The Kroger Co. Form 10-Q Summary
Reporting period: The supplied filing is for the 12- and 40-week periods ended November 6, 2010, compared with November 7, 2009. This conflicts with the request metadata identifying “2009 Q3”; the filing text clearly covers third quarter 2010.
Business Context
Kroger is a U.S. food retailer operating supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities, and related businesses. Management attributed sales growth to positive identical-supermarket sales, higher fuel prices, increased fuel volumes, and inflation. Identical supermarket sales excluding fuel increased 2.4% in the quarter and 2.5% year to date, with 28 consecutive quarters of positive growth.
Financial Performance and Position
| Metric | Third quarter 2010 | Third quarter 2009 | 40 weeks 2010 | 40 weeks 2009 |
|---|---|---|---|---|
| Sales | $18.698 billion | $17.662 billion | $62.258 billion | $58.179 billion |
| Operating profit (loss) | $406 million | $(758) million | $1.623 billion | $585 million |
| Net earnings attributable to Kroger | $202 million | $(875) million | $838 million | $(185) million |
| Diluted earnings per share | $0.32 | $(1.35) | $1.30 | $(0.29) |
| Operating margin | Approximately 2.2% | Negative, due primarily to impairment | Approximately 2.6% | Approximately 1.0% |
| Net margin | Approximately 1.1% | Negative | Approximately 1.3% | Negative |
- FIFO gross margin was 22.14% in the quarter, down 56 basis points from 22.70%; excluding fuel, the rate declined 10 basis points. Year-to-date FIFO gross margin was 22.46%, down 101 basis points.
- OG&A expense was 17.11% of sales in the quarter and 17.03% year to date, compared with 17.76% and 17.61%, respectively, in the prior-year periods.
- Interest expense was $103 million in the quarter and $337 million year to date, down from $105 million and $383 million, respectively.
- Effective income tax rates were 31.7% for the quarter and 33.9% year to date. Favorable resolutions of tax matters reduced tax expense by approximately $10 million in the quarter and $23 million year to date.
- Net cash provided by operating activities was $2.534 billion year to date, compared with $2.375 billion in 2009.
- Cash used in investing activities was $1.400 billion, including $1.423 billion of capital expenditure payments. Cash used in financing activities was $800 million.
- Cash and temporary investments were $758 million at November 6, 2010, compared with $424 million at January 30, 2010.
- Total debt, including current maturities, capital leases, and financing obligations, was approximately $7.8 billion at quarter-end, down from approximately $8.1 billion at year-end 2009 and the prior-year quarter-end. The filing reports a carrying value of total debt excluding certain obligations of $7.331 billion and an estimated fair value of $8.391 billion.
- Total liabilities were $18.494 billion and Kroger shareowners’ equity was $5.264 billion at November 6, 2010.
Material Changes Versus the Prior Comparable Period
- Reported earnings improved substantially because the third quarter and first three quarters of 2009 included a $1.113 billion goodwill impairment charge, primarily related to the Ralphs division. Management estimated the after-tax effect at approximately $1.05 billion.
- Excluding the 2009 impairment charges, third-quarter 2010 net earnings increased from approximately $177 million to $202 million, while year-to-date net earnings declined from approximately $866 million to $838 million.
- The year-to-date earnings decline excluding the impairment was primarily attributable to lower non-fuel FIFO gross margins from price investments, higher shrink, and higher warehouse and transportation costs. Higher fuel operating profit, lower LIFO expense, lower interest expense, and a lower tax rate partially offset the decline.
- Supermarket fuel sales increased 25.9% in the quarter and 38.5% year to date, reflecting higher retail fuel prices and increased gallons sold.
- Capital expenditure payments declined to $1.423 billion year to date from $1.766 billion. Kroger opened, acquired, expanded, or relocated 28 food stores and completed 99 within-the-wall remodels during the first three quarters.
- Kroger repurchased 13.8 million shares for $292 million year to date, including 2.9 million shares for $64 million in the third quarter. The company reported 635.95 million shares outstanding as of December 10, 2010.
- In February 2010, Kroger acquired the remaining interest in The Little Clinic LLC for $86 million, recording the transaction as an equity transaction without gain or loss.
Guidance, Outlook, Risks, and Unusual Items
- Fiscal 2010 diluted EPS guidance was $1.65 to $1.78, with management targeting the upper half of the range.
- Management expected identical supermarket sales excluding fuel to increase 2.5% to 3.0%, capital investments excluding acquisitions and leased-facility purchases of $1.8 billion to $2.0 billion, and food-store square footage growth of approximately 1.0% to 1.4%.
- Management expected approximately $50 million of annual LIFO expense, approximately $450 million of interest expense, a fuel margin of approximately $0.12 per gallon, and a 2010 effective tax rate slightly below 35%.
- Kroger entered into a new $2.0 billion unsecured revolving credit facility on November 8, 2010, replacing its $2.5 billion facility. The new facility matures May 15, 2014, subject to permitted extensions, and includes a maximum leverage ratio of 3.50:1.00 and a minimum fixed-charge coverage ratio of 1.70:1.00.
- As of November 6, 2010, Kroger had no borrowings under its credit facility, money-market lines, or commercial paper program; $267 million of letters of credit reduced available revolving capacity. Management estimated next-twelve-month liquidity needs at approximately $2.2 billion and expected operating cash flow and available borrowing sources to be adequate.
- A pending Ralphs tax dispute could require a cash payment of up to approximately $509 million if the company receives an adverse ruling. A decision was expected within the following 12 months.
- Kroger faces ordinary-course litigation, including antitrust, wage-and-hour, civil-rights, and product-liability matters. Management did not expect the California mutual strike assistance litigation to have a material adverse effect, but acknowledged that litigation outcomes remain uncertain.
- Multi-employer pension plans are believed to be underfunded. Kroger expected meaningful increases in related expense over the next several years and estimated 2010 contributions of approximately $250 million, subject to collective bargaining.
- Key operating risks include labor negotiations and potential work stoppages, commodity inflation or deflation, fuel-margin volatility, competitive pricing, cautious consumer spending, pension obligations, liquidity and credit-market conditions, impairment risk, tax changes, weather, and supply-chain disruption.
Investor Verification Checklist
- Confirm the reporting period, because the supplied filing is for third quarter 2010 rather than third quarter 2009.
- Separate the 2009 goodwill impairment effect from recurring operating performance when assessing earnings trends.
- Verify the sustainability of positive identical-sales growth and whether margin investments continue to pressure FIFO gross margin.
- Review the new $2.0 billion credit agreement, covenant compliance, available capacity, and future debt maturities.
- Assess the potential cash and earnings impact of the Ralphs tax litigation and other legal contingencies.
- Monitor multi-employer pension funding requirements, withdrawal exposure, and future contribution increases.
- Compare actual fiscal 2010 results with the stated EPS, identical-sales, capital-spending, fuel-margin, tax-rate, and liquidity guidance.