, it was the game changer. If we had not changed the trajectory and price back then, we think we would be left holding a really tough bag right now. So we had to. It was an imperative. But as years have gone on and we've made that investment and we've added to that investment, and we've been very strategic about that, it becomes less of an imperative and a little bit more of a choice. Now on the long run, there are still plenty of places that we think adding price investment would be valuable, a good return for shareholders, a good long-term effort. But we're at a point where we can do those in a more orderly process, and we think pair those with cost improvements and allow, then, the operating profit margin to grow. It won't grow quickly, as Mike said, it would be gradual. But our intent is to not over invest in price over, at least over any long period of time. Our intent is to try to make sure it's quite balanced and that we would improve the operating profit margin. Do you want to add to that?

J. Michael Schlotman

No, I mean, it's really about balance, and it's what we've started to do over the last several quarters. It hasn't been perfect every quarter and 12 weeks is a short period of time for everything to be perfect. But if you look at a slightly growing operating margin in a rolling 4 quarters basis, continued strong idents [ph], the natural outcome has to be what Dave said, better performance in the core. And as we get more prudent and diligent over a rolling 4-quarter period, about how and what we invest in and how many dollars are falling to the bottom line to grow that operating profit margin, it's really the natural outcome of the math. We'll move on to -- Mark, do you have a question? Pass this mic right up. There you go.

Mark Wiltamuth - Morgan Stanley, Research Division

Mark Wiltamuth from Morgan Stanley. I guess I want to dig a little more on what's really changing in the return profile because you're still sticking with the tone of a flat to rising operating margin, so that's kind of the same tone. The comp is still relatively strong. So is it more of a change in what's going on with the denominator of return on the invested capital? Is it that you're going to do more buyback or more dividend and that's going to be what really moves you on an upward plane?

J. Michael Schlotman

Well, the 8% to 11%, obviously, doesn't contemplate the dividend. The 2.5% yield is on top of the 8% to 11%, so it would give you a total return of 10.5% to 13.5% when you add our current dividend yield. And it's -- Mark, I wouldn't say it's necessarily a trajectory change, it's just a firmer commitment and holding ourselves accountable for actually delivering that rolling 4 quarter's operating profit margin increase. Will it be perfect every time? No, there'll be bumps along the road. There'll be some quarters that aren't right. But we think on an annual basis, we certainly have the ability to balance our investments with the cost savings we have and the strength of our ID sales at that point in time where volume is in the like to be able to manage our way through on an annual basis to have that kind of an outcome.

Mark Wiltamuth - Morgan Stanley, Research Division

And I guess also on the -- how does the operating environment factor in here, because I think back to your analyst meeting a couple of years ago, you kind of gave us a message that, I hear you, investors, that we should be putting more margins through, but the operating environment didn't exactly cooperate in the following 2 years. So how much of a cushion do you have in your plans if the operating environment is kind of aggressive on pricing, and can you react to that?

David B. Dillon

I think the operating environment issue is more one for the customers kind of environment are they living in today. And we think the economy, of course, has improved gently, and that helps the picture a bit. But the value customers are still stretched. We still are getting a lot of food stamps, very high dollar amount, a very high percentage amount, and that is definitely problematic. So I think it's that operating environment that actually is more important to our overall long-term success. Now the competitive market, of course, plays into it in the short term. And we, of course, have been successful in operating in that kind of environment before, and think we're pretty good at a street fight actually. I don't expect one. I think -- I actually think the environment is fairly sane right now. People are making very logical judgments. Yes, Deborah has one up here. We'll pass the mic on up.

Deborah L. Weinswig - Citigroup Inc, Research Division

Deborah Weinswig from Citigroup. You stated, as you have in the past, you continue to look at fill-in markets versus new markets, but, obviously, we're in a very interesting time in the world of traditional food retailing. Can you talk about that kind of focus on growth and why at this point, your kind of growth pattern, you continue to look at fill-in markets?

J. Michael Schlotman

I think Rodney has some slides that I think are going to demonstrate how we think the value of our fill-in markets are, where he's going to compare and contrast a few markets and look at potential share or potential opportunities in the fill-in markets, so I don't want to steal his thunder. When we look at new markets, this is organic growth in new markets, this is not acquisition. Obviously, if the right acquisition was there that had the right metrics, we, frankly, think our operating model is better than many of the operating models that we may be able to acquire. It's really just the confidence and comfort we have with the foundation that we built so far, and we think it's time to look at moving that model to some new geographies.

Deborah L. Weinswig - Citigroup Inc, Research Division

And then, Dave, you spoke about the kind of growth opportunity with the value conscious consumer. Can you talk about how you continue to evolve your business model to further take care of that customer?

David B. Dillon

I won't give a lot of the details but, suffice it to say, that there's a wide range of choices, and we're actually working on all the fronts. So for example, in our existing store base, product choice and entry price points in the categories that matter most to the value customer are an example of ways in which we address that group. Certain stores, what we will display and what will be promoted will be important to that group. We have -- we've worked -- done some work in stores that are specifically value stores that tend to have more value customers, too, that are more price oriented and had some -- and had good success with that as well. So it's going to be a wide range of specific targets in a store to what we offer in all stores because every store has some value customers. In fact, value customers aren't just people who have a really tight budget. They're people who make decisions, purchase decisions, based upon choice of price, not so much even on promotion but actually more on entry-level price, how inexpensive can I put this meal on for my family? And so we actually do address it in every store.

J. Michael Schlotman

Also, don't think about it as somebody who's just on a budget, it's really the whole mantra in the states of the value consciousness of many customers today. And regardless of your demographics, there are plenty of people in multiple demographics that want to save money, and food isn't something that what they want to spend a lot of money on, and it's about going after all of the value conscious people not just the shopper on a budget.

Deborah L. Weinswig - Citigroup Inc, Research Division

And, obviously, your dunnhumby data gives you better insight into that customer than maybe some of your peers?

David B. Dillon

Absolutely. The dunnhumby data not only tells us within a store what's happening and what customer combinations are there, but within households, what's going on in these households, and then what do they like to buy over a long period of time. It's one thing to look at a basket of goods and see what they buy together at one moment, but we can see what they buy over a long period of time. And with work we do in other data pieces in the market, we're able to see not only what they buy at Kroger but also what they buy in other places too. So it's actually quite insightful. Thank you. Did you have a question down here? Did you have one over here? You just need to grab it.

John Heinbockel - Guggenheim Securities, LLC, Research Division

John Heinbockel, Guggenheim. So just to follow on the issue of M&A. Do you think, given the condition some of your peers are in, do you think there will be more -- I wouldn't talk about their individual markets but more decent assets, traditional food retail asset stores coming to market in the next 18, 24 months than we've seen in the last couple of years?

David B. Dillon

I don't know that I would speculate on that, actually. It's a dynamic market. It's always changing. And on the acquisition front, we've said the same thing, actually pretty routinely, that we look at lots of things, intentionally look at anything that comes across to our knowledge because we want to be aware what's happening. But generally speaking, the things that have worked the best for us are some fill-in acquisitions that go in to existing markets that allow us to extend that market. Those have actually worked quite well and those -- that's what we've done most of.

John Heinbockel - Guggenheim Securities, LLC, Research Division

So what about transformational, what you've done in the past, right?

David B. Dillon

We've occasionally done those. The Fred Meyer acquisition was, of course, transformational for us, and that's how I came to Kroger, too, in 1983, when Kroger bought the Dillon company. So that was, I think, transformational both for Dillon and I hope for Kroger. And those kind of steps, yes, we do take those, but those are -- you can see, from 1983 to 1999, those are far apart. They come across every once in a while. It takes the right combination of assets, the right combination of people and the right pricing position. I mean, it just takes lots of things to happen at the same time, and they sometimes happen.

J. Michael Schlotman

One of the things we always look for in that kind of a situation is what can the company that we want -- might merge with would bring to the party. And in both of those instances, Dillon companies brought something to it. One, great bench strength -- no harm and sucking up a little -- it brought -- we probably wouldn't be in the supermarket fuel business if not for the Dillon acquisition because of the convenience stores they have and their expertise in buying and selling fuel. Because even today, the fuel acquisition for our supermarket fuel centers is done by the convenience store supermarket -- the petroleum group.

David B. Dillon

In fact, the guy who does the buying for supermarket gas, who leads that operation for us, I went to high school with him. I've known him, basically, my entire life, and he is damn good.

J. Michael Schlotman

If you look at the Fred Meyer merger, we wouldn't -- our non-foods, our general merchandise and the things we've done with the marketplace format, we would -- that would not exist today without having had that strength that they brought us. We brought things to the party the other way. But we truly look for mergers, not acquisitions. And it can't be a merger if only one party brings something to the table.

John Heinbockel - Guggenheim Securities, LLC, Research Division

So more likely, if there is something transformational, and you think about format versus geography, it can't really be just geography. Format and know-how has to be a more important part.

David B. Dillon

I think the team would be very important, sure.

J. Michael Schlotman

Let's go right to Andy.

David B. Dillon

Yes, let's go to this side. Sorry, I wasn't trying to ignore you intentionally.

Andrew P. Wolf - BB&T Capital Markets, Research Division

That's fine. Andy Wolf, BB&T. I want to get back to the new store growth. I didn't see your press release or K, 8-K, but I don't know if out's there, but did you -- are you formerly saying you're going to be actually adding that -- new stores? Or are you going to build through a square footage growth goal that is greater than what you've been doing?

David B. Dillon

We do intend to add more stores. Do you want to add...

J. Michael Schlotman

There'll be both a press release and an 8-K that goes out. Obviously, we wanted you to hear the news from Dave not by reading it. And since we're webcast, we didn't have to put it out in advance because we're okay under FD. I won't be updating square footage guidance in that 8-K, it's really purely updating the 2012 metrics. And when we announce earnings in March for the full year, that's when we'll update you on our growth targets for '13 and what we expect our square footage growth to be at that point in time. But you should assume, as we go down this path and we spend more capital, my expectation is, is that square footage will grow over time, or at least store count. Sometimes we'll close two 40,000 square-foot stores and build one 120,000 square-foot marketplace store. So store count may go down. So it's a dynamic situation.

Andrew P. Wolf - BB&T Capital Markets, Research Division

One other quick one on the competitive environment, and Walmart is committed to ramping up neighborhood markets. Can you talk about your typical Kroger experience when -- store experience when the neighborhood market opens against it versus a typical supermarket opening against a Kroger store, and I guess a supercenter, highly productive center.

J. Michael Schlotman

Write that question down. Ron is also going to address some points particular to how we compete against Walmart in different markets, and hopefully his slide will answer part of that, and we can defer the answer to that after his comments when you see what Ron is going to talk about in those markets.

David B. Dillon

Okay, yes. Cindy, do you want to take the mic back there?

J. Michael Schlotman

We'll crisscross. We need a traffic light.

David B. Dillon

Okay. I got it. We'll go to this side over here.

Edward J. Kelly - Crédit Suisse AG, Research Division

Dave, Ed Kelly, Credit Suisse. So I 'd say I find this meeting, so far, pretty interesting, right, because I think a lot of times, we come out and see you guys present and we get the impression that you sort of manage your business looking over your shoulder. And today, it seems like there's been a bit of a change in tone, managing it from a -- more of a position of strength. So I was hoping you can maybe just talk to us about what's changed over time on that front. And then just a follow-up, maybe, to Andy's question. We did have a Walmart meeting last week, right? And Walmart is obviously looking to be a more aggressive player. So to what extent did that factor into the way that you're thinking about this guidance going forward?

David B. Dillon

Well, let me answer the first question first. I'd say you recapped it quite well. It would be one thing to say, and I think you would be accurate to say, that I tend to be, I personally tend to be, a little on the conservative side. I like to under-promise and over-deliver. I don't like to do that in the extreme, but I do to have that tendency. And so you could draw the conclusion that maybe I'm just getting over my conservatism, but that's not it at all. What really happened is that our management team got together, and we reflected on where we were and what our performances has been, and it was just like I've said, we're happy with what our customers have experienced at Kroger. we're happy with what our associates have experienced at Kroger. In fact, we're ecstatic about how well our associates have done and the job they've done in connecting with our customers, but we're not happy about our stock price. And we had to have a serious review ourselves, and ask ourselves, So what's holding us back? And our conclusion was that we weren't stepping out intentionally in growing our business in a way that produce shareholder value, and that was holding us back. And so we identified some very tactical, tangible steps, and more than what I've outlined but the ones I outlined are the ones we're willing to talk about. We identified some very specific tangible steps that we think we can take that will add to the trajectory of our core business. Our core business already, in our view, will produce a better result than the 6% to 8%. We think by the efforts we make there, that will matter. But then adding these other steps will make it better and will get us into the range long-term that we're after. We decided that we have to be counted on. We decided that if you're going to ever believe that our stock price deserves to be rewarded, we have to step out and say, We can do this. And we can do this. We are a confident group, and it's not confidence just based on saying and wishing and hoping. It is based on our track record, last 3 years in particular, but I would even argue, the last 10 years shows what we're capable of doing. And we're stepping out today to be counted. That's the answer.

J. Michael Schlotman

Meredith?

Meredith Adler - Barclays Capital, Research Division

Sort of underlying your assumptions about the ability to grow the business is assumptions about expense growth, and you haven't really talked very much. I think one of the concerns, overhangs for the whole group, is pension expense, especially multi-employer, that's what you guys have to worry about. But maybe you could talk about whether you have a view of what the growth rate of expenses is going to be over the next couple of years, or what's assumed in your 8% to 11%?

David B. Dillon

Meredith, thank you. I'll let Mike talk about pension but, before he does, let me just add this comment. The dynamics between our gross margin and our expenses over a long period of time is a dynamic combination. So in any given year or any given several years, you may run into times when expenses are our problem, in which case you modify what your plan is regarding gross margin, or expenses may be better than we were expecting, in which case you might be able to try to put the combination together and grow the margin a bit. There's lots of ways in which that works, and it's something we call almost like an audible, every year you look at that as a different play. Now to get these kind of long-term guidance, we have to look out further than just a year and say, what are we really expecting, and why would we have confidence just by looking at that kind of distance? In that context, you may want to comment about...

J. Michael Schlotman

Yes, obviously, pension continues to be something that's out there. As you know, last January through December, we announced that we took that issue off the table for about 1/3 of our obligation, and we're now in control. We have a 10-year agreement on what that pension benefit will be. We're in control of the investment side of those assets. I look at it, not only do -- have our labor negotiators done a good job, but if you look at the last -- couple of the last contracts that have been approved, those contracts have actually been contracts who participate in the new pension plan. So when you take that big elephant off the table and you can rationally negotiate work rules, health care and wages and have that overall contacts and have certainty of what your health -- your pension costs is going to be, that puts us in a favorable spot. We have estimates built in for where we think multi-employers are going to go in the rest of those funds. Keep in mind that, that obligation is a very, very long-term obligation. There's not a single event out there that causes you to write a great big check in the near-term. And we think over time, we'll continue to be smart people, work toward smart resolutions for the pension exposure over time.

Meredith Adler - Barclays Capital, Research Division

I wanted go back to Dave, just for one second. You talked about your ability to balance, I think, what you see going on in expenses, and how much you would invest the gross margin. But can you say to us with confidence, since you're a conservative guy, that you're in control of that process of balancing the gross margin versus the expenses?

David B. Dillon

We -- I can say with confidence that we are in control of that combination over a longer period of time. Sometimes quarter-to-quarter numbers have aberrations in them, and we don't -- we, frankly, don't try to manage that. Because what I've found is if you do try to manage it -- we can manage it if we choose to, we choose not to. Because if we chose to manage it, while we would hit numbers that you might like, we'll do damage to the business. But we can manage it with confidence over a longer period of time, say a rolling 4 quarters. I think that's a better way to think about it. And that's how I feel about this, and that's a good question to ask our team as they present in a little while because Rodney and Mike, in particular, will be talking about topics that will be relevant to that, so bring that up again. So where do you want to go? I'll let you decide that.

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

Scott Mushkin with Jefferies. So I obviously applaud the move that you guys have made, particularly on the return on invested capital market share. My question is, and I'm sorry I'm not familiar with the proxy, but I wanted to understand a little bit, now that you've drawn out these 4 measures, how will they work through, not just us, but also your computation and your incentives as a management team, maybe even down a little bit.

David B. Dillon

You want to comment or shall I...

J. Michael Schlotman

A quick recap on what our bonus structure is and it's -- today it's primarily based on sales -- ID sales performance without fuel. It's based on EBITDA growth not earnings per share growth, because I can buy a lot of stock and do great on that metric and not grow EBITDA, so it's based on EBITDA growth. And then there are metrics about our Customer 1st strategy whereby there are certain strategic elements we want to have to reach milestones on a given year, so it's really the collective results of the organization and how we did on that. Those are the 3 main pillars of it. There's not a specific return metric within our current bonus structure. My guess is, as we start talking about an ROIC kind of metric, as far as holding ourselves accountable for it, it won't surprise me if at some point in time, our comp committee elects to put an ROIC kind of metric into our -- if not our annual bonus plan, our long-term plan. So my guess is, is now that we're going to go public with that, our comp committee and one of those plans will probably put part of our compensation on our results compared to that. We haven't done that, but it's certainly something that's becoming more and more contemporary in every company's bonus plans.

David B. Dillon

As a philosophy, we believe that what we do and pay should be in alignment with the strategy that we're attempting to execute. And so it would be logical to have a conversation with the comp committee, which we would intend to have, about what are the implications of these kinds of measure and our long-term objectives, what are the implications of that with the compensation model that we currently have. And over time, I've learned you don't want to take compensation plans and take hard right or hard left turns suddenly, but, rather, you want to move them in a direction of alignment with what the strategy you're trying to support. And so we'll have that conversation. We've not had that conversation yet because we not had a comp committee meeting since middle of the summer. So at the next one, though, it will be part of the dialogue.

J. Michael Schlotman

And I said when I talked about the ROIC, it's a longer term lagging measure, so trying to have that in an annual plan is a little bit difficult to have meaningful movement on a 12-month basis. But in our long-term plan that covers 3 years, that's a different dynamic.

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

And when's the next meeting of the company?

David B. Dillon

I don't think we publish that. We have several meetings a year, though, so it won't be too far down the path.

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

And will there be an announcement if there's a change? I would assume yes.

David B. Dillon

Well, of course, it would be described in the proxy. I don't know the timing on when that would be, but our intent would be -- it's not something we try to hide. In fact, it's something we're proud of. Because at Kroger, we see performance as essential to our conversation plan, and we wanted to actually reflect performance that matters. Our board does, our management team does, and so there's no reason we wouldn't want you to know. The only question is, what's the reasonable timing to disclose it once we figured out what we've done. Once we've communicated it in the organization, I would think fairly shortly after that we would make it known. We certainly won't hide it.

David B. Dillon

Do you want to take time for a couple more?

J. Michael Schlotman

Yes, we'll go now to Chuck.

Charles Edward Cerankosky - Northcoast Research

Charles Cerankosky of Northcoast Research. I like the idea of the ROIC target being there and increasing. Can you tell us how you would raise it without taking into -- and having that target while you're going to step up CapEx, can you tell us how you're going to grow it without means that reduce the denominators, such as buying back stock and increasing the dividend?

J. Michael Schlotman

Well, the denominator on the invested capital is, when you look at the assets minus the payables and the accrued, that would be the invested capital that we would look at, not necessarily the stock side of it. So the other part that's in there is if we can get better on working capital performance and reduce our investment in working capital or net owned inventory, that certainly will help the ROIC metrics. We really do believe that as we invest this incremental capital, the time frame from when an investment happens until the store starts to produce a better return than historical performance, that, that time frame is shortened. And there's still that immediate drag upfront, but I go back to Dave's earlier comment that this isn't all about the incremental capital, the $2 billion to $2.2 billion base capital will have to generate a better performance. And everybody knows we've changed how we allocate capital for new relocated and expanded stores, and part of our confidence is, is what we're seeing in those projects that come in. The number of the projects and the strength of those projects, all of those have played a role in getting us to where we are today. We probably have time for one more question.

