The Kroger Co. Form 10-K Summary
Reporting period: The supplied filing is the Form 10-K for the 52-week fiscal year ended January 30, 2010, covering fiscal 2009, with comparisons to fiscal 2008 and 2007. This does not match the request metadata identifying “2008 Q4.” The filing also presents unaudited fourth-quarter 2009 data for the 12 weeks ended January 30, 2010.
Business Context
Kroger is a U.S.-only retail food, drug, multi-department, convenience-store, jewelry, fuel and manufacturing business. At year-end it operated 2,468 supermarkets and multi-department stores, 893 with fuel centers, 777 convenience stores, 374 fine-jewelry stores and 40 manufacturing plants. Retail operations are the company’s only reportable segment. Kroger employed approximately 334,000 people, with most employees covered by collective bargaining agreements.
Key Financial Metrics
| Metric | 2009 | 2008 | Change |
|---|---|---|---|
| Sales | $76.733 billion | $76.148 billion | 0.8% increase |
| Operating profit | $1.091 billion | $2.452 billion | Decline, primarily from impairment |
| Net earnings attributable to Kroger | $70 million | $1.249 billion | Sharp decline |
| Diluted EPS | $0.11 | $1.89 | Sharp decline |
| Adjusted diluted EPS | $1.71 | $1.89 | Excludes 2009 impairment charges |
| Cash flow from operations | $2.922 billion | $2.896 billion | 0.9% increase |
| Capital expenditures, including construction-payable changes | $2.315 billion | $2.153 billion | Increase |
| FIFO gross margin | 23.23% | 23.38% | 15-basis-point decline |
| OG&A as a percentage of sales | 17.46% | 17.14% | Increase |
| Net interest expense | $502 million | $485 million | Increase |
| Total debt, including leases and financing obligations | Approximately $8.1 billion | Approximately $8.1 billion | Down approximately $7 million |
Sales excluding fuel remained comparatively resilient: supermarket sales excluding fuel increased 2.9% to $65.649 billion, while supermarket fuel sales declined 10.6% to $6.671 billion because of lower fuel prices. Identical supermarket sales increased 2.1% excluding fuel, but only 0.6% including fuel. Market share increased approximately 60 basis points across 17 divisions.
The 2009 effective tax rate was 90.4%, distorted by the largely nondeductible goodwill impairment. Excluding the impairment, the effective tax rate was approximately 35.8%. Cash and temporary cash investments increased to $424 million from $263 million. Total assets were $23.093 billion, and Kroger shareowners’ equity was $4.832 billion.
Material Changes Versus the Prior Comparable Period
- Net earnings fell to $70 million from $1.249 billion, primarily because Kroger recorded a $1.113 billion pretax, approximately $1.036 billion after-tax, goodwill impairment charge related to the Ralphs reporting unit in Southern California.
- Adjusted net earnings were approximately $1.1 billion and adjusted diluted EPS was $1.71, reflecting management’s exclusion of the noncash impairment charge.
- FIFO gross margin declined because of heightened competition, deflation and investments in the Customer 1st strategy. Lower LIFO expense partly offset the pressure: $49 million in 2009 versus $196 million in 2008.
- Retail fuel margins declined, contributing to lower operating profit despite higher nonfuel identical sales.
- Operating cash flow remained approximately $2.9 billion, while capital expenditures increased to $2.315 billion.
- Kroger reduced share repurchases to $218 million from $637 million in 2008 to preserve liquidity and financial flexibility. Dividends paid increased to $238 million from $227 million.
- Goodwill declined to $1.158 billion from $2.271 billion after the Ralphs impairment. Net property, plant and equipment increased to $13.929 billion from $13.161 billion.
- The company opened 14 supermarkets and nine relocated stores, but closed 27 stores operationally and 10 through relocations, ending with 2,468 supermarkets versus 2,481 a year earlier.
Liquidity, Debt and Commitments
- Kroger had no borrowings under its $2.5 billion revolving credit facility, $100 million of uncommitted money-market lines or commercial paper program at year-end.
- The company had approximately $1 billion of daily commercial-paper borrowing capacity, subject to credit-market conditions and ratings. Outstanding letters of credit reduced credit-facility availability by approximately $313 million.
