The Kroger Co. 2013 Form 10-K Summary
Reporting period: Fiscal year ended February 1, 2014 (52 weeks), compared primarily with the 53-week fiscal year ended February 2, 2013. The request metadata identifies “2012 Q4,” but the provided filing is an annual 2013 Form 10-K, not a 2012 quarterly filing.
Business Context
Kroger operates domestic food and drug stores, multi-department stores, convenience stores and fine jewelry stores. Retail operations represent more than 99% of consolidated sales and EBITDA and are reported as one segment. At year-end, the company operated 2,640 supermarkets and multi-department stores, 786 convenience stores and 320 fine jewelry stores, with approximately 375,000 employees.
On January 28, 2014, Kroger acquired Harris Teeter for approximately $2.4 billion. Harris Teeter was included in the year-end balance sheet, but its operating results were not material to fiscal 2013 because the transaction closed near year-end.
Key Financial Metrics
| Metric | 2013 | 2012 | Change or comment |
|---|---|---|---|
| Sales | $98.375 billion | $96.619 billion | Reported increase of 1.8%; 3.9% increase versus 2012 on a comparable 52-week basis |
| Net earnings attributable to Kroger | $1.519 billion | $1.497 billion | Increased modestly |
| Diluted EPS | $2.90 | $2.77 | Increased 4.7%; adjusted EPS was $2.85 versus $2.52 |
| Operating profit | $2.725 billion | $2.764 billion | Reported margin declined to 2.77% from 2.86% |
| FIFO operating profit, excluding fuel and adjusted items | $2.574 billion | $2.389 billion | Margin increased to 3.24% from 3.13% |
| Gross margin | 20.57% | 20.59% | Declined slightly |
| FIFO gross margin | 20.62% | 20.65% | Declined slightly |
| Net interest expense | $443 million | $462 million | Decreased despite higher debt |
| Effective tax rate | 32.9% | 34.5% | Lower due primarily to tax credits and the Domestic Manufacturing Deduction |
| Cash from operating activities | $3.380 billion | $2.833 billion | Increased $547 million |
| Capital investments, excluding acquisitions | $2.305 billion | $1.990 billion | Increased |
| Cash paid for acquisitions | $2.344 billion | $122 million | Primarily Harris Teeter |
| Total debt, including capital leases and financing obligations | $11.3 billion | $8.9 billion | Increased approximately $2.4 billion |
| Cash and temporary cash investments | $401 million | $238 million | Increased |
Sales, Profitability and Cash Flow
- Supermarket sales excluding fuel increased 4.0% to $76.666 billion; fuel sales increased 3.0% to $18.962 billion.
- Identical supermarket sales increased 3.6% excluding fuel, marking the company’s 41st consecutive quarter of positive comparable sales growth.
- Estimated market share increased approximately 50 basis points across Kroger’s 18 reported marketing areas.
- Gross margin pressure reflected investments in lower prices, increased shrink and higher advertising costs. The $52 million LIFO charge was broadly consistent with the $55 million charge in 2012.
- Operating, general and administrative expense improved to 15.45% of sales from 15.37% on a reported basis; adjusted for unusual items, the rate improved to 15.43% from 15.52%.
- Cash from operations funded capital spending, dividends and a portion of acquisition and debt-related requirements. Financing activities provided $1.554 billion, primarily because of $3.548 billion of long-term debt issuance.
Material Changes Versus the Prior Comparable Period
- Fiscal 2013 had 52 weeks versus 53 weeks in fiscal 2012, reducing reported year-over-year comparability. Management estimated that the extra week contributed approximately $58 million after tax, or $0.11 per diluted share, in 2012.
- Adjusted 2013 net earnings were $1.496 billion, or $2.85 per diluted share, versus adjusted 2012 net earnings of $1.365 billion, or $2.52 per diluted share. Management cited higher FIFO non-fuel operating profit and lower interest expense.
- The Harris Teeter acquisition added approximately $901 million of goodwill and $558 million of intangible assets, and increased total assets by approximately $4.6 billion year over year.