Unknown Attendee

Mike Becker [ph]. Just you talked about the FIFO operating margins going too far, too low. Just wondering if you wanted to share with us a target, maybe 3 to 5 years out, where you think you could -- you could be. And then a follow-up to that would be, what are the drivers to get there? And do you need to drive a higher ID to leverage your fixed cost base going forward as part of that?

J. Michael Schlotman

Yes, I'm not really ready to go out any further on guidance numbers than the broad numbers that Dave talked about today. I probably even won't, in March, talk about a specific goal for where operating margin could be. I think a firm commitment from the management team to growing the operating margin, the FIFO operating margin, excluding fuel, is a fundamental part of our ability to have that higher earnings growth. So I would be very surprised if we actually got to establish a specific target, because we want to maintain the flexibility. We had a question about the competitive environment. There may be a year that you can grow a few more basis points than another year, but if the competitive environment is a little more difficult -- and as Dave said, we're okay with street fights, we haven't had any in a while -- and if that's the case, we may only want to grow it 1 basis point or 2 basis points and not very much at all. So we want to maintain that flexibility without putting in a specific target out there and happen to mess up the rest of the foundation I spoke of just to hit a specific operating profit margin number that for that year maybe good but for the next 2 or 3 years, may not be very good for us or you. With that...

David B. Dillon

Okay, let me summarize. Is that all right? This is what we talked about. Growth strategy at Kroger, call it, growing Kroger. First is fully diluted earnings per share long-term growth guidance of 8% to 11%. Second is targeted increase in capital expenditures, incremental $200 million a year beginning next year. Third is a higher dividend over time, and I would add to that the stock buyback and that authority that we put in place today at the $500 million, and then adopting the key metrics of success and looking at a peer group that actually matters as we do that. This is what we're committing to. This is what we believe will grow Kroger and will grow shareholder value in the future. We think it's an exciting time. We do think it is a difference from what you've seen from us in the past, and we appreciate you being here to see this.

Before we break for lunch now, we're going to show a video and this video is about sustainability at Kroger. It's a different topic, but we think you'll enjoy hearing a little bit about it. It's very short. And once it's over, we'll have lunch over here in the lunch line, or you can use the tables where we are.

How long, Cindy, will we have for lunch?

Cindy Holmes

[indiscernible]

David B. Dillon

Okay, so we have plenty of time, you can return phone calls, and we can even have some informal chat time during that time. So let's play the video.

[Presentation]

David B. Dillon

Lunch.

Cindy Holmes

Good afternoon. I hope you all enjoyed the lunch. That was very good. Our first speaker after lunch is Rodney McMullen, Kroger's President and Chief Operating Officer. Rodney is a 34-year Kroger veteran with responsibility for all supermarket divisions, advertising, customer relationship, marketing, manufacturing, merchandising and procurement, pharmacy and retail operations. Rodney serves as a Director on several Boards, and is an alumni of the University of Kentucky. As Rodney makes his way up, I want to play another video for you. This video demonstrates just a few of the many ways that Kroger supports our associates and the communities where we work and live. I've seen this video several times, and it's very moving every time I watch it. It really makes me proud to say that I work at Kroger. Thank you.

[Presentation]

W. Rodney McMullen

Good afternoon. To me, I have to agree with Cindy, every time I look at the video, I just -- it reminds me of one of the things that creates the connection with your associates and customers, well deeper than what the price of Tide was last week or milk or anything else, and it really is connecting with the customer at a higher level. And you've seen us over the last several years, in Mike's chart, you saw the progress we're making on our connection with our customers in Customer 1st tracker. These are the things that we're doing to change that connection with the customer, to really make it deeper, and obviously, with our associates, the same thing. Because we all, in what we do, we want to make sure we have meaning in what we do on a daily basis. And when you can make people's lives better, what more excitement do you get out of being able to do that. And that's what our associates are able to do, is to make people's lives better and make each other's lives better. So hopefully, you enjoyed that video as much as we do.

In terms of looking where we are now, let me talk a lot more about executing to deliver the results. I'll give a little bit of detail on the capital expenditures and where we're planning to invest capital, and why, and why we think we'll get the return for it. And then the other 3 pieces I'll talk about is people, products and shopping experience. And as Cindy mentioned early on, one of the things that we got feedback when we did our investor survey was that, You only talk about price, so why don't you talk about things other than price? And as you know, if you've been following Kroger for very long, we have our 4 keys, and we really focus on our people, our products, our shopping experience and price, because we think all 4 together is what creates a unique, competitive position for us versus the folks we compete against. So I thought it would be good to talk about those 3 in a little bit deeper detail.

In terms of capital expenditures, Dave talked about increasing capital by $200 million per year over the next several years. So that's $200 million in '13, $200 million on top of that in '14, which would be $400 million, and then $600 million, et cetera. You get the drift. The reason why we really feel good about that, if you look over the last several quarters, or a couple of years now, our performance to budget on the capital that we've spent continues to improve and we're actually doing better than what we have projected when we spent that capital. So if you look at our track record in terms of the capital that we've spent, we are getting much more comfortable and confident that we can spend capital at a higher level and still deliver that higher return. And, obviously, we see tons of great opportunities.

One of the things every year when we go through our capital planning process, as we've improved our connection with our customers and our associates, we're finding better opportunities to expand stores and to build new stores. So it's really all of those pieces together, it's what's giving us the confidence to increase the capital that Dave talked about.

And when you look at it, as you know, we compete -- we have 42 major markets, and a major market is where we have 9 or more supermarkets. When you look at those, 71% of Kroger's volume is in those 42 major markets. Of those 42 markets, we're #1 or #2 in market share in 38 of those 42. And I'll show here -- you here in a couple of minutes, we have tremendous opportunity to grow market share in our existing markets, and you'll hear us refer to that as fill-in markets. And I'll give you a second for this slide, but if you just look at this slide, it's separating those 42 major markets, 1/3, 1/3, 1/3. So the top 1/3, that's where our market share is 32% to 57% share, so that's our highest market-share market. If you look in those markets, Walmart is the #1, #2 or #3 competitor in every one of those 14 markets. Kroger is #1 or #2 in every one of those 14 markets. If you look at the middle 1/3, our market share is 21% to 32%. Walmart is also #1, #2 or #3 in 11 of those 14 markets. We're #1 or #2 in all 14 of those markets. And then if you look at the markets where we're lowest in market share, the bottom 1/3, our market share is from 2% to 21%. The 2% would be Chicago, for example. Walmart is #1, #2 or #3 in 10 of the 14, and we're #1 or #2 in 10 of the 14 as well.

The thing that you should feel really good about is the higher our market share, the higher our return on asset is. So if you look at the top 1/3 market, that would be where our highest return on asset is, so our ROIC. The middle would be in the middle, and then the bottom would be the bottom. What we find is as we gained market share, our return improved. So even with sister-store impacts or whatever you want to use to call in terms of impacting volume, we have a higher return on asset when we have a high market share. So that's one thing that should give you comfort as we spend capital.

The next -- this slide, what it's doing, is looking at our #1 competitor. So all these numbers are looking at our #1 competitor across all of Kroger. And this is separating by 1/3s based on their market share, so if you look at the markets were they -- in those 42 markets where they have the highest market share. So this is our #1 competitor and it's the same on all 3 columns. Our average market share where our #1 competitor's highest market share is, is 35%. Their market share, on average, is 27%. Our return on asset in those markets is 13%. So where our competitor has the highest share, we have the highest market -- return on assets.

If you look at the middle 1/3 markets, this is -- our competitor's average market share is 18%. Kroger's share in those markets is 24%. Our return on assets is 9% in those markets. And then if you look at the bottom 1/3, our competitor's market share, on average, is 8%, our market share is 22%, and our return on asset is 8% there.

So this should give you a complete -- this should give you confidence that even when we compete against a very good, solid competitor, we still produce great return on asset. And just because they do well, it's not mutually exclusive, and it's actually, it's kind of nice that we both can be successful in a market. So that's really what we're trying to show there. And remember, it's the same competitor in each bucket on this slide, and it is our largest competitor. Yes, but I won't name them. Mike might later, but I won't.

In terms of one of the things that Dave talked about, is new markets. And you'll -- and what you should see, if you look at over the next couple of years, you should see us going into one or 2 new major markets. And as you know, it's been a long time since we've entered a new market. So if you think about the growth strategy and the use of the capital, it will be to fill in markets additionally, and to go into a new market or 2. And we're in the early planning stages of that, we've actually started on it a few months ago. Just identifying markets where we think there's an opportunity, both from a competitive standpoint and the way a competitor connects with their customer. Because as you know, we're very, very focused on how do we deliver for the customer's experience. So we've done a lot of research making sure we understand how well in these new markets our -- would our future competitors be connecting with customers in that market, and what type of opportunities does that create for us in terms of what type of store we operate. Because we're finding more and more, as we have improved our experience, there's more and more competitors that aren't delivering at that same level of performance for customers. So that's really what we're looking at there.

Also as you know, we operate a variety of formats. We have a combination store, marketplace store, multi-department store, convenience stores, price-impact warehouse stores, price-impact stores. And you'll see us in markets getting better about utilizing all the formats together in a market for the benefit of the customer. And I think one of the things that we, probably, a disservice we've done to ourselves and for our shareholders, is we talk about combination stores. And Cindy was nice enough to talk about how long I've been around, which is a while plus a little. The -- when I was early in my career, we talked about combination stores. And a combination store, at that point in time, was called a combination store because we added drug/GM and pharmacy. And that's the reason why we called it a combination store. Well, what -- a combination store today doesn't remotely look like what a combination store looked like 20 years ago. But we call it the same thing. They're bigger, they connect with the customer better, they offer tremendous more service and variety of product with higher-quality perishables. So I always think we do a disservice because, if you followed us for a long time, a combination store is a combination store, we've been talking about it for years. But from a customer standpoint, that store isn't remotely the same, and it keeps evolving to something different.

And one of the formats that you see us rolling out now is what we call a marketplace store. The same thing is happening there, what a marketplace store was last year or 3 years ago, the marketplace store, going forward, looks completely different. And you may or may not have had a chance to see it, but I think it was a week ago or 2 weeks ago, Saturday, the TODAY Show actually did a segment on our marketplace store in Mansfield, Kentucky -- or Ohio. And I just thought, you would -- if you didn't see it, you would find it of interest. But to me, it's a great illustration of taking a store format and continuing to change it, based on customer feedback, to better connect with the customer. So with that, let me just share the video.

[Presentation]

W. Rodney McMullen

To me, the video, it just really illustrates the evolution of a format. And what a format is tomorrow, will be different than what it was yesterday. And we believe with our customer insights and the work that we have, we'll be able to continue to improve the connection with the customers so that we'll have exactly what they want. And I always -- on the end of that clip, where the one customer said, I wouldn't buy anything, and then she ended up buying a couple of raincoats, that is our customer. And it really is just trying to make it convenient, to find something stylish at a good price. I mean, that's what we're trying to accomplish. And I feel really excited about the opportunity because we're already producing good returns in those stores, and as we connect better with the customer, the opportunity is even bigger there.

The next thing I thought it would be helpful to do, is share a little bit about market opportunities, and one of the things that Dave talked about on the capital is fill-in markets. And just what we thought it would be helpful for you, is to compare a couple of markets and look at the returns on those markets and what the potential is. And if you look at this chart, and it's got a lot of numbers in it, so I'm kind of taking my time: Market A, column 2005, and Market A, column 2012, is exactly the same market. And it's just looking at, if you go back in 2005, the population for that market was 1.9 million people. Today, it's a little over 2 million people. If you look at our market share in 2005, it was 43.5%. If you look at it today, our market share is a little over 50%. If you look at our return on assets, in 2005, it was 18%; if you look at 2012, it's 14%. We have aggressively invested capital into that market is the reason for the decline, but if you look at the returns for the capital we've spent, they have fantastic returns and growing very nicely. So the decline on return for this particular market wasn't surprising, it's actually what was expected because we've just -- we have aggressively spent capital, and obviously that's been what helped -- part of what helped our market share.

Our average stores today, about 7 years old, it was a little over 6 years old a few years ago, you can see significant change in store size. The chart that surprised me is, this is a market where we have over 50% share, and it's still only 67% of the customers are within 2 miles of a Kroger store. And it was true, 7 years ago, it's true today. And if you take that to 3 miles, it's 83%. So that really surprised me. So if you think about the EBITDA that this market produces, in 2012, it's up about 50% or 60% over 2005. So a significant improvement in EBITDA in a market where we already had market -- high market share.

Now if you go all the way to the right, the Market B, that's a market where would be in the bottom 1/3. So that's the market where we see tremendous fill-in opportunity. The population in this particular market is a little over 1.2 million people. Our market share today is about 16%. Our return on asset is about 10%, average store age is a little over 3 years. This is a market where we're aggressively building stores in the market, and we're having a fantastic performance to budget, and we're connecting with the customer in a really good way. And it happens to be a market where our biggest competitor just changed not too long ago, and since then, we are now the #1 rated retailer in that market.

Today, only 32% of our -- of customers in the market are within 2 miles of one of our stores, and only 54% is within 3 miles. So you can see, there's a tremendous amount of opportunity in this market to improve share, and we believe that over time, there's a tremendous opportunity to improve returns as these assets mature. And one of the things I'm sure Mike or Cindy or both of them have shared with you over time, when we open a store, the first year, it doesn't make any money, and it might make slightly positive or slightly negative. Those stores will mature, beyond our company average, for 5 to 7 years. And then after -- somewhere between 5 and 7 years, it starts looking more like a typical maturity pattern. So if you look at our identicals overall. So the return on assets for that new investment continues to improve for the first 5 to 7 years, up and -- over and above the base improvement. So that's one of the reasons why when you look at fill-in markets, we feel like there's a tremendous amount of opportunity, there's about 30 markets that would fit into this category, Market B. Obviously, we'll be very selective and targeted, based on the opportunities that we see. And when you look at some of the base capital that Mike talked about, and the $200 million that Dave talked about incrementally each year, that'll be very targeted for these fill-in opportunities that we see and the new market opportunities.

The other thing you might find of interest, if you look at the EBITDA for Market A, it's 6x bigger than the EBITDA for Market B. And realize, there's 2 million people versus 1.2 million. So if you adjust that for the population, the potential is still 4x more EBITDA in Market B than what we're producing today. And that's the other reason why we see the opportunity is so big.

With that, I'll turn over and start talking about -- executing some of the keys. And as you know, I mentioned before, we have 4 keys: People, product, shopping experience and price. The one I'll start with is people. And I really want to talk about associate engagement and finding talent, those two things. And Dave mentioned earlier about the improvement that we've made in associate engagement. Every year, we survey all of our associates for them to give us feedback on how we're doing. And every year, we have between 225,000 and 250,000 associates give us feedback in terms of how we're doing. If you see the red line, the company that we worked with through this is Towers Watson. And that's their benchmark of companies where they do associate surveys. And you can see, their actual performance out in the marketplace has been a decline from other companies. So this is companies that are -- everybody else that they work with, how are they doing on associate engagements. And you can see in the last 3 years, they've actually declined. The blue line is Kroger results. You can see for a couple of years, we have been flat, but this year, as Dave mentioned before, we made a significant improvement. The other thing I think is incredibly exciting on this is, if you look at our GAAP versus the benchmark, we've had a tremendous amount of spread there. Our level of performance today would start putting us up into the 75th type percentile, in terms of on their benchmark. So there's still about 20% to 35% of the companies that connect better than we do. So it's one of those things where you look at things half-full or half-empty. The half-empty is obviously we're not the best; the half-full is we've made a tremendous amount of progress. And there's still -- and there's 75% to 80% of the company behind where we are. So we feel really good about the progress we've made, we feel even better about the opportunity in front of us.

The other thing is finding talent. And one of the things, if you look at our senior leadership team, about 1/3 of our senior leadership team had meaningful time of their career somewhere other than Kroger. And we always think it's very important to have a mix of outside thinking and inside thinking. Now obviously today, who you're hearing from are all of us have been around Kroger for a long time, but if we had the broader group, you would see a much more diverse background, and different lengths of service with Kroger. Well, one area that a couple of years ago that we weren't happy with the progress we made -- we're making was in that area of people. And a couple of years ago, we went to the outside and hired a woman by the name of Katie Barclay, and the way we found Katie was we really talked to several different people in the HR industry and said, Who's the best out there? And Katie had run the HR function worldwide for General Motors for years. And every -- several different people that we talk to, Katie was the person that kept coming up as being the best. And we really did have to fundamentally improve how we were connecting with our own associates. And Katie's been with us almost 2 years, it will be 2 years in December. And she's just made a ton of difference in our company. And I would give Katie and her team a huge amount of credit for that improvement that you saw on people scores. Obviously, it's our operating folks, operating on a daily basis, but Katie and her team is doing a wonderful job giving us tools to use on a daily basis. When you think about talent, this is a chart our HR folks look at. They always want to make sure we have the right person in the right role at the right time, and making sure those things tie to our business strategy. So we have the recruit what we need. Sometimes it's internal recruitment, sometimes it's external recruitment. And it really depends on where we are trying to get. If you look at, like our corporate brand products, we believe today, we have best-in-class in the United States in corporate brands. We do not believe we have best-in-class in the world. And we just hired somebody from a retailer that has an incredibly strong corporate brand program from the outside to help us in that area, to take it to a different level. And we think he will help lead us to best-in-class across the world. If you look at our human resource function, I already mentioned Katie, but the #2 person in HR, we recruited from P&G. But a completely different experience base, and a level of accountability and how to get trained and teach people to deliver at a higher level. Those are just a couple of examples of where we supplement our internal talent with external talent when we're trying to get a specific area improved.

Obviously, one of the things, anytime you're working on talent, is building their capacity. So how do you train them for their next job, so that they'll hit the ground running? And one of the things we really have to know is knowing our associates, and knowing what their interests are from a career standpoint. So when you took -- talk -- tie all this together, it's really to have strong, accountable leaders, and we've got to know, we've got to build and we've got to recruit. So when you think about the higher capital level spending and the commitment on terms of improving our connection with our associates and customers, we've got to improve the quality of the talent that we have. One of the huge benefits Kroger has is our associates care so much about the company. And it, to me, the video that we started off, that shows you how people care about our company and care about their customers. And it's really left up to us to give them the tools to operate at this higher level.

In terms of innovation, Mike briefly talked about it, but I just want to talk a little bit about a couple of areas. Corporate brands and some of the things that we're doing on fresh. If you look at innovation of products, Simple Truth is one of the products up here, and Jeff Burt, in a few minutes, is going to talk a lot more about Simple Truth, so I won't steal his thunder and tell you how many items we've introduced during the event. I assume you didn't want me to do that, did you, Jeff?

Jeffrey D. Burt

[indiscernible]

W. Rodney McMullen

Okay. But this picture is just a few of the items. One of the things that is incredibly important is continually innovative with product, both in terms of line extension and new products itself. One of the best examples I can talk about on innovation is a corporate brand yogurt item that we call Carb Master. It is the only product in the market place that's serving this niche. The only one. We have -- there's no national brand. There's no other private label. We have 16 flavors. We sell over 600 million units a year of this particular product. And every time I drive by the McDonald's where it says, Billions and billions served, I always think about on yogurt, should we be looking and counting to see how many billions of servings of yogurt that we've provided to our customers, because this is just one item. But to me, this product is just a great illustration of innovating our product, and it's not just figuring out some national brand out there and copying it, but how do you figure out that the customer needs are, and what their wants are, and then how do you deliver against that. And customers that are diabetic, this is a fabulous product for that customer, and it way over-indexes with that customer and customers that are watching the waistline. So those are just one illustration of innovation.

