The Kroger Co. Form 10-Q Summary
Reporting period: The filing is for the 12- and 40-week periods ended November 9, 2013, compared with November 3, 2012. The request metadata identifies “2012 Q3,” but the filing itself is a 2013 third-quarter report. Amounts are in millions except per-share data.
Business context
Kroger operates supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities, specialty pharmacies and in-store health clinics. Management attributed sales growth to higher identical supermarket sales, increased fuel gallons, product cost inflation and a favorable calendar shift related to the prior year’s 53rd week.
Financial performance
| Metric | Third quarter 2013 | Third quarter 2012 | First three quarters 2013 | First three quarters 2012 |
|---|---|---|---|---|
| Sales | $22,505 | $21,807 | $75,270 | $72,598 |
| Operating profit | $534 | $596 | $2,007 | $1,944 |
| Operating margin | 2.37% | 2.73% | 2.67% | 2.68% |
| Net earnings attributable to Kroger | $299 | $317 | $1,097 | $1,035 |
| Diluted earnings per share | $0.57 | $0.60 | $2.09 | $1.89 |
| Cash flow from operations | Not separately provided | Not separately provided | $2,917 | $2,268 |
- Third-quarter sales increased 3.2%; first-three-quarter sales increased 3.7%.
- Identical supermarket sales excluding fuel increased 3.5% in the quarter and 3.4% year to date.
- Gross margin was 20.51% in both the quarter and year-to-date period, compared with 20.29% and 20.44%, respectively, in the prior-year periods.
- FIFO gross margin was 20.57% in both current periods. Excluding fuel, FIFO gross margin declined 25 basis points in the quarter and 17 basis points year to date, primarily because of price investments and higher shrink.
- The LIFO charge declined to $13 million from $15 million in the quarter and to $42 million from $96 million year to date.
- Net interest expense was $108 million in the quarter, compared with $103 million, and $336 million year to date, compared with $350 million.
- The effective tax rate was 29.3% in the quarter and 33.9% year to date, compared with 35.5% and 34.8%, respectively.
- Return on invested capital for the rolling four quarters was 13.42%, compared with 13.34%.
Cash flow, liquidity and capital structure
- Operating cash flow was $2,917 million, up from $2,268 million, primarily due to improved working-capital cash generation.
- Investing cash outflows were $1,818 million, including $1,786 million for property and equipment and lease buyouts, compared with $1,488 million.
- Financing cash outflows were $993 million, compared with $533 million. The change primarily reflected a $1,220 million reduction in commercial paper borrowings.
- Cash and temporary cash investments were $344 million at November 9, 2013, compared with $238 million at February 2, 2013.
- Total debt, including capital leases and financing obligations, was approximately $8.3 billion at quarter-end, down from approximately $8.9 billion at year-end 2012 and at the prior-year quarter-end.
- Debt included $425 million of commercial paper. Kroger had no borrowings under its $2.0 billion unsecured revolving credit facility or $75 million of uncommitted money-market lines; $13 million of letters of credit reduced revolving availability.
- Management estimated next-twelve-month liquidity needs of approximately $3.8 billion, including approximately $600 million of debt maturities, excluding the Harris Teeter transaction. Management believed operating cash flow and available borrowing sources were adequate.
- Capital investments excluding acquisitions and leased-facility purchases were $1.8 billion year to date, compared with $1.5 billion. The company opened, acquired, expanded or relocated 32 food stores and completed 132 remodels.
- Kroger repurchased $384 million of common stock year to date, including 10.4 million shares, and declared dividends of $0.465 per share year to date.
Material changes versus the prior comparable period
- Reported third-quarter net earnings and diluted EPS declined 5.7% and 5.0%, respectively, despite higher sales, mainly because the prior-year quarter included a $74 million after-tax benefit from a credit-card settlement and UFCW pension obligation adjustment.
- Excluding identified items, third-quarter adjusted net earnings increased to $276 million from $243 million, and adjusted diluted EPS increased to $0.53 from $0.46.
- Year-to-date reported net earnings increased 6.0% and diluted EPS increased 10.6%. Adjusted net earnings increased 12.7% and adjusted diluted EPS increased 17.0%, aided by higher operating performance, lower LIFO expense, improved fuel results and fewer shares outstanding.
- Operating margin declined in the quarter, while remaining broadly stable year to date. Management cited price investments and higher shrink as offsets to sales growth, productivity, lower rent and depreciation rates, and improved fuel profitability.
- Kroger issued $1.0 billion of senior notes in July 2013: $600 million due in 2023 at 3.85% and $400 million due in 2043 at 5.15%. It also repaid $400 million of 5.00% senior notes and reduced commercial paper.
Guidance, outlook and unusual items
- Fiscal 2013 diluted EPS guidance was $2.73 to $2.80, excluding certain tax items and the pending Harris Teeter merger.
- Management expected 2014 diluted EPS growth of 8% to 11%, excluding the merger and tax items.
- Fourth-quarter 2013 identical supermarket sales excluding fuel were expected to increase 3.0% to 3.5%.
- Management expected a slight expansion in 2013 FIFO non-fuel operating margin, a full-year LIFO charge of approximately $55 million, interest expense of approximately $430 million and capital investments of approximately $2.4 billion, excluding mergers, acquisitions and leased-facility purchases.
- Kroger agreed to acquire Harris Teeter for approximately $2.5 billion in cash. Closing was expected in the fourth quarter of fiscal 2013, subject to Federal Trade Commission review and customary conditions. A bridge facility permitted up to $850 million of borrowing, with funding expected from cash and new short- and long-term debt.
- Long-lived asset impairment charges were $30 million year to date, compared with $10 million. Management did not anticipate goodwill impairments in 2013.
- Pending litigation includes antitrust, wage-and-hour, civil-rights and product-liability matters. Management considered the aggregate expected exposure not material, but acknowledged that actual outcomes could differ materially.
- Key risks include labor disputes, competitive pricing, economic and consumer-spending conditions, commodity and fuel costs, refinancing and commercial-paper access, tax-rate changes, LIFO estimates, impairment risk and execution of growth plans.
Important facts for investors to verify
- Reconcile reported versus adjusted earnings, particularly the 2012 $74 million benefit and 2013 tax benefits and Harris Teeter merger costs.
- Confirm completion, financing, regulatory approval and integration risks associated with the approximately $2.5 billion Harris Teeter acquisition.
- Monitor debt refinancing, commercial-paper availability and the approximately $600 million of debt maturities expected within 12 months.
- Assess whether identical-sales growth and fuel profitability offset continued price investments, shrink and generally thin supermarket margins.
- Review the sustainability of operating cash flow relative to planned capital investments, dividends, share repurchases and acquisition funding.
- Evaluate litigation, labor, tax, LIFO and potential impairment exposures, for which the filing does not provide a clear quantified maximum loss.