Business Context and Reporting Period
Company: The Kroger Co.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Third quarter and three quarters ended November 6, 1999.
Key Context: The Company completed a merger with Fred Meyer, Inc. on May 27, 1999, accounted for as a pooling of interests. Financial statements are restated to include Fred Meyer for all periods presented. The Company also changed its fiscal year-end to the Saturday nearest January 31. Due to differing reporting periods between 1998 and 1999 (12-week vs. 16-week quarters), direct year-over-year comparisons are not practicable without adjustment.
Key Financial Metrics
| Metric (in millions) | 3rd Qtr 1999 | 3 Quarters 1999 | 3rd Qtr 1998 | 3 Quarters 1998 |
|---|---|---|---|---|
| Sales | $10,329 | $34,111 | $11,501 | $31,877 |
| Gross Profit | $2,723 | $8,953 | $2,949 | $8,092 |
| Operating Profit | $388 | $1,188 | $425 | $922 |
| Net Earnings | $129 | $382 | $144 | $3 |
| Diluted EPS (Net) | $0.15 | $0.45 | $0.17 | $- |
| Cash from Operations | N/A | $1,311 | N/A | $1,465 |
| Capital Expenditures | $625 | $1,470 | $495 | $1,164 |
| Total Debt (Long-term + Current) | $8,393 | $8,393 | N/A | N/A |
| Cash & Equivalents | $283 | $283 | N/A | N/A |
Note: 1998 figures include results from Dillon Companies and Fred Meyer for varying periods and are not directly comparable to 1999 results due to fiscal calendar changes.
Material Changes and Analysis
- Sales Growth: Adjusted for fiscal calendar changes and divestitures, sales increased 6.6% in the third quarter and 5.7% year-to-date. Identical food store sales grew 1.6%, while comparable food store sales rose 2.5%.
- Merger Integration Costs: Significant merger-related costs were incurred, totaling $69 million in the third quarter and $304 million year-to-date. These include distribution consolidation, systems integration, store conversions, and transaction costs.
- Profitability: Earnings before extraordinary loss, excluding one-time items, were $202 million ($0.24 diluted EPS) in the third quarter, a 33% increase over the estimated prior year. Year-to-date adjusted earnings were $635 million ($0.74 diluted EPS), a 25% increase.
- EBITDA: EBITDA (defined per credit agreements) was $696 million for the third quarter and $2,280 million year-to-date, up from $691 million and $1,984 million respectively in 1998.
- Inventory: Cash flow from operations decreased year-to-date largely due to increased inventory levels in anticipation of the holiday season and millennium.
Guidance, Outlook, and Risks
- EPS Target: Management targets a 16%-18% average annual increase in earnings per share over the next three years, effective with the year 2000.
- Capital Expenditures: Expected to total $1.7-$1.8 billion for the full year 1999, net of acquisitions.
- Synergy Savings: The Company expects to achieve $380 million in synergy savings over the next three years from mergers ($155M in 1999, $260M in 2000, $345M in 2001).
- Year 2000 Readiness: The Company is 97-99% complete with remediation and testing of IT and non-IT systems. Total estimated project cost is $47 million, with $44 million incurred to date. Risks include potential system disruptions if vendors or partners fail to resolve issues.
- Legal Proceedings: A class action lawsuit regarding egg price-fixing in Southern California was decided in favor of Ralphs/Food 4 Less (a subsidiary) in September 1999; plaintiffs are expected to appeal.
- Contingencies: The Company is a 50% owner of Santee Dairies, which is now excess capacity; efforts to dispose of this interest may result in a loss.
Investor Verification Checklist
- Fiscal Calendar Adjustments: Verify that year-over-year comparisons account for the shift from a 52/53-week year to a 52-week year and the inclusion of Fred Meyer in 1998 restated figures.
- Merger Cost Sustainability: Assess the trajectory of merger-related costs ($304M YTD) and the realization of projected $380M synergy savings.
- Inventory Levels: Monitor inventory build-up ($4,276M) and its impact on working capital and future cash flows.
- Debt Covenants: Confirm continued compliance with EBITDA-based covenants given the high debt load ($8.7B net debt).
- Year 2000 Execution: Review progress on the final 3-7% of system remediation and testing to ensure no operational disruption at the millennium turn.