Another is just innovation and products itself. When you think about the fresh products, the fresh departments of a store, when you want fresh, you have to come into the store every day or at least every other day to get those products. Well, Mike and Jeff are doing a ton of things to try to make sure that we improve the freshness of products for our customers. I could give you 100 different examples, I'll give you one here in a minute, and Jeff will talk more about this in a minute, but the opportunity is just huge because our competition really isn't delivering against this the way customers want and need it.

Now peanut butter is one where -- if -- a few of you would happen to know my wife, my -- I think my wife could live on peanut butter. I really do. I was telling Dave on the way back up here, a couple of weeks ago, I was on vacation, the very first thing we do when we go on vacation is my wife goes and buys a jar of peanut butter and we hike, so she can eat peanut butter when we're hiking. Well, for Kroger, peanut butter's a huge competitive advantage. We produce our own peanut butter in our peanut butter plant in Georgia. Obviously, very close to the peanut butter's -- the peanut supply. By controlling the whole supply chain, we're able to produce the peanut butter and have it in our stores faster than any of our competitors. When we do taste panels on peanut butter, almost every time, our peanut butter scores the highest of any brand of peanut butter. And that's both national brand and other private label brands. So we just go to our competitors and buy their products, and we buy out of our stores, our own product. Almost every single time, our peanut butter scores #1 in those taste panels. So when you think about freshness, freshness even applies to peanut butter.

Now I want to spend a few minutes talking about the shopping experience. And I'll talk about the front end experience, some of you have been exposed to it both in person, or heard Mike or Cindy talk about it, and then I'll talk a little bit about our digital strategy, a couple of additional ways of how we're going to grow our business. As you know, how many people here like to wait in line a long time when they're checking out? I'm asking the obvious question, I could have asked it the other way and everybody would've raised their hand. Obviously, one of the most -- customers tell you one of the most painful things they have is checking out of a supermarket. And over the last several years, we've done a lot of innovation and spent quite a bit of capital in terms of improving that checkout experience. One of the keys to all of this, anybody can go out and spend the capital. That's not that hard to do. But you have to integrate it into your system in a way that makes our associates' job easier, and you have to make sure you do a good job communicating with our associates, Why is it so important? And we've done a ton of effort with our associates to make sure they understand why we're doing this, and why it's so important versus just doing it, explaining the why behind it, and really engaging them from the very front. We also want to make sure that we've engaged our customers in terms of advertising and communicating to our customers what we do. So we use our associates to promise to our customer that they'll spend less line -- less time in line. And if you go back 5 or 6 years ago, our average customer spent about 6 minutes in line. If you go back about 4 years ago, our average customer spent about 4 minutes in line. Today, our customers spend between 27 and 32 seconds in line. So every time a customer shops, we've given them 3.5 minutes back of their time to do however they want to. And obviously, they come to our stores multiple times a week, so our associates are committing to our customers that they're going to have a faster checkout, and they actually do. And it's a huge competitive advantage because our competitors aren't delivering at that same level of performance on checkout time.

The other thing that I just love is our -- as I mentioned, our commercials are our associates, and I'm going to show you 2 of our commercials. These are not paid people, they are Kroger associates, they do not have a script. The camera gets turned on, and the microphone is turned on and they talk, and then our team puts all of those pieces together. So with that, I'll show you a couple of the videos.

[Presentation]

W. Rodney McMullen

Obviously, when you look at those 2 different commercials, they were filmed in different parts of the country, they are market specific. And it's an awful lot of fun when I happen to be in a store where one of our associates that was in one of the commercials, how many of our customers say something to them. And we also have them on billboards and everything else, but it really is making our associates the star of the show, and our associates promising to our customers they're going to have a better experience. So to me, what more could you ask for. We could have done 50 different examples of innovation and how we're trying to make the customer shopping experience better. Mike reviewed several of those. But just wanted to show a couple of them in terms of going a little bit deeper so you can see the specifics of a particular point. There are several others that we could do, and it's just, we picked these. Obviously, we could do the whole program on things we're doing to make the experience better. One other area that we're working hard to change is the digital strategy. And as you know, with dunnhumby we have a tremendous amount of insight in terms of what customers like and what they want to do. One of the things we find is not every customer wants to be connected with digitally. So what we're really working on is having a customer, can connect with us the way a customer wants to connect with us, not the way we tell them you have to connect with us. So it can either be digital, it can be paper, it can be all the above, it can be a newspaper still, but it's really understanding how does the customer want to engage with us.

If you look at the Kroger app, it is downloaded once every 30 seconds. So to me, when I think about that, if you think about just the meter running, like the -- the meter, the thing here for the national debt. Every time I walk by that I always like to see that because it just reminds me, Well, this is a positive one, this is a good one. But I always think about, we're going to have a counter in our building every time it gets downloaded, looking, Hey that's another customer getting connected. Because what we find is, when a customer engages with us, through an app and other methods, they produce better -- they give us more of their share of market. So if you look at a typical customers' spend, when they connect multiple ways, we get a higher share of that customer's basket. So we make their shopping easier, but we also, it's good for us and it's good for our shareholders.

We have 5 digital coupons downloaded every second. So every second, there's 5 digital coupons getting downloaded. And I, as I mentioned before, a digital household is more loyal to us and spends more money with us than a non-digitally enabled household.

One of the things that we thought you would find interesting and kind of fun is actually -- Mike's back there is saying a prayer -- is actually showing our app and having that demo-ed. And Dave is gracious enough -- now for a few minutes now, Dave is going to be Vanna White rather than Dave Dylan. So just think about it this way, and Dave's going to actually review the app itself on his iPhone, and we'll see if it works.

David B. Dillon

Okay, so Brian, go ahead and bring up my phone, if you have a signal. See when he gets it up here.

No? Or I need to set it again? Sometimes, he told me it might come off of there. Let's see. Oh yes, it did come off. There we go. Apple TV.

W. Rodney McMullen

Let the record show, this is Dave.

David B. Dillon

Okay, so now, then, see if you get a signal now. There we go. I want you to meet a new friend of mine. This is Ben. Ben was born 2 weeks ago, and is my 6th grandchild. Yes, isn't that great? That's my favorite part of the presentation. And now, I'll just sit down and be done. Does that sound all right?

W. Rodney McMullen

I think there's more to it, Dave, than a...

David B. Dillon

Okay. So, while you're looking at Ben just for a second, I'm going to go ahead and sign into the Kroger app here. And I have that now. And you can see the app that's from my phone. There are several things to demonstrate on here. This is the newest version, this is the one you would get if you download it today. And you can do several things. So look at the weekly ad in your area, and you can look at all the items or you can just check out the beer supply. And look at -- Blue Moon's on this week, and so if I want to add it to my list, I just press that little green dot there, and it goes to my list; or I can take it off, if I want; or if I'm going to have really good week, I'll have Boulevard also, and add that to my shopping list. So the first thing I do is to shop the ad, then I can look and see what coupons are out there. And you can either get a full list or you can just pick up a few specific ones, and you'll see 3 coupons here that are available. So let's take this one.

W. Rodney McMullen

I assume the grandkids must be over, with the Cocoa Puff.

David B. Dillon

Yes. Yes, you can see the items that I'm picking out here. They are not actually over, but I hope they will be soon. So I'm going to load this one to my cart, and I'm loading it actually now, and I can take it off, too, if I choose. Now you can put as many as the coupons on there -- well, actually, there is a limit how many coupons you can put on.

One other interesting feature is, you've heard about our gas rewards, these are my rewards, this is actually my phone and my numbers. In September, that's what I had left after I filled up with gas a few times. But in the month of October, this is what I have left after my next fill up, 582 points. So if I'm coming to the store and I'm going to fill up for gas, I can see how close I am. And if I think if I'm going to get over 600, I might wait, go ahead and shop, then go get gas, and then get $0.60 off a gallon on that fill up, actually get $0.65 because I'll use my Kroger Personal Finance card and get an extra $0.05 when I do that. But those are live points, that if I walk out of the store after checking out, that's what it will be. And this shows my year-to-date plus card savings down here on the bottom. So the rewards are really interesting, and it is real-time.

Then I go to my shopping list. This is the shopping list. You see a couple of the items I just added, The Boulevard and Blue Moon. And as I shop, I just click them off as having bought them, so they go off the list, I've got Pampers for our grandkids. And the coupons that I talked about before, well, here's one of them that I had, so I can have that to remind me that I have a coupon on my card, I want to go buy that item. I can hide the coupons if it gets too noisy, but if I want them up there, I can show them all as I go through the list. And then at the end, after I've checked all of these out -- whoops, pressed too many buttons there. Sorry. Okay, on the list. Once I've checked out here, I can get down to the bottom, and I've got a few that I've checked off here and I delete those as having checked out, and they will come right off the list.

So this is really -- I've used this, actually, for a long time as a list. And then the last thing I want to demonstrate is a fairly new feature. This is to refill a prescription. I brought a prescription refill, or a tag here, and so all I'm going to do is try to get the scan bar code on there. So you scan it, or you can punch in the numbers, if you prefer. You punch the -- your last 4 digits of your phone number, and then you put in the phone number for the pharmacy, which I have to look at, because this is not my normal pharmacy, this is out of our Dayton, one of our Dayton pharmacies. Okay, so it's ready, and I want to pick it up as soon as possible instead of tomorrow, and I submit that. And this is live, going to the pharmacy right now, and it tells me it will be ready, pickup time 5:20 p.m. on the 16th. I can refill another one or I can be done.

So you can see we have -- there is a lot more this can do over time, we have a lot of great ideas with what we'll do with this, we've had updates on this. I'd say we've updated it about every 6 weeks or so.

W. Rodney McMullen

If not sooner, yes.

David B. Dillon

Yes. And this is the most recent one. Mark?

Unknown Attendee

[indiscernible]

David B. Dillon

The loyal customer mailing?

W. Rodney McMullen

Repeat the question.

David B. Dillon

Yes, the question -- you didn't have a mic, so I'll say the question. He wondered whether the personalized ads, the personalized coupons that we have at dunnhumby, whether those are directed through this unit yet. And the answer is, I'm checking, I don't think it is, they're not -- there are some. Mike?

Unknown Attendee

[indiscernible]

David B. Dillon

Through -- yes, the dunnhumby offers that they're making for individuals, are those directed through here now?

Unknown Attendee

The LCMs are not.

David B. Dillon

Right, the LCMs are not. I did not think they would, but eventually. The digital will overcome the paper for those customers who want it. That's the point Rodney was making, is that we're going to give people those choices. We also have a store locator.

W. Rodney McMullen

Some of the coupons that are directed to you, individually, are targeted.

David B. Dillon

Yes, yes. Actually, there are some hunch on here that I could show you that are targeted to me as well. So there are some directed to individuals, just not the LCMs.

W. Rodney McMullen

It's one of those that's under construction and as Dave mentioned, we come up with updates. I mean, it is a 4- to 6-week cycle, update cycle. And there's a whole list of enhancements, and we just continually make those enhancements for the benefit of the customer.

David B. Dillon

So I'm going to search for stores, and I -- obviously, there's no stores around here, but this is my own home, zip code. And these are the stores that are in my area, that happens to be the store I shop the most often. So that helps you, wherever you happen to be, you want to find the nearest store, you can look it up that way. So we thought you'd have fun seeing that, and more importantly, I thought you'd have fun seeing my grandson. Thank you.

W. Rodney McMullen

Thanks, Dave. So looking, in summary, hopefully, Dave started off talking about how Kroger is going to grow. This is just some examples of how we expect to grow. We expect the things that I talked about will produce a higher earnings growth rate, create a higher shareholder return, and it's a resilient and sustainable strategy. So it's not a strategy that's just based on what we're doing this quarter, but it's a strategy that continues to increase the depth of connection with customers over time. And, obviously, we feel very good about our future, and confident in our future in terms of improving our experience, improving your shareholder return, improving our experience for our customers and our associates. And as Mike mentioned, in every retail segment, there's winner and -- winners and losers, and there always has been. And we don't think the future will be any different, but we feel very confident Kroger will be one of those winners.

So with that, Cindy, do you have time for questions?

With that, I'll -- I'm happy to answer some questions.

W. Rodney McMullen

John?

Unknown Attendee

So if you look at the incremental capital dollars, what percent of that do you think will go toward new market expansion? And then when you look at the new market expansion, what formats will drive that? And then if it will be driven by more combo stores or marketplace? Just talking about the challenges of doing that, in sort of non-value formats in new market expansion. Because historically, that's kind of been -- there have been more failures than successes.

W. Rodney McMullen

Good question. If you look in the earlier years, so if you think about over the next 2 or 3 years, you'll see the capital -- incremental capital dollars more focused to fill-in markets. Because we think the -- one, we already have the cycle going, so it's a lot easier to add stores into the process there. Obviously, we have a very good track record. In going into new markets, in all likelihood, the marketplace store will be the first format that we'll go in with. What we have found is the changes that we make, our customers are rating that store very well in terms of how they like it. And we find with that format, we can price very strong in a market. So we actually think it'll be closer -- from a pricing standpoint, it'll be a lot closer to a value format than what most people would expect. And you get the service of people products and shopping experience.

Unknown Attendee

And then I guess just as a follow-up to that, if it's going to be marketplace, to what degree does the GM mix allow you to sort of subsidize lower food pricing? And, let's say, you go into a market, Walmart is particularly strong, how do you look at GM pricing versus a Walmart?

W. Rodney McMullen

On the GM pricing today, we would -- we would look at Walmart today and GM pricing just like we look at GM pricing in grocery. I mean, pricing in grocery. So we don't see it any different. As a general rule, the quality of the product we have is a point of difference for us. And we actually, like in the Mansfield store, we, for our associates, we actually had actual things that were bought in stores to say, Here's the quality of what our competitor offers, and here's the quality of what we offer. So if you think about a T-shirt, this one has a single stitch, this one has a double stitch. So it's being priced competitively, but we definitely have a higher quality product. And obviously, the first thing you have do is make sure your associates understand that difference in quality. But we would look at pricing on that side just as much as we would look at pricing in grocery. We don't really look at one subsidizing the other. I guess there would be some extent where that wouldn't -- if something created so much loyalty that it completely, fundamentally change the economic model, that would be one thing. But at this point, we don't really see it as a model where we use one side to subsidize the other side. Yes, good question.

Michael Ellmann

Michael Ellman, Mayo Capital. In the slides that you posted with the market share data, I think you cited Nielsen Home Scan as your primary source for the market share. I think everyone in this room is aware that Nielsen has recently introduced new products that incorporate, I guess, scanner data from your largest unnamed competitor. Why would you not be using that product now to do your market share study?

W. Rodney McMullen

We find the Home Scan data is more meaningful in terms of the quality of the data. And remember, we actually know what customers are doing also. So we're able to say what customers -- if you look at the Nielsen data, there's a lot of competitors that's not included. So if you think about a Costco, their data is not included. If you think about Dollar stores, if you think about Aldi, Save A Lot, people like that, their data is not in it. So we find the home panel data is actually a higher quality of data for the stuff that we use. So that's the reason why we use it and we've been -- and we've used it for several years. But we look at both, but we just find it a higher quality.

Unknown Attendee

You mentioned fresh, and I think you said that your competitors are not necessarily delivering there. So I'm wondering what you think you're doing in fresh that's maybe differentiated? And how do you use dunnhumby on the fresh side?

W. Rodney McMullen

Well, it's multiple levels. I mean, one is, we've spent a tremendous amount of capital on our supply chain. And if you look it over the last 5, 10 years -- and Mike, I don't know if you happen to know the number off the top of your head, but we have reinvented over half of our warehouse supply chain structure. Obviously, when you do that, it allows you to get products to your stores quicker. So part of what we're able to do from a freshness standpoint is because of all the resources we put into our supply chain, and we've also spent capital on technology there. In terms of using dunnhumby, I would say that today, we use dunnhumby the same in the fresh area of the store as we do the center of the store. But if you go back 5 years ago, that would have not been true. And that is an area where, initially with dunnhumby, we felt like we didn't put enough resources behind it, and we really have changed the level of resources, both from a dunnhumby standpoint and from an internal standpoint in terms of understanding the importance of fresh for customers and why. I don’t know, Mike, is there anything that you think I should add to that because -- okay, other question? Whoever has the microphone.

Unknown Attendee

Two questions, actually, one is a follow-up on Mark's. But I think I'm going to go my first one on return on invested capital. Rodney, you put up that slide with Market A, and I'm just trying to really square these numbers. And I think you showed that your market share had gone up. I think you said, verbally, your EBITDA dollars have gone up significantly. Yet your return on invested capital had actually fallen from 18 to 14, which suggests, actually, your incremental returns on capital being deployed in that market is coming down. And I'm just trying to understand how I'm supposed to think of that as a positive.

W. Rodney McMullen

You really need to look at in terms of where it will be a few years out. It's a market where we hadn't spent enough capital on. So if you look at the return on assets in 2005, it was higher than a sustainable level. If you look at -- and I look at it in terms of the capital that we've spent, how is it performing versus budget. And obviously, we would include a projected growth going forward. And if you look at the projected growth going forward, the return in that market, it'll probably take another 3 or 4 years, but the return in that market will get back to where it was before at a much higher capital base. So part of it is just the timing of the spending. Because any time when you go out and aggressive -- I'm looking at a specific market. If you look at Kroger overall, it gets blended more. But this is a market where we significantly invested in capital and it's a market where we put in marketplace stores in a meaningful way. So if you look at -- on your question, if you go out 3 to 5 years, we would expect returns in that market to get back to where it was in 2005. If you look at the incremental return on that capital, it's still -- it's well in excess of our cost of capital.

J. Michael Schlotman

[indiscernible] operating margin in the entire company, so that certainly would have had an effect in this particular market as well, because some of the investments we made would have been happening in this market and the question behind Scott's question is, if that's the case there, why are you spending more capital goods? The combination of the higher capital as well as the commitment to growing operating profit margin without fuel, we think the combination of those 2 will help increase our ROIC over time. And again, that was ROA not ROIC, so the calculations were slightly different, we just don't have ROIC down to the 40s, the market level.

Unknown Attendee

And my second follow-up question was to Mark's. When will you have personalized coupons, like one of your other big competitors does, on your smartphone? Do you guys have a date for when that will be available?

W. Rodney McMullen

I'm going to let Mike answer that. Or Mike, do you want to answer that when you've review dunnhumby?

J. Michael Schlotman

Yes. When we're up, we're going to address some of that, yes.

W. Rodney McMullen

Yes. And Mike will be after me, and he has a section on dunnhumby in terms of what we're doing with that, and we'll include it there. And if it doesn't get answered, Scott, make sure that you bring it back up, so we can get it answered.

Unknown Attendee

I want to ask you about the decision to start building new stores in a more meaningful way, and potentially entering new markets. You guys have been very thoughtful about pretty much all of the steps you've taken over the last 10 years that the industry has evolved. And this one just strikes me as an interesting one because, I mean, I think most people in this room will probably say, if this industry has a problem, and say you've got a pie that doesn't really grow much beyond inflation every year, and then you've got all of these competitors of various stripes adding new footage into that going after that pie that isn't growing, whether it's dollar or neighborhood market or warehouse club or Whole Foods, whatever it is, it's coming from all sides. So you would think that one thing you wouldn't want to do in that kind of environment is add to the problem, by yourself also expanding footage and just splitting that relatively stagnant pie up amongst an even larger base of footage. So can you walk us through a little bit, how you think about that central problem in the industry of the increasing square footage chasing the stagnant pie and why you wanted to -- why you decided it was time for you to sort of go along with everybody else and start adding footage?

