Kroger Co. 2017 Form 10-K Summary
Period clarification: The supplied filing is Kroger’s Form 10-K for the 53-week fiscal year ended February 3, 2018, referred to as fiscal 2017, with comparisons to the 52-week years ended January 28, 2017 and January 30, 2016. It does not correspond to “2016 Q4” as stated in the request metadata.
Business Context
Kroger is a U.S. grocery retailer operating supermarkets, pharmacies, fuel centers, convenience stores, fine jewelry stores, food production facilities and digital commerce platforms. As of February 3, 2018, it operated 2,782 supermarkets, 782 convenience stores, 274 fine jewelry stores, an online retailer and 37 food production plants. Retail operations represented more than 97% of consolidated sales and constituted the company’s only reportable segment.
Kroger employed approximately 449,000 full- and part-time employees, with a majority covered by collective bargaining agreements. Digital pickup services were available at 1,056 supermarkets.
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Sales | $122.7 billion | $115.3 billion | +6.4%; comparable adjusted sales increased 4.4% |
| Operating profit | $2.1 billion | $3.4 billion | Down $1.4 billion |
| Operating margin | 1.70% | 2.98% | Down 128 basis points |
| Net earnings attributable to Kroger | $1.9 billion | $2.0 billion | Down 3.4% |
| Diluted earnings per share | $2.09 | $2.05 | Up 2.0% |
| Adjusted diluted EPS, excluding adjusted items and extra week | $1.95 | $2.12 | Down 8.0% |
| Gross margin | 22.01% | 22.40% | Down 39 basis points |
| Interest expense | $601 million | $522 million | Up $79 million |
| Net cash from operating activities | $3.4 billion | $4.3 billion | Down $859 million |
| Free cash flow | $706 million | $397 million | Up $309 million |
Identical supermarket sales excluding fuel increased 0.7%. Digital revenue increased 90%, driven primarily by ClickList and online sales through Vitacost.com. Fuel sales increased 13.9%, principally because of higher average retail fuel prices and modestly higher gallons sold.
Total assets were $37.2 billion, total shareholders’ equity attributable to Kroger was $6.9 billion and total debt, including commercial paper and capital or financing obligations, was approximately $15.6 billion at year-end. Cash and temporary cash investments were $347 million.
Material Changes Versus the Prior Comparable Period
- Sales benefited from an additional 53rd week, higher fuel prices, supermarket square-footage growth and the full-year inclusion of ModernHEALTH.
- Operating profitability deteriorated materially. Gross margin declined because of price investments, higher warehousing, transportation and shrink costs, and ModernHEALTH’s lower margin profile. OG&A increased as a percentage of sales because of pension-related charges, digital investments, higher wages, healthcare costs and other employee-related expenses.
- 2017 included significant unusual items: $550 million of pre-tax multi-employer pension charges, $184 million for a voluntary retirement offering, $110 million of Kroger Specialty Pharmacy goodwill impairment, $502 million for a company-sponsored pension plan termination, and a $922 million tax benefit from the Tax Cuts and Jobs Act.
- The company contributed $1.0 billion to company-sponsored pension plans and paid $467 million to satisfy Central States Pension Fund withdrawal obligations. Total multi-employer pension contributions were $954 million, compared with $289 million in 2016.
- Total debt increased approximately $1.5 billion to $15.6 billion, primarily because of new senior notes and higher commercial paper borrowings.
- Kroger repurchased approximately $1.6 billion of common shares and paid $443 million in dividends during 2017, returning approximately $2.1 billion to shareholders in total.
- Return on invested capital declined to 12.03% from 13.09% on Kroger’s stated non-GAAP methodology.
Liquidity, Debt and Capital Resources
Kroger estimated next-12-month liquidity needs of approximately $6.9 billion, including working capital, capital investments, interest and scheduled debt principal payments, net of cash and temporary investments. Management believed operating cash flow, commercial paper capacity and the revolving credit facility would be adequate.
- Commercial paper capacity was approximately $2.75 billion, with $2.1 billion outstanding at February 3, 2018.
- The company had a $2.75 billion unsecured revolving credit facility, expandable by up to $1.0 billion, maturing August 29, 2022. No borrowings were outstanding under the facility at year-end.
- Approximately $2.1 billion of commercial paper and $1.3 billion of senior notes were scheduled to mature within the following 12 months.
- The leverage ratio was 2.45 to 1 against a covenant maximum of 3.50 to 1; the fixed-charge coverage ratio was 4.49 to 1 against a minimum of 1.70 to 1. Kroger was in compliance with its covenants.
- Contractual obligations totaled approximately $32.4 billion, including $14.8 billion of long-term debt, $7.8 billion of operating leases and $6.5 billion of long-term debt interest.
Guidance, Outlook and Management Commentary
- 2018 identical supermarket sales excluding fuel target: 1.5% to 2.0% growth.
- 2018 diluted EPS expectation: $1.95 to $2.15.
- 2018 capital investments, excluding mergers, acquisitions and leased-facility purchases: approximately $3.0 billion.
- Expected 2018 tax rate: approximately 22%.
- Management launched the “Restock Kroger” plan, focused on customer experience, partnerships, talent development and investment in the company’s purpose and infrastructure.
- On February 5, 2018, Kroger announced an agreement to sell its convenience store business to EG Group for $2.15 billion. The related assets and liabilities were classified as held for sale at year-end and were not treated as discontinued operations.
- On March 16, 2018, Kroger obtained a $1.0 billion term loan facility; the funds were drawn on March 26, 2018, and used to reduce commercial paper borrowings.
Principal Risks and Contingencies
- Intense competition from traditional grocers, discount retailers, online platforms, delivery services and non-traditional entrants may pressure prices, margins and market share.
- Labor negotiations, work stoppages, wage increases, healthcare costs and approximately 360 collective bargaining agreements could increase operating costs or disrupt operations.
- Multi-employer pension plans are materially underfunded. Kroger estimated its share of underfunding or withdrawal exposure at approximately $2.3 billion, although this is generally not a direct recorded liability unless triggering conditions make a liability probable and estimable.
- Cybersecurity, privacy and technology failures could disrupt operations, expose customer or employee data and result in litigation, regulatory costs or reputational damage.
- Fuel-price volatility, weather events, natural disasters, product safety issues, economic conditions and changes in government regulation could adversely affect results.
- Pending litigation includes antitrust, wage-and-hour, civil rights and product liability matters. Management stated that the aggregate estimated loss range was not material, but acknowledged that outcomes remain uncertain.
- Most leases remained off balance sheet under the applicable accounting rules. The company expected the future lease standard to significantly increase recognized lease assets and liabilities.
Most Important Facts to Verify
- Confirm that the intended period is fiscal 2017, ended February 3, 2018, rather than 2016 fourth quarter.
- Reconcile reported EPS of $2.09 with adjusted EPS of $1.95 after excluding unusual items and the extra week; the Tax Act benefit and pension-related charges materially affected comparability.
- Assess whether lower operating margins, higher labor and digital costs, and increased interest expense are consistent with the 2018 EPS outlook.
- Monitor refinancing of approximately $3.4 billion of commercial paper and senior notes identified as maturing within 12 months, as well as commercial paper exposure to credit-rating changes.
- Evaluate the potential cash and earnings impact of multi-employer pension underfunding, withdrawal liabilities and future collective bargaining agreements.
- Verify completion and proceeds of the planned $2.15 billion convenience store sale and the use of those proceeds.
- Review the effect of upcoming lease accounting adoption on reported assets, liabilities, leverage and covenant calculations.