Gary Millerchip
Senior Vice President and Chief Financial Officer at Kroger
Thank you, Rodney, and good morning, everyone. Kroger's second quarter results demonstrate the resiliency of our value creation model. The investments we have made over recent years to strengthen and diversify our business are enabling us to deliver consistent results despite a difficult environment, and this was very much evident when you consider the key trends we saw in our business in quarter two. While industrywide disinflation continues to impact food-at-home sales, our team is doing an excellent job managing the effects of this trend on our business. Key highlights for the quarter include EPS growth despite a significant year-over-year headwind from fuel profitability and underlying operating results, excluding fuel, improved versus prior year due to strong gross margin management, tight cost controls, and continued growth in alternative profit businesses.
I'll now provide more detail on our results this quarter. Identical sales without fuel grew 1%. Underlying growth would have been 2.6% after adjusting for the effect of the previously communicated decision to terminate our agreement with Express Scripts. Similar to the first quarter, the terminated agreement with Express Scripts had a positive effect on our FIFO gross margin rate, excluding fuel, and a negative effect on the OG&A rate, excluding fuel and adjustment items. The overall effect on operating profit during the second quarter was slightly positive, and we would expect this to continue to be the case for the remainder of 2023. Our decision to terminate the agreement with Express Scripts reflects our commitment to making decisions that we believe are in the long-term best interests of our customers and shareholders.
Turning back now to Identical sales without fuel. In the second quarter, results were at the low-end of our internal expectations as we saw food-at-home inflation decelerate at a faster-than-expected pace. Inflation ended the quarter approximately 350 basis points lower than the start of the quarter. Our sales growth was underpinned by strength in our digital business, which grew 12%. Our unique combination of assets, including stores and fulfillment centers, helped us achieve growth in both pickup and delivery channels. The growth in delivery was led by a continued ramp in volumes through our CFC network and Boost membership.
Gross margin was 21.8% of sales. Our FIFO gross margin rate, excluding fuel, increased 35 basis points compared to the same quarter last year. Our team is doing a highly effective job balancing the impact of inflation, and the improvement in rate was primarily attributable to strong Our Brands performance, lower supply chain costs, sourcing benefits, and the effect of our terminated agreement with Express Scripts. These tailwinds were partially offset by higher shrink and promotional price investments. Importantly, as Rodney shared earlier, this improvement in rate was achieved while also improving our price position relative to key competitors.
Supply chain efficiency is one of many components of our strategy to expand margin over time while continuing to invest in greater value for our customers. This quarter, we achieved meaningful operational efficiencies in supply chain through improved transport capacity utilization and increased productivity in our warehouses and across our network. We continue to invest in our supply chain as we see significant opportunities to further lower costs while also improving freshness for customers by eliminating waste in our ecosystem.
Shrink increased during quarter two, primarily due to rising theft and organized retail crime. We are implementing initiatives to mitigate the financial impact, including increased security and new technology solutions, but would expect shrink trends will continue to be a challenge for the remainder of the year.
During the quarter, we recorded a LIFO charge of $4 million compared to a charge of $148 million for the same quarter last year. This $144 million year-over-year tailwind from LIFO partially offset the $192 million headwind we experienced in fuel operating profit during the quarter. The decrease in our LIFO charge was primarily attributable to a downwardly revised inflation outlook for the remainder of 2023.
Kroger's OG&A rate was flat, excluding fuel and adjustment items. Our team continues to do an excellent job controlling costs, and after adjusting for Express Scripts, we saw underlying improvement in our OG&A rate, excluding fuel and adjustment items. Our cost-saving initiatives are focused on simplification and utilizing technology to enhance the associate experience without impacting the customer. For example, we are improving productivity in our stores by expanding shelf-ready packaging and introducing data-driven enhancements to associate mobile devices that optimize the restocking process. We remain on track to deliver our sixth consecutive year of $1 billion in cost savings.
