Kroger Co. Form 10-Q Summary
Period covered: Third quarter and first three quarters ended November 7, 2015, compared with November 8, 2014. The filing states that the periods represent 12 and 40 weeks, respectively. Note: The request metadata identifies “2014 Q3,” but the supplied filing is for 2015 Q3.
Business Context and Reporting Period
Kroger is a U.S. supermarket operator with fuel centers, pharmacies, convenience stores, manufacturing operations, specialty pharmacy, health clinics, digital coupon services and online sales, including Vitacost.com. Identical supermarket sales excluding fuel increased 5.4% in the quarter and 5.5% for the first three quarters. Management reported positive identical sales across all geographies and supermarket departments and 48 consecutive quarters of positive identical supermarket sales growth.
The company completed a two-for-one stock split effective July 13, 2015; all share and per-share data were retrospectively adjusted.
Financial Highlights
| Metric | Third Quarter 2015 | Third Quarter 2014 | First Three Quarters 2015 | First Three Quarters 2014 |
|---|---|---|---|---|
| Sales | $25.075 billion | $24.987 billion | $83.665 billion | $83.258 billion |
| Operating profit | $772 million | $651 million | $2.648 billion | $2.225 billion |
| Operating margin | 3.08% | 2.61% | 3.17% | 2.67% |
| Net earnings attributable to Kroger | $428 million | $362 million | $1.480 billion | $1.210 billion |
| Diluted earnings per share | $0.43 | $0.36 | $1.50 | $1.20 |
| Net cash from operations | Not separately provided | Not separately provided | $3.766 billion | $3.384 billion |
Sales increased 0.4% in the quarter and 0.5% year to date. Supermarket sales excluding fuel increased 5.6% in both periods, while fuel sales declined 23.4% in the quarter and 23.0% year to date because average retail fuel prices declined approximately 28.6% and 28.4%, respectively. Fuel gallons sold increased 7.3% in the quarter and 7.6% year to date.
Gross margin was 22.32% in the quarter versus 20.90% in the prior year and 21.95% year to date versus 20.77%. FIFO gross margin was 22.36% versus 21.24% in the quarter and 22.02% versus 20.94% year to date. Excluding fuel, FIFO gross margin declined modestly because of investments in lower prices and higher shrink costs.
OG&A expense increased to 16.63% of sales from 15.83% in the quarter and to 16.24% from 15.66% year to date. The increase reflected lower fuel sales, an $80 million UFCW pension contribution and higher pension, credit card, healthcare, incentive and shrink costs, partly offset by productivity and cost controls.
The effective tax rate was 35.8% in the quarter versus 32.0% in the prior year and 34.9% year to date versus 33.9%. Management attributed the changes primarily to state taxes, tax credits, deductions and favorable tax audit conclusions.
Cash Flow, Debt and Liquidity
- Operating cash flow increased to $3.766 billion from $3.384 billion year to date.
- Investing cash outflow was $2.580 billion, including $2.532 billion of property and equipment payments, versus $2.298 billion in the prior year.
- Financing cash outflow was $1.180 billion versus $1.223 billion, including $659 million of share repurchases and $283 million of dividends paid.
- Cash and temporary cash investments were $274 million at November 7, 2015, compared with $268 million at January 31, 2015.
- Total debt, including capital lease and financing obligations, was approximately $11.3 billion, down from approximately $11.6 billion at fiscal year-end 2014 and $11.5 billion at November 8, 2014.
- The company had $1.375 billion of commercial paper outstanding, no borrowings under its $2.75 billion revolving credit facility, and $13 million of letters of credit reducing facility availability. Management stated that debt covenants were satisfied.
- Estimated liquidity needs for the following 12 months were $4.75 billion to $5.25 billion, including approximately $1.4 billion of commercial paper, $789 million of senior notes and $89 million of miscellaneous borrowings maturing within 12 months.
Material Changes and Unusual Items
- The LIFO charge declined to $9 million from $85 million in the quarter and to $58 million from $138 million year to date, primarily because of lower expected product-cost inflation.
- Third-quarter 2014 earnings included a $17 million after-tax benefit from certain tax items and a $25 million charitable contribution. First-three-quarter 2014 results also included a $56 million after-tax effect from an $87 million multi-employer pension obligation.
- The 2015 results included an $80 million contribution to the UFCW Consolidated Pension Plan, recorded in OG&A.
- Long-lived assets with a $38 million carrying value were written down to $5 million, resulting in a $33 million impairment charge during the first three quarters of 2015.
- Kroger invested $2.6 billion in capital investments year to date, compared with $2.1 billion in the prior year, and opened, acquired, expanded or relocated 47 food stores while completing 105 major remodels.
- On November 11, 2015, Kroger announced an agreement to acquire Roundy’s for approximately $800 million, including assumed debt. The transaction was expected to be financed with existing credit facilities and commercial paper and remained subject to tender-offer completion and regulatory approval.
Guidance, Outlook and Risks
- Fiscal 2015 diluted EPS guidance was increased to $2.02 to $2.04.
- Identical supermarket sales excluding fuel were expected to grow 4.0% to 4.5% in the fourth quarter and approximately 5.0% to 5.25% for the full year.
- Management expected 2015 capital investments, excluding mergers, acquisitions and leased-facility purchases, to slightly exceed $3.3 billion and supermarket square footage to grow approximately 1.75% to 2.0% before mergers, acquisitions and operational closings.
- Management expected approximately $75 million of annual LIFO expense, $480 million of interest expense, an effective tax rate of approximately 35%, and higher year-end ROIC than in 2014. Reported rolling-four-quarter ROIC at November 7, 2015 was 14.16%.
- Key risks include labor negotiations, competition and pricing pressure, fuel-price and fuel-margin volatility, pharmacy reimbursement and third-party payor changes, multi-employer pension obligations, refinancing and commercial-paper market access, economic conditions, weather, cyberattacks and data-security breaches, EMV-related payment-card liability, execution of growth plans and integration of Harris Teeter.
- Various antitrust, wage-and-hour, civil-rights and product-liability claims were pending. Management believed aggregate exposure was not material, but acknowledged that adverse outcomes could materially affect financial condition, results or cash flows.
Investor Verification Items
- Verify that the applicable filing period is 2015 Q3 rather than the “2014 Q3” period stated in the request metadata.
- Reconcile reported EPS growth with prior-year tax benefits, the UFCW contribution, pension-related items and the lower LIFO charge.
- Assess the sustainability of operating-margin improvement excluding the benefit from lower fuel costs and reduced LIFO expense.
- Review refinancing plans for commercial paper and other debt maturities and the incremental borrowing expected for the Roundy’s acquisition.
- Monitor labor negotiations, underfunded multi-employer pension exposure, litigation, cyber and EMV risks, and the integration of acquired businesses.
- Distinguish GAAP results from management’s non-GAAP FIFO margin, FIFO operating profit, adjusted earnings and ROIC measures.