The Kroger Co. Form 10-Q Summary
Reporting period: The source metadata identifies “2010 Q3,” but the filing is a quarterly report for the 12- and 40-week periods ended November 5, 2011, compared with November 6, 2010. Amounts are in millions except per-share data.
Business context and reporting period
Kroger operates supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities and other businesses in the United States. Third-quarter results benefited from higher fuel prices and gallons sold, product-cost inflation, positive identical supermarket sales, productivity improvements and cost controls.
- Identical supermarket sales excluding fuel increased 5.0% in the quarter and 4.9% year to date.
- Identical supermarket sales excluding fuel increased for the 32nd consecutive quarter.
- All 18 supermarket divisions and every supermarket department reported positive identical sales growth in the quarter.
Financial performance and key metrics
| Metric | Third quarter 2011 | Third quarter 2010 | Year-to-date 2011 | Year-to-date 2010 |
|---|---|---|---|---|
| Sales | $20,594 | $18,667 | $68,969 | $62,165 |
| Operating profit | $405 | $406 | $1,703 | $1,623 |
| Operating margin | 1.97% | 2.17% | 2.47% | 2.61% |
| Net earnings attributable to Kroger | $196 | $202 | $909 | $838 |
| Diluted EPS | $0.33 | $0.32 | $1.50 | $1.30 |
| FIFO gross margin rate | 20.87% | 22.12% | 21.13% | 22.44% |
| OG&A as a percentage of sales | 16.09% | 17.08% | 15.93% | 17.00% |
| Interest expense | $99 | $103 | $334 | $337 |
- Quarterly sales increased 10.3%; year-to-date sales increased 10.9%.
- Supermarket fuel sales increased 42.7% in the quarter and 48.7% year to date, driven by higher fuel prices and volumes.
- Quarterly net earnings decreased 3.0%, primarily because the LIFO charge increased by $50 to $62 and the effective tax rate increased to 35.3% from 31.7%.
- Year-to-date net earnings increased 8.5%, primarily due to higher fuel and non-fuel operating profit.
- Diluted EPS increased despite lower quarterly net earnings because of substantial share repurchases, including 67 million shares repurchased over the preceding four quarters.
- The quarterly FIFO gross margin rate declined 125 basis points, while the rate excluding fuel declined 34 basis points, primarily due to investments in lower prices and product-cost inflation.
- OG&A leverage improved, with the rate declining 99 basis points for the quarter and 107 basis points year to date.
Cash flow, balance sheet, debt and liquidity
- Year-to-date cash provided by operating activities was $2,410, compared with $2,534 in the prior-year period.
- Year-to-date cash used in investing activities was $1,419, including $1,405 of capital expenditure payments and $51 of acquisition payments.
- Year-to-date cash used in financing activities was $1,600, including $1,274 of treasury stock purchases and $191 of dividends paid.
- Cash and temporary cash investments declined to $216 at November 5, 2011, from $825 at January 29, 2011.
- Total debt was approximately $7.7 billion at quarter-end, down $202 from year-end 2010. The company had $330 of commercial paper outstanding and no borrowings under its credit facility or money-market lines.
- The company maintained a $2 billion unsecured revolving credit facility, with $20 of outstanding letters of credit reducing availability.
- Management estimated next-12-month liquidity needs of approximately $3.3 billion and believed operating cash flow and available borrowing sources would be adequate.
- Capital expenditures, excluding acquisitions and purchases of leased facilities, were approximately $1.5 billion year to date. The company opened, acquired, expanded or relocated 34 food stores and completed 96 within-the-wall remodels.
Material changes versus the prior comparable period
- Sales growth accelerated materially, supported by fuel and non-fuel sales increases, but the higher fuel mix pressured reported gross margin.
- Quarterly operating profit was essentially unchanged despite 10.3% sales growth; the operating margin narrowed because of higher LIFO expense and margin investment.
- Year-to-date operating profit increased $80, while net earnings increased $71.
- Share repurchases increased substantially: $1,274 year to date in 2011 versus $292 in the prior-year period.
- Debt declined following repayment of $478 of senior notes at maturity, partly offset by $330 of commercial paper borrowings used to fund repurchases.
- Forward-starting interest-rate swaps totaled $1.0 billion at quarter-end and increased to $1.2 billion after quarter-end to hedge anticipated refinancing of approximately $1.7 billion of debt maturing in 2012 and 2013.
- Long-lived asset impairment charges increased to $30 year to date from $21 in the prior-year period.
Guidance, outlook, risks and unusual items
- Fiscal 2011 diluted EPS guidance was $1.95–$2.00, excluding the expected contribution to the new consolidated multi-employer pension fund.
- Fiscal 2011 identical supermarket sales growth excluding fuel was expected at 4.5%–5.0%; annualized LIFO expense was expected to be approximately $185.
- Fiscal 2011 capital investments were expected to be slightly above $1.9 billion, excluding acquisitions and leased-facility purchases.
- Management expected fiscal 2012 diluted EPS growth of 8%–10%, excluding the 2011 pension contribution effect, with a 53rd week excluded from that growth estimate. Full 2012 guidance was expected in March 2012.
- Kroger entered into an MOU with UFCW locals concerning consolidation of four multi-employer pension funds. The company committed to fund the new plan to 95% funded status by March 31, 2018. The existing funds were approximately $800 underfunded as of January 1, 2011.
- Kroger could contribute approximately $650 pre-tax, or $413 after-tax, before fiscal year-end. If made in the fourth quarter, management estimated an earnings reduction of approximately $0.73 per diluted share; the amount and timing were not final.
- Management expected meaningful increases in multi-employer pension expense over the next several years, while the new arrangement was expected to reduce fiscal 2012 pension expense by $0.04–$0.06 per diluted share.
- Key risks include labor negotiations and potential work stoppages, product-cost and fuel-price volatility, competitive pricing, consumer spending, liquidity and commercial-paper market conditions, pension underfunding, interest rates, litigation, impairment charges, weather and changes in tax or accounting rules.
- A pending Ralphs tax dispute could require a cash payment of up to approximately $545, including interest, if the company receives an adverse final outcome. The Tax Court had ruled favorably for Kroger, subject to remaining proceedings and potential appeal.
- Management stated that disclosure controls were effective and that no material change occurred in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm that the intended period is third quarter 2011, not third quarter 2010, because the filing date and financial statements cover November 5, 2011.
- Assess whether sales growth from fuel prices and product inflation is translating into sustainable profit growth despite lower FIFO margins.
- Monitor the timing and size of the multi-employer pension contribution and its effect on fourth-quarter earnings, cash flow and debt ratings.
- Review the company’s ability to refinance approximately $1.7 billion of debt maturing in 2012 and 2013 at acceptable rates.
- Evaluate liquidity after substantial share repurchases, declining cash balances and expected capital expenditures.
- Track LIFO expense, product-cost inflation, fuel margins, labor negotiations, pension funding requirements and potential litigation or tax liabilities.