The Kroger Co. Form 10-Q Summary
Business context and reporting period
This filing is for Kroger’s first quarter of fiscal 2017, the 16-week period ended May 20, 2017, compared with the 16-week period ended May 21, 2016. The request metadata identifies “2016 Q1,” but the filing itself is clearly a 2017 first-quarter report. The financial statements are unaudited.
Kroger operates supermarkets, fuel centers, pharmacies, convenience stores, digital and specialty businesses. The quarter included the ModernHEALTH merger and continued investments in pricing, labor, digital capabilities and store growth.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $36.285 billion | $34.604 billion | 4.9% increase |
| Operating profit | $622 million | $1.200 billion | 48.2% decrease |
| Operating margin | 1.71% | 3.47% | Down 176 basis points |
| Net earnings attributable to Kroger | $303 million | $696 million | 56.5% decrease |
| Diluted earnings per share | $0.32 | $0.71 | 54.9% decrease |
| Adjusted diluted EPS | $0.58 | $0.71 | 18.3% decrease |
| Net cash from operating activities | $2.309 billion | $2.079 billion | Increase of $230 million |
| Capital investments | $921 million | $1.145 billion | Decrease of $224 million |
| Net cash used in financing | $1.531 billion | $914 million | Increase of $617 million |
Gross margin declined to 22.06% from 22.93%; FIFO gross margin declined to 22.13% from 22.98%. Management attributed the deterioration primarily to price investments, deflationary pricing and cost effects, higher fuel sales, increased logistics and shrink costs, ModernHEALTH’s lower margin profile and a higher LIFO charge. OG&A expense increased to 17.57% of sales from 16.70%, reflecting labor, wage, digital strategy and other investments.
Identical supermarket sales excluding fuel decreased 0.2%. Total supermarket sales excluding fuel increased 1.4%, fuel sales increased 20.5% to $4.702 billion, and other sales increased 40.7% to $1.642 billion. Supermarket square footage increased 3.4% excluding mergers, acquisitions and operational closings.
At May 20, 2017, cash and temporary cash investments were $356 million. Total debt, excluding capital leases and financing obligations, was $12.702 billion, including $880 million of commercial paper. The company had no borrowings under its $2.75 billion unsecured revolving credit facility, which could be increased by $750 million. Management stated that debt covenants were satisfied.
Kroger returned $884 million to shareholders through $772 million of share repurchases and $111 million of dividends paid. It repurchased approximately 25.5 million shares at an average price of $30.27 per share. The quarterly dividend declared was $0.12 per share, compared with $0.105 in the prior-year quarter.
Material changes versus the prior comparable period
- Sales increased 4.9%, but operating profit fell 48.2% and net earnings attributable to Kroger fell 56.5%.
- Reported results included a $199 million pretax charge, or $126 million after tax, for withdrawal liabilities associated with two multi-employer pension plans.
- Reported results also included a $184 million pretax charge, or $117 million after tax, for a voluntary retirement offering accepted by approximately 1,300 non-store associates. Management expects related future cost savings and planned to complete payments by the end of the fourth quarter of 2017.
- The combined after-tax effect of these items was $243 million, reducing diluted EPS by $0.26. Excluding them, adjusted net earnings were $546 million and adjusted diluted EPS was $0.58.
- Operating cash flow increased despite lower earnings, primarily because of higher non-cash expenses and favorable working-capital changes.
- Financing cash outflows increased because commercial-paper borrowings declined by $545 million, compared with net commercial-paper borrowings of $256 million in the prior-year quarter.
- The effective tax rate was broadly stable at 33.3%, compared with 33.5%.
Guidance, outlook, risks and unusual items
Management’s 2017 guidance includes reported diluted EPS of $1.74 to $1.79, adjusted diluted EPS of $2.00 to $2.05, identical supermarket sales growth excluding fuel of flat to 1.0%, and a full-year FIFO operating-margin decline of approximately 20 to 30 basis points, excluding fuel, the 2017 adjusted items and the 2016 restructuring of certain multi-employer pension obligations.
Capital investments are expected to be $3.2 billion to $3.5 billion, supermarket square footage growth is expected to be approximately 1.8%, and the tax rate is expected to be approximately 35%, excluding specified items. Management expects approximately $80 million of annualized LIFO charges, $110 million of company-sponsored pension expense and approximately $360 million of contributions to multi-employer pension funds.
Management estimates next-twelve-month liquidity needs of $6.0 billion to $6.5 billion, including working capital, capital expenditures, interest and scheduled debt payments. Approximately $880 million of commercial paper and $800 million of senior notes mature within the next twelve months; management expects to refinance these obligations.
Key risks include labor negotiations, competitive pricing, deflation or inflation in product costs, fuel-price and fuel-margin volatility, consumer spending, pharmacy reimbursement and healthcare-industry consolidation, multi-employer pension obligations, refinancing and commercial-paper market access, cyberattacks, adverse weather, litigation, and execution and integration risks associated with growth initiatives and acquisitions.
Kroger disclosed pending antitrust, wage-and-hour, civil-rights and product-liability matters, including potential class actions. Management believes aggregate exposure is not material, but acknowledges that adverse outcomes or changes in estimates could materially affect results.
Recently issued lease accounting guidance is expected to significantly increase reported lease assets and liabilities when adopted. Revenue-recognition guidance may affect customer loyalty programs and gross-versus-net reporting; the filing states that the company was still evaluating the impact.
Most important facts to verify
- Confirm the applicable period: the filing covers Q1 fiscal 2017, not Q1 2016.
- Assess whether the $243 million after-tax adjusted-item exclusion appropriately reflects recurring or nonrecurring costs.
- Evaluate the sustainability of the 0.2% decline in identical supermarket sales excluding fuel and the effect of continued price investments on margins.
- Review refinancing requirements for the $880 million of commercial paper and $800 million of senior notes maturing within twelve months.
- Monitor multi-employer pension withdrawal liabilities, including the possibility of additional demand letters or revised obligations.
- Reconcile the filing’s balance-sheet date presentation, which contains an apparent year-label inconsistency, against the filed financial statements and subsequent reports.
- Compare future results with the company’s guidance for EPS, identical sales, FIFO margin, capital spending and pension contributions.