The Kroger Co. Form 10-Q Summary
Period covered: Quarterly period ended August 12, 2023, comprising 12 weeks for the second quarter and 28 weeks for the first two quarters. The request metadata identifies “2022 Q2,” but the filing text is for Kroger’s 2023 second quarter and compares against August 13, 2022.
Business Context and Reporting Period
Kroger operates an omnichannel food retail business supported by supermarkets, fuel, pharmacies, digital pickup and delivery, private-label products, data analytics and third-party media services. Management emphasized investments in price, associates, digital capabilities, fresh products, personalization and alternative profit businesses.
The filing was signed September 15, 2023. The financial statements are unaudited and prepared under U.S. GAAP.
Financial Performance and Position
| Metric | Second Quarter 2023 | Second Quarter 2022 | First Two Quarters 2023 | First Two Quarters 2022 |
|---|---|---|---|---|
| Sales | $33.853 billion | $34.638 billion | $79.018 billion | $79.238 billion |
| Sales excluding fuel | $29.900 billion | $29.577 billion | $69.969 billion | $68.288 billion |
| Operating profit (loss) | $(479) million | $954 million | $991 million | $2.459 billion |
| Net earnings (loss) attributable to Kroger | $(180) million | $731 million | $782 million | $1.394 billion |
| Diluted EPS | $(0.25) | $1.00 | $1.07 | $1.89 |
| Adjusted diluted EPS | $0.96 | $0.90 | $2.47 | $2.36 |
| Adjusted FIFO operating profit | $989 million | $1.110 billion | $2.658 billion | $2.711 billion |
| Cash flow from operations | Not separately provided | Not separately provided | $4.364 billion | $2.427 billion |
Reported profitability was materially affected by $1.413 billion of second-quarter opioid settlement charges, or $1.113 billion after tax. First-half opioid-related charges totaled $1.475 billion before tax. Excluding specified adjusted items, adjusted net earnings increased 5.7% in the quarter and 3.9% for the first half.
- Second-quarter total sales declined 2.3%, primarily because fuel sales declined 21.9%. Sales excluding fuel increased 1.1%.
- First-half total sales declined 0.3%, while sales excluding fuel increased 2.5%.
- Identical sales excluding fuel increased 1.0% in the quarter and 2.4% for the first half. Excluding the effect of the terminated Express Scripts agreement, growth would have been 2.6% and 4.0%, respectively.
- Digital sales increased 12% in the quarter and 14% for the first half, led by delivery growth of 24% and 27%, respectively.
- FIFO gross margin excluding fuel increased 35 basis points in the quarter and 28 basis points for the first half.
- The reported gross margin rate was 21.79% in the quarter and 22.10% for the first half, compared with 20.92% and 21.32%, respectively, in the prior-year periods.
- Adjusted FIFO operating profit declined 10.9% in the quarter and 2.0% for the first half, reflecting lower fuel profitability and higher operating expenses.
Cash Flow, Debt and Liquidity
- Operating cash flow was $4.364 billion for the first two quarters, up from $2.427 billion in the prior-year period.
- Cash used in investing activities was $1.795 billion, including $1.954 billion of payments for property and equipment and lease buyouts.
- Cash used in financing activities was $1.164 billion, including $708 million of debt repayments and $376 million of dividends.
- Cash and temporary cash investments increased to $2.420 billion from $1.015 billion at fiscal year-end.
- Total debt, including finance lease obligations, declined $587 million from fiscal year-end to approximately $12.8 billion. Kroger repaid $600 million of 3.85% senior notes during the quarter.
- At August 12, 2023, long-term debt excluding finance leases had a carrying value of $10.688 billion and an estimated fair value of $9.537 billion.
- Kroger had a $2.75 billion unsecured revolving credit facility, expandable by $1.25 billion, with no outstanding revolver or commercial paper borrowings and $2 million of letters of credit outstanding.
- The company stated that it was in compliance with its financial covenant and expected available cash, operating cash flow and other liquidity sources to satisfy foreseeable needs.
- Capital investments excluding mergers, acquisitions and leased facilities totaled approximately $1.8 billion in the first half, compared with $1.5 billion in the prior-year period.
Material Changes Versus the Prior Comparable Period
- Reported earnings shifted to a second-quarter loss because of the opioid settlement accrual, despite higher adjusted EPS.
- Fuel sales and fuel profitability declined substantially as retail fuel prices and gallons sold decreased.
- Gross margin improved through lower LIFO charges, private-label performance, sourcing benefits and lower transportation costs, partially offset by shrink and promotional price investments.
- Operating, general and administrative expense increased substantially, including opioid settlement charges, merger-related costs, associate investments, self-insurance reserves and strategic margin-expansion investments.
- The Express Scripts pharmacy agreement ended December 31, 2022, reducing pharmacy sales by approximately $475 million in the quarter and $1.1 billion in the first half.
- Operating cash flow improved significantly because of more favorable working-capital changes, including inventory, receivables, taxes and accrued liabilities.
- Debt declined through repayment of senior notes, while share repurchases remained limited as Kroger prioritized deleveraging in connection with the proposed Albertsons merger.
Guidance, Outlook, Risks and Unusual Items
- Management expected identical sales excluding fuel to be at the low end of its full-year guidance range but reaffirmed full-year adjusted FIFO operating profit and adjusted diluted EPS guidance. The filing text does not provide the numerical guidance ranges.
- Kroger targets a net total debt-to-adjusted EBITDA ratio of 2.30 to 2.50 and intends to maintain its investment-grade debt rating.
- Management’s long-term total shareholder return target is 8% to 11%, excluding the effect of the proposed Albertsons merger.
- Kroger and Albertsons agreed to a proposed merger implying approximately $24.6 billion of enterprise value. The transaction remained subject to regulatory approval and other closing conditions.
- Kroger and Albertsons announced a definitive agreement to sell 413 stores, eight distribution centers, two offices, selected brands and other assets to C&S for approximately $1.9 billion, with potential for up to 237 additional stores to be purchased to address regulatory requirements.
- The proposed merger was expected to close in early 2024, subject to regulatory clearance. A $600 million termination fee could apply under specified circumstances if the merger did not close by the outside date, subject to extension rights.
- The nationwide opioid settlement framework contemplated up to $1.2 billion for states and subdivisions, $36 million for Native American tribes and approximately $177 million for attorneys’ fees and costs. Settlement effectiveness depended on participation and satisfaction of remaining conditions, and the final loss could differ materially from the recorded estimate.
- Other key risks include inflation or deflation, fuel-price and fuel-margin volatility, labor negotiations and work stoppages, competition, supply constraints, interest rates, refinancing and liquidity conditions, cyberattacks, regulatory approval of the merger, pharmacy payor changes, litigation, and execution of the company’s digital and technology initiatives.
Important Facts for Investors to Verify
- Confirm the requested period: the supplied filing is for Q2 2023, not Q2 2022.
- Review the reconciliation between GAAP results and adjusted EPS and adjusted FIFO operating profit, particularly the opioid settlement and unrealized investment gains.
- Monitor the final terms, participation levels and payment schedule of the opioid settlement, including any changes to the $1.413 billion accrued second-quarter charge.
- Verify regulatory developments, divestiture requirements, financing commitments and closing conditions for the Albertsons transaction.
- Assess whether cash flow remains sufficient for capital investments, debt repayment, dividends, settlement payments and potential merger funding.
- Track identical sales excluding fuel, fuel profitability, pharmacy trends after the Express Scripts termination, digital growth and gross-margin sustainability.
- Review debt maturities, interest-rate exposure, covenant headroom and the company’s ability to maintain its targeted leverage range.