The Kroger Co. 2014 Form 10-K Summary
Business context and reporting period
This filing is Kroger’s annual report for the 52-week fiscal year ended January 31, 2015. The request metadata identifies “2013 Q4,” but the supplied filing is not a 2013 quarterly filing; it reports fiscal 2014 and compares it primarily with fiscal 2013, ended February 1, 2014.
Kroger operates domestic retail food and drug stores, multi-department stores, convenience stores, jewelry stores, manufacturing facilities, and online retail operations. At year-end it operated 2,625 supermarkets and multi-department stores, 782 convenience stores, 326 fine jewelry stores, 1,330 supermarket fuel centers, 37 manufacturing plants, and an online retailer. Retail operations represented more than 99% of consolidated sales and EBITDA and were the company’s only reportable segment.
The company employed approximately 400,000 people, with most employees covered by approximately 300 collective bargaining agreements. Harris Teeter was included for a full year in fiscal 2014 following its January 2014 acquisition. Kroger also acquired Vitacost.com for $287 million in August 2014; its results were not material to fiscal 2014.
Key financial metrics
| Metric | Fiscal 2014 | Fiscal 2013 | Change or context |
|---|---|---|---|
| Sales | $108.465 billion | $98.375 billion | Increased 10.3%, primarily from Harris Teeter and 5.2% identical supermarket sales growth excluding fuel |
| Operating profit | $3.137 billion | $2.725 billion | Operating margin increased to 2.89% from 2.77% |
| Net earnings attributable to Kroger | $1.728 billion | $1.519 billion | Increased 13.8% |
| Diluted earnings per share | $3.44 | $2.90 | Increased 18.6%; average diluted shares declined to 497 million from 520 million |
| Adjusted diluted EPS | $3.52 | $2.85 | Increased 24%; non-GAAP measure excluding identified adjusted items |
| Gross margin | 21.16% | 20.57% | Improved primarily from Harris Teeter, higher fuel margins, and lower warehouse and transportation costs |
| FIFO gross margin | 21.30% | 20.62% | Excluding fuel, the rate decreased three basis points |
| Operating, general and administrative expense | 15.82% of sales | 15.45% | Increased due to pension-related charges, contributions, fuel, Harris Teeter, credit-card fees, and incentive costs |
| Interest expense | $488 million | $443 million | Increased primarily from higher net debt |
| Effective tax rate | 34.1% | 32.9% | Increased primarily due to lower tax benefits |
| Cash flow from operations | $4.163 billion | $3.573 billion | Increased $590 million |
| Capital investments excluding acquisitions and lease buyouts | $2.752 billion | $2.305 billion | Increased with store, technology, logistics, and other investments |
| Total debt | $11.085 billion | $10.780 billion | Included $1.275 billion of commercial paper |
| Cash and temporary cash investments | $268 million | $401 million | Decreased $133 million |
| Total assets | $30.556 billion | $29.281 billion | Increased primarily from acquisitions and capital spending |
Gross margin benefited from a fuel margin of approximately $0.19 per gallon versus $0.14 in the prior year. The benefit was partly offset by a substantially higher LIFO charge of $147 million versus $52 million. Depreciation and amortization was $1.948 billion, compared with $1.703 billion.
Material changes versus the prior comparable period
- Sales increased 10.3%, with Harris Teeter contributing to the increase and identical supermarket sales excluding fuel rising 5.2%.
- Operating profit increased $412 million, and operating margin expanded 12 basis points.
- Net earnings increased $209 million, while diluted EPS benefited from both higher earnings and share repurchases.
- Cash from operations increased to $4.163 billion from $3.573 billion.
- Capital investments increased to $2.752 billion from $2.305 billion, while acquisition spending declined sharply to $252 million from $2.344 billion because the prior-year amount primarily reflected Harris Teeter.
- Financing activities used $1.236 billion of cash, compared with providing $1.361 billion in the prior year, reflecting higher treasury-stock purchases and lower debt issuance.
- Total debt increased $305 million. Kroger issued $500 million of 2.95% senior notes and repaid $300 million of 4.95% senior notes at maturity.
