The Kroger Co. 10-Q Summary
Period covered: Quarter ended August 12, 2017, comprising the second quarter and first two quarters of fiscal 2017. The request metadata identifies “2016 Q2,” but the supplied filing is for 2017 Q2 and compares against August 13, 2016.
Business Context and Reporting Period
Kroger is a U.S. grocery retailer with supermarket, fuel, pharmacy, convenience, digital and related businesses. Results include the impact of the ModernHEALTH merger and continued investments in pricing, digital capabilities, labor hours, wages and customer experience.
Financial Performance
| Metric | Second Quarter 2017 | Second Quarter 2016 | First Two Quarters 2017 | First Two Quarters 2016 |
|---|---|---|---|---|
| Sales | $27.6 billion | $26.6 billion | $63.9 billion | $61.2 billion |
| Operating profit | $678 million | $665 million | $1.3 billion | $1.9 billion |
| Net earnings attributable to Kroger | $353 million | $383 million | $656 million | $1.079 billion |
| Diluted EPS | $0.39 | $0.40 | $0.71 | $1.11 |
| Net cash from operating activities | Not separately provided | Not separately provided | $3.325 billion | $3.032 billion |
- Second-quarter sales increased 3.9%; sales for the first two quarters increased 4.4%.
- Identical supermarket sales, excluding fuel, increased 0.7% in the quarter and 0.2% year to date.
- Digital revenue increased 126% in the second quarter, driven by ClickList; digital revenue includes curbside pickup and Vitacost.com online sales.
- Gross margin declined to 21.70% from 22.09% in the quarter and to 21.90% from 22.57% year to date. Management cited price investments, higher LIFO charges, shrink, transportation and the lower-margin ModernHEALTH business.
- Operating margin was 2.46% in the quarter versus 2.50% in the prior-year quarter, and 2.04% year to date versus 3.05%.
- Adjusted diluted EPS was $0.97 year to date versus $1.18 in the prior-year period. Adjusted results exclude the 2017 multi-employer pension withdrawal and voluntary retirement offering charges and the 2016 pension restructuring charge.
- Free cash flow was approximately $1.9 billion year to date versus $1.1 billion in the prior-year period, calculated as operating cash flow less investing cash flow.
Balance Sheet, Debt and Liquidity
- Cash and temporary cash investments were $819 million at August 12, 2017, compared with $322 million at fiscal year-end.
- Total debt, including current and long-term portions of capital leases and financing obligations, was approximately $14.1 billion, down modestly from fiscal year-end. Debt excluding such obligations was $13.284 billion.
- Kroger issued $1.5 billion of senior notes during the quarter and repaid $1.425 billion of commercial paper during the first two quarters. No commercial paper or revolver borrowings were outstanding at August 12, 2017.
- The company had a $2.75 billion unsecured revolving credit facility, with $6 million of letters of credit reducing availability. An amended facility entered into on August 29, 2017 extends the termination date to 2022 and permits up to an additional $1 billion of capacity, subject to conditions.
- Management estimated next-twelve-month liquidity needs of $4.7 billion to $5.0 billion, including working capital, capital expenditures, pension contributions, interest and scheduled debt payments. Management believes available cash flow and financing sources are adequate.
- Capital investments were $1.6 billion year to date, excluding mergers, acquisitions and leased-facility purchases, compared with $2.2 billion in the prior-year period.
- Kroger repurchased approximately $1.0 billion of common stock and paid $221 million of dividends during the first two quarters, returning approximately $1.3 billion to shareholders.
Material Changes and Unusual Items
- Year-to-date earnings included a $199 million pretax charge, or $126 million after tax, related to withdrawal liabilities from two multi-employer pension plans.
- Year-to-date earnings also included a $184 million pretax charge, or $117 million after tax, for a voluntary retirement offering accepted by approximately 1,300 associates.
- Kroger contributed $1.0 billion, or $650 million net of tax, to its company-sponsored pension plan in the third quarter and expects a fourth-quarter settlement charge related to participant distributions.
- Interest expense increased to $138 million in the quarter from $116 million and to $315 million year to date from $271 million.
- The effective tax rate increased to 35.0% from 31.1% in the quarter and to 34.2% from 32.7% year to date, partly because prior-year results benefited from excess tax benefits related to share-based compensation.
Guidance, Outlook and Risks
- 2017 diluted EPS guidance was $1.74 to $1.79, including an estimated $0.09 benefit from the 53rd week. Adjusted diluted EPS guidance was $2.00 to $2.05, excluding 2017 adjusted items.
- Management expected identical supermarket sales growth, excluding fuel, of 0.5% to 1.0% for the remainder of fiscal 2017 and a full-year FIFO operating margin decline of approximately 30 to 40 basis points, excluding fuel and adjusted items.
- 2017 capital investments were expected to range from $3.0 billion to $3.3 billion, with approximately 55 major projects and 175 major remodels.
- Management expected an approximately 35% tax rate, an annualized LIFO charge of approximately $80 million, approximately $90 million of company-sponsored pension expense and approximately $360 million of multi-employer pension contributions.
- Guidance did not include potential effects from Hurricanes Harvey or Irma or the expected pension settlement charge.
- Key risks include labor negotiations, competition and price investments, fuel-price and fuel-margin volatility, inflation or deflation in product and operating costs, pension obligations, liquidity and refinancing conditions, natural disasters, cybersecurity incidents, healthcare and pharmacy changes, and integration of Harris Teeter, Roundy’s and other businesses.
- Pending litigation includes antitrust, wage-and-hour, civil-rights and product-liability matters. Management considers the aggregate exposure not material, but acknowledges that outcomes could differ materially from estimates.
Important Facts for Investors to Verify
- Confirm that the intended filing is 2017 Q2, not 2016 Q2, based on the August 12, 2017 period end.
- Assess whether sales growth, digital growth and market-share gains can offset declining gross margins and higher labor, technology and customer-investment costs.
- Reconcile GAAP EPS of $0.71 with adjusted year-to-date EPS of $0.97 and evaluate the recurring nature of excluded pension and retirement charges.
- Monitor the expected fourth-quarter pension settlement charge and the continuing exposure to multi-employer pension plans.
- Evaluate debt maturities, interest expense, credit-facility availability and the company’s ability to fund buybacks, dividends, capital expenditures and pension obligations.
- Review the effects of fuel sales, LIFO charges, hurricanes, labor negotiations and competitive pricing on full-year guidance.
- Review the forthcoming accounting effects of revenue-recognition and lease standards, particularly the expected significant increase in reported lease assets and liabilities.