The Kroger Co. Form 10-K Summary
Reporting period: Fiscal year ended January 28, 2012 (52 weeks), with comparative fiscal years ended January 29, 2011 and January 30, 2010. The request metadata references “2010 Q4,” but the supplied filing is the fiscal 2011 annual Form 10-K and includes fourth-quarter 2011 data.
Business Context
Kroger is a domestic food and drug retailer with one reportable retail segment representing more than 99% of consolidated sales and EBITDA. At year-end, it operated 2,435 supermarkets and multi-department stores, 791 convenience stores, 348 fine jewelry stores, 1,090 supermarket fuel centers, and 39 manufacturing plants. The Company employed approximately 339,000 people, most of whom were covered by collective bargaining agreements.
Financial Performance and Position
| Metric | 2011 | 2010 | Change or observation |
|---|---|---|---|
| Sales | $90.374 billion | $82.049 billion | Increased 10.1% |
| Net earnings attributable to Kroger | $602 million | $1.116 billion | Declined primarily because of the UFCW pension charge |
| Diluted EPS | $1.01 | $1.74 | 2011 included the pension charge |
| Adjusted diluted EPS | $2.00 | $1.76 | Excludes specified unusual impairment or pension charges |
| Operating profit | $1.278 billion | $2.182 billion | Reduced by the pension charge |
| FIFO gross margin | 21.13% | 22.31% | Decreased 118 basis points |
| Net cash from operations | $2.658 billion | $3.366 billion | Decreased because of lower reported earnings and working-capital use |
| Capital expenditures | $1.958 billion | $1.897 billion | Remained broadly stable |
| Total debt, including capital leases and financing obligations | Approximately $8.2 billion | Approximately $7.9 billion | Increased approximately $273 million |
| Cash and temporary investments | $188 million | $825 million | Declined substantially |
Identical supermarket sales increased 4.9% excluding fuel and 9.2% including fuel. Fuel sales increased 42.6%, reflecting higher average retail fuel prices and higher gallons sold. Market share increased approximately 50 basis points across Kroger’s 19 marketing areas, according to Nielsen Homescan data.
The 2011 FIFO gross margin rate declined because of investments in lower prices, product-cost inflation, and higher transportation expenses. The LIFO charge increased to $216 million from $57 million in 2010. OG&A expense was 16.98% of sales versus 16.85% in 2010 and included the UFCW pension charge.
Year-end total assets were $23.476 billion and total liabilities were $19.510 billion. Kroger shareowners’ equity declined to $3.981 billion from $5.296 billion, primarily reflecting share repurchases and accumulated other comprehensive losses.
Cash Flow, Debt and Liquidity
- Operating cash flow was $2.658 billion, compared with $3.366 billion in 2010.
- Investing activities used $1.908 billion, principally for capital expenditures.
- Financing activities used $1.387 billion, including $1.547 billion of treasury-stock purchases and $257 million of dividends.
- Kroger repurchased approximately $1.5 billion of common stock in 2011 and had $475 million remaining under its September 2011 repurchase authorization at year-end.
- Commercial paper borrowings were $370 million. No borrowings were outstanding under the $2.0 billion revolving credit facility or $75 million of money-market lines.
- Management estimated next-twelve-month liquidity needs of approximately $3.6 billion, including approximately $1.3 billion of debt maturities. Management stated that operating cash flow and available borrowing capacity were adequate.
- The year-end leverage ratio was 1.85 to 1 versus a 3.50 to 1 covenant limit, and the fixed-charge coverage ratio was 4.42 to 1 versus a 1.70 to 1 minimum. Kroger was in compliance with its covenants.
Material Changes and Unusual Items
- Kroger entered into an agreement with 14 UFCW locals to consolidate four multi-employer pension funds. It recorded a $911 million pre-tax charge for the estimated unfunded actuarial accrued liability and a total UFCW pension-related charge of $953 million pre-tax, or $591 million after tax.
- Kroger contributed $650 million to the consolidated UFCW pension plan in the fourth quarter. Estimated Kroger-attributable multi-employer plan underfunding was $2.3 billion pre-tax as of December 31, 2011, although the filing states this is generally not a direct liability except in specified circumstances.
- Multi-employer pension contributions increased to $946 million from $262 million in 2010. Kroger expected approximately $240 million of such contributions in 2012, subject to collective bargaining and capital-market conditions.
- No goodwill impairment was recorded in 2011. This compares with an $18 million pre-tax goodwill impairment charge in 2010 and a $1.113 billion pre-tax charge in 2009.
- Asset impairment charges were $37 million in 2011 versus $25 million in 2010.
- Debt increased through $450 million of 2.20% senior notes and higher commercial-paper borrowings, partially offset by repayment of $478 million of 6.80% senior notes.
- Kroger opened or acquired stores but closed 55 supermarkets during the year, resulting in 2,435 supermarkets at year-end versus 2,460 at the beginning of the year. Food-store square footage remained approximately 149 million square feet.
Guidance, Outlook and Risks
- 2012 diluted EPS guidance was $2.28 to $2.38, including the benefit of a 53rd week, lower expected LIFO expense, share repurchases, pension-plan consolidation, and anticipated prescription transfers from Express Scripts.
- Management expected identical supermarket sales growth excluding fuel of 3.0% to 3.5% and a 2012 LIFO charge of approximately $140 million to $190 million.
- Expected 2012 capital investments were $1.9 billion to $2.2 billion, excluding acquisitions and purchases of leased facilities. Food-store square footage was expected to grow approximately 1.3% to 1.5% before acquisitions and operational closings.
- Management expected interest expense of approximately $450 million and an effective tax rate of approximately 36.5%, excluding tax-issue resolutions.
- Key risks include intense price competition, cautious consumer spending, food-safety issues, labor negotiations and potential work stoppages, rising health-care and pension costs, underfunded multi-employer plans, product-cost inflation, fuel prices, information-security disruptions, weather and natural disasters, regulatory changes, impairment risk, interest-rate and refinancing risk, and litigation.
- A pending Ralphs tax dispute could require a cash payment of up to approximately $553 million, including interest, if Kroger ultimately receives an adverse decision. The Tax Court had previously ruled in Kroger’s favor on a significant issue, but remaining issues and potential appeals were unresolved.
Investor Verification Checklist
- Verify the reconciliation between reported 2011 EPS of $1.01 and adjusted EPS of $2.00, including the treatment of the $953 million pre-tax UFCW pension charge.
- Assess the sustainability of identical-store sales growth and the effect of fuel prices, inflation, pharmacy generic conversions, and competitive pricing on margins.
- Review the estimated $2.3 billion share of multi-employer pension underfunding, future contribution requirements, and potential withdrawal liabilities.
- Evaluate liquidity against approximately $1.3 billion of debt maturities, planned capital spending, share repurchases, and only $188 million of year-end cash.
- Review the Ralphs tax litigation exposure of up to approximately $553 million and other legal, insurance, labor, and food-safety contingencies.
- Compare 2012 guidance with actual results, particularly identical-store sales, LIFO expense, pension costs, capital expenditures, and operating margins.