- Credit ratings were BBB/Baa2/BBB. The leverage ratio was 2.22 to 1 against a 3.50-to-1 default threshold; fixed-charge coverage was 3.82 to 1 against a 1.70-to-1 threshold. Kroger was in compliance with its covenants.
- Long-term debt maturities totaled $549 million in 2010, $513 million in 2011, $933 million in 2012, $1.514 billion in 2013, $312 million in 2014 and $3.755 billion thereafter.
- Total contractual obligations were $20.710 billion, including $7.576 billion of long-term debt, $4.107 billion of interest, $6.959 billion of operating leases and $473 million of capital leases. The table excluded pension and multi-employer plan funding.
- Estimated Kroger’s share of multi-employer pension underfunding was $2.7 billion pretax, or $1.7 billion after tax, as of December 31, 2009. The estimate is not a direct balance-sheet liability but could affect future contributions, expenses, credit ratings and withdrawal liabilities.
Guidance, Outlook and Management Commentary
- For fiscal 2010, management expected diluted EPS of $1.60 to $1.80 and identical supermarket sales growth excluding fuel of 2.0% to 3.0%.
- Nonfuel operating margins were expected to range from a slight reduction to a slight improvement, excluding the 2009 impairment charge.
- Fuel margin was expected to average approximately $0.11 per gallon, with continued growth in fuel gallons sold. The expected 2010 LIFO charge was approximately $50 million.
- Capital investments were expected to range from $1.9 billion to $2.1 billion, excluding acquisitions and purchases of leased facilities. Food-store square footage was expected to grow approximately 1.0% to 1.5% before acquisitions and operational closings.
- Kroger planned to reduce internal capital plans by approximately $1 billion over three years and expected average annual capital expenditures below $2 billion during that period.
- Expected 2010 contributions included approximately $110 million to company-sponsored defined-benefit plans and $250 million to multi-employer pension plans. Management expected meaningful increases in multi-employer pension funding and expense over the following five years.
- Management believed operating cash flow and available borrowing capacity would be adequate for working capital, capital expenditures, interest and scheduled principal payments.
Risks, Contingencies and Unusual Items
- Intense price competition, supercenter expansion, nontraditional competitors, consumer trading down, deflation and uncertain fuel margins could pressure sales and profitability.
- Approximately 305 labor agreements were outstanding, with significant negotiations scheduled in 2010. Strikes or higher wage, health-care and pension costs could materially affect results.
- Food-safety incidents, product recalls, information-technology failures or data breaches could disrupt operations and damage customer trust.
- The Ralphs impairment demonstrates sensitivity to changes in projected cash flows, competitive conditions, market multiples and Southern California operating performance. Management stated that additional goodwill impairments were not reasonably possible, but identified remaining sensitivity at certain reporting units.
- A pending U.S. Tax Court dispute involving a 1992 Ralphs transaction could require a cash payment of up to approximately $488 million, including interest, if Kroger loses.
- New patent litigation involving fuel-rewards programs was filed in March 2010. Management did not expect a material adverse outcome, but the litigation was subject to substantial uncertainty.
- Legal proceedings, including antitrust, wage-and-hour, civil-rights and product-liability matters, could produce outcomes differing materially from recorded estimates.
- Company-sponsored pension obligations were underfunded by approximately $1.109 billion in aggregate at year-end, including $610 million for qualified plans, $187 million for the nonqualified plan and $312 million for other benefits.
Investor Verification Checklist
- Reconcile reported net earnings and EPS with adjusted results by separately assessing the $1.113 billion pretax Ralphs goodwill impairment.
- Review nonfuel FIFO margin trends, fuel margins, deflation/inflation assumptions and the sustainability of the 2.1% identical-sales increase.
- Verify debt maturities, refinancing needs, credit ratings and compliance with leverage and fixed-charge covenants.
- Assess the potential cash and earnings impact of the $488 million Ralphs tax contingency and other litigation.
- Evaluate the reliability of the estimated $2.7 billion share of multi-employer pension underfunding and the expected future contribution increases.
- Compare actual fiscal 2010 results with the stated EPS, identical-sales, capital-expenditure, fuel-margin and pension-contribution guidance.