Kroger Co. Form 10-Q Summary
Business context and reporting period
The filing covers Kroger’s second quarter and first two quarters of fiscal 2011, ended August 13, 2011, compared with August 14, 2010. The filing contains 12-week and 28-week results, respectively. Although the request metadata identifies “2010 Q2,” the filing itself is for 2011 Q2.
Kroger operates supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities and related businesses in the United States. Management attributed sales growth primarily to higher identical supermarket sales, product-cost inflation, higher fuel prices and increased fuel gallons sold.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | YTD 2011 | YTD 2010 |
|---|---|---|---|---|
| Sales | $20.913 billion | $18.760 billion | $48.374 billion | $43.498 billion |
| Operating profit | $488 million | $494 million | $1.299 billion | $1.217 billion |
| Net earnings attributable to Kroger | $281 million | $262 million | $713 million | $636 million |
| Diluted EPS | $0.46 | $0.41 | $1.17 | $0.98 |
| Operating margin | 2.33% | 2.63% | 2.68% | 2.80% |
| FIFO gross margin | 21.00% | 22.49% | 21.24% | 22.57% |
| Net cash from operating activities | Not separately provided | Not separately provided | $2.193 billion | $2.319 billion |
- Q2 sales increased 11.5%; year-to-date sales increased 11.2%.
- Identical supermarket sales excluding fuel increased 5.3% in Q2 and 4.9% year to date. Including fuel centers, Q2 identical sales increased 10.4%.
- Q2 net earnings increased 7.3%, while year-to-date net earnings increased 12.1%. Diluted EPS rose 12.2% in Q2 and 19.4% year to date, aided by share repurchases.
- Q2 FIFO gross margin declined 149 basis points, primarily because of fuel mix, investments in lower prices and product-cost inflation. Excluding fuel, the decline was 53 basis points.
- The LIFO charge increased to $35 million in Q2 from $12 million and to $81 million year to date from $27 million.
- Cash and temporary cash investments were $643 million at August 13, 2011, compared with $825 million at January 29, 2011.
- Total debt, including current and long-term portions of capital leases and financing obligations, was approximately $7.3 billion at quarter-end. Debt declined primarily because of repayment of $478 million of senior notes at maturity.
- Kroger had no borrowings under its $2 billion revolving credit facility, money-market lines or commercial paper program; $29 million of letters of credit reduced revolver availability.
- Year-to-date investing cash use was $926 million, including $924 million of capital-expenditure payments. Financing cash use was $1.449 billion, including $803 million of treasury-stock purchases and $533 million of debt repayments.
Material changes versus the prior comparable period
- Sales growth accelerated, supported by higher fuel prices, increased fuel volume and stronger identical supermarket sales.
- Operating profit declined slightly in Q2 despite higher sales, reflecting lower non-fuel operating profit and margin pressure; year-to-date operating profit increased.
- Fuel sales increased 50.8% in Q2 and 51.4% year to date, while the average retail fuel price increased 34.9% and 32.1%, respectively.
- OG&A expense as a percentage of sales improved to 16.01% in Q2 from 17.05%, and to 15.87% year to date from 16.97%, partly because fuel sales dilute the ratio.
- Share repurchases increased materially: $803 million and 33.8 million shares were repurchased year to date, compared with $228 million in the prior-year period.
- Debt declined, but cash also declined because of debt repayment and increased share repurchases.
- Effective tax rates decreased to 27.6% from 31.6% in Q2 and to 33.8% from 34.6% year to date, including benefits from favorable resolution of tax matters.
Guidance, outlook, risks and unusual items
- Fiscal 2011 diluted EPS guidance remained $1.85 to $1.95; management expected results near the top of the range.
- Fiscal 2011 identical supermarket sales excluding fuel guidance was increased to 4.0%–5.0%.
- Management expected a 2011 LIFO charge of approximately $150 million, product-cost inflation of 3.0%–4.0%, interest expense of approximately $435 million and capital investments above $1.9 billion, excluding acquisitions and purchases of leased facilities.
- Management expected fuel margins of approximately $0.115 per gallon in the second half of 2011 and continued growth in fuel gallons sold.
- Kroger estimated next-twelve-month liquidity needs of approximately $2.5 billion and stated that operating cash flow and available borrowing capacity should be adequate. The company anticipated refinancing $888 million of debt maturing within one year.
- After quarter-end, Kroger entered into $450 million of forward-starting interest-rate swaps to hedge a portion of anticipated fixed-rate debt refinancing.
- Kroger expected approximately $52 million of sponsored pension-plan contributions in Q3 2011 and approximately $300 million of contributions to multi-employer pension plans during 2011. Multi-employer plan underfunding could result in meaningful expense increases and potential withdrawal liabilities.
- Material uncertainties include labor negotiations and possible work stoppages, competitive pricing, product and diesel-cost inflation, fuel-margin volatility, consumer spending, pension obligations, litigation, tax matters, liquidity-market conditions and potential impairment charges.
- An adverse outcome in the Ralphs tax litigation could require a cash payment of up to approximately $536 million, including interest. Management reported that the Tax Court had upheld Kroger’s position on the principal issue.
- Management stated that it did not anticipate goodwill impairments in 2011. The filing also states that disclosure controls were effective and that no material change occurred in internal control over financial reporting.
Investor verification checklist
- Verify the actual filing period and fiscal-calendar convention because the filing is for 2011 Q2, not 2010 Q2.
- Assess how much earnings growth was attributable to fuel operations, tax benefits and share repurchases versus underlying non-fuel performance.
- Track FIFO gross-margin pressure, LIFO charges and the ability to pass product-cost inflation through to customers.
- Reconcile planned debt refinancing, interest-rate swaps, maturities and available revolver capacity with projected liquidity needs.
- Monitor pension and multi-employer plan funding requirements, labor negotiations and potential withdrawal liabilities.
- Review the Ralphs tax litigation, other class-action or antitrust matters and the adequacy of recorded loss provisions.
- Compare subsequent results with the company’s EPS, identical-sales, fuel-margin, capital-spending and pension-contribution guidance.