The Kroger Co. Form 10-Q Summary
Reporting period: The supplied filing is for the 12- and 28-week periods ended August 15, 2015, compared with August 16, 2014. This differs from the request metadata identifying “2014 Q2.” The filing is unaudited and should be read with Kroger’s fiscal 2014 Form 10-K.
Business Context
Kroger operates supermarkets, fuel centers, convenience stores, pharmacies, jewelry stores, manufacturing operations, health clinics and digital businesses, including Vitacost.com. Identical supermarket sales excluding fuel increased 5.3% in the quarter and 5.5% for the first two quarters. Management reported positive identical sales across all geographies and supermarket departments and 47 consecutive quarters of positive identical supermarket sales growth.
A two-for-one stock split became effective July 13, 2015; all share and per-share amounts were retrospectively adjusted.
Key Financial Metrics
| Metric | Second Quarter 2015 | Second Quarter 2014 | First Two Quarters 2015 | First Two Quarters 2014 |
|---|---|---|---|---|
| Sales | $25.539 billion | $25.310 billion | $58.590 billion | $58.271 billion |
| Operating profit | $774 million | $644 million | $1.876 billion | $1.574 billion |
| Operating margin | 3.03% | 2.54% | 3.20% | 2.70% |
| Net earnings attributable to Kroger | $433 million | $347 million | $1.052 billion | $848 million |
| Diluted EPS | $0.44 | $0.35 | $1.06 | $0.84 |
| Gross margin | 21.44% | 20.44% | 21.79% | 20.71% |
| FIFO operating profit | $795 million | $670 million | $1.919 billion | $1.625 billion |
| Cash flow from operations | Not separately provided | Not separately provided | $2.755 billion | $2.592 billion |
Fuel sales declined 18.8% in the quarter and 22.8% year to date, primarily because average retail fuel prices decreased 24.5% and 28.4%, respectively. Fuel gallons sold increased 7.6% and 7.7%.
OG&A expense was $4.068 billion in the quarter and $9.422 billion year to date. OG&A as a percentage of sales increased to 15.93% from 15.49% in the quarter and to 16.08% from 15.60% year to date, primarily reflecting lower fuel sales and higher pension, credit card and incentive-plan costs.
Liquidity, Debt and Capital Allocation
- Cash and temporary cash investments were $268 million at August 15, 2015, unchanged from January 31, 2015.
- Total debt, including current and long-term portions of capital leases and financing obligations, was approximately $11.3 billion at quarter-end, compared with $11.6 billion at fiscal year-end 2014 and $11.1 billion at the end of the second quarter of 2014.
- Debt excluding capital leases and financing obligations was $10.695 billion, including $928 million of commercial paper. The fair value of total debt was $11.509 billion versus a carrying value of $10.695 billion.
- Kroger had a $2.75 billion unsecured revolving credit facility, with capacity to increase by $750 million, and no borrowings under the facility. Outstanding letters of credit reduced availability by $9 million.
- Operating cash flow of $2.755 billion exceeded investing cash use of $1.710 billion and financing cash use of $1.045 billion, resulting in no net change in cash.
- Capital investments, excluding mergers, acquisitions and leased-facility purchases, were $1.727 billion year to date, compared with $1.382 billion in the prior-year period.
- Kroger repurchased $628 million of common shares year to date and paid $181 million in dividends. A new $500 million repurchase authorization was approved on June 25, 2015.
- Management estimated next-twelve-month liquidity needs of approximately $4.9 billion, including working capital, capital expenditures, interest and scheduled debt maturities. Management expects operating cash flow, commercial paper and bank facilities to be sufficient.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 0.9%, while year-to-date sales increased 0.5%; non-fuel supermarket sales increased 5.2% and 5.6%, respectively.
- Quarterly net earnings increased 24.8%, and year-to-date net earnings increased 24.1%. Diluted EPS increased 25.7% in the quarter and 26.2% year to date, aided by higher earnings and share repurchases.
- Year-to-date 2014 results included an $87 million pretax, $56 million after-tax charge related to multi-employer pension plan agreements. Excluding that item, 2014 adjusted net earnings were $904 million, or $0.90 per diluted share, versus $1.052 billion and $1.06 in 2015.
- Operating margin expanded 49 basis points in the quarter and 50 basis points year to date. Management attributed the improvement to higher supermarket sales, productivity, cost controls, fuel operations and lower workers’ compensation and general liability costs.
- Capital investment increased materially, while financing cash use declined because share repurchases were lower than in the prior-year period.
- Depreciation and amortization increased to $477 million in the quarter and $1.097 billion year to date, reflecting recent capital investments, acquisitions and lease buyouts.
Guidance, Outlook and Risks
- Fiscal 2015 diluted EPS guidance was increased to $1.92-$1.98.
- Management expected 2015 identical supermarket sales growth excluding fuel of 4.0%-5.0%, non-fuel FIFO operating margin to exceed its goal of slight expansion, and year-end ROIC to increase slightly from fiscal 2014. Rolling-four-quarter ROIC was 14.24% at August 15, 2015.
- Expected 2015 capital investments were at the high end of the $3.0-$3.3 billion range, with supermarket square footage expected to grow approximately 2.0%-2.5% before mergers, acquisitions and operational closings.
- Management expected approximately $90 million of annualized LIFO expense, interest expense of approximately $480 million, an effective tax rate of approximately 35% excluding certain tax items, and no goodwill impairments.
- Approximately $928 million of commercial paper and $500 million of senior notes were expected to mature in the third quarter of 2015. Management expected to refinance these obligations on favorable terms.
- Management expected approximately $5 million of company-sponsored pension contributions and $315 million of multi-employer pension fund contributions in 2015. Labor negotiations with UFCW and the Teamsters were identified as challenging.
- Key risks include refinancing and commercial-paper access, interest rates, labor disputes, competitive pricing, fuel-price and fuel-margin volatility, commodity inflation or deflation, pharmacy reimbursement and competition, multi-employer pension obligations, cyberattacks and data breaches, adverse weather, litigation, and integration of Harris Teeter.
- Various antitrust, wage-and-hour, civil-rights and product-liability claims were pending. Management believed aggregate exposure was not material, but acknowledged that actual outcomes could differ materially from estimates.
Important Facts for Investors to Verify
- Confirm the reporting-period discrepancy: the supplied filing is the quarter ended August 15, 2015, not 2014 Q2.
- Reconcile GAAP gross margin and operating profit with management’s non-GAAP FIFO measures, including LIFO charges of $21 million in the quarter and $48 million year to date.
- Assess the sustainability of earnings growth after adjusting for the prior-year $56 million after-tax pension-plan charge and considering lower fuel prices.
- Review refinancing of the $928 million commercial paper balance and $500 million senior-note maturity, as well as continued covenant compliance.
- Evaluate whether capital spending, share repurchases and dividends remain consistent with the stated liquidity and investment-grade debt objectives.
- Monitor multi-employer pension commitments, labor negotiations, pharmacy cost inflation, fuel margins and the integration of Harris Teeter and Vitacost.com.