- Kroger repurchased approximately $1.283 billion of its common shares and paid $338 million of dividends during the year.
- The company’s estimated share of underfunding in participating multi-employer pension plans increased to $1.8 billion pre-tax from approximately $1.6 billion, primarily because of lower-than-expected plan investment returns.
Liquidity, debt, and commitments
Kroger estimated its next-twelve-month liquidity needs at approximately $5.2 billion, including working capital, capital expenditures, interest, and scheduled debt payments, net of cash and temporary investments. Management believed operating cash flow, commercial paper capacity, and its credit facility would be adequate for those needs.
- The company maintained a $2.75 billion unsecured revolving credit facility, expandable by up to $750 million, terminating June 30, 2019 unless extended.
- Commercial paper capacity was approximately $2.75 billion, with $1.275 billion outstanding at year-end and no borrowings under the revolving credit facility.
- The leverage ratio was 2.06 to 1, compared with a 3.50 to 1 covenant limit. The fixed-charge coverage ratio was 4.99 to 1, compared with a 1.70 to 1 minimum.
- Approximately $1.3 billion of commercial paper and $500 million of senior notes were expected to mature within the next twelve months. Management expected to refinance these obligations.
- Total contractual obligations were reported at $24.654 billion, including $11.085 billion of debt, $6.369 billion of operating leases, $4.541 billion of interest on long-term debt, and $684 million of capital lease obligations.
Guidance, outlook, risks, and unusual items
Management forecast fiscal 2015 diluted EPS of $3.80 to $3.90, identical supermarket sales growth excluding fuel of 3.0% to 4.0%, slight expansion in FIFO non-fuel operating margin, an annualized LIFO charge of approximately $75 million, interest expense of approximately $480 million, and an effective tax rate of approximately 35.0%. Capital investments excluding mergers, acquisitions, and leased-facility purchases were expected to be $3.0 billion to $3.3 billion, with food-store square footage expected to grow approximately 2.0% to 2.5% before acquisitions and operational closings.
- Fiscal 2014 included a $39 million after-tax net charge related primarily to pension-plan restructuring commitments and withdrawal liabilities, partially offset by tax benefits.
- The company made $140 million of charitable and pension contributions charged to operating expenses, including $85 million to its charitable foundation and $55 million to the UFCW Consolidated Pension Plan.
- Kroger was required to contribute an additional $75 million over four years related to pension-plan restructuring and expected approximately $250 million of multi-employer pension contributions in fiscal 2015.
- Collective bargaining negotiations were expected in several markets and with Teamsters-covered distribution and manufacturing facilities. Work stoppages, wage increases, health-care costs, and pension obligations could affect results.
- Principal risks include intense price competition, changing consumer spending, fuel-price and fuel-margin volatility, product safety, labor relations, cyberattacks and data breaches, adverse weather, regulatory changes, litigation, self-insurance claims, debt refinancing, and integration of acquired businesses.
- Various antitrust, wage-and-hour, civil-rights, personal-injury, and product-liability matters were pending. Management believed the aggregate exposure was not material, but acknowledged that outcomes could differ materially from estimates.
- The annual goodwill impairment review produced no impairment, and management did not anticipate goodwill impairment in fiscal 2015.
Important facts investors should verify
- Reconcile reported growth with the effects of the Harris Teeter acquisition and the smaller Vitacost.com acquisition.
- Assess whether the unusually strong 2014 fuel margin of $0.19 per gallon is sustainable.
- Review the higher LIFO charge and the sensitivity of margins to product-cost inflation and deflation.
- Monitor debt maturities, commercial paper refinancing, credit ratings, and compliance with leverage and fixed-charge covenants.
- Evaluate the estimated $1.8 billion share of multi-employer pension underfunding and potential withdrawal liabilities.
- Track collective bargaining negotiations, required pension contributions, and health-care and wage-cost trends.
- Compare fiscal 2015 results with management’s EPS, identical-sales, margin, LIFO, tax-rate, and capital-investment guidance.
- Review acquisition integration, e-commerce execution through Vitacost.com, cybersecurity controls, and any changes in litigation or regulatory exposure.