Kroger Co. Form 10-Q Summary
Filing-period clarification: The supplied filing is for the third quarter ended November 4, 2017, with comparative periods ended November 5, 2016. The request metadata identifies “2016 Q3,” but the filing itself is the 2017 Q3 report. The third quarter covered 12 weeks; the year-to-date period covered 40 weeks.
Business Context and Reporting Period
Kroger is a U.S. supermarket operator with fuel centers, convenience stores, pharmacies, digital and online businesses, jewelry stores, food production, and related services. Management highlighted investments in digital capabilities, store labor, customer experience, lower prices, and its “Restock Kroger” strategy. Digital revenue increased 109% year over year in the quarter, driven by ClickList and Vitacost.com.
Financial Highlights
| Metric | Q3 2017 | Q3 2016 | First 3 Quarters 2017 | First 3 Quarters 2016 |
|---|---|---|---|---|
| Sales | $27.749 billion | $26.557 billion | $91.631 billion | $87.726 billion |
| Operating profit | $740 million | $713 million | $2.041 billion | $2.578 billion |
| Net earnings attributable to Kroger | $397 million | $391 million | $1.053 billion | $1.469 billion |
| Diluted EPS | $0.44 | $0.41 | $1.15 | $1.52 |
| Net cash from operations | Not provided for quarter | Not provided for quarter | $3.054 billion | $3.456 billion |
| Capital investments | $658 million | $817 million | $2.277 billion | $3.006 billion |
| Free cash flow | Not provided for quarter | Not provided for quarter | $1.0 billion | $183 million |
- Q3 sales increased 4.5%; year-to-date sales increased 4.5%.
- Identical supermarket sales excluding fuel increased 1.1% in Q3 and 0.4% year to date.
- Q3 gross margin was 22.41%, compared with 22.23% in the prior-year quarter. Year-to-date gross margin was 22.05%, compared with 22.46%.
- Q3 operating margin was 2.67%, compared with 2.68%. Year-to-date operating margin was 2.23%, compared with 2.94%.
- Q3 effective tax rate was 35.6%; the year-to-date rate was 34.8%, compared with 33.3% in the prior-year period.
- Cash and temporary cash investments were $352 million at November 4, 2017, versus $322 million at January 28, 2017.
- Total debt, including current and long-term portions of capital leases and financing obligations, was approximately $14.1 billion, up approximately $770 million from fiscal year-end.
- The company had $1.4 billion of commercial paper outstanding, no borrowings under its revolving credit facility, and $6 million of outstanding letters of credit reducing facility availability.
- The amended unsecured revolving credit facility totals $2.75 billion, may be increased by up to $1.0 billion, and terminates August 29, 2022 unless extended.
- Share repurchases totaled $1.292 billion year to date, and dividends paid totaled $333 million. The quarterly dividend declared was $0.125 per share.
Material Changes Versus the Prior Comparable Period
- Quarterly net earnings increased 1.5%, while diluted EPS increased 7.3%, aided by lower shares outstanding from repurchases.
- Year-to-date net earnings declined 28.3% and diluted EPS declined 24.3%. Adjusted year-to-date diluted EPS declined 11.3% to $1.41 after excluding unusual pension-related and voluntary-retirement charges.
- Year-to-date operating profit declined $537 million, primarily because of lower gross margin, higher OG&A and depreciation expense, and higher LIFO charges.
- OG&A increased to 16.97% of sales in Q3 from 16.73% and to 17.03% year to date from 16.75%. Drivers included digital investments, higher store wages, healthcare and incentive costs, and pension contributions.
- Fuel sales increased 15.2% in Q3 and 13.6% year to date, partly reflecting higher retail fuel prices. Fuel sales contributed to revenue growth but carry substantially lower margins than supermarket sales.
- Year-to-date operating cash flow declined $402 million, primarily because of lower earnings and a $1.0 billion contribution to company-sponsored pension plans. Lower capital spending increased free cash flow to approximately $1.0 billion.
- The company contributed $1.0 billion to company-sponsored pension plans and made an incremental $111 million pre-tax contribution to the UFCW Consolidated Pension Plan.
Guidance, Outlook, Risks, and Unusual Items
- Management expected fourth-quarter identical supermarket sales excluding fuel to exceed 1.1% and expected fuel margins to moderate.
- 2017 diluted EPS guidance was $1.74 to $1.79, including an estimated $0.09 from the 53rd week. Adjusted diluted EPS guidance was $2.00 to $2.05.
- Management expected full-year FIFO operating margin, excluding fuel, specified pension and retirement items, and the UFCW contribution, to decline approximately 25 to 35 basis points from 2016.
- Expected 2017 capital investments were approximately $3.0 billion, with supermarket square-footage growth of approximately 1.8% before mergers, acquisitions, and operational closings.
- The company classified $604 million of assets and $259 million of liabilities, primarily related to its convenience-store business, as held for sale and expected to complete a sale within the following year.
- Year-to-date unusual charges included a $199 million pre-tax withdrawal liability charge related to multi-employer pension plans and a $184 million pre-tax voluntary retirement offering charge. The company expects the VRO to generate future OG&A savings.
- On December 5, 2017, the company settled certain pension obligations and expected a fourth-quarter 2017 non-cash settlement charge of approximately $400 million, subject to final valuation. Management stated that the charge would not have a 2017 cash-tax effect.
- The company expects approximately $470 million of 2017 contributions to multi-employer pension funds, excluding potential additional restructuring or withdrawal liabilities.
- Management estimated next-twelve-month liquidity needs of $5.0 billion to $5.3 billion and believed operating cash flow, commercial paper, and credit-facility capacity would be adequate. Approximately $1.4 billion of commercial paper and $200 million of senior notes were scheduled to mature within twelve months.
- Principal risks include competitive pricing, labor negotiations, multi-employer pension obligations, fuel-margin volatility, commodity and operating-cost inflation, economic conditions, refinancing and commercial-paper availability, cyber and data-security incidents, weather events, healthcare and pharmacy-market changes, and integration of acquired businesses.
- Pending litigation includes antitrust, wage-and-hour, civil-rights, and product-liability matters. Management believes aggregate exposure is not material, but acknowledges that outcomes could differ materially from current estimates.
- Future lease accounting adoption is expected to significantly increase reported lease liabilities and right-of-use assets, although the company was still evaluating other effects.
Most Important Facts for Investors to Verify
- Confirm that the applicable filing period is Q3 2017, not Q3 2016, and reconcile all comparisons to the November 5, 2016 period.
- Assess whether year-to-date margin pressure and higher OG&A represent a persistent trend after excluding unusual pension and retirement charges.
- Monitor the approximately $400 million pension settlement charge expected in Q4 2017 and any additional multi-employer pension liabilities.
- Evaluate debt refinancing needs, commercial-paper dependence, covenant compliance, and remaining revolving-credit availability.
- Verify the timing and proceeds of any convenience-store sale and the treatment of assets and liabilities held for sale.
- Compare realized fourth-quarter sales, fuel margins, EPS, capital spending, and LIFO expense with management’s 2017 guidance.
- Assess whether digital growth and store investments can offset lower grocery margins, wage inflation, healthcare costs, and competitive pricing pressure.