The Kroger Co. Form 10-Q Summary
Reporting period: The filing covers the 16-week first quarter ended May 19, 2012, with comparison to the 16-week period ended May 21, 2011. The request metadata identifies “2011 Q1,” but the filing itself is a 2012 first-quarter report.
Business Context and Key Financial Metrics
Kroger operates U.S. supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities, pharmacies and related businesses. Management attributed sales growth to higher identical supermarket sales, product cost inflation, increased transaction counts, higher average basket size, pharmacy performance and increased fuel prices and gallons sold.
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Sales | $29.065 billion | $27.461 billion | +5.8% |
| Operating profit | $814 million | $811 million | +$3 million |
| Net earnings attributable to Kroger | $439 million | $432 million | +1.6% |
| Diluted earnings per share | $0.78 | $0.70 | +11.4% |
| Operating margin | Approximately 2.8% | Approximately 3.0% | Lower |
| FIFO gross margin | 20.70% | 21.42% | Down 72 basis points |
| Effective tax rate | 34.5% | 37.4% | Lower |
| Net cash from operating activities | $1.304 billion | $1.235 billion | +$69 million |
| Capital expenditures paid | $542 million | $521 million | +$21 million |
Identical supermarket sales excluding fuel increased 4.2%, while identical sales including fuel increased 5.5%. Supermarket fuel sales rose 13.4%, driven by a 4.3% increase in average retail fuel prices and an 8.7% increase in gallons sold.
Operating profit was approximately 2.8% of sales and net earnings attributable to Kroger were approximately 1.5% of sales. FIFO gross margin declined primarily because of investments in lower customer prices, partly offset by warehouse and logistics productivity improvements and lower advertising costs. OG&A expense declined to 15.36% of sales from 15.79%.
At May 19, 2012, cash and temporary cash investments were $511 million, compared with $188 million at January 28, 2012. Total current assets were $7.596 billion and current liabilities were $9.354 billion. Total debt, including current and long-term capital lease and financing obligations, was approximately $8.1 billion; reported debt excluding those obligations had a $7.701 billion carrying value.
Kroger generated $1.304 billion of operating cash flow, used $527 million in investing activities and used $454 million in financing activities. It repurchased 14.7 million shares for $345 million and declared dividends of $0.115 per common share, up from $0.105.
Material Changes Versus the Prior Comparable Period
- Sales increased 5.8%, but operating profit increased only modestly because of lower gross margin and continued price investments.
- Net earnings rose 1.6%, while diluted EPS increased 11.4%, helped by the repurchase of approximately 58 million shares over the preceding four quarters.
- The effective tax rate decreased to 34.5%, primarily because of the favorable resolution of certain tax issues.
- Interest expense increased to $141 million from $138 million, reflecting a higher weighted-average debt balance and lower interest-rate-swap benefits, partly offset by lower average interest rates.
- Cash flow from operations increased $69 million, while financing cash use declined substantially from $1.120 billion to $454 million, primarily because of debt issuance and lower share repurchases.
- Kroger issued $850 million of senior notes, consisting of $500 million due in 2022 at 3.40% and $350 million due in 2042 at 5.00%, and repaid $491 million of 6.75% senior notes at maturity.
- Long-lived asset impairment charges declined to $2 million from $9 million.
- During the quarter, Kroger opened, acquired, expanded or relocated seven food stores and completed 27 remodels.
Guidance, Outlook, Risks and Unusual Items
- Fiscal 2012 diluted EPS guidance was increased to $2.33-$2.40. Management expects second-quarter growth broadly in line with its long-term 6%-8% range and stronger growth in the third and fourth quarters.
- Fiscal 2012 identical supermarket sales excluding fuel are expected to increase 3.0%-3.5%. Management noted that generic substitutions following brand-drug patent expirations could reduce pharmacy sales dollars.
- Expected 2012 LIFO expense is approximately $140 million-$190 million, interest expense is approximately $460 million, and capital expenditures excluding acquisitions and leased-facility purchases are expected to be $1.9-$2.2 billion.
- Management expects approximately $75 million of contributions to company-sponsored defined benefit pension plans and approximately $240 million of contributions to multi-employer pension plans in 2012. Multi-employer pension expenses are expected to increase meaningfully over the next several years.
- Kroger estimated next-twelve-month liquidity needs at approximately $3.3 billion, including approximately $1.3 billion of debt due within twelve months. Management believes operating cash flow, commercial paper capacity and bank facilities will be sufficient.
- As of May 19, 2012, Kroger had no borrowings under its $2 billion revolving credit facility, its $75 million aggregate money-market lines or commercial paper program. Letters of credit reduced facility availability by $14 million, and the company was in compliance with financial covenants.
- Subsequent to quarter-end, Kroger entered into an additional $350 million of forward-starting interest-rate swaps, bringing the total notional amount to $850 million. It also repaid $346 million of 6.2% senior notes in the second quarter.
- A tax dispute involving Ralphs Grocery could require a cash payment of up to approximately $561 million if the Tax Commissioner ultimately prevails; the Tax Court entered a decision favorable to Kroger, subject to a potential appeal.
- Principal risks include labor negotiations and possible work stoppages, food-industry competition, commodity and fuel-cost volatility, pricing pressure, pharmacy patent expirations, pension underfunding, refinancing and interest-rate risk, litigation, impairment charges, adverse weather and economic weakness.
Facts Investors Should Verify
- Confirm that the 2012 first-quarter results and fiscal-year guidance are not being confused with the “2011 Q1” period stated in the request metadata.
- Reconcile reported total debt of approximately $8.1 billion with the $7.701 billion debt carrying value presented in the debt note, including capital leases and financing obligations.
- Assess whether gross-margin pressure from lower prices and the growing low-margin fuel business is offset by volume, productivity and cost-control gains.
- Monitor the sustainability of pharmacy growth, including the benefit from Express Scripts prescription transfers and the impact of brand-drug patent expirations.
- Evaluate refinancing needs of approximately $1.5 billion in fiscal 2013 and 2014 and the related interest-rate hedges.
- Review multi-employer pension underfunding, expected contribution increases and potential withdrawal liabilities.
- Track the Ralphs tax litigation, labor-contract renewals and other litigation contingencies for changes that could materially affect cash flow or earnings.