The Kroger Co. Form 10-Q Summary
Business context and reporting period
The filing is Kroger’s unaudited Form 10-Q for the 16-week first quarter ended May 22, 2010, compared with the 16-week period ended May 23, 2009. The request metadata identifies “2009 Q1,” but the filing itself reports first-quarter 2010 results. Kroger operates supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities, and related businesses in the United States.
Financial performance and liquidity
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Sales | $24.764 billion | $22.789 billion | 8.7% increase |
| Operating profit | $723 million | $844 million | 14.3% decrease |
| Net earnings attributable to Kroger | $374 million | $435 million | 14.0% decrease |
| Diluted earnings per share | $0.58 | $0.66 | 12.1% decrease |
| FIFO gross margin | 22.66% | 24.34% | Down 168 basis points |
| Operating margin | 2.92% | 3.70% | Down approximately 78 basis points |
| Net margin | 1.51% | 1.91% | Down approximately 40 basis points |
| Net cash from operating activities | $1.553 billion | $1.288 billion | 25.5% increase |
| Capital expenditures paid | $542 million | $635 million | 14.6% decrease |
| Cash and temporary investments at period end | $602 million | $638 million | Prior-year comparison |
Identical supermarket sales increased 2.4% excluding fuel and 6.8% including fuel. Total supermarket fuel sales increased 63.9%, driven by higher fuel prices and increased gallons sold. Average fuel prices were 39% higher than in the prior-year quarter.
Operating cash flow benefited from improved working capital and lower pension contributions. Cash used in investing activities was $544 million, primarily for capital expenditures. Cash used in financing activities increased to $831 million, principally because of $544 million of debt repayments, $80 million of treasury stock purchases, dividends of $61 million, and an $86 million investment in the remaining interest of The Little Clinic LLC.
Total debt, including capital leases and financing obligations, was approximately $7.5 billion at quarter end, down $388 million from the prior-year quarter and $531 million from January 30, 2010. Long-term debt carrying value was $6.997 billion, while the estimated fair value of total debt was $7.919 billion. Kroger had no borrowings under its $2.5 billion revolving credit facility, money market lines, or commercial paper program; $315 million of letters of credit reduced available revolver capacity.
Material changes versus the prior comparable period
- Sales growth was driven by positive identical supermarket sales, higher fuel prices, increased fuel volume, and product-cost changes.
- Profitability declined despite higher sales. Non-fuel FIFO gross margin decreased primarily because Kroger invested in lower customer prices. Management stated that favorable commodity costs benefited the first quarter of 2009.
- Retail fuel operations improved profit by approximately $0.04 per diluted share year over year and partially offset weaker non-fuel margins.
- Interest expense declined to $132 million from $163 million because of lower debt, lower average interest rates, and greater benefits from interest-rate swaps.
- OG&A expense increased in dollars to $4.195 billion but declined as a percentage of sales to 16.95% from 17.67%; excluding fuel, the OG&A rate increased 13 basis points due mainly to health care, pension, and credit-card costs.
- Kroger paid $500 million of 8.05% senior notes at maturity and had previously issued $500 million of 3.90% senior notes due 2015.
- Kroger repurchased approximately 3.8 million shares during the quarter for $80 million at an average price of $21.88 per share. The board later authorized a new $500 million repurchase program.
- In February 2010, Kroger purchased the remaining interest in The Little Clinic LLC for $86 million. The transaction was recorded as an equity transaction because the entity was already consolidated.
Guidance, outlook, risks, and unusual items
- Management confirmed fiscal 2010 guidance and stated that it was pursuing the upper half of the earnings range.
- Expected 2010 diluted EPS was $1.60-$1.80, identical supermarket sales growth excluding fuel was expected at 2.0%-3.0%, and the effective tax rate was expected to be approximately 37.0%.
- Expected 2010 capital expenditures were $1.9-$2.1 billion, excluding acquisitions and purchases of leased facilities. Food-store square footage was expected to grow approximately 1.0%-1.5% before acquisitions and operational closings.
- Management expected approximately $443 million of interest expense, a $50 million annualized LIFO charge, approximately $100 million of contributions to company-sponsored pension plans, and approximately $250 million of contributions to multi-employer pension plans.
- Key risks include commodity inflation or deflation, volatile fuel margins, competitive pricing, cautious consumer spending, labor negotiations and potential work stoppages, pension underfunding, liquidity and commercial-paper market conditions, impairment charges, litigation, and changes in tax or accounting requirements.
- A tax dispute involving a 1992 Ralphs transaction could require a cash payment of up to approximately $496 million if Kroger receives an adverse ruling. Management believes its position is more likely than not to be sustained, but a decision was expected within 12 months.
- Kroger reported a $33 million reduction to the LIFO reserve and a $20 million after-tax increase to beginning accumulated earnings to correct prior-year promotional-allowance treatment. Management considered the correction immaterial to individual years and quarters.
- The company stated that it expects meaningful increases in expense from multi-employer pension contributions over the next several years and could face substantial withdrawal liability if it exits certain markets or ceases contributions.
- Management concluded that disclosure controls were effective and that there were no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the filing period with the request metadata: the filing is for Q1 2010, not Q1 2009.
- Assess whether continued price investments and non-fuel margin pressure are consistent with the full-year EPS and operating-margin outlook.
- Monitor fuel margins, fuel volumes, and the effect of fuel sales mix on reported gross margins.
- Verify debt maturities, interest-rate exposure, revolver availability after letters of credit, and progress in reducing leverage.
- Evaluate the potential cash and earnings effect of the Ralphs tax litigation and other pending claims.
- Track multi-employer pension underfunding, expected contribution increases, and potential withdrawal liabilities.
- Compare actual capital spending, store growth, repurchases, dividends, and operating cash flow with management’s 2010 plans.