The Kroger Co. Form 10-Q Summary
Reporting period: The provided filing is for the second quarter and first two quarters of fiscal 2010, ended August 14, 2010, with comparable periods ended August 15, 2009. This does not match the request metadata identifying “2009 Q2.” The quarter covered 12 weeks and the year-to-date period covered 28 weeks. Financial statements are unaudited.
Business Context and Key Financial Metrics
| Metric | Second quarter 2010 | Second quarter 2009 | Year-to-date 2010 | Year-to-date 2009 |
|---|---|---|---|---|
| Sales | $18.796 billion | $17.728 billion | $43.560 billion | $40.517 billion |
| Operating profit | $494 million | $499 million | $1.217 billion | $1.343 billion |
| Net earnings attributable to Kroger | $262 million | $255 million | $636 million | $690 million |
| Diluted earnings per share | $0.41 | $0.39 | $0.98 | $1.05 |
| FIFO gross margin rate | 22.51% | 23.11% | 22.59% | 23.80% |
| Effective tax rate | 31.6% | 34.6% | 34.6% | 36.0% |
| Net cash from operating activities | Not separately provided | Not separately provided | $2.319 billion | $2.166 billion |
Second-quarter sales increased 6.0%, driven by higher identical supermarket sales, higher fuel prices and gallons sold, product-cost inflation, and increased other sales. Identical supermarket sales excluding fuel increased 2.7%; 17 of 18 supermarket divisions reported positive growth. Supermarket fuel sales increased 25.9%.
Second-quarter operating margin was approximately 2.63% of sales versus 2.81% in the prior-year quarter. Year-to-date operating margin was approximately 2.79% versus 3.32%. The filing attributes margin pressure primarily to lower non-fuel FIFO gross margins, investments in lower customer prices, higher shrink, and higher warehouse and transportation costs.
Year-to-date cash flow from operations of $2.319 billion exceeded capital expenditures of $952 million and supported dividends, debt repayment, share repurchases, and other financing uses. Investing cash outflow was $939 million, while financing cash outflow was $767 million. Cash and temporary investments increased to $1.037 billion from $424 million at fiscal year-end.
At August 14, 2010, total debt, including current maturities, capital leases, and financing obligations, was approximately $7.8 billion. Consolidated current liabilities were $7.925 billion versus current assets of $7.546 billion. Kroger had no borrowings under its $2.5 billion revolving credit facility, money market lines, or commercial paper program; $308 million of letters of credit reduced revolver availability. The company stated that it was in compliance with debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales rose 6.0% in the quarter and 7.5% year to date, largely reflecting fuel-related growth and positive identical supermarket sales.
- Quarterly net earnings increased 2.7%, but year-to-date net earnings declined 7.8% because of lower operating profit and lower non-fuel FIFO margins.
- Quarterly diluted EPS increased 5.1% to $0.41, supported by earnings growth and approximately 17 million shares repurchased over the preceding four quarters. Year-to-date diluted EPS declined 6.7% to $0.98.
- Interest expense declined to $102 million from $115 million in the quarter and to $234 million from $278 million year to date, primarily because of lower weighted-average interest rates and increased interest-rate-swap benefits.
- The second-quarter effective tax rate benefited from an approximately $15 million adjustment to tax contingency reserves following the conclusion of an IRS examination.
- Kroger issued $300 million of 5.40% senior notes due 2040 during the quarter. It had previously repaid $500 million of 8.05% senior notes at maturity in the first quarter.
- Year-to-date share repurchases totaled $228 million for 10.9 million shares. The company authorized a new $500 million repurchase program in June 2010.
- The company purchased the remaining interest in The Little Clinic LLC for $86 million in February 2010; the transaction was recorded as an equity transaction without gain or loss.
- A LIFO reserve correction increased beginning accumulated earnings and reduced the LIFO reserve by $33 million, or $20 million after tax. Management stated the correction was not material to any individual year or quarter presented.
Guidance, Outlook, Risks, and Unusual Items
- Fiscal 2010 diluted EPS guidance was $1.60 to $1.80, with dividends expected to enhance shareholder return by 1.5% to 2.0%.
- Management expected 2010 identical supermarket sales growth excluding fuel of 2.0% to 3.0%, fuel margins of approximately $0.11 per gallon, and an annualized LIFO charge of approximately $50 million.
- Expected 2010 interest expense was approximately $450 million, effective tax rate approximately 35.5%, capital investments excluding acquisitions and leased-facility purchases of $1.9 billion to $2.1 billion, and food-store square-footage growth of approximately 1.0% to 1.5% before acquisitions and operational closings.
- Management expected approximately $140 million of contributions to company-sponsored pension plans and approximately $250 million of contributions to multi-employer pension plans in 2010. It anticipated meaningful increases in multi-employer pension expense over the next several years.
- Key operating risks include competitive pricing, cautious consumer spending, commodity inflation or deflation, volatile fuel margins, labor negotiations and potential work stoppages, execution of store and technology investments, and the ability to achieve planned cost savings.
- The Ralphs tax litigation could require a cash payment of up to approximately $502 million, including interest, if Kroger receives an adverse decision. A decision was expected within 12 months of the filing.
- On August 17, 2010, the Ninth Circuit held that a mutual strike assistance agreement involving Ralphs violated Section 1 of the Sherman Act. Management did not expect the ultimate resolution to materially affect financial condition, results, or cash flows, but litigation outcomes remain uncertain.
- Insurance claims, antitrust, wage-and-hour, civil-rights, product-liability, and other litigation could produce liabilities exceeding recorded estimates. Pension obligations are sensitive to asset performance, interest rates, healthcare costs, and actuarial assumptions.
Important Facts for Investors to Verify
- Confirm the intended period: the supplied filing is fiscal 2010 second quarter, not fiscal 2009 second quarter.
- Assess whether fuel sales growth and higher fuel prices are masking weaker underlying non-fuel margin performance.
- Reconcile the decline in year-to-date operating profit and earnings with management’s 2010 EPS guidance.
- Review debt maturities, interest-rate swaps, covenant headroom, and the availability of the revolving credit facility after letters of credit.
- Evaluate the potential cash and earnings impact of the Ralphs tax litigation and other legal contingencies.
- Monitor pension and multi-employer plan funding requirements, particularly the expected future increases in contributions and expense.
- Verify the sustainability of share repurchases and dividends relative to operating cash flow, capital expenditures, and debt obligations.
- Review the assumptions supporting fuel margins, LIFO expense, product-cost trends, capital spending, and identical-store sales guidance.