The Kroger Co. 10-K Summary
Business context and reporting period
This filing is Kroger’s Form 10-K for the 52-week fiscal year ended February 2, 2019, referred to as fiscal 2018. The request metadata identifies “2017 Q4,” but the filing is an annual report for fiscal 2018; fiscal 2017 was the 53-week year ended February 3, 2018. Kroger operates 2,764 supermarkets in 35 states and the District of Columbia, including 2,270 pharmacies and 1,537 fuel centers. Retail operations represent 97% of consolidated sales and are the company’s only reportable segment.
Kroger employed approximately 453,000 people and operated 37 food production plants. Pickup services were available at 1,581 supermarkets, and home delivery covered 91% of Kroger households.
Financial performance and liquidity
| Metric | Fiscal 2018 | Fiscal 2017 |
|---|---|---|
| Sales | $121.2 billion | $122.7 billion |
| Net earnings attributable to Kroger | $3.11 billion | $1.91 billion |
| Diluted earnings per share | $3.76 | $2.09 |
| Operating profit | $2.61 billion | $2.61 billion |
| Operating margin | 2.16% | 2.13% |
| Gross margin | 21.68% | 22.01% |
| Net cash from operating activities | $4.16 billion | $3.41 billion |
| Capital investments | $3.02 billion | $2.98 billion |
| Total debt, including lease obligations | $15.2 billion | $15.6 billion |
| Total assets | $38.1 billion | $37.2 billion |
| Kroger shareholders’ equity | $7.89 billion | $6.93 billion |
Total sales declined 1.2% on a reported basis, primarily because fiscal 2017 included an extra week and because Kroger sold its convenience store business. Sales increased 0.6% versus 2017 on an adjusted 52-week basis. Identical sales excluding fuel increased 1.8%, while digital revenue grew more than 58%, primarily driven by Pickup.
Adjusted operating net earnings per diluted share were $2.11 in 2018 versus $1.95 in 2017, an 8.2% increase after excluding unusual items and the prior-year extra week. Return on invested capital was 11.02%, down from 12.08%.
Cash provided by operations increased to $4.16 billion. Restock cash flow, Kroger’s non-GAAP measure of funding available for dividends, debt management, repurchases and strategic investments, increased to $1.91 billion from $735 million. Cash used in investing activities was $1.19 billion, including $2.17 billion of net proceeds from the convenience store sale. Cash used in financing activities was $2.90 billion, reflecting debt repayments, share repurchases and dividends.
Year-end cash and temporary cash investments were $429 million. Kroger had $800 million of commercial paper outstanding and no borrowings under its $2.75 billion revolving credit facility. The company reported a leverage ratio of 2.64 to 1, versus a 3.50 to 1 covenant limit, and a fixed charge coverage ratio of 4.17 to 1, versus a 1.70 to 1 minimum. Management stated that liquidity was adequate for the next twelve months and the foreseeable future.
Material changes versus the prior comparable period
- Kroger sold its convenience store business on April 20, 2018, for $2.2 billion and recognized a $1.78 billion pretax gain, or $1.36 billion after tax.
- Kroger acquired Home Chef on June 22, 2018, for $197 million net of cash, with potential earnout payments of up to $500 million. A $91 million contingent consideration liability was recorded at acquisition.
- Kroger entered into a partnership with Ocado to enhance digital and automated fulfillment capabilities and purchased Ocado securities. The investment produced a $228 million mark-to-market gain in 2018.
- Reported diluted EPS rose 79.9% because of the convenience store sale, the Ocado gain and other unusual items. Adjusted operating EPS increased 8.2% to $2.11.
- Gross margin declined 33 basis points, reflecting investments in lower prices, a higher LIFO charge, product mix and increased transportation and advertising costs. OG&A as a percentage of sales declined to 16.76% from 17.15%.
- Total debt declined by approximately $360 million. Kroger paid down $1.3 billion of commercial paper and $1.3 billion of maturing long-term debt, partially offset by new senior notes and a $1.0 billion term loan.
- Kroger returned approximately $2.4 billion to shareholders through share repurchases and dividends, including a $1.2 billion accelerated share repurchase program.
Guidance, outlook, risks and unusual items
For fiscal 2019, management targeted identical sales growth excluding fuel of 2.0% to 2.25%, diluted EPS of $2.15 to $2.25, FIFO operating profit of $2.9 billion to $3.0 billion, capital investments of $3.0 billion to $3.2 billion excluding mergers and acquisitions, and an effective tax rate of approximately 22%. Management expected a higher weighted-average interest rate and potentially higher interest expense.
Key 2018 unusual items included the convenience store sale gain, the Ocado mark-to-market gain, $155 million of pretax multi-employer pension withdrawal liabilities, a $33 million contingent consideration revaluation, and a $42 million financial instrument impairment. Fiscal 2017 included significant pension charges, a voluntary retirement offering charge, a Kroger Specialty Pharmacy goodwill impairment, a pension plan termination charge and a $922 million tax benefit related primarily to the Tax Cuts and Jobs Act.
Material risks include intense food retail and digital competition, pricing pressure, labor negotiations and approximately 360 collective bargaining agreements, underfunded multi-employer pension plans, product safety and recalls, cyberattacks and technology disruptions, fuel-price volatility, adverse weather and natural disasters, economic conditions, regulatory changes, litigation, debt refinancing and execution of the Restock Kroger strategy.
Kroger estimated its share of multi-employer pension plan underfunding or withdrawal liabilities at approximately $3.1 billion, or $2.4 billion after tax, as of December 31, 2018. This estimate is not recorded as a direct liability except when withdrawal obligations become probable and reasonably estimable. The company contributed $358 million to multi-employer plans in 2018.
Kroger expected adoption of the new lease standard in fiscal 2019 to add approximately $6.7 billion of right-of-use assets and lease liabilities; including existing capital leases, total lease assets were expected to be approximately $7.4 billion and total lease liabilities approximately $7.6 billion. Management did not expect a material effect on net earnings or cash flows.
Subsequent events included the March 2019 sale of You Technology to Inmar for $565 million and a definitive agreement to sell Turkey Hill Dairy. Kroger also repaid its $1.0 billion term loan on March 15, 2019 using increased commercial paper borrowings.
Important facts for investors to verify
- Confirm that comparisons use the 52-week fiscal 2018 period versus the 53-week fiscal 2017 period and distinguish reported from adjusted results.
- Separate recurring operating performance from the $1.78 billion convenience store gain and $228 million Ocado mark-to-market gain.
- Assess whether identical-sales growth, digital growth and alternative-profit initiatives can offset margin pressure and competitive pricing investments.
- Review debt maturities, refinancing requirements, interest-rate exposure and the effect of higher borrowing costs on 2019 earnings.
- Evaluate the potential cash and earnings impact of multi-employer pension underfunding, withdrawal liabilities and collective bargaining negotiations.
- Review the financial effects and strategic execution of Home Chef, Ocado, You Technology and Turkey Hill transactions.
- Assess the effect of the new lease standard on reported assets, liabilities, leverage metrics and credit ratings.
- Consider exposure to pharmacy reimbursement pressure, fuel volatility, cyber risk, product recalls, litigation and adverse weather.