- Debt increased materially to help finance the acquisition and refinance maturities. Commercial paper borrowings declined to approximately $1.2 billion from $1.6 billion.
- Share repurchases decreased to $609 million from $1.3 billion, while dividends paid increased to $319 million from $267 million. A new $1 billion repurchase authorization was announced in March 2014.
- Estimated Kroger’s share of multi-employer pension plan underfunding was $1.6 billion pre-tax, or $1.0 billion after tax, at December 31, 2013, down approximately $150 million pre-tax from the prior year.
Liquidity, Debt and Commitments
Kroger estimated next-twelve-month liquidity needs of approximately $4.5 billion, including working capital, capital expenditures, interest and scheduled debt payments. Management expected operating cash flow, commercial paper and its credit facility to provide adequate liquidity.
- The company had a $2.0 billion unsecured revolving credit facility, expandable by $500 million, expiring January 25, 2017.
- Approximately $1.2 billion of commercial paper and $300 million of senior notes were scheduled to mature within the next twelve months.
- Year-end leverage ratio was 2.30 to 1 versus a covenant maximum of 3.50 to 1; fixed-charge coverage was 4.83 to 1 versus a minimum covenant of 1.70 to 1. Kroger was in compliance with its covenants.
- Total contractual obligations were $23.105 billion, including $10.780 billion of long-term debt, $6.608 billion of operating lease obligations and $3.091 billion of interest on long-term debt.
Guidance, Outlook and Unusual Items
- Fiscal 2014 diluted EPS guidance: $3.14–$3.25, representing expected growth of 10%–14%, including Harris Teeter accretion.
- Expected identical supermarket sales growth excluding fuel: 2.5%–3.5%.
- Expected FIFO non-fuel operating margin: slight expansion versus 2013 adjusted results.
- Expected LIFO charge: approximately $55 million; expected interest expense: approximately $490 million.
- Expected capital investments excluding mergers, acquisitions and leased-facility purchases: approximately $2.8–$3.0 billion.
- Expected effective tax rate: approximately 35%, excluding unexpected tax resolutions and certain tax benefits.
- Expected multi-employer pension contributions: approximately $250 million. Management also expected labor negotiations in several markets during 2014.
- Reported 2013 earnings included a $23 million after-tax net benefit, consisting primarily of $40 million of tax benefits partially offset by $17 million of Harris Teeter merger costs.
- 2012 earnings included benefits from the extra week and a $74 million after-tax benefit related to the Visa/MasterCard settlement and UFCW pension liability adjustment. Fiscal 2011 included a $591 million after-tax UFCW pension charge.
Principal Risks and Contingencies
- Intense grocery price competition, aggressive supercenter expansion, nontraditional competitors and changes in consumer spending could pressure sales and margins.
- Integration of Harris Teeter may involve unforeseen costs, delays, liabilities or lower-than-expected synergies.
- Approximately 300 collective bargaining agreements create labor disruption and wage, health care and pension cost risks; several significant agreements were scheduled for negotiation in 2014.
- Multi-employer pension plans are substantially underfunded in many cases and could require higher contributions or create withdrawal liabilities.
- Debt refinancing, commercial paper access, interest rates and credit ratings are important liquidity risks.
- Product safety, recalls, data security, self-insurance claims, adverse weather, fuel prices and regulatory changes could materially affect results.
- Kroger reported various antitrust, wage-and-hour, civil-rights and product-liability matters. Management believed the aggregate exposure was not material, but outcomes remain uncertain.
Investor Verification Checklist
- Reconcile reported growth with the 52-week versus 53-week calendar and review management’s non-GAAP adjusted results.
- Assess whether Harris Teeter delivers the expected sales growth, synergies and EPS accretion after full-year consolidation.
- Monitor debt reduction, refinancing of near-term maturities and compliance with leverage and fixed-charge coverage covenants.
- Evaluate the sustainability of comparable-store sales growth and the effect of price investments, shrink, advertising and fuel mix on margins.
- Review changes in multi-employer pension funding requirements, plan investment performance and potential withdrawal liabilities.
- Track labor negotiations, litigation, tax audits and other contingencies not fully quantifiable from the filing.