W. Rodney McMullen

If this ends up being more answer, Mike, than what is helpful, just interrupt me. But to me, if you look at the journey that Kroger has been on that Mike started out, the first part of the journey was we had to get price right in the marketplace. The second part of the journey was we had to connect with our associates and customers in a much deeper way than what we had before. And we really feel good about the progress that we've made on both of those points. By having that foundation in place, we feel very confident that we can -- and if you look at our performance, the actual capital that we spent over the last several years, we feel very confident that we had a process where we've identified good opportunities. We operate our stores in such a way that they'll connect with the customer, so that we'll get volumes that we can make good money for our shareholders. So it's really, when you think about those buckets together, it's the combination of those things together is what gives us confidence that we can invest capital at a higher level and get a good return for our shareholders. One of the things about being around this industry forever is we -- there's always -- everybody will say there's too much square footage. And anybody that's been around for 20 years, that was the comment then, it will be the comment 10 years from now. The real key is doing something for the customer that your competitors aren't doing in the right mix. And we feel very confident that we can deliver for our customers in a way that they reward us, which will reward our shareholders. And that's why we feel confident on increasing capital. If you look at the capital process that Mike has shared with you over the years, we have a -- we have significantly more projects identified than we can spend today on the capital that we've committed that we would spend. So we actually, over the next couple of years, we already have projects identified that'll be -- that will easily satisfy the pipelines that Mike and Dave talked about. And in it -- so it's 2 pieces. One, being confident on the capital that we've spent, the returns there. Two, the process that we used identify the opportunities, we feel really strong that there's a tremendous amount of opportunity going in front of us. So I understand the question completely. And if our roles were to reverse, I would ask you the exact same question. But that's the reason why we're comfortable and confident that it's good for our shareholders, and then obviously good for our associates and customers.

Unknown Attendee

Follow-on to that question. As far as the competitive set has changed, obviously, and you feel confident in investing some of these markets, how much of it would you say is defense to maintain the high returns and that maybe some of these markets, to your point, and the one, the example in '05 that was over earnings versus a pure incremental growth opportunity?

W. Rodney McMullen

If you look at the capital that we've spent over the last few years, a good chunk of that would be what I would consider more defensive oriented. And part of that was to make sure that we were improving the connection with the customer. If you look at the incremental capital that we're talking about, plus some of the base capital -- I don't know, Mike, I've not -- I got to believe at least 90% of it is offense rather than defense. I mean, it is really oriented to playing the offense.

Michael J. Donnelly

Of the amount that's allocated to the supermarket divisions, I would absolutely agree with you.

W. Rodney McMullen

Yes. But if you look at incremental capital, it really is focused on offensive situations rather than just trying to defend where we are today. Good question. Yes, Deborah?

Unknown Attendee

Rodney, you talked about some of the innovation in terms of your own brands. Can you talk about the potential for additional expansion there and also potentially, exclusive labels. And then as you are doing more in apparel, are there other categories? And what's, also, the opportunity in apparel as well?

W. Rodney McMullen

Yes, when you look at the innovation in our own brand, it's kind of fascinating because you've got to balance volume with innovation. And I won't -- there's a couple of specific things that we've done over the last couple of years that's been very innovative, but the volume wasn't enough for the category that it mattered, and it wasn't creating a unique competitive position for us. So I think it's very, very important to make sure that we always balance on the innovative items and corporate brands, because -- I mean, one of the innovative items we did was strawberry ice cream with peppercorn. It's a very unique product that no one had ever done it before. And I think it was Dave and 8 other customers liked it. And Dave wasn't involved in the taste panel, so he wasn't the reason we introduced it, to begin with. But we really have to always make sure that we don't get so focused on things that are innovative that we lose sight of -- we really do need to move a $90 billion needle. So to me, it's one of those things where you always have to balance those 2 pieces. The example that I gave you, there's another product that we've just introduced into our stores, that was introduced at the same time the national brand, one national brand introduced the item, and it actually came from a suggestion from one of our employees. So I think it's incredibly exciting, when you go to Europe, it's really some of the best-in-class in the world on corporate brands, or private label or whatever you want to call it. And there, you'll find people with shares that are easily doubled where we are today and we're best-in-class in the U.S. On apparel, in terms of the potential, I would broaden the question and say, Mike mentioned, when we do -- or Dave, I don't remember who, there was a question earlier on mergers. And one of the things we always think is important on a merger is what things would a company bring to us. Well, if you look at Fred Meyer on the non-food side of the general side, Kroger's doesn't have that skill set or how to get those items. Now I would -- if you want to be critical and say, Well, why is it taking you so long? If you do that, I'm going to agree with you. But I think the potential is huge in terms of -- no, I think it's enough to where it actually affects our earnings. Does it cause earnings per share to go from $2 and something to $4 and something, it's not that kind of scale. But I'd certainly think it's a scale that will help us support the 8% to 11% growth rate.

Unknown Attendee

In also feels like the innovation in your company is accelerating. Can you talk about what's kind of pushed you in that direction?

W. Rodney McMullen

Yes. I think an awful lot of the push in acceleration, I think, we've been working on it for several years. And every time you do something, you learn what to do and what not to do. And I just think about the next level, the next thing of innovation that we'll do, that's actually getting rolled out right -- that's getting rolled out right now. We'll roll it out at probably 3x or 4x the speed that we rolled out the front end. But we wouldn't have been able to do that without our experience in the front end. So you learn how to get things done faster. So the cardinal sin is making the same mistake twice. I never worry about making a mistake. Now making the same mistake twice is shame on us. So part of it, I wouldn't say it's necessarily more innovation, it's just learning how to get things that are innovative into the system. The other thing is, if you think about the phases that I've talked about, Mike and Dave too, in terms of getting the pricing right, then getting the connection with the customer better, once you get some of those basics done, then you can start spending some of the time resources on things to grow versus defending. So part of it's just being able to reallocate time.

Edward J. Kelly - Crédit Suisse AG, Research Division

Ed Kelly, Credit Suisse. I wanted to get back to the question about growing the business in an industry where the pie doesn't grow. It seems to me like a lot of the share gains that you could achieve come from conventional competitors, and conventional supermarket competitors. And your market share in your market just on average, just seems like maybe it's in the high-20% range. Could you just enlighten us as to how much share conventional supermarket competitors have within your markets still today? And then maybe, specifically, how does your price position compare to them; how does your service position compare; how does the quality of the store base compare? We've heard a lot today about lobbying investments that you've been making that we don't hear others talk about. And then at this point, how difficult is it for other conventional competitors to catch up?

W. Rodney McMullen

I'm trying to remember all of those questions. If you look at the markets where we operate, our market share is a little over 21%. So that's taking all of the markets and adding them together. So that's taking the 2% to the 57%. If you look at, in those same markets are conventional, competitors would have just slightly less than 30% share, if I remember the numbers right. Obviously, if look at that conventional share outside of -- and we've gained 2% market share in the last 5 years. If you look out outside of us, that segment has lost share. In terms of how hard is it for somebody to turn around, I think it takes an awful lot of work. When I look at -- when I think about today and the commitments that we're making to our future to you that we can deliver, we started this journey early in 2004 on fundamentally changing our company. And I don't think it's something that you can just do in a quarter. I mean, it takes a ton of work by a lot of good people to get to where we are today. So when I think about some of those conventional competitors, I don't think it's something that they can just, all of a sudden in one quarter, say we're going to change and it's different. Now some of those conventional competitors are really good people, that when you think about a Publix or an H.E.B. or some of those folks, they're already there. So I wouldn't say all of that, basically, 30% is available. But I certainly think a chunk that will be able to support the growth that we're talking about is easily available. And there's some of those segments that give up share also. So it's not just at the expense of the conventional competitors. And I was thinking you had one other question, Ed?

Edward J. Kelly - Crédit Suisse AG, Research Division

Price positioning and service positioning.

W. Rodney McMullen

Yes, price positioning and service positioning, I look at things -- you talk about the program in your head or the one in the store, and if you look at what our customers tell us, almost all of -- if you look at most, almost all of our conventional competitors, our customers would tell us that we do a better job than they do on people, products, shopping experience and price. Now, if talk about the Publix and H.E.B., that would be a different comment. But if you look at an awful lot of the conventional competitors, that would be the case. If you look at, in reality, what we do, certainly when you look at pricing surveys on real numbers, we certainly are very well-positioned. Now we never talk about a specific percentage, but we're very well-positioned versus our competitors in that regard.

Joseph I. Feldman - Telsey Advisory Group LLC

Jo Feldman, Telsey Advisory Group. Back to the store growth question again, a 2-part question. So as you infill markets, what type of box should expect to see? Would it be a smaller box, would it be more productive, or just there's more space in those markets? And then also on the new territories, should we anticipate kind of just contiguous markets or would you just plop down in the Boston area, for example? Or would you'd need to buy something in Boston?

W. Rodney McMullen

It's 2 good questions. In terms of new markets, we will use our infrastructure to support that growth. I would be shocked if we would go to Boston as a first step. Boston, I can tell you, wasn't even on the list of the cities that we're evaluating. Because --

Michael J. Donnelly

[indiscernible]

W. Rodney McMullen

Yes, I appreciate that, Mike. Because it isn't using the benefits that we already have in terms of that structure. In terms of the fill-in markets and the opportunity there, those returns are very, very strong, and it's probably one of the lowest risk investments that we can do in terms of that opportunity. So I appreciate it.

Cindy Holmes

There's a lot of question but we need to move on. There will be a general Q&A session at the end of the day.

W. Rodney McMullen

The next 2 speakers is Mike Donnelly and Jeff Burt. They're going to talk a lot about the fresh products, dunnhumby and some of the other innovative things that we're doing that's exciting. Mike is Senior Vice President, Merchandising. He's been with Kroger for 34 years. He's run several different jobs within a division; and then he ran 2 of our divisions over the last several years, our Fry's and Ralph's division. Mike would have responsibility for day-to-day relationship with dunnhumby: Merchandising, marketing, procurement, logistics, would be some of the key areas that Mike has responsibility for.

Jeff has been with Kroger, he's group Vice President of Perishables. He's been with Kroger for 25 years. He would have produce, meat, deli, bakery, those perishable departments. In addition to that, he works a lot with -- over the last several years, we've transitioned a lot of things to Cincinnati. And Jeff would have a daily responsibility in terms of managing our sales planning team on things that we've consolidated into Cincinnati.

So with that, I'll turn it over to Mike.

Michael J. Donnelly

Thank you, Rodney. Well done. Looks like it's restroom time, I think, I don't know. Oh, sorry, Mike. That's right, he reports to somebody else. Good afternoon. Well, Jeff and I are going to talk to you about a few things. We're going to talk about some customer insights, we'll get into some customer trends and -- I'm looking for my slides. There we go. How is that? Way to go, Jules [ph]. So we're going to about customer insights, we're going to get into a little bit about what might be in the future, we're going to talk a little bit about the past also.

But first and foremost, we're going to talk a little bit about sales. And as you can see, we like this chart. We've used it a couple of times this morning and this afternoon. But we are fairly proud of what we've accomplished over the last 35 consecutive quarters. So as you look at that, and obviously, this is -- sales are basically an operator's best friend, when you think about the leverage that they give you. So we have outpaced most of the industry, and this is actually something that we would continue to look for us to do that.

So as we move forward, some of the things that we're going to cover with you today, you may already know. Some of those that you may not, and what we're going to try to do is connect some of the dots. So if you look at knowing our customers, we actually know our customers better than anybody in the industry. We know what they buy, we know who they are, right? We talk to 56 million households throughout the year, right? Coupled with that, we do over 2 million surveys, customer surveys, every year. So what that does is, if we bring the 2 surveys and the household data together, that gives us better insights to make better decisions as we go forward.

So let me illustrate a little bit about this, how we work in the customer data, and actually going from the top to the right, it goes into customer insight. Customer insights are segmentation, loyal customers, loyal shoppers, what they do, price-sensitive shoppers, right? How shoppers may shop a category. How customers or how shoppers might view different promotions.

So than what we do with those insights is we actually then move down to the bottom and it's the customer solution. We actually build solutions from our customer insights. Those solutions could be -- 2 big ones that we use, we use this information to actually determine what kind of price investments, pricing strategies, that we might actually employ. It also, if you think about using the insights, to actually better connect on a personalized basis with our customers on a best customer communication, right?

Then what you hope from what happens from there is you create loyalty, right? And creating loyalty, obviously -- in creating loyalty, why do we want to create loyalty? Because loyal customers are so important to us, right? You think about one loyal customer is probably equal to 8 uncommitted customers. It doesn't mean we don't want uncommitted, we want to always try to strive to get more loyals.

So what I'd like to do is take you on a little journey of how we look at customer insights that drive solutions outside of the illustrations that I just used. We use -- obviously, we've talked about price, we'll talk about that here in a minute. Obviously, it's a big piece of how we do things. It's a big piece, pricing promotion is -- it's important to our growth and important to our customers.

We also use our customer insights to actually drive assortments, so we know actually what items should be in what store, and what is relevant locally. So whatever works in L.A. doesn't necessarily work in Atlanta. So we actually have the insights that could tell us what should go in what store in what city.

You may have heard Rodney talk a little bit about this center store design. So when we look at center store, we take the insights and the information that we have, and we actually apply that to a store and we look at category adjacencies and actually how do you improve the customer's shopping experience through design. And I will tell you, this has progressed, and we are actually, over the last 4 years, and today, we are a much more progressive in this mode.

Best customer communication, we'll talk about here in a minute, but obviously it's a big piece of our arsenal. Fuel, we think is -- certainly incentivize -- Dave and Mike, both have pretty good fuel reward points. But it incentivizes our loyal customers as well. So really, it's more than just price, it's more than insights give us so many more things. And this is just a sampling of what those might be.

So I'm going to give you a couple of examples that we look at, that you've heard. One is about this whole thing about price. All retailers spend money on price. Obviously, there's some that do it better than others. We think we had insights that actually give us an advantage, and we use that. We use the insights, we target customer segments. We look at customers, price-sensitive customers and not price-sensitive customers. We focus on items that matter the most, but the bottom bullet point, I think, is the most intriguing thing that we are learning.

It's really how do you optimize, and it's not necessarily always how you pick the right items, it's really optimizing items within category, but also optimizing categories, right? So we think that, that not only helps the investment, but actually, we think, creates loyalty long-term. So if you look at what's happened over the years, and Rodney has talked quite a bit about the 4 keys.

If you look back on where we were positioned back in the early 200s -- or 2000s, we actually didn't have very good price reputation. And our customer perception has grown quite a bit since that time. Since '05, this is our -- price perception has grown 15%. Several other competitors, and we actually look at this every quarter, we track it every quarter, we know where we're at based on what market, based on what competitor, and we can actually show that we've actually made some significant progress.

So another example is our best customer communication. This is what we call personalization, we've been doing it for -- since '05, and it's touching each customer, and giving customer the right coupon offer, the right item, their rewards, their behavior with us. We touch over 10 million households every quarter. And I'm going to show you now how engaged they are.

Our customers really view our Best Customer communication as a personal offering to them. Our engagement levels had -- have more than tripled. If you look back in the early days of 2005 and where we are today, this is a significant go-to-market strategy that we actually think connects really well with the customer, and is proven out over time.

So let me tell you about what's next and how Kroger will take advantage of what is in the future. If you look at big data, and I know everybody here, this is kind of a new word, but if you look at data and how much we've actually -- we're leading up to 2003, it's illustrated there, that's how much data we collected. And today, 48 hours, we collect the same amount of data as we did back then, which is quite amazing. But if you think about in 2020, what potentially the data -- what potential data is out there, it will be 50x the amount of data that we have today. So the real question is, it isn't what you know, it's how you use it. And so when we look at the future and we look at actually strategically making decisions, we look at it based on our partnership with dunnhumby and how we use our insights today. And then, how are we going to use this data going forward to better actually drive our business?

So I know Dave did a really nice job of coming up here and illustrating some of the digital things that are happening. But think about the extension of what's going to happen. If you think about how we use data today, if you think about the digital world, we're going to know where you browse, we're going to know what you watch, we're going to know where you are. So if we can do the things that we think we can do, using big data and coupling it with our insights, we think is going to be a competitive advantage. It's really bringing big data in what we do to a personal level. We'll know where, or in and out of stores, on and offline, before and during the shopping trip. Can you imagine, if you walk into a Kroger, and you don't have to worry, but your list is already on your phone and you walk in there, it's done. All you have to worry about is buying that incremental product that we need so you can -- so we can make some profit, huh? That's what I'm talking about. All right, so big data and where we're going in the future. Personalization is part of it. We've been doing it for some time, all right? And we do think that the future personalization is important.

So with that, I'm going to have Jeff come up. He's going to talk a little bit about megatrends and some fresh ideas. Jeffrey?

Jeffrey D. Burt

Good afternoon. Honored to be here with you all, today. I want to talk to you a little bit about the megatrends, and I know it's not news that there are megatrends that are out there that we're all watching. Growth will occur in the 5 megatrends. We've already talked a little bit about the biggest one. Mike talked to you a lot about the quest for value. That is by far the biggest megatrend and what we're focused on. We've also talked about the strategy to price right, which creates value for our customers.

In addition, Mike talked to you a little bit about personalization and the importance of that is in the competitive advantage that, that gives us. There's also authenticity, convenience and age and health. And what I'd like to do is spend a little time talking about age and health.

One specific example in the age and health megatrend is the shift to natural and organics. This channel is growing at a rapid clip, 12%, well above the total store. And what's more important, Kroger is growing much faster than the industry in this important category. We expect this trend to continue to grow at double-digit rates for the next several years, and Kroger to continue to grow faster than the industry in this important category.

What about some of the items that we sell? This is a fun stuff. Did you know that Kroger sells more vitamin water than anyone in the United States? We do. A lot of healthy people out there. How about organic milk? Kroger sells more Horizon Organic Milk than anyone in the U.S., and customers can depend on us to have a great price on it every day. 97% of every household in the U.S. will buy natural and organic this year. 97%. So we think that this is a huge, huge opportunity for us.

Kroger is deepening its connection in a big way with our customers who are passionate about health and wellness. The Simple Truth brand is our natural and organic brand. And it's easy, it's honest and it's affordable. It's available across our stores. It's available in meat, produce, natural foods, dairy, grocery, all those departments. There will be over 350 Simple Truth items in our store next year. It's free from 101 artificial preservatives and ingredients that some customers said that they don't want in these products. So we definitely listen to the customer when we developed this line.

I'm the perishable guy, so I have to tell you that fresh is important, too. It's very important to our customers. And we've talked to thousands of customers about what influences them to shop for groceries. Fresh is super important. We found that different groups of customers are influenced by different departments. This affects how we go to market in different locations.

And what does "fresh" mean? It really means top-quality produce, fresh selection, a fresh meat and a sustainable seafood, colorful and aroma-filled floral shops, extraordinary bakery products and mouthwatering deli items. We've done a lot to make freshness a competitive advantage. Rodney talked on a couple of them. We've improved logistics and transportation methods to reduce transit time. We've done some other stuff as well. We've implemented produce direct sourcing. We'll improve our direct importing from around the world, resulting in much lower cost and much higher quality. We've also improved our processes in local and in transportation that gives us the ability to react quickly to fresh products and local products around the country.

A big part of fresh in our deli is our fresh meal solutions. Many of you have heard about ready-to-eat and ready-to-heat products. This is an ongoing shift in customer habits that we have responded to. Convenience is so consistent and a growing need. Our fresh meal solutions help our time-starved customers bring home convenient and delicious dinners. We've extended our offerings to the most important family meal, which is dinner. We want our customers to relax because we're making dinner for her. We're particularly proud, and this is a shameless plug for Margaret McClure back there. So Margaret, listen up. We're particularly proud of our fresh oven-roasted chicken. It's seasoned with our signature blend of spices. It's roasted to golden brown perfection, and it's always juicy. And perhaps, most importantly, we guarantee it's available in our stores every day from 11 to 7.

So we've talked to you about ready-to-eat and ready-to-heat. Now we want to talk to you a little bit about what we're doing in our meat departments with ready-to-cook product, which we call, easy for you. Easy for you is ready-to-cook, restaurant-quality protein made fresh in our stores. It's seasoned and ready to go right into the oven. Oven-ready containers help with preparation of these meals, so you can get -- be done with it in 30 minutes or less. These solutions really help our time-starved customers. They are the hero at dinnertime, giving her more ideas and products to prepare for her family and spend time with them around the table.

