The Kroger Co. — Form 10-Q Summary
Reporting period: The supplied filing is for the quarter ended November 3, 2012, covering 12 weeks and the first 40 weeks of fiscal 2012, with comparative periods ended November 5, 2011. Although the request identifies “2011 Q3,” the filing itself reports third-quarter 2012 results. Financial statements are unaudited and amounts are in millions except per-share data.
Business Context and Reporting Period
Kroger operates U.S. supermarkets, fuel centers, pharmacies, convenience stores, jewelry stores, manufacturing facilities and related businesses. Management attributed sales growth to positive identical-supermarket sales, higher fuel gallons sold and higher average fuel prices. Identical supermarket sales excluding fuel increased 3.2% in the quarter and 3.7% for the first three quarters, extending positive growth to 36 consecutive quarters.
Financial Performance and Key Metrics
| Metric | Third Quarter 2012 | Third Quarter 2011 | First Three Quarters 2012 | First Three Quarters 2011 |
|---|---|---|---|---|
| Sales | $21,807 | $20,594 | $72,598 | $68,969 |
| Operating profit | $596 | $405 | $1,944 | $1,703 |
| Operating margin | 2.73% | 1.97% | 2.68% | 2.47% |
| Net earnings attributable to Kroger | $317 | $196 | $1,035 | $909 |
| Diluted earnings per share | $0.60 | $0.33 | $1.89 | $1.50 |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $2,268 | $2,410 |
- Sales increased 5.9% in the quarter and 5.3% year to date. Fuel sales increased 15.2% in the quarter and 10.7% year to date.
- Gross margin declined to 20.29% from 20.57% in the quarter and to 20.44% from 20.92% year to date. Management cited greater fuel mix, price investments, shrink and distribution costs.
- FIFO gross margin was 20.35% in the quarter and 20.58% year to date, compared with 20.87% and 21.13%, respectively, in the prior-year periods.
- OG&A expense declined to 15.16% of sales from 16.11% in the quarter and to 15.37% from 15.96% year to date.
- The LIFO charge was $15 in the quarter and $96 year to date, compared with $62 and $142, respectively, in the prior-year periods.
- Interest expense was $103 in the quarter and $350 year to date, compared with $99 and $334, respectively.
- Effective tax rates were 35.5% in the quarter and 34.8% year to date, compared with 35.3% and 34.2% in the prior-year periods.
Liquidity, Debt and Capital Allocation
- Cash and temporary cash investments were $435 at November 3, 2012, compared with $188 at January 28, 2012.
- Total current assets were $8,277 and total current liabilities were $10,548, indicating reliance on operating cash flow and external financing for working-capital needs.
- Total debt, including capital leases and financing obligations, was approximately $8.9 billion at quarter-end, compared with $8.2 billion at year-end 2011 and $7.7 billion at the end of the prior-year quarter.
- Debt included $114 of commercial paper and $1.0 billion drawn under the revolving credit facility. The $1.0 billion facility borrowing was precautionary during Hurricane Sandy and was repaid in the first week of the fourth quarter.
- Kroger maintained a $2.0 billion unsecured revolving credit facility, expandable by $500, terminating in January 2017 unless extended. Management reported compliance with debt covenants.
- Operating cash flow was $2,268; capital expenditure payments were $1,471; investing cash flow was negative $1,488; and financing cash flow was negative $533 for the first three quarters.
- Kroger repurchased $1,204 of common stock during the first three quarters, including 52.9 million shares at an average price of $22.76. Quarterly repurchases totaled 14.5 million shares for $333.
- Quarter-end shareowners’ equity was $3,762, including $9,228 of treasury stock at cost.
- Management estimated next-twelve-month liquidity needs of approximately $3.6 billion, including working capital, capital expenditures, interest, scheduled debt payments and UFCW pension funding. Approximately $900 of senior notes was expected to mature during the next twelve months.
Material Changes Versus the Prior Comparable Period
- Reported diluted EPS increased 81.8% in the quarter and 26.0% year to date, driven by higher operating results, lower LIFO expense, fuel profitability and share repurchases.
- Third-quarter results included a $115 reduction in OG&A expense, or a $74 after-tax benefit, from a Visa and MasterCard settlement and a reduction in the UFCW consolidated pension obligation. Management classified these as adjusted items.
- Excluding adjusted items, diluted EPS was $0.46 for the quarter and $1.76 year to date, compared with $0.33 and $1.50 in the prior-year periods.
- Cash flow from operations declined from $2,410 to $2,268 year to date, while capital spending increased modestly and financing cash usage fell substantially because of debt issuance and increased borrowings.
- Total debt increased primarily because of the $1.0 billion credit-facility draw and recent senior-note issuances, partly offset by debt maturities and lower commercial-paper borrowings.
- Rolling four-quarter ROIC declined to 13.3% from 13.5%, using Kroger’s non-GAAP methodology.
Guidance, Outlook, Risks and Unusual Items
- Management projected fiscal 2012 adjusted diluted EPS of $2.44–$2.46, implying fourth-quarter adjusted diluted EPS of $0.68–$0.70. Guidance included an estimated $0.09–$0.12 benefit from the 53rd week.
- Fourth-quarter identical-supermarket sales excluding fuel were expected to increase 3.0%–3.5%.
- Management expected 2012 LIFO expense of approximately $125, interest expense of approximately $462, capital investments of $1.9–$2.2 billion, and 2013 capital investments of approximately $2.4 billion, excluding acquisitions and leased-facility purchases.
- The company expected approximately $75 of contributions to company-sponsored defined-benefit pension plans and approximately $240 of contributions to multi-employer pension plans during 2012.
- Management identified risks from labor negotiations, competitive pricing, commodity and fuel costs, inflation or deflation, cautious consumer spending, prescription-drug patent expirations, pension funding, interest rates, debt refinancing, liquidity-market disruptions, weather and natural disasters, litigation and potential asset impairments.
- Various antitrust, wage-and-hour, civil-rights and product-liability claims remained pending. Management considered aggregate expected exposure immaterial, but acknowledged that adverse outcomes could materially affect earnings or cash flows.
- The Ralphs tax litigation was finally resolved when the Ninth Circuit dismissed the government’s appeal with prejudice on November 14, 2012.
- During the fourth quarter, Kroger acquired Axium Pharmacy, a specialty pharmacy. The filing does not provide the purchase price or acquisition terms.
Investor Verification Checklist
- Verify that the intended period is third-quarter 2012, not third-quarter 2011.
- Reconcile GAAP EPS of $0.60 with adjusted EPS of $0.46 and assess the sustainability of the $74 after-tax unusual-item benefit.
- Monitor debt refinancing requirements, including approximately $900 of senior notes maturing within twelve months and the planned refinancing of $1.5 billion maturing in 2013–2014.
- Assess whether declining gross-margin rates and continued price investments are offset by productivity and OG&A savings.
- Evaluate the effect of fuel mix, pharmacy generic-drug substitution and identical-sales trends on future margins and revenue.
- Review pension obligations, multi-employer plan contributions and labor-contract renewals for potential cash-flow or earnings volatility.
- Confirm subsequent-period developments related to the Axium Pharmacy acquisition and repayment of the Hurricane Sandy-related credit-facility borrowing.