KROGER CO quarterly report, Q1 FY2015

The Kroger Co. Form 10-Q Summary

Business context and reporting period

This filing is for the 16-week first quarter ended May 23, 2015, with comparison to the 16-week period ended May 24, 2014. The request metadata refers to 2014 Q1, but the filing text clearly identifies the reporting period as first quarter 2015. Kroger reported consolidated results for its supermarket, fuel, pharmacy, convenience, digital and related operations. The filing was signed June 30, 2015.

Key financial metrics

Metric	Q1 2015	Q1 2014	Change
Sales	$33.051 billion	$32.961 billion	0.3% increase
Operating profit	$1.102 billion	$930 million	18.5% increase
Operating margin	3.33%	2.82%	Up 51 basis points
Net earnings attributable to Kroger	$619 million	$501 million	23.6% increase
Diluted earnings per share	$1.25	$0.98	27.6% increase
Net cash from operating activities	$1.755 billion	$1.751 billion	Essentially unchanged
Capital investments, excluding acquisitions and leased facilities	$915 million	$709 million	Increase of $206 million

Identical supermarket sales excluding fuel increased 5.7%; all supermarket departments and operating divisions reported positive identical sales.
Supermarket sales excluding fuel rose 5.8% to $27.356 billion. Fuel sales fell 26.0% to $4.573 billion because the average retail fuel price declined 31.4%, partly offset by a 7.8% increase in gallons sold.
Gross margin increased to 22.06% from 20.92%. FIFO gross margin increased to 22.14% from 21.01%, although FIFO gross margin excluding fuel declined seven basis points.
OG&A expense increased to $5.354 billion from $5.168 billion, and OG&A as a percentage of sales increased to 16.20% from 15.68%.
Depreciation and amortization increased to $620 million from $581 million, primarily reflecting prior capital investments, acquisitions and lease buyouts.
The effective income tax rate was approximately 34.6% in 2015 versus approximately 35.0% in 2014.
Cash and temporary cash investments were $252 million at May 23, 2015, compared with $268 million at January 31, 2015.
Total assets were $30.468 billion and total equity was $5.536 billion at May 23, 2015.
Total debt, including capital leases and financing obligations, was approximately $11.3 billion. Debt excluding capital leases and financing obligations had a carrying value of $10.746 billion, including $990 million of commercial paper.
The $2.75 billion unsecured revolving credit facility, expandable by $750 million, had no borrowings outstanding; $8 million of letters of credit reduced availability.
Return on invested capital for the rolling four quarters ended May 23, 2015 was 14.03% under Kroger’s non-GAAP methodology.

Material changes versus the prior comparable period

Reported net earnings increased $118 million, but the comparison benefits from a $56 million after-tax charge in Q1 2014 related to multi-employer pension plan restructuring agreements. Excluding that item, 2015 net earnings increased 11.1% from $557 million, and diluted EPS increased 14.7% from $1.09.
Improved non-fuel FIFO operating profit reflected higher supermarket sales, productivity improvements, cost controls, and lower transportation and advertising costs. These benefits were partly offset by investments in lower prices, higher shrink, pharmacy cost inflation, pension, healthcare, credit-card and incentive-plan costs.
Fuel earnings declined slightly because lower fuel margins more than offset higher gallon sales.
Operating cash flow remained stable, while investing cash usage increased by $155 million due primarily to higher capital spending.
Financing cash usage declined to $913 million from $1.184 billion, mainly because share repurchases decreased. Kroger repurchased approximately $585 million of shares during the quarter.
Shares used in diluted EPS declined to 492 million from 507 million, reflecting repurchases and contributing to EPS growth.
Long-lived assets with a carrying value of $25 million were written down to $3 million, resulting in a $22 million impairment charge, compared with an $8 million charge in Q1 2014.
Kroger completed its August 2014 merger with Vitacost.com; no changes were made to the preliminary purchase price allocation during the quarter.
A new accounting standard required debt issuance costs to be presented as a reduction of debt rather than in other assets. The adoption did not affect earnings.
On June 25, 2015, the board approved a two-for-one stock split, effective for shareholders of record July 6, 2015. Reported historical share and per-share amounts in the filing are pre-split.

Guidance, outlook, risks and unusual items

Fiscal 2015 diluted EPS guidance was $3.80 to $3.90, based on adjusted 2014 EPS of $3.52. The post-split range was $1.90 to $1.95.
Fiscal 2015 identical supermarket sales excluding fuel were expected to increase 3.5% to 4.5%; management increased both ends of this range following first-quarter results.
Management expected slight expansion in full-year FIFO non-fuel operating margin, an approximately $90 million annual LIFO charge, approximately $480 million of interest expense, and an effective tax rate of approximately 35%, excluding certain tax items and legislative changes.
Capital investments excluding mergers, acquisitions and purchases of leased facilities were expected at $3.0 billion to $3.3 billion, with supermarket square footage expected to grow approximately 2.0% to 2.5% before mergers, acquisitions and operational closings.
Management estimated next-twelve-month liquidity needs of approximately $5.0 billion and expected operating cash flow, commercial paper and the revolving credit facility to be sufficient. Approximately $990 million of commercial paper and $500 million of senior notes were expected to mature within twelve months and were expected to be refinanced.
Management expected approximately $5 million of contributions to company-sponsored pension plans and $250 million to multi-employer pension funds in 2015. It continued to evaluate potential exposure to underfunded multi-employer plans.
Planned labor negotiations included UFCW agreements in Columbus, Denver, Memphis and Portland and Teamsters agreements covering Memphis and Southern California distribution centers.
Principal risks included fuel-price and fuel-margin volatility, competitive pricing, labor negotiations, pharmacy reimbursement and healthcare-industry consolidation, inflation or deflation, consumer spending, adverse weather, cyberattacks and data breaches, multi-employer pension obligations, debt refinancing and liquidity-market conditions, tax changes, goodwill impairment, and integration of Harris Teeter.
Various antitrust, wage-and-hour, civil-rights and product-liability claims were pending. Management considered the aggregate expected exposure immaterial, but acknowledged that outcomes could differ materially from current estimates.

Facts investors should verify

Confirm that the intended period is Q1 2015, not Q1 2014, because the filing covers the quarter ended May 23, 2015.
Reconcile reported EPS and guidance for the June 2015 two-for-one stock split; the filing presents historical amounts on a pre-split basis.
Assess the quality and sustainability of 5.7% identical supermarket sales growth, including the contributions from household growth, visit frequency and product-cost inflation.
Monitor non-fuel margin pressure from price investments, pharmacy inflation, shrink and labor-related costs, despite reported operating-margin expansion.
Verify refinancing plans for $990 million of commercial paper and $500 million of senior notes maturing within the next twelve months.
Review the effect of share repurchases and the new $500 million repurchase authorization on share count, leverage and liquidity.
Evaluate potential liabilities from multi-employer pension plans, labor negotiations, pending litigation and the $22 million long-lived-asset impairment.
Track the adoption assessment for the new revenue-recognition standard and any future effects on reported results or disclosures.