Now I will bring Mike back up to close it out.

Michael J. Donnelly

Thanks, Jeffrey. So if you think about where we've been, we've grown our business through knowing our customers better. We think we are uniquely positioned to leverage the data going forward. And we think our insights will drive our growth and set us apart from our competition.

So we appreciate the time. We have time, Cindy, for questions? Yes? Okay. So we'll open it up to the floor.

Mark Wiltamuth - Morgan Stanley, Research Division

Mark Wiltamuth from Morgan Stanley. For Jeff, since you're focused on fresh, what's your view on the current drought and how's that going to affect pricing into next year? If you look at 2011, we got up to inflation numbers that were up around 6%. We actually saw volumes decline for the industry. Kroger managed to keep flattish on volumes. What do you think is going to happen as we roll into next year on pricing? And I guess it's a split between the perishable side and what could happen on center of store also?

Jeffrey D. Burt

Yes. We're very pleased with our current tonnage in fresh right now. It's really -- we have some great momentum. Obviously, all the United States will be impacted by what happened with the drought this summer. That's something that we look at, and we're in front of, I think. But we see some inflation in our proteins next year, for sure, in our meat department. It's still a little tough to tell how much that will be. There's a lot of factors that can go into that, and everybody's trying to posture right now to kind of set the thing up. But I think we're in good shape to handle it.

Michael J. Donnelly

Scott?

Colin Guheen - Cowen and Company, LLC, Research Division

I just -- Colin Guheen of Cowen and Company. I want to ask a question on big data. It seems like we're going to make incremental exponential step up to the amount of data that you can collect. The big theme in this space has been channel blurring. Can you just maybe walk us through maybe the case that data allows you to regain loyalty with customers?

Michael J. Donnelly

I'm sorry. I'm trying to...

Colin Guheen - Cowen and Company, LLC, Research Division

All the way in the back. How'd the question go?

Michael J. Donnelly

Oh, okay. Try that one more time. How's that?

Colin Guheen - Cowen and Company, LLC, Research Division

We're making exponential gains in data over the next 5 years. Channel blurring has been a key theme in the space for the last 5 years. Maybe walk us through the case, given how much more data you're going to have, how to regain loyalty? And what do you think that -- how do you think that affects what has emerged, which has really been people shopping more channels?

Michael J. Donnelly

Well, so honestly, I've got to tell you that one of the illustrations that we used was where people shop, where people watch and where they browse. So obviously, if we think about how do we actually get that so that we can couple it with what we use today? And actually, it's exciting for us to be able to think about what's the potential to actually contact those customers in different ways. And we think that actually is the big play. How do we actually contact them or communicate with them in a different way than we do today, whether it's digitally or when they come into the stores. So we still think that, that's a pretty big play.

Edward J. Kelly - Crédit Suisse AG, Research Division

Over here. Two questions for you. Actually, one's probably for Dave. But the first one is on your price perception versus Walmart. Could you talk to us about how that has evolved over time? I'm assuming that you measure that, so maybe give us a little bit of insight there? And then my second question is, I think, more for Dave, but you talked a lot about growth in natural and organic product. Clearly, there's other players out there that are doing a very good job on that front. As you think about other concepts, I mean why not open up a smaller store, natural and organic concept? It seems like you've got the infrastructure to do it. It seems like you have the knowledge in that space, so -- that's it.

David B. Dillon

Okay. Well, it's better, and it has improved quite nicely. I don't want to single out any competitor, but if you look at surveys, what we do in a quarterly basis, and we know that you saw what Rodney presented, we feel much better today about where we are positioned versus '05. And I can tell you, and that's across most markets where we compete with different competitors. But do we have a ways to go? Yes, I mean, we do. The thing that I would always want you to understand is that we have more things in our arsenal than what some other competitors do, okay? So if you think about the best customer communication or you think about price or you think about promotions or you think about fuel, and you think about adding those things up and really start to evaluate this whole value equation to the customers, there's a lot of competitors that only have price, right? And so, we actually think the best way to go about it is certainly closing the gap, and taking price off the table, would be great. That would be where we would want to get to, right? But there's more to our story, and we think our customers connect nicely with our story, right? So the second question was about format, and I'm sorry, natural and organic, smaller format exactly. Well, they better not want to ask me that question, so I don't know if you guys want to take that question?

Michael J. Donnelly

You want to turn my mic on and I'll answer that question real fastly. The short answer is that -- and what Ed asked was whether or not we ought to open a small store that would be a natural food store since we have all the product. And I think our answer is, is that the audience has expanded, the customer base has expanded for organics and natural foods so sufficiently that we think it's a more effective and efficient result is if we carry those products in our regular mainstream stores, which is what we're doing. So we're working on improving our distribution, improving the selection, improving the pricing, improving the methods we get the product there, and you saw the results on the screen. So we're quite pleased with that. We certainly could do what you're saying. That is a niche market. And I think we prefer to address the wider audience.

Andrew P. Wolf - BB&T Capital Markets, Research Division

Andrew Wolf, BB&T. A few, couple of few years ago, it's pretty well-known, Kroger made a big price investment in the natural product departments. And I think it's fair to say that jump-started sales have boosted them a lot. My question is, did that higher rate of sales growth, did it maintain itself? Is there something about the price investment in that category or in categories in general? When they're done, would the insights that you and dunnhumby bring to it, is that sort of self-sustaining, number 1? And number 2, does it have the carryover effect? And particularly in that department, it's kind of alluded to, that's strategic to other parts of the store, or other departments in the store?

Michael J. Donnelly

Yes, let me talk about the price investment and how we actually decide. We use the insights to do that. I'll talk a little bit about natural, natural food and organic. Traditionally, a long time ago, that was actually a fairly high margin, right, for a lot of companies, right? So we actually said -- and the industry changed, customer shopping habits changed, lots of things changed. So we started to address it in the way you just said 2 or 3 years ago. And we actually -- we found some nice insights, and we've actually reduced price in that category every year for the last 3 years, and we continue to do that. So it has evolved into something that we actually like. There's a pricing strategy that actually, if you think about what I said about optimization going forward, we think that has a lot to do -- or a lot of good things that can happen in that category when we talk about optimization. So we like what we see there. When I talk about price investments and how we make price investments today versus how we made them in '05, it's totally different. How's that? I'll tell you that we're smarter today about what we do, right? That doesn't mean they're not still painful at some point in time, but there's a lot of our price investments that actually we call crossing the lines, right? Or as a much less of an investment than we actually anticipated it being on the front side. The thing that we do, we do have what we call levers. When we have to get aggressive, we have to get aggressive. As the market gets aggressive, we get aggressive. And that's who we are. That's how we've run them. But when it's not, and I'll tell you there's categories now where the market is reacting fairly calm, right? So when we see that, we're okay, right? We work there. But if we think we have to get aggressive with some pricing strategies, and we think it's going to be a competitive advantage, we'll do that, so...

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

Yes, Scott Mushkin again with Jefferies. So I wanted to get back to the fresh question -- statements here and thoughts. Fresh, from our research, is this transcending generation, certainly important to the millennial, so is natural organic. As we look at the fresh category, though, there's not a lot of information available. Traceability seems to be a building issue. Freshness, it's hard to know what's fresh, what's not fresh. So the question is, given your prowess in the technology, and data, can that translate itself into the fresh category, where as a consumer for Kroger, you'll understand that it's fresher, it's traceable? And did -- will that drive a competitive advantage? And then, when will you, in turn, get higher sales coming from those fresh categories that can drive profitability? I know it's a long question, but...

Jeffrey D. Burt

Well, it was really a great statement, actually. And it's -- you're right, Scott. I mean, you're really -- you're dead on. And the answer to that is yes, we can take advantage of the amazing data that we have, and we're also big enough to drive some things for the whole industry. But we view freshness as so important that we've actually put together a freshness department that resides in the perishable team. We have a director of freshness, and his only existence and his team is to help us become fresher. And he looks at all aspects of freshness, from our warehousing to our transportation, all the way up to store level, how we handle it. We look at freshness impressions as customers walk in the store. And what are big freshness keys? So, so much being done there. There are some things that we do with dating and other things with our produce department and our packaged produce and so forth, that I think is really industry-leading and will help us kind of set the bar there. But it's absolutely a big deal. It's not going away. It's going to get more important. Like I said, I think you made a really great statement there.

David B. Dillon

One more question.

Charles X. Grom - Deutsche Bank AG, Research Division

Back here, Chuck from DB. Last week, a lot of us were down in Bentonville, and they were certainly touting their add match campaign, and I'm just wondering if you guys have seen any impact from that? And then, a lot of us were in Virginia last week, and another Dollar Store talked about some weakness in Southern California, and I'm wondering if you guys have experienced any of that, given your presence there?

David B. Dillon

Is there something going on in Bentonville? So I probably won't go there with -- just let me address it this way. I think I've been around for 34 years, and I think I have seen price surveys done in many different ways. Certainly, there might be one going on now, but I don't really know that. But I will tell you that anybody can do a price survey, and you can actually go about your business. I think what we do at Kroger is we're going to actually work on our strategy, not work on somebody else's strategy. So if price, what I told you earlier, if it gets aggressive, then we get aggressive. If we are targeted, then we'll do something about it. So I will tell you, firsthand, that we see no differences in the markets that we have seen some reactions than what -- we can't see anything different today than we see in the months previous. So that's about all I'll say on that. Your other...

Charles X. Grom - Deutsche Bank AG, Research Division

And then just on Southern Cal?

David B. Dillon

I'm sorry?

Charles X. Grom - Deutsche Bank AG, Research Division

Southern California, they called out the higher gas prices are starting to have an impact on the consumer. I was wondering if you guys have seen anything?

David B. Dillon

So I think we're happy with Southern California. How's that? And I would just tell you that what we're seeing, you obviously know we did some things in Southern California last year -- or this year with -- from a pricing standpoint. And I would tell you that, actually, we like what we see. We have ways to go, but we like what we see. And when you had $5 gas down in Southern California, it was pretty shocking, but we actually like what we see today. Okay? Michael, anything else? Cindy?

Cindy Holmes

We're going to take a break, and we'll come back in 15 minutes, so about 5 till -- wait a minute -- what time is it?

[Break]

Cindy Holmes

Okay, thank you. We're now ready to begin our general question-and-answer session. We will -- as we did earlier today, have 2 mics around the room to be sure that all the questions get on the webcast.

As everybody gets situated up here, we're going to show you 1 more video today. And this video really shows what today is all about. Behind this organization are 339,000 associates that go to work every day, caring about customers, caring about each other and delivering results for you.

[Presentation]

David B. Dillon

We shared that video with you because it demonstrates what Kroger really is all about. Our associates are the reason that we are as successful as we are, and it takes every one of them. And in addition, every person really matters. Every person in our organization contributes in ways that is meaningful and helps produce those overall results. We may be a big company, but we try not to act like one. We thought we'd share that just to set that theme.

David B. Dillon

The rest of our program, as we've promised, we're going to have plenty time for questions. And so the rest of our program is questions of this group. So we have -- do we have mics roaming around? So we have a mic on each side of the room, which we'd be happy to share.

And as you're raising hands and handing out the mics, for the first one, I actually was asked a question at break I want to ask, and Mike will answer this one. And that is: Give us some sense -- the question was: Give us some sense of what we should think about in identical sales or on rates of inflation or other metrics that would help us construct what the pieces are to end up with the 8% to 11% growth in earnings?

Unknown Executive

So Mike, you [indiscernible]

J. Michael Schlotman

They warned me, so I'm not [indiscernible] here. It's a good question. And as I said earlier, we're not in a position at this point and aren't going to give any guidance specifically on '13 or any longer-term guidance on the top line. From a guidance standpoint or thinking about how to build a model standpoint from this, I think the results we've had over the last several years, and if you think about where IDs have been with the backdrop of where inflation have been, clearly in that kind of a range, I think we've accomplished enough growth in dollars to be able to support the growth model we've had, particularly as we balance the investment we make and growing the operating margin over that time frame. So I know that's not specific, I haven't given you a number just to plug into cell C-3, but as you sit and think about it and think in your own minds, because this is how we do it, we sit and think about where's inflation look like it's going, where's the consumer look like it's going, what do we see in tonnage, and we make a judgment on what we think we may be able to generate in identical food store sales without fuel, every year, with that as a backdrop. That's one of the reasons we've always been a little bit skittish to give long-term ID sales guidance, because all those metrics change every year, and you have to adjust how you go to market to deliver the earnings per share at the bottom of the page, with the backdrop in mind of how the top line is going to be. Beth -- or Meredith, I'm sorry.

Meredith Adler - Barclays Capital, Research Division

I have several questions. I'll start with, right off, what you just said. Not too long ago, when you were talking about inflation moderating, there was some discussion about what happened to tonnage, and I think there was concerns that you would still see weak tonnage even if inflation moderated because it wasn't going to turn negative. Has there been any change in that view, that the customer is still very stressed and not -- you're not necessarily seeing a big improvement in tonnage?

J. Michael Schlotman

Well, if you think about what I said in my -- in some of my opening comments, and it seems like yesterday, it's been a long day. And but if -- where we were at the second -- when we released second quarter earnings, that was September 7, so we were just a few weeks into the third quarter. If you look at that, since that point in time, inflation overall has continued to moderate, specifically in the center of the store categories, the grocery categories have moderated. But our ID sales without fuel and our tonnage is a little bit better than we were experiencing at that point in time. So as inflation has moderated, tonnage has actually improved a little bit, which is -- it's actually happening a little faster than I would have guessed. Because I've been asked that question by a lot of you, and I've cautioned you that lower inflation doesn't mean a switch is going to get flipped and immediately more tonnage has happened. But we've seen a slight uptick in tonnage since September 7.

David B. Dillon

I would agree with Mike's comments. And on the margin, both of them have happened a little faster than I would have guessed. The inflation slowed down a little faster than I would have guessed, but tonnage has picked up a little more than I would have guessed.

J. Michael Schlotman

I agree.

Meredith Adler - Barclays Capital, Research Division

Another question I have is really back to somebody else's question, and, Rodney, you answered it. But I wasn't sure -- I thought there was more you could say about the square footage growth that's coming into the market. And sometimes in the past, you've talked about square footage growth exiting the market. And are you still seeing that? And do you feel like that, that's meaningfully helpful in offsetting the square footage that's coming in?

David B. Dillon

Certainly, we continue to see square footage going down. Now you have the competitors closing, and about half of the ones that close end up getting reinvented into something that's usually a little better than what they've -- than what left. So if 30 or 40 stores closed, half of the those will end up at some other type of grocery retailer, whether it's one of the specialty-type retailers or neighborhood store or something like that. So it's a meaningful number. We used to track it a lot more aggressive than we do today. We track it, but not really that aggressively.

J. Michael Schlotman

I've -- We're trying to recreate that wheel that Rodney talked about tracking, or dig that information back out. I think that the amount of square footage that's gone down has been meaningful, particularly in certain markets. And you can have a smaller footprint kind of store open that might be 20,000 square feet and it may be more specialty, and you lost the 60,000-square-foot store somewhere in that market, that was more of a full-service shop, that was a destination shop. So that 60,000 might go away, the 20,000 may pick up some of that volume and we may pick up some of that volume. So I continue to think there's a lot of give-and-take out there.

David B. Dillon

Certainly with our traditional competitors, most of those are announced, but you see them continuing to close stores on a regular basis.

W. Rodney McMullen

I think one of the observations I would make related to that and to the question that was asked before on that question on that theme, is that not all square footage is equal. That when you look at square footage leaving, that square footage has already deteriorated often to a certain extent. And even if it continues to exist, it doesn't necessarily mean that you have excess square footage in a market when we go add some -- a store in a market that has a lot of square footage, if some of that is not very high quality square footage, you may even stay in business but it's not going to compete very well. And yet our new box will. So you really have to get in -- the devil is in the detail. It's interesting to look at those graphic numbers for the company, but the devil is in the detail.

Meredith Adler - Barclays Capital, Research Division

And, I'm sorry, I'm going to ask this one more question. Apparel. I guess I'm old-fashioned, or old, it creates all kinds of markdown risks. And I know you've got Fred Meyer and I know there's a lot of experience. But could you just maybe talk about, since you've had apparel, has that been an issue? How are you going to manage it going forward? And is it ever going to be a meaningful piece of the business?

David B. Dillon

Do you want to answer? It was your presentation, I don't want take it.

Unknown Executive

Come on, chief merchant.

W. Rodney McMullen

The apparel, in terms of markdown exposure, is one of those where we're comfortable with what that is. Obviously, it swings from season to season. So when a season is a little better than you expect, it's not as bad; and when it's worse, it's worse than you expected. In terms of affecting Kroger numbers overall, one of the things that we're working hard, is changing the supply chain so that you don't have the whole season worth of products in the store when you ship it in, so the store can get replenished. So you're not having to take as much exposure. So you take the exposure collectively rather than individually. Now obviously that will take continued improvement in technology to execute that to the level you'd like to. But it would be a long time before I would think that, that's something we're -- there's a risk of us having to talk about it in terms of affecting the numbers in a way that we'd have to say, Well, we miss because of. And then, Mike?

David B. Dillon

So the only thing I probably would add is that if you think the marketplace store, it's about 10 years old, right? When we started our first one in '02 or whatever. And really, it hasn't changed on the home side since that time, right? And really, we should have innovated that maybe earlier. What this does is it gives us a look at something that's new, fresh and different. And do we know if apparel is going to work yet? No, we've got one store. We got a lot of press, it was good. But guess what we like? We like what we see. So it's early in the game and we're going to learn a lot. We'll probably do some more. But I think that whole innovating and getting something new and fresh into the store, I think that's something that we have to continue to do.

J. Michael Schlotman

You also have to consider the productivity of the square footage of what it was doing when it hadn't been innovated in 10 years and what the productivity can be even on a net basis with markdowns of a new idea.

David B. Dillon

The other thing I think is important, if you get a chance to actually see the store, it's more than just apparel, and there's a lot more to that side to try to create excitement for the customer versus where we were before. And I agree with Mike, we probably should have -- we did a few of the pieces a little earlier, but this is the first time we just radically changed what we were offering. Stephen?

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Over here. Stephen Grambling from Goldman Sachs. Just to piggyback on that question on apparel. Maybe if you can talk about what' you're seeing on the food side of those stores? If adding apparel maybe impacts the way the consumer shops on the less discretionary versus the other stores?

J. Michael Schlotman

Yes, if you look -- the customers, on those stores, the customers like them better in their totality than our other stores. So when a customer rates us in that store, they would gave us higher ratings in terms of how we're doing. In terms of saying that it affects food or they switch how they're spending money, we can't -- we don't see any of that at all. It really isn't incremental purchase in terms of -- it's something they would have bought somewhere else, but they found the right price of an item from a style standpoint they like.

W. Rodney McMullen

And Rodney, that's all marketplace stores, not just the Mansfield store.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Great. And then kind of changing gears a little bit. In the 8% to 11% guidance, I know you said that -- the EPS guidance, you referenced that you didn't want to talk about ID sales. Maybe help us think about gross margin that's embedded in there. In the past, there was a little bit of sticker shock when you made a comment around 50 basis points of price investment on a 2-year average going forward. So has that changed? And is that embedded in that 8% to 11%?

J. Michael Schlotman

Those tapes haven't been destroyed? Think about it in terms of operating margin -- operating profit margin, we clearly have gotten away from talking about gross margin and OG&A as a specific rate and what they did over a short period of time. But just wrap your head -- everybody should wrap their head around our commitment to growing operating margin over time and our commitment to balancing how we make investments to how we're saving money elsewhere, or how strong IDs are to give us incremental leverage somewhere else in the income statement. So we're clearly focused on continuing to drive strong operating -- or strong ID sales growth without fuel, as well as slightly improving our operating margin on an annual basis. And those are the 2 cornerstones of growing the 8% to 11%.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

And just given the size of the fuel business, will that continue to be pressuring the consolidated operating margin over time?

