Business Context and Reporting Period
Company: The Kroger Co.
Filing Type: Form 10-K (Annual Report)
Period Ended: February 1, 2003 (52 weeks)
Business Overview: One of the largest grocery retailers in the United States, operating approximately 2,488 supermarkets, 784 convenience stores, and 441 fine jewelry stores. The company also manufactures and processes food products. Operations are primarily domestic, with retail operations representing approximately 99% of consolidated sales.
Key Financial Metrics
| Metric | Fiscal 2002 | Fiscal 2001 | Fiscal 2000 |
|---|---|---|---|
| Sales | $51,760 million | $50,098 million | $49,000 million |
| Gross Profit | $13,950 million | $13,700 million | $13,196 million |
| Gross Profit Margin | 26.95% | 27.35% | 26.93% |
| Net Earnings | $1,205 million | $1,043 million | $877 million |
| Diluted EPS | $1.52 | $1.26 | $1.04 |
| Operating Cash Flow | $3,183 million | $2,347 million | $2,359 million |
| Total Assets | $20,102 million | $19,069 million | $18,179 million |
| Total Debt | $8,574 million | $8,830 million | $8,546 million |
| Shareowners' Equity | $3,850 million | $3,502 million | $3,089 million |
Note: Fiscal 2000 was a 53-week year. Fiscal 2002 and 2001 were 52-week years.
Material Changes vs. Prior Period
- Revenue Growth: Sales increased 3.3% to $51.8 billion, driven by new store openings and acquisitions, though identical food store sales were flat compared to 2001.
- Profitability: Net earnings rose 15.5% to $1.2 billion. Diluted EPS increased 20.6% to $1.52. This growth was significantly aided by the elimination of goodwill amortization ($103 million expense in 2001) following the adoption of SFAS No. 142.
- Margin Pressure: Gross profit margin decreased to 26.95% from 27.35% in 2001. This was attributed to the Strategic Growth Plan (price reductions), increased fuel center sales (lower margin), and deflation in certain commodity groups.
- Debt Reduction: Total debt decreased by $256 million to $8.6 billion, utilizing strong operating cash flows to pay down obligations.
- Accounting Changes: Adoption of SFAS No. 142 resulted in a $16 million cumulative effect charge (net of tax) related to the impairment of jewelry store division goodwill. Adoption of EITF Issue No. 02-16 resulted in a $28 million pre-tax charge offset by a corresponding LIFO credit.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- 2003 EPS Guidance: Management estimates earnings per share of $1.63 for fiscal 2003. This includes expenses for systems conversions and division consolidations.
- Sales Outlook: Identical food store sales (including fuel) are expected to be positive in 2003. Square footage is expected to grow 2.5% to 3.0%.
- Cost Reductions: The Strategic Growth Plan has reduced costs by approximately $306 million as of February 1, 2003. Management expects to exceed the original goal of $500 million in cost reductions by the end of fiscal 2003.
- Capital Expenditures: Expected to be approximately $2.0 billion in 2003, excluding acquisitions and synthetic lease asset purchases.
Risks and Contingencies
- Competition and Pricing: Fierce competition from supercenters, mass merchandisers, and drug stores may force price reductions, impacting margins.
- Health Care and Pension Costs: Rising costs are expected to increase pension expense by approximately $62 million and health care costs by $120 million in 2003.
- Union Contracts: Several UFCW contracts expire in 2003; prolonged work stoppages could materially affect operations.
- Legal Proceedings: Various antitrust and civil rights lawsuits are pending. While management believes liabilities will not be material, antitrust damages could be trebled.
- Energy Commitments: The company has excess energy purchase commitments marked to fair value, with a remaining liability of $45 million as of February 1, 2003.
Investor Verification Checklist
- Goodwill Amortization Impact: Verify the adjusted EPS comparison between 2001 and 2002, as the elimination of goodwill amortization significantly boosted 2002 earnings.
- Identical Store Sales: Confirm the flat identical store sales performance in 2002 despite overall revenue growth, noting the impact of fuel center sales.
- Strategic Growth Plan Execution: Monitor progress on the $500 million cost reduction target and the impact of price reductions on gross margins.
- Debt Covenants: Review compliance with financial covenants, specifically EBITDA-based ratios, given the company's leverage.
- Accounting Adjustments: Review the impact of the item-cost conversion for Fred Meyer inventories ($91 million charge) and EITF 02-16 adoption on merchandise costs.
- Union Negotiations: Track the status of expiring UFCW contracts in 2003 for potential labor disruptions.