Fuel is an important part of our overall value proposition, and our fuel rewards program continued to drive customer engagement in the second quarter. The average retail fuel price was $3.65 this quarter compared to $4.62 last quarter, and our cents per gallon fuel margin was $0.45 this quarter compared to $0.62 last year. While fuel profitability was a significant headwind compared to prior year, we were cycling historically high results from 2022, and fuel margins remain very healthy relative to historical trends.
I'd now like to provide a brief update on labor relations. During the second quarter, we ratified new labor agreements with the UFCW for Dallas Clarks[Phonetic], Southern Illinois Clarks and Meat, and Smith's Utah Clarks and Meat, covering more than 30,000 associates. In the third quarter, we have also ratified a new labor agreement with the UFCW for fries, food, and drugstores associates.
Turning now to liquidity and free cash flow. Kroger continues to generate strong free cash flow through consistent operating results and working capital improvements. At the end of the second quarter, Kroger's net total debt to adjusted EBITDA ratio was a record low of 1.31. This compares to our net total debt to adjusted EBITDA target range of 2.3 to 2.5. The Company expects to continue to pay its quarterly dividends and expects this to increase over time, subject to Board approval. As a reminder, we have paused our share repurchase program to prioritize deleveraging, following the proposed merger with Albertsons.
We continue to be disciplined with our deployment of capital, prioritizing the highest return opportunities that support our growth strategy and TSR model. This discipline is reflected in our ROIC results, which have now improved in each of the last three years and is significantly above our cost of capital.
This morning, Kroger announced a nationwide opioid settlement framework to settle substantially all opioid lawsuits and claims against Kroger. As a result, included in our financial results is a $1.4 billion charge related to the settlement, resulting in a loss per share of $1.54 this quarter. This amount was excluded from our adjusted FIFO operating profit and our adjusted EPS results to reflect the unique and nonrecurring nature of the charge. Under this settlement, Kroger has agreed to pay up to approximately $1.4 billion or $1.1 billion after tax, with approximately $1.2 billion to be paid over 11 years, and approximately $177 million to be paid over six years each in equal installments. Initial payments will begin in December 2023 and would total approximately $140 million per year pretax for the first six years, and approximately $110 million per year pretax for the following five years.
This settlement is not an admission of wrongdoing or liability by Kroger, and Kroger will continue to vigorously defend against any other claims and lawsuits relating to opioids that the final agreement does not resolve. We believe that resolving these claims is in the best interest of Kroger and its customers, associates, and shareholders, and all of those affected by the opioid crisis. Additionally, this settlement and the payment terms will not affect Kroger's ability to complete its proposed merger with Albertsons, and we remain on track to achieve a net total debt to adjusted EBITDA ratio of 2.5 within 18 to 24 months post-close.
In closing, I'd like to provide additional color on our outlook for the remainder of the year. As I shared earlier, disinflation is occurring at a greater rate in 2023 than we originally anticipated, and our customers are continuing to feel the effects of macroeconomic conditions. For these reasons, we believe the remainder of the year will continue to present challenges to navigate, and we expect identical sales without fuel will now be at the low-end of our full year guidance range of 1% to 2%. We would expect identical sales without fuel to be slightly negative in the second half of the year. As a reminder, this guidance reflects the effect of Express Scripts, which is reducing our reported identical sales without fuel by approximately 150 basis points in 2023.
Despite slowing sales, as demonstrated in our year-to-date results, we believe we have the flexibility within our model to navigate the impact of this environment through effective cost management and growing alternative profits. We are maintaining our adjusted net earnings per diluted share and adjusted net operating profit guidance, and would expect adjusted EPS to be in line with the prior year in the third quarter and slightly ahead of the prior year in the fourth quarter before including the approximately $0.15 benefit of the 53rd week.
Kroger delivered another quarter of consistent results built on the foundation of record growth over the past three years. While macro uncertainties remain, we are confident the strength and resiliency of our value creation model will allow us to continue to deliver attractive and sustainable total shareholder returns.
And now, I'll turn it back to Rodney.