J. Michael Schlotman

Yes. I think we gave a lot more clarity on fuel and non-fuel business this time in the second quarter queue, and I would expect to go forward. It shouldn't be any surprise that, that's out there now. I couldn't really say we're going to report on a metric that we aren't going to report on. So that's one of the reasons we kind of did a dry run this quarter. It's just not that you should scour our queue to see what we're going to announce next. But clearly, we had to start disclosing the operating margin without fuel. We literally talk so little about the operating margin including fuel. My guess is most of us wouldn't even be able to tell you exactly what the number is, but we have a pretty darn good feel where the operating margin is when you exclude fuel. We know what the effect on the EPS is from fuel and what it adds, and that's how we think about it, what EBITDA generates, but the effect on operating margin is really just an outcome.

David B. Dillon

We also look at return on assets, and add business and returns and assets in the core business.

J. Michael Schlotman

Well, the ROA in fuel, when you think about it, we sell a load of fuel 2x or 3x before we pay for the first one. So the return on investment now that -- and with no investment in working capital or inventory, if you will, and in fact, a negative investment, you can make a nice ROIC or ROA in that business without a very high operating margin. If you don't have the tonnage, then you can't have that same outcome.

Unknown Attendee

I wanted to get back to -- just touching in on volumes. But I also want to talk about market share for a second. Our research -- and I think you guys have been gaining share now for a while. I think it ebbs a little bit at the beginning of the year and then is picked up in force. And all our research suggested that it's accelerating since maybe midsummer. So one of the things I want to understand is, why are you able to see such good market share growth? What do you think the driver of that is? Two, why is it accelerating? And is the acceleration sustainable? And is that also what's giving you confidence in raising your numbers?

David B. Dillon

Let me make a comment or 2 about market share and reading that. We generally, when we've given our market share data, we've generally done that once a year. And we do that for a reason, is that there's a lot of noise in market share data. Almost any way you want to measure it, there's a lot of noise in it. And so we tried to, ourselves, not overread it, so what happened this month, what happened in the last 3 months, even what happened in the last 6 months, because I think you can overread it. We, instead, the way we manage our business, is we look at the market share over long enough periods of time, say once a year. And then we look at our sales trends compared to what we had thought our sales would be and try to get a sense of whether we're picking up steam or not. And then every period we do read loyal households. We try to get a sense of whether we're growing loyal households as we have consistently been doing for a long time, and to what extent, and how those trade-offs are working. So I don't think we would have a whole lot of comments about short-term reads on market share. We do think it's true to say that we have generally, though, been increasing market share, and that's been a true statement for a very long time. Now there's been a few times, maybe it wasn't a lot of gain, but I think it's been continually a gain for quite a while. And I think our belief is, that it is the summation of everything we're doing. It's not one thing, it's not an add, it's not the pricing, it's not what a division is doing within our organization, it's not dunnhumby -- it is dunnhumby, but it's not just dunnhumby, it's everything multiplied together. Because what attracts you to come to our store and what attracts someone over here to come to our store will vary. And it will vary by just like that picture of all the different pictures of employees at Kroger. Same thing would be true of all of our customers, and you would see so many different reasons to shop with us. So I think it's the totality of that. Do you want to add to that?

J. Michael Schlotman

No. Your point that you made on the long-term market share gain certainly would be some of the things that cause the confidence in terms of what we've talked about. Yes, that's true. I mean, that's true.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

And as a quick follow-up to the volumes, and that's why I'm looking at volumes and package food as a proxy for market share. Is it true to think that volume begets volume? In other words, there's a halo effect from market share gains and volume gains from people that supply you that puts you in a much different position and maybe some of your competitors as you continue to gain share to continue to gain volumes?

W. Rodney McMullen

I'm not quite sure I follow exactly with the question. But if I understood, what you're saying is, do we get some beneficial effect from our suppliers given that we have increases in market share?

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Correct. And there are a lot of these people are not seeing volume gains and you are seeing them.

W. Rodney McMullen

It would be true to say that the vendors that we deal with, assume we have partnerships, and I don't mean obviously in the legal partnership, but a partnership where we're working together to construct a common outcome that we both benefit. In those situations, we are generally gaining good sales and good results. And when we have successes in those programs, often, that same vendor and often other vendors, because they see the results for that vendor, want to participate similarly. And so I would say that our success in these partnerships with various vendors does contribute to additional partnerships. They do go to where they think they can get volume because that's what they're after today. It's an environment where it's hard to get volume, because of any kind of margin for the C2G company. And so they come to us because we can get sales. And so, yes, I would say yes.

David B. Dillon

And we're certainly focused on execution.

Michael J. Donnelly

Yes. If you look at the criticism we had maybe 10 years ago, our vendors would say, we weren't delivering. We weren't executing on what we said we'd do. We didn't give them the kind of improvements that they expected from a program that we did. And we went to work to be able to execute. And we execute now as well as anybody, probably better than most. Over here, on this side.

Unknown Attendee

So you've talked about in the past that if you're going to increase or accelerate unit or square footage growth, that you would commit to a higher rate of earnings growth. And that's, obviously, part of what you've done this morning and -- or today. But I guess the question is, with kind of your incremental CapEx, it's look looks like that's about 1.5% unit growth or square footage growth. How much of that are you flowing into the earnings number, like is it 1% of that -- the 1.5%, you think 1% in earnings? Does that make sense?

J. Michael Schlotman

I actually haven't done the math and looked at what the $200 million would actually do to a percentage of square footage growth. But I will tell you that, as Rodney described in some of his comments, the maturity curve of our stores are shortening and it's actually lasting a little bit longer. So as you first spend a little more capital, it's not a huge pop right at the outset. But over time, we believe that the model we have is going to be a very valuable spend. So I would hate to say, A plus B equals C, because when you think about a fill-in market, if you think about dropping a new store in Dayton, Ohio, I have no more overhead. So not only is that store fairly productive, and even if that's fairly a flat-line store per year, it makes no money, every other store in that market just became a little bit more profitable because it's now sharing the overhead cost of the district team and sharing the overhead cost to the advertising. So the core gets a little better when you have a good fill-in strategy, as well, because of the shared expense of the overhead, and it's really one of the reasons Rodney talked about Boston won't be on the list because we want to leverage the infrastructure we have because it's such a huge advantage to leverage that fixed cost and spread it over a bigger store base.

Unknown Attendee

Okay, thanks and just -- sorry.

W. Rodney McMullen

What I was going to say is that the first year, the earnings growth versus the square footage growth would be not there. When you get to the third or fourth year, the earnings growth from that square footage growth is actually more than the square footage growth when you just look at the pure number.

J. Michael Schlotman

Right.

Unknown Attendee

Okay. And then just following up on the dividend, I know, obviously, it just increases by a healthy percent. But the cash outflow associated with that is not that material, given your share count and your share count keeps going down. So what would it take for you guys to actually increase your dividends to more like the mid-3s or even a 4% range?

David B. Dillon

I don't think we'll be able to answer that exactly. But I will tell you that our board regularly reviews our dividend policy, and that we made a recent judgment as we put together -- in fact, it very much relates to the announcement of our higher long-term earnings targets. Because someone asked me in one of the breaks is, we could have just as easily taken the opposite direction, raised the dividend or put our money in stock buybacks, spend less capital. That certainly was one of the choices. And as the management team, as we go through all the various choices, we have to ask ourselves which do we think produces the better long-term results for the shareholder. And our view was, that while we like dividends and we liked increasing the dividends and the big increase that we just put in place was important to say a message that we intend to have a dividend that has a respectful yield, and we expect it to increase the payout ratio as this move did. It's also intended to say that we think our really big move comes from the fact that we are a well-run business, that we invest our capital well. And then in 5 years, the operating business will be worth more because we made this choice rather than because we made the choice to increase the dividend even further. So we will be reviewing the dividend every year. We do have the inclination that we'd like to raise it every year, maybe not 30% every year, but we'd like to raise it each year. And the board will evaluate that as we go through it, and see what's the best choice at that particular point in time. Mike, do you want to add any more to that?

Michael J. Donnelly

No. That's it.

David B. Dillon

Jack [ph]?

Unknown Attendee

You're talking about adding square footage and you've been hinting that the acquisitions could be part of that. Could you give us an update on what your acquisition criteria would be? For example, I know for a long time, it's been you wouldn't buy a broken retailer or something you have to put a lot of management, fix up time into?

David B. Dillon

Our view of acquisitions really hasn't changed. About the only thing that has changed is your-all appetite to ask us the question because -- and I don't mean that in a critical way, there are opportunities out there that you-all see and say, What about this, what about that? But our criteria has not changed. And as a result, our answer really is the same, that we always look at these things. We had better results with the smaller end market in-fill kinds of acquisitions. There are some big ones that we could construct that we might have interest in, but we're never going to talk about any specific one, either hypothetically or if we're actually occurring. So I don't know I have much more to offer, unless you have greater insight that you want to offer on that question.

Michael J. Donnelly

No, sir. I remember coming away from a conference one time and the headline was, "Kroger CFO okay with big acquisition," and I don't want that to be the headline again.

David B. Dillon

If it is this time, they've definitely taken it out of context. Jack, did you have another question?

Joseph I. Feldman - Telsey Advisory Group LLC

Joe Feldman, again, back here, from Telsey Advisory Group. Wanted to ask about e-commerce and any thoughts there, or a lot of others are shipping from the store to home, and just what you guys are currently thinking on that front?

W. Rodney McMullen

Well, so you saw some examples of digital. You got to look back on probably last year, 1.5 year, and take yourself on our journey. Because our journey was we were really not proactive in any of that space. We were actually probably behind. We think we've made some great strides in the digital space, which made today eloquent. So honestly, I would say that was the first part of the journey, is to actually figure out how do we get into the space, the digital space, in a way that's meaningful, that's respectful, that actually customers can go on and view and like, right? That doesn't mean we don't have a parallel path that we're looking at as far as e-commerce goes, because we are. But we aren't as far along on that journey as we wanted to be, getting up to speed in the digital space, so we have bigger opportunity there. Do we see something in the horizon? Yes. Some could say we're late; some could say maybe that's okay. Because being early means that you'd spent a lot of money getting up to speed in that world. So we're going to learn a little bit as we go through this journey. But we hope over the next year or so, that we'll have a better position with e-commerce.

Joseph I. Feldman - Telsey Advisory Group LLC

Great. Can I follow up on the digital as well? With -- I may have missed during the presentation, but with the -- like the iPad app that they were working still working with, how far away are we from like the self-checkout, scanning, dropping it in the bag and assorting yourself and walking out and paying?

David B. Dillon

If you look at, we're certainly at testing versions of that and we have been for a while. A point in time that we had something that we felt was scalable from a return standpoint, you'd see us doing this. Do we think there's something there? Yes, or we wouldn't be working hard trying to create that innovation. But we don't think it's something that you can get a return for at this point.

Kelly A. Bania - BofA Merrill Lynch, Research Division

Kelly Bania from BofA Merrill. Just wanted to go back to your outlook on the operating margin x fuel. And the history was great on the how much you've invested on price and loyalty over the years, the past 10, 15 years. But it seems like some of your competitors maybe haven't invested as much and are going to be some doing some catchup in that regard. So I'm wondering, why now the commitment to grow operating margins in light of that? And I think as we kind of leave here today and think about our models, I think where should we think about more is the opportunity coming from? Is it more on the gross margin and SG&A front? And I know you're trying to get away from the guidance on those specific line items, but longer-term, kind of what's changed and where do you see more opportunities?

David B. Dillon

I will admit I did not expect to be asked today whether we should have increased our commitment to increase the operating profit margin, because I had thought, from feedbacks of many of you, that some of you already have taken that as a given. But it's actually a really logical question. And I think of it as a puzzle, that the pieces start coming together at the right time in the right way, you believe this model will work fine and then this is where you want to go. And so, for instance, we see lots of opportunity to spend capital. Rodney, I think, made the point that we have more projects than we have capital to fund. And we always want to ration capital. In fact, there's a really big value in rationing capital. But if you're rationing capital too much, that is you starve yourself of funding the projects that you think have merit, you really sub-optimize the return that the shareholders would get from the company. And I think we were beginning to see, moving into that direction, that we needed to increase capital. And it was our opinion from the very beginning, that if we're going to increase capital on some of these areas, that we're going to spend money in some of these areas, we should only do that if we can produce a higher return. And as we look at it, when we then said we want to produce a higher return, we believe the operating profit margin x fuel, FIFO, was one of the contributors to how we produce that higher return. What really convinced me was looking at it over a long period of time and seeing how much it has declined as we went in through the recession. And we said to ourselves that it should be able to come back up a little. And that shame on us if we can't accomplish that, so we started from that frame of reference. So I don't know if that helps you give you a sense of how the pieces started falling in place. But it became actually pretty obvious to us that now is the right time to do that. Any additional?

David B. Dillon

Yes, go ahead, Rodney.

W. Rodney McMullen

I was just going to say if you look at finding cost to take out of the business, we continue to find opportunities that make process change to take fundamental cost out of the business. And we've accomplished that over the last several years. I think we had declining OG&A without fuel for, I don't know, what is it, like 29 out of the last 30 or 28, something like that. But continuing finding those kind of opportunities to take cost out in a way that doesn't change the customer experience would be the other thing that would allow that. But that's just an additional FYI on top of what Dave talked about.

David B. Dillon

Rodney, why don't you kind of repeat the comments you had in your presentation, or in your Q&A earlier, about our results of the 4 keys of our customer-first strategy and the competitive position that puts us in?

W. Rodney McMullen

If you look at what our customers tell us versus our traditional competitors, I mean, it puts us in a very good light. And that gap has been improving. If you look at some of our nontraditional competitors that are pretty good size, we're significantly better than they are on people, product and shopping experience. And as Mike mentioned, we've greatly improved the reputation on price. And remember, there's 2 pieces to price, everyday price and promotional price. And on promotional price, we're significantly better than even they are on that particular part of the price equation. So we've made a lot of progress. Now if you talk to us internally, you'll hear all the things that we think we can get better at. And I always tell people in retail, if you ever think you've figured it out, it's the end. And internally, we would focus much more in terms of who's better than us at something and how do we get better than where they are. What are they doing that we were not. I don't know, Mike...

Michael J. Donnelly

Yes, that's exactly the comment. Because it's not just -- we have 4 keys to our customer-first strategy for a reason. And it's hard, once you get that advantage over everybody, for them to come back and beat you on all 4. They may gain ground on 1, but we've got an advantage on almost all 4 of them now.

W. Rodney McMullen

Yes, I always tell people, look at it as a puzzle, and the key is having more pieces to the puzzle. And when you look at having a unique competitive position, somebody can neutralize on one, but it makes it really hard to neutralize you on all of them. And it's something -- I mean, this journey we've been on for 7 or 8 years, so it's not something you can just go and create tomorrow.

Unknown Attendee

My question relates to strength. Last quarter, you mentioned that you had made less progress year-over-year in shrink. And I think it was one of the areas of a little bit of pressure on the gross margin. Could you maybe shed a little bit more light on that? And then also talk about whether you've been able to work on that line item in this current quarter and going forward?

David B. Dillon

Rodney? Either of the 2 of you.

W. Rodney McMullen

If you look in terms of it didn't -- the shrink number in the second quarter didn't surprise me. Was it where we would like to have been? No. But one of the things, just the dynamics of when you have inflation changing from a lot of inflation to not as much inflation, there's always an effect on shrink rate. Now we are focused on improving our shrink. Now you won't see us making huge turns trying to get all the correction in one quarter because the way you would -- the way you would correct things in one quarter would affect sales performance. So you'll see us always trying to get a little better versus just trying to fundamentally get it back to where it was. Long-term, we feel really good about some of the things we had going on shrink, and it's not something that suddenly we're looking at a long-term business model with a different level of shrink than before. Mike...

Unknown Attendee

And just a second question for you on technology. And the work that you've done on QueVision is pretty impressive. So it seems like it's sort of one of those big ideas, but are there other things like that in the pipeline? As you think about investing in your stores and customer service and experience, maybe you could sort of frame how much of your CapEx actually goes to things like that as opposed to renovations in the stores?

W. Rodney McMullen

There's several of those types of opportunities that we're working on. And from a shareholder standpoint, you -- and we only have to have 1 out of 10 of them to work to have a phenomenal return. So it's one of those where there's -- it has such a big effect because you get to do it 2,500x, the return is huge on it for our customers and our shareholders. I don't know that -- I'm trying to think if there's any that we would be in a position that we're willing to talk about. There's certainly a couple of them that, if they got to the point where we could roll it out, it would take up some of our capital budget. But it would be within the capital outlines that Mike talked about. We have a pretty meaningful dollars allocated to technology. We don't allocate the specifics to a project until we have a project to allocate it to.

Unknown Attendee

And are you marketing QueVision in every market from a advertising standpoint? And when did you start that?

W. Rodney McMullen

We're -- trying to think if there's any -- we're almost advertising it in every market we operate, and we start advertising it when we know we're delivering for the customer. And when we have incredible execution on anything that would blow your mind, that's when we start telling our customer what we do for them, because it really is our associates making that promise.

Jason DeRise - UBS Investment Bank, Research Division

It's Jason DeRise, UBS, again. A few questions that I don't think were quite asked this way yet. But in terms of the ROI key going up, has your criteria for making a decision on CapEx changed? Are you expecting a faster payback? Can you talk about that?

W. Rodney McMullen

It's not so much that we're expecting a faster payback. As we've stepped back and looked at how we have allocated the new relocated and expanded dollars, it was clear that there was activity going on, and all the questions about square footage and the like. But we've had competitors open up square footage in our space, as well, and their stores have done incredible volumes. You asked the questions of the division, Well, why didn't you submit that project because you could have had that site, and, Well, we ran out of capital. So it became clear that as we step back, that there were market opportunities we were missing, because every division had a certain amount of dollars to spend on new relocated and expanded stores. By looking at that across the entire enterprise now, we can get insight into the best 50 to 100 projects that the divisions may think that they think they have. And really by going through that list of stores and what are the metrics of each one of those stores and which ones look like they have the highest chance of success, it's really that process of looking for the 25 or 30 or 50 best projects, not a division's 2 best projects. And that may mean the division doesn't have capital to spend in a particular year, and that may mean another division has 5 stores that open in a particular year. But it's really the fact that by competing broadly against the company, that it's not that the projects are better, it's that the project that get funded are the best 50 in the company, not a few in every division. I don't know if that -- there is a subtle difference there.

Jason DeRise - UBS Investment Bank, Research Division

No. And I think you alluded to that a couple of conference calls ago. Okay, that makes sense. Another thing, just to try to get clarity about the guidance. I'm going to try to say what you guys have said, and you tell me if I'm wrong. That, okay, so I'll ask about the first piece that you've talked about for many, many years, it's about the others. But I guess there's a trade out there. A lot of your IT sales growth has been fueled by that. So should we assume slower IT sales growth, a better balance of price, but net-net, the gross profit on an identical-store basis is the same or better in terms of trend? Is that maybe a takeaway, something like that?

J. Michael Schlotman

Well, I'll start, and let Ron here or Dave chime in. But when you think about something like QueVision, we made those -- that progress that Rodney spoke of without adding incremental labor to the store. So we spent some capital dollars one time. We did some training upfront, that clearly was an expense. But we didn't add hours to the stores to accomplish that great increase or decrease in the time customers wait in line. When you think about something like that, that's not an investment in price. At the end of the day, it was a relatively small investment in training once you had the capital and you had the process deployed.

That is probably a sales driver without an investment in price. And the reason we have all 4 keys is we think there's elements of all 4 keys that help drive IDs. And I don't -- one thing I don't think you should walk away from is the impression that price isn't something we're going to continue to invest in. We will continue to invest in all 4 keys. Just some of the feedback we've gotten is we really haven't done a very good job of explaining some of the investment in the other 3 keys and we've been too focused on talking about price investments, primarily because it's the most obvious.

Jason DeRise - UBS Investment Bank, Research Division

Okay, that makes sense. And just very, very ^^ last one, but I just -- I thought it was interesting some of the comments before about this that growing square footage with big box versus small box, when thinking about stock up versus fill-in trips. You had a very clear answer but it seemed like there was maybe a little debate. I wanted to put it out there and see if they're [indiscernible] as a preview for tonight's debate.

J. Michael Schlotman

The question that I answered is more in terms of new market, what do we think is the best way to go into a new market, what's the most likely. If you look at in fill-in market, you'll see more of a combination of the different formats. You'll see us using broader uses of the formats we have when we have a model that you can replicate. It's just basically a cookie-cutter. But you'll see us, as we get better about using some of those smaller formats in terms from a return standpoint -- and when I say "smaller," I'm talking about 5,000 or 10,000 square feet -- then you'll see that as part of the equation as well. The one in the back?

Unknown Attendee

Just to peel the onion some more on this capital -- CapEx increase. To hear that you were -- had projects that were starved, I think sounds a little surprising because you had a pretty good repurchase level. So there was some decisions made there that I would love to have been in the room. And now if we're going to have an increase return on invested capital, what's the kind of timeline for those returns? Maybe 1/3 of it is rather quick and easy and another 1/3 of it is 2 to 3 years? How do you envision increasing your returns on capital now that you've told us you want to spend more capital?

J. Michael Schlotman

I think that there's multiple -- peeling the onion is a good example there because there are multiple layers there. When you think about -- I go back to the comment that the increase in the ROIC and the increase in the earnings per share guidance isn't purely driven by the $200 million of incremental capital. There's the expectation that the core is going to generate a better return than it has because we're going to -- to generate that operating profit margin increase, we're going to have to balance our investment and our savings better, depending where ID sales are, to be able accomplish that over time. So I think there's -- there are multiple things that are going to contribute to the ROIC. As Rodney said, when you invest in a new store and a new market, the increase in the square footage happens faster than the benefit to earnings per share. But when you're doing that in the fill-in market and you gain those leverages I had, that the core does wind up getting help as a result of that. Your earlier question, I'm glad you asked that because there's obviously an element of confusion or, slash, concern on having projects that were starved and we've been spending a lot of money on capital. Part of the way we used to allocate and have given divisions responsibility for how they spent their capital, is they essentially had a fixed pot of capital and everybody has a lot of things to do, and if 3 stores that they had in the pipeline were going to use up their capital, we weren't very generous with giving them incremental capital so they went and worked on something else rather than bringing us their fourth or fifth project. But what we had found out over time is that division's fourth or fifth project may have been better than another division's first or second project, and we just never had insight into that. And as we started talking internally about a better way to spend our capital on new relocate and expand, it's because the divisions still have responsibility for remodels. It just became apparent that there were market opportunities we were missing. We think this process is going to yield better results because we're just seeing a broader array of projects in all geographies.

Unknown Attendee

Now it's clear that the whole machine has to produce increase return on capital. But again, just go back to the incremental CapEx, hopefully, will have an additive return on invested capital. And when that happens, will it be in a short-term, long-term, medium-term? How do you envision return on invested capital on incremental CapEx?

J. Michael Schlotman

Yes, I would say for the first couple of years that incremental spend from year 1 won't do a lot, and then you have year 2 that doesn't do a lot. But as you tier that down over time and you get several years out, now you have 3 or 4 years of $200 million each year that are starting to generate. And the incremental $200 million you're spending this year, while it's not generating your return, you have the ones from the early years, as Rodney talked about earlier, that mature over 7 years or so, really starting to add to that. So it's going be slow at first. It's like I said in my prepared comments. Yes, we want to increase return on invested capital. You shouldn't expect that it's going to be turned on a dime and all a sudden it's going to go up 100 basis points. I mean, just do the math of what the EBITDA has to be to increase return on invested capital by 100 basis points, even if we don't change the denominator. But it's clearly a goal, and we know it's a need to increase that ROIC over time.

Unknown Executive

Over here?

Unknown Attendee

So how do you think about the consistency of the 8 to 11? Is that you're viewing it more as a 3- to 5-year average with some volatility but because of the way you run the business today, there's more consistency than there may have been in the past, recognizing the macro can move around a lot?

David B. Dillon

I think of it -- I think of long-term guidance to mean to you -- for you, what our target is each year that we set our business plan, our objective is going to be to have it fall within that range. It's a little hard to look out into the future and promise you there will never be a year that we think will fall out of that. But on the other hand, I believe that our intent is to do our business plans around and our forecast around and all of our efforts around, in advance and during, to produce a year that will fall within that range. And that would begin with 2013. We obviously aren't giving specific guidance for 2013. We'll do that in March. Unless you want to do it sooner, we'll do it in March

J. Michael Schlotman

I want a ride home.

David B. Dillon

Yes. There you go. But you can presume that it's certainly, we're targeting that kind of a range beginning right away. So there shouldn't be any big surprise there.

Unknown Attendee

And the incremental capital doesn't move that up, or maybe it moves up gently over time as you get up to year 3 or 4?

David B. Dillon

Yes. Yes. Because as we pointed out, there's enough variation year-to-year in how much you're able to achieve just because of all of the outside circumstances. And those variations will probably be, certainly in the early years, as much impact as what the incremental capital will provide. So you have to look at all of the factors together. And as we describe each year, we'll try to describe to you the factors that we think cause us to shape the year that we're forecasting and put in our business plan. And I certainly expect that the incremental capital will be helpful, but I don't think it's going be helpful very soon, a few years before it really has materially.

J. Michael Schlotman

John, just to add a little, a couple more data points to that. When you think about the timing of when that capital may contribute to the 8% to 11%, and I don't want anybody to hint or even think from your answer -- or the question that in 5 years with all this capital, we're automatically going to make the 8% to 11% higher. We're going to balance all of this. And one of the reasons that we went ahead and increase the buyback authorization today, as an early part of this, we'll continue to buy back shares, and there will be some element of this, more in the earlier years than the later years, that will come from a buyback program as we also balance the capital and that capital begins to mature. And I think as that incremental spend starts to mature and starts to contribute, hopefully at some point in time with a growing company, your multiple should expand and the model, itself, can generate a return on invested capital that's going to be enough without having to rely on too big of the share buyback program, and we can continue to use those dollars to invest back in the business, and grow the business by growing rather than grow the business earnings per share being the business, rather than doing it just by shrinking our share base.

David B. Dillon

Where's the mic?

Unknown Attendee

I have 2 more questions about capital allocation and store development. The first would be that your friends, the nameless competitor in Bentonville, has talked about reducing capital expenditures in their domestic business by 8% next year. And they're doing that despite a projection of an increase in square footage of 3% to 4% in part by reducing the cost of putting up the store by 10%. And the question is, I've not talked -- I've not heard Kroger comment about your ability or desire to reduce the amount of money it costs to put up the store. Is that a possibility?

David B. Dillon

Well, we work very hard on cost per square foot and where ours has changed is we've increased the square footage of the stores we've built -- in not every store but many of our stores have been marketplace stores or at least bigger stores. And as a result, the total dollars of a store went up for us. But we have had lots of success over the last 5, even 10 years actually. We've had efforts on this to reduce our cost per square foot. And Mike, you may want to comment on that? Still, the engineering group has done a terrific job on that.

J. Michael Schlotman

They've done a great job of that. You also have to step back and look at how you go to market versus other competitors go to market, and you certainly can't go to market with a lot of fresh product and the things that Jeff and Mike talked about in their presentation. And that adds incremental cost to a store to have that kind of product and rollout a new product and those kinds of things, whether you need a hot case or a cold case for that product, and if it used to be an ambient case, that's an incremental cost, both in operating cost and the cost of the case. So I think you have to step back and look at it over time. I will tell you that our facility folks are very dedicated to trying to continue to value -- engineer our projects and make sure that we're doing them the best possible way. When we see a competitor that looks like they may be building a store at a cost per square foot and doing things that might be unique or a little different, and they go to market generally the same way, they spent a lot of time in their stores and can at times be seen crawling in coolers in trying to get model numbers to figure out where the case came from or counting per square footage of cases and things like that, and you have a general feel for what their sales are. So we do a lot of looking at competitors, both domestic and in Europe, trying to understand who's the best in class at building a store. Now also, your math, as they increase potentially square footage and reduce spend, they also are concentrating on a smaller footprint as they're talking about building the stores as well. So...

Unknown Attendee

So could you -- what do you think has been sort of your trend over time in your cost per square footage?

J. Michael Schlotman

Well, it's been flat to slightly down. Some of that depends on where different markets are, like copper and some of the building components that are in there. There's conventional wisdom that with the downturn in the economy and the lack of construction, particularly in the housing market that, that ought to bode well for the cost of constructing the store. But putting up 2x4s is putting up -- is different than putting up a steel-based building. So the skills of somebody who's out of work building a house don't automatically transfer to building the steel structure. So there haven't been the same kind of benefits there, but I've been very happy with what our folks have done over time. And we have a target depending on the geography, the number of contractors in the market for every one of them. But just today, I won't go into the specifics on those amounts.

Unknown Attendee

And the second query is about operational closings. I guess in 2011, you had 41 operational closings and you had 90 stores and 12 relocations. In very rough numbers, it looks like the operational closings have sort of outnumbered the number of new stores plus relocations by almost 2:1 for the past 3 to 4 years. Now it may be an apples-to-oranges situation where you're closing small stores and opening very large ones, that you just suggest, but given -- I'm sort of assuming that an operational closing is, in a sense, a non-ideal result from the shareholders' perspective.

David B. Dillon

Well, in a long-term, that's probably true. But let me give you a really long-term picture. In 1930, Kroger had 5,500 stores. Today, we have 2,500 stores, almost. So we went through a process of having lots of operational closings and a process of lots of new openings, and that was a remaking of the company. Now it didn't happen overnight. It happened in several different iterations. And I think anybody in our organization, and probably anybody in this room will look back at that and say, Well, of course, in 1930, they were small stores, weren't very effective stores, they didn't produce a lot. That's all true. Well, many of the stores that we closed operationally in the last few years were -- they weren't the size of the 1930 stores, but they had some of the same characteristics. They were in bad areas that've changed, customers dissipated, lots more competition, they had been outgunned as a store. It just had reached the point where it was working for us and we needed to close it. It did go through periods of time like that. So from the shareholder point of view, actually, I think, shareholders, if you looked at those details, would be happy with the choice that we did for closing those particular stores. Now, you wouldn't be happy, and I know you're not happy and shouldn't be happy, about the fact that we're shrinking the number of stores, over time, you'd like that number of stores to go up. But our square footage per store has gone up and our total sales have gone up. Our identical sales, of course, have gone up too, but total sales have really gone up. When you take Fuel out and look at our trends, we've had really good solid growth there. And that's a strong indicator, of course, we do have, of producing far more than what you lose from the stores that closed.

Unknown Attendee

Is it your assumption that operational closings will diminish over time? And is that an important component to the higher growth rate that you...

David B. Dillon

I believe that operational closings will diminish over time, but I don't know the time frame that they'll diminish. Mike, you may have something...

J. Michael Schlotman

No, I mean, we've been pretty aggressive the last 5 years of calling out some underperforming stores. It's part of what Dave said, where there've been a marketplace strategy that's a convenient spot to put a marketplace and 2 nearby stores may consolidate into the 1 bigger store. But we've actually also been very aggressive on calling out some underperforming stores. And at some point in time, that kind of activity does naturally have to slow down. I'm not going to sit here and call it is going to slow down today, but I think we actually have a reasonable chance of having an increase in our store count this year. I'm protected by FT [ph] today, so -- but I -- just looking out, if I look at the list of projects in the pipeline and what potential original closings are out there, it looks we have a reasonable chance of maybe that happening for a change. And that's one of the reasons this whole management team is so excited to be here today, to talk about growth. And when our store count stops going down and starts going up, that's just another component of growth to talk about.

David B. Dillon

So in the cocktail hour, maybe what we'll do is do an over-under on that estimate of whether or not we'll have an increase in that.

J. Michael Schlotman

See Dave for that.

David B. Dillon

Can we webcast the cocktail hour for that?

Unknown Executive

No, we can't.

Mark Wiltamuth - Morgan Stanley, Research Division

So I think -- this is Mark Wiltamuth again. Just wanted to wrap up. Several of the comments here, we're starting to get more color on where the increased optimism is for the near-term, because it sounds like the incremental capital spending doesn't necessarily move the earnings near-term. So the core has to deliver the 8% to 11% earnings growth. But there's going to be a little more balance of buyback here in the near-term, so that's going to be part of the increased optimism. It sounds like there's going to be some margin pressure because of the new stores. So are you -- are we to imply that there's some increased optimism on the comp outlook in what you're talking about?

David B. Dillon

I mean, keep in mind, you have $200 million a year. It's not like we're going to go from the number of stores we're doing today to 70 new stores in a year overnight. So the drag on the results and the drag on margins, I don't think is going be something that's an insurmountable issue for us. It'd be a whole lot different than if we sat here today and we say we're going to add $1 billion to capital next year. I would be giving you an entirely different answer. I probably wouldn't, frankly, be sitting here if that was my recommendation. But this is a balanced approach. And we think it's one that's going to be manageable over time. And Rodney talked about the maturation of the stores are starting to happen a little quicker on some of the ones we've been opening recently and they last for a little bit longer period of time. So when you have a base of, let's call it, 2.1% or 2.0% or 2.1-or-so, it's capital spend already, and you add 10% to that, it's not going to dramatically change the needle. One, it's not going to help the earnings per share growth a lot in the first years, but it's also not going to attract from it in a major way either. But I don't want to characterize it, I don't want the takeaway to be that it's going to put margin pressure on us, because I just don't think it's big enough overall that it's going to put margin pressure. And by the time it gets to be $600 million or $800 million, 4 or 5 years out, you've got those first 3 years that are actually contributing to it to absorb the incremental spend in the out years.

Mark Wiltamuth - Morgan Stanley, Research Division

Well, I know you don't want to give guidance, but the big buckets on where you'd be incrementally more optimistic here to get to the 8% to 11% just in the near-term, because it's going to come from the core, so what are the major -- which buckets do you think are the bigger contributors?

David B. Dillon

I'm optimistic on really most of the parts of our business. I think they all contribute to the answer there. And the one other piece we didn't talk about in that moment, that you've talked but several times today, is the role that stock buyback plays, too, in being able to achieve it. In the early years, Mike described it, as the bigger contributor than in the later years. But it's still a reasonably meaningful contributor. So that's one element. But I think the most important elements are really that we're cranking on all cylinders in a very positive way. We're having good performance in terms of how effective we are at getting sales, at targeting our pricing and reducing our costs, and the combination of all of those. We're optimistic about where our sales have been of late, as we've described. I mean, they're not robust of the go-go years of a few years ago, but we're coming out of a really lousy recession, and we're coming out of it quite slowly. And when we're coming out in that kind of a situation, to have the kind of sales that we have, I think we actually feel quite positive about that.

J. Michael Schlotman

Mark, a way to think about it, as well, is should we go back to the last December when we actually talked a little bit early about guidance for this year in December because of the strong stock buyback we did, and one of the comments we made is we don't think it's giving value to shareholders. At the time, our guidance was 6% to 8%. And we actually told you a year ago December, that this year was going to be higher than that because of the strong stock buyback. And obviously, we had some strong stock buyback this year. And we just don't think our old guidance of 6% to 8% and a lot of stock buyback is really giving you value, because that infers no contribution from the core, and that's not what our value proposition is.

John Harris

John Harris from Sequoia Fund. I wanted to talk about the comment, Dave, you've made just a little bit earlier about store closings and how those are not necessarily a good thing for the business or the shareholder. And I mean, to me, the idea of closing underperforming stores, closing stores in that bottom third category that you guys showed in the presentation, and using your available capital to buy back huge amounts of the company at 9x earnings, seems like an incredibly good thing for the shareholders.

David B. Dillon

I think it's a really good thing to close underperforming stores. And you should be happy with it. In fact, you should demand it of us. The only part that's not good news is that we have underperforming stores. But our objective would be to have fewer of them so that there's fewer doors out there to close.

John Harris

Because I just look at that slide and I think, Gosh, as a shareholder, with the stock trading where it is, what would I like more than anything in the world? I'd like to own a lot more of the company every year, and have the part of the company I own increasingly be the good 2/3 that's performing at this really high level...

David B. Dillon

Yes. We would completely agree with that. Absolutely, we would agree with that.

J. Michael Schlotman

One of the -- and if you're referring to the slides Rodney had on the thirds of how we split up our market share, don't infer from that, that those markets are underperforming, or that underperforming stores are concentrated in those markets. Some of those markets -- the results of some of those markets, they don't have -- necessarily have underperforming stores. They just don't have the density or market share to be in the middle 1/3 or the top 1/3. And we really think that's part of the story, is many of those -- many of those markets have great opportunity to move up that spectrum from the bottom 1/3 to the middle 1/3 to the top 1/3. So it's not a one-for-one, that if you were in the right-hand side of Rodney's slide that there's a lot of stores in those markets that are getting closed because they're underperforming. It's not always that way.

David B. Dillon

One comment from an operational standpoint. One of the things, culturally, we try to create is a lot of times when somebody does an operational close, they look at it as a compete failure. And we want to make sure that our vision, if it's the right economic position for our shareholders, is that our internal team will suggest closing a store. And we've done an awful lot of work to make sure that we understand the economics of that particular site, what's it worth to operate and what's it worth to sell or to close. And I also look at what's the return on time. And in some of these operational closings, in towns that the store may be doing $200,000 a week or $250,000 a week and it's basically cash flow neutral, and you look at that market and you're never going to have a store that does much business. If you do really well, you might have $300,000 a week. And a lot would rather see us spend that time in a market where the potential is so much bigger. So we've done a lot culturally to trying to make sure that if it's the right economic decision to close a store, the people say, Let's do that and move on.

Unknown Attendee

[indiscernible]. So obviously, a lot of retailers are closing stores for a lot of reasons, and back to the prior question about reengineering or remodels. As we think about this additional $200 million in CapEx, so it sounds like you'll kind of further expand on your digital strategy, both mobile and e-commerce. But as we think about your physical kind of further expansion, is there an opportunity also to grow in an unprecedented way also in terms of both big box and small box as you kind of further fill out your markets to take advantage of some of these, let's just say, to be unprecedented opportunities as retailers are, let's just say, leaving certain markets as well.

David B. Dillon

You want to comment?

J. Michael Schlotman

Well, the -- to say unprecedented, I think it would -- we're all kind of, what Dave started out the meeting in terms of trying to make sure that we under-promise and over-deliver. And we have to make sure that we improve our business one step at a time. Now from our perspective, do we think the potential is there? Yes, but we've got to deliver one step at a time. And the first step is to make sure that we take the $200 million each year incrementally and get a good return for it and continue to improve our customer and associate experience as what we have and committed to do. Obviously, as we deliver against that, that would create a different level of optimism and comfort in terms of what we can deliver. So I always think that it's really important to make sure you focus on what you're good at, keep delivering against that, but don't get out in front of yourself so that you end up expanding something that's beyond the people capacity, because we have to make sure that we've developed people that can operate at this level also. And if we get out in front of that, that would be the worst thing that could happen.

Unknown Attendee

Okay. And then one of the megatrends that was cited was health and wellness. Can you talk about your experience in pharmacy and how should we think about Little Clinics, further immunizations, and what's your opportunity there?

David B. Dillon

Either the 2 of you would be good.

J. Michael Schlotman

Well, I mean, when you look at health and wellness, obviously, pharmacy is an important business, and we've had a phenomenal year in pharmacy. We would've had a phenomenal year with or without Express Scripts. So you decide how you want to look at it. We've had a fantastic year, but we would've had a fantastic year anyway. If you look at like The Little Clinic, I mean, the reason why we created that partnership 3 or 4 years ago is we believe there's a long-term trend in health care and we don't think the current health care system provides -- when you know what's wrong with you, but you need to see somebody just to verify it and make sure you get the right script, we just think it's a wonderful opportunity, and it fits so much into our model in terms of convenience and the things that we already offer. And we would see plenty of potential even beyond the things that we're already doing on health and wellness. So for us, it's a huge growth opportunity. We ought to be able to help our customers do things in a convenient way that set aside that health and wellness. So we've had phenomenal growth in both parts of the businesses that you referenced, and I even feel excited about, going forward, even more growth.

Unknown Attendee

And just lastly, as we look at the jewelry business and the increase in presence in the supermarkets and the decrease in presence in the malls, just how should we think about that category in your commitment going forward?

J. Michael Schlotman

If you look at jewelry, we really look at the free cash flow that it generates. The mall business, as a general rule, the leases, you can't assign them. So you have to let those run out, and what you have seen over the last several years is we continue to let those run out because we're not happy with the return on assets to that part of the business. But if you look at, in the Fred Meyer stores in the marketplace stores, it does create -- then one more thing that makes it more than what's normally expected, and it creates a little fun. And if you look at the return on that business, it would have a completely different set of dynamics because obviously, it's a lot cheaper from a rent and from a construction standpoint than anything in the mall would be. Will it cause the earnings growth rate to change? No. But it generates nice return for what it's worth.

Scott Andrew Mushkin - Jefferies & Company, Inc., Research Division

It's Scott Mushkin. One last one for you guys, and to the gentleman in front of me, I wanted to talk about the share repurchases. I think you said a couple of times that more of the earnings growth would come form share repurchases to start with, and less as we get into like a 5-year period. Embedded in that assumption, if I look at everything with the ROIC going up and, at the same time, capital going up, that means operating cash flow would have to be rising and free cash flow would be rising. So to make that statement, it seems to me that you would have to think that your share price is going be significantly higher because if it wasn't, you could be buying the back and buckets? Or am I missing something?

David B. Dillon

Mike?

J. Michael Schlotman

Well, Scott, it's a matter of balance and where it's going to be the best return to the shareholder over time. And obviously, we made an incremental commitment to the dividend with the 30% increase. Karen's absolutely right in her earlier comment that it didn't take as many dollars as it would've 3 years ago to do that because of the shares we bought back. And we really think it's a matter of balance, and we believe that if we become -- have an element of the story that's a little bit of growth, at some point, we ought to have a multiple expansion. And there'll always be the opportunity we believe to buy some stock back because there's always those periods of time. But it really becomes a question of balance of your user free cash flow, and we think there's a better long-term return as particularly as we do fill-in markets and look at some of these new markets for the incremental CapEx rather than biding in the boat loads. We're obviously aware enough that you-all are a skeptical bunch, you're paid to be a skeptical bunch. My guess is, is you are. I mean, that's your job as an analyst, is to a question, and that's obvious today from the number of questions. So any benefit to take the stock to a price that would cause me to just shut off a stock buyback program, I don't see in the cards in the near-term because you're all -- there's going to be an element of, Show me that you're really generating the return that the model says you're going to return. And that's why I think when you look at it from the short-run, there'll be a bigger opportunity in the next 2 years than perhaps in the next 3 years relative to buying 60 million or 70 million shares of stock on an annual basis. But we always think that there's going to be an element of opportunity to buy the stock.

Unknown Attendee

So just a few questions. I guess the first thing is, what is contemplated in terms of the economic environment within -- embedded within your guidance? And then the second question is, obviously, there were some numbers given out about the neighborhood market openings and those are accelerating. So what is the impact to your stores from a neighborhood market opening up against you versus a supercenter? And do you have any insight on how many will be opening up against you next year?

David B. Dillon

Let me comment about the long-term economic outlook, and then Rodney can maybe comment on the supercenters and neighborhood stores. I would suggest that there's not a particular economic assumption embedded in the long-term guidance that we're giving. But instead, a recognition that at Kroger, our success has been because we are able to adjust to the dynamic marketplace. And so at times of recession, we've done relatively well. I recognize our earnings actually dropped then, but not near as much as most people's earnings dropped. And I think through all the other times, we've really held our own in a wide variety of economic situations. So if inflation is, in a particular year, looks like it's going to be a little higher, we try to adjust. If it looks like it's going to be a little lower, we try to adjust in terms of how we do our business. So we didn't assume to the long-term guidance that there was a specific economic outlook. Now in the next year or so, we view that to be pretty much like what we've seen, continued slow recovery, probably some interruptions with pieces of inflation that were driven by the drought, by the high core in price and the effect on, for instance, fresh meat. But those are -- those you just deal with during that period, and then it passes, and you come to something a little bit more normal. But I think we look at next year a lot like we looked at this year, slow recovery, some unpredictability, but that's how we're seeing the short-term future. Longer-term future will adjust as we see it a little more closely. Any additional comment on that, Mike, we will get; then Rodney will comment a little on supercenters and neighborhood stores.

Michael J. Donnelly

If you -- in terms of absolute number, each division would have what they think would be for them. If you look at the effect on us, the effect over the years, whether it's a neighborhood store or supercenter, it significantly declined, and it continued to decline. And part of that is, if you think about it, there's a market with 3 or 4 competitors and you have another one open, that's a completely new format that's not been offered before, it completely changes the dynamic of the marketplace, and it takes a while for that to settle in. So I've always believed that part of it is there's a new, completely new game. Well, when it's an incremental gain, the effect on us isn't nearly as much because I showed the returns on markets, where a big competitor has higher market share. And what happens is both of us can be successful because really, our customer, there's not a huge amount of overlap between the 2 customer base. So it's not a customer either shops here or shops there. It's really we do just fundamentally offer something different for the customers' experience. And obviously, we would focus a lot more on the fresh side of the house, our produce, meat, all those kind of things, we would -- the customers tell us we do a significantly better job. So it's a good question. The impact continues to decline over time, but that's been true for several years. Certainly, a neighborhood market doesn't affect as much as a supercenter, but I can show you, I can give you examples of things where it would fall outside of that. But as a general rule, it certainly, by no means, at the end of the day, not at all.

Unknown Attendee

I was wondering if you could help me understand your decision to increase your capital is implicit from buying back stock to capital spending? You're saying real estate is cheaper than buying back your stock. Or is it more of a diversification strategy that says, We need to hedge our best, and say, We need to have some growth. Could you help me understand? Are you saying that real estate and a new store will be better a return on capital than buying back your stock? Or what's your thinking behind that?

David B. Dillon

I think the thinking that Mike described, first of all, think about balance. We're not trying to do one to the exclusion of the other. So we're going to have stock buyback as part of our ongoing strategy, just as we have CapEx spending as part of our ongoing strategy. So start with that. But secondly is, when we look back at our choices, it was a matter of, do we want to emphasize more in this direction or more in this direction? And if you emphasize more in the stock buyback direction, you are electing to say that you don't have a vehicle, a business that is going to be able to physically grow in terms of how much it can add their stores and grow in this business and be successful. But you believe and said that you should tend to shrink the business or hold it static and reap the benefits by reducing the number of shares outstanding. On the other hand, you could go to the other direction, and that's the best that we're making, is that we believe that adding new stores, adding additional markets add long-term benefit and value to our shareholders, that it is a good investment, a good return on investment. And in balance, we think that, that's a better use of the dollars. Some companies conclude the opposite, but that's generally when they don't see that they have a good vehicle to ride, as we think we have. Mike, do you want to add any more to that?

Michael J. Donnelly

No, it was perfect.

David B. Dillon

Okay. Any more questions over here?

Unknown Executive

Okay, well let me do -- let me just wrap up just for a second. You guys could stay if you want or not. We have a couple of things still left. We have a really great treat for you in just a second. And Jeff Burt's going to introduce that in just a moment, introduce him and the treat. The treat comes after him. But I want to just summarize with what we started out with today, so I'm going to switch to these slides.

When we started today at the very beginning, we said we were going to describe higher earnings growth, which I think we've done. We said that we would show you how we expect to achieve higher shareholder return, and this is both higher earnings growth, higher dividend and stock buyback. The combination of all of that is how we see the higher shareholder return. And we wanted to describe to you how we believe this will be resilient and sustainable as a strategy. And by that, we mean it's something we can do for a long period of time. It's not next year or the year after, it's a lot of years. It's as far out, actually, as we're able to successfully see.

So we wanted to summarize that because we think that's what we've accomplished in this discussion. I appreciate your questions a lot. I hope you found that we've been responsive to the suggestions that you've given us, both in the survey and the comments you've given us throughout the year. We actually do truly listen to your thoughts. Your opinions help us shape our strategy. Your opinions help us think about the strength of the choices that we make. You are our shareholders, or at least our potential shareholders, and our objective is to give you something to really brag about.

So that's what we've hoped we have accomplished today. I thank you for that. And now, I'm going to turn it to Jeff Burt, who will introduce a guest speaker and a guest treat coming up. Do you need this? Okay, there you go. Thank you.

Jeffrey D. Burt

Thanks. Well, this is pretty cool. I get to do this. How many of you have been to Murray's Cheese in Greenwich? I see -- yes, a few of you have been there. I know it comes to mind when you think about Murray's Cheese, probably incredible cheese selection and amazing, incredible customer service. And then just an amazing brand, right? Just incredible brand that permeates everything they do.

I'm honored to introduce Rob Kaufelt to you today. He's just an amazing guy, and we're thrilled to have him here. Let me just give you a little bit of his background, if I can. He received his BA in Government from Cornell University. And then Rob joined Mayfair Foods, and many of you that have been around a while probably remember Mayfair Foodtown, the family business in Elizabeth, New Jersey. He was President of Foodtown from 1980 to 1985, and he established the company's upscale development when he was doing that. He then left to open up Kaufelt's Fancy Groceries, a full-service specialty food shop, and that was in Summit and in Princeton, New Jersey. And then in 1991, after selling Kaufelt food, he purchased the oldest cheese shop in New York, Murray's, in Greenwich Village.

In 2004, Rob was profiled in the New Yorker. And in 2006, Random House published Murray's Cheese Handbook. I'm sure a few of you might have that. Murray's has been named the best cheese shop in New York by The Times. New York Magazine and Forbes has named it the world's finest, best cheese shop.

In 2007, Rob partnered with Kroger's to open cheese shop in selected markets throughout the Kroger various trading areas. And by the end of 2013, Murray's will have over 100 units in our grocery stores under operation. Rob's wife, Nina Planck, who just came in -- Hi, Nina -- served as New York City's Greenmarket Director, and will soon publish her fourth book, the Real Food Cookbook. They divide their time between a newly purchased -- between SoHo and a newly purchased farmhouse, 18th century farmhouse, in Stockton, New Jersey, with their 3 children.

When I first met Rob in 2005, I was very impressed, not just with the cheese, but the commitment to training, the passion for the business and his impeccable standards. But perhaps more importantly, it wasn't just about selling expensive cheese, it was about bringing great cheese to the masses, and that was something that we could definitely align with.

So without further ado, I'd like to bring up Rob Kaufelt, Murray's Cheese president.

Robert Kaufelt

Don't leave, not because you want to hear me, but because we do have cheese. We brought some of our best cheese. And after this, we're going to go downstairs and have some. Anyway, thank you. Good afternoon, Mike, Mike, Margaret, Nina, Jeff -- shout out to Jeff, a big 5-0 coming up, happy birthday, Jeff -- Rodney and Dave and friends and colleagues. Everyone knows that -- and Matt Wiant, our president. Welcome, Matt.

Everyone knows that even though specialty cheese is a growing segment in food retailing, that still cheese jokes are forever and always. For example, it's customary when asked how business is, to reply, It stinks, in our particular field. My son, however, a first grader, informs me that I might use a better word, a word he learned from Shrek in the original book by William Steig, which is "odoriferous." So I'm proud to say that the cheese business is truly odoriferous.

By the end of next year, as Jeff said, Murray's Cheese will have 100 shops in Kroger's across the land. Of course, my staff has learned that Kroger is not just Kroger, but King Soopers, Fred Meyer, QFC, Ralphs, Fry's and other well-known regional brands operating a wide range of stores in all sizes and shapes, and with all kinds of features. To manage this behemoth, which is approaching $100 billion in sales, 10x the size of Whole Foods, and do it profitably in recessionary times, is a tribute to the management team in this room.

But let's go back a bit. It's 1981 and I'm in my first year as president of our family supermarket chain, Mayfair Foodtown in New Jersey. And I persuaded my father, Stanley Kaufelt, the founder and chairman, to let me upscale a recent unit we acquired from Stop & Shop. He reluctantly agrees. 3 months past the planned opening date and $1 million over budget, he calls me into his office to ask, When are we going to open? I'm not finished tweaking things yet, I tell him, and we'll open in the new year. He says, Are you out of your effing mind? I want it open next week. It does. It opens to triple the projected sales, and we're off to the races with the first chain in our market of popularly priced upscale stores serving a new and growing class of foodies.

In the next 5 years, my term as president, our stock rises 2,500%, and we're #3 in our country of all companies in the then OTC market. So I leave the family business on a high note to do my own thing in specialty foods. Fast forward 10 years, now I'm living in Greenwich Village, pockets nearly empty from my divorce. My excursion into my gourmet store is in shambles, and I'm clueless about what to do next. Murray Greenberg, a Jewish immigrant and communist from Eastern Europe came to New York City, where he opened a wholesale butter and egg shop, which eventually moves into cheese. Like all good communists, he had a knack for capitalism and he retired with some wealth after selling his shop to his clerk, Louis, an Italian immigrant. When I walked in one day for a hunk of parmigiano, Louis told me he was about to lose his lease and head home for Calabria. I bought the shop with my last $50,000 and moved it across the street.

When I told that to my dad, when I tell my dad, I bought an old cheese shop, he says, Are you out of your effing mind? Nobody eats cheese anymore. Privately, I fear he's correct, but I have another hunch, or hope, that he's wrong. But my purchase is not just about my passion for cheese and specialty foods nor even the need to make a living. It's also about rescuing for some unrealistic, romantic notion an old neighborhood shop, much like my immigrant grandfather ran in Perth Amboy, New Jersey before World War II and the family supermarket business.

Fast forward again, Don Becker, then Head of Merchandising at Kroger, and a man willing to take risks; and Jeff Burt, then head of deli, another risk-taker, come to visit. They asked whether I'd be willing to put shops within shops in Kroger. Why, I ask? Because, they say, You and your team have passion and expertise. You know how to merchandise. You know how to teach. You find the best cheese. You've got that old-time service, and we need help with cheese. Thanks, I say, but what has Murray's got to do with the largest chain in the country, a company with more than 300,000 employees and 2,500 stores? So I turned them down.

For the next 2 years, though, I ponder it, trying to figure out how it might be done. We then do a 3-store test run in Cincinnati for a year. It works. We decide to roll it out. As I said, I'm pleased to report at the end of 2013, we'll have 100 shops and perhaps another 100 after that. Murray's will finally realize its mission to bring great cheese to America, and I've sort of returned to my roots as a third-generation grocer. My dad, now 92 and retired in Boca Raton, of course, has long since sold the family business to Ahold. And you guessed it, has become a true believer in cheese, Murray's and Kroger. Smart fellow.

Meanwhile, since boyhood, I've been watching the grocery industry change. As a boy, the change I heard about were Penn Fruit and Farinks [ph]. Later, when I was president at Mayfair, Pathmark dominated our market, Jewel set the standard in Chicago and Balducci's here in New York was a store we all came to see. When the box stores came, everyone predicted the demise of the conventional food markets. Never mind that the conventional markets had been upscale and now, featured fabulous delis with prepared foods, fresh fish on ice, prime butcher shops, heirloom tomatoes and micro greens and bakeries with artisan breads. The box stores would clobber them.

And so it's been for my 40 years in the business. Some chain's on the rise, some in decline. New formats to me were Walmart, Whole Foods, Trader Joe's and Costco, all fresh ideas and all greeted with doleful music predicting the decline of conventional food shopping.

So here's one message. Don't believe everything the analysts tell you. Put your money on the best operators. Put your money on the company that gives up margin for sales. Put your money on those that deliver great customer service. Put your money on the company which is willing and able to ensure quality. Put your money in a company that's willing to put a Greenwich Village mom-and-pop in a 100,000 square-foot store. Put your money on the company that educates its staff and builds loyalty, one customer at a time. Put your money in the company Forbes called the Most Generous in America, donating more than 160 meals through the Feeding America Partnership. Put your money in the company whose sustainability policy has produced 19-0 waste manufacturing plants. Put your money on the conservative-looking Midwestern-run company that is doing so many innovative things in the hinterlands quietly and out of the public eye.

Specialty food sales are on the rise. Sales led by chocolate and cheese are up 11% in the last year. At Murray's, we're about discovering new foods, entertainment, theater, education, and especially flavor. We are most interested in that. Cheese is the #1 specialty food category in the United States, with sales last year of $3.4 billion. According to the NASFT, total specialty food sales last year were $75 billion.

At Kroger, a new Murray's shop increases specialty cheese sales anywhere from 20% to 60%, and doubling in sales in 2 to 3 years. Our new Louisville store increased cheese sales in that Kroger by 100% in the first week. And stores with wine, the category lift is 15% in wine sales, and we haven't even begun our plans cross-promotions yet. And I probably wasn't supposed to say any of that. Christine, Mike, sorry.

For those of us who live in New York, we must not be misled by how and where we shop. No one knows better than I that our sophisticated cosmopolitanism is often little more than the naïve provincialism. My wife, Nina, was the Executive Director of the New York City Greenmarkets. I got Mario Batali, a Wall Street favorite, his first restaurant. Friends and colleagues range from Ruth Reichl to Thomas Keller, from Tony Bourdain to Daniel Boulud. It's a great world, New York food. Even our little cheese bar in Bleecker Street has become a big hangout at night. But make no mistake, as my staff and I travel the country, we see one thing clearly, the vast majority of Americans minding their dollars in this never-ending recession want what every customer has wanted since the housewives trooped into my grandfather's shop in the 1920s, and surely long before that. Their perception of value doesn't change that much. It's still a combination of great quality and great prices with great variety and great service in a clean, well-organized shop.

To predict that FreshDirect will take over the world or that Fairway after an overpriced IPO will eliminate all local conventional markets is no truer now than my earlier belief as a young man that Pathmark would drive our family chain out of business or that Food Emporium would totally own the upscale market here in New York. What is certain is that some operators improve while others decline. Some food trends are real trends, cheese as it happened luckily, and some are fads. The best operators understand the changes in the market and adapt, while some never do and die. By my reckoning, the modern food revolution -- that's my world of local food, real food, slow food, call it what you will -- is at least 40 years old or 2 generations. And I believe that the next 40 years will continue to see this revolution or evolution come to fruition. It will be 80 years, perhaps a century, and our children and grandchildren will complete this cycle, and perhaps return to eating the grass-fed beef, the unhomogenized milk and the pesticide-free produce that my grandfather sold in his little shop on Smith Street a long, long time ago.

Thank you very much. And now, I invite you all to join us this evening at a cocktail party, featuring wonderful cheeses from Murray's Cheese underneath the shop on Bleecker Street. Thank you.

Cindy Holmes

Thank you, very entertaining. Just a couple of things in closing. We are going to have the cocktail reception on the trading floor at 6:00, so we all have to be escorted down there. So if we just can congregate around the elevators where we came up a little bit before 6:00, then we'll get down there. Let's see. And I want to -- today's slides will be available on our redesigned website tonight at ir.kroger.com. And in case you didn't see it, we did file an 8-K and a press release earlier today.

So this concludes our 2012 conference, and we hope to see you downstairs. Thank you.

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Source: The Kroger Co. - Shareholder/Analyst Call
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