The Kroger Co. Form 10-Q Summary
Reporting period: Quarter and six months ended August 16, 2014, covering 12 and 28 weeks, respectively. The request metadata identifies “2013 Q2,” but the filing is for fiscal 2014 second quarter and compares against August 17, 2013. Amounts are in millions except per-share data.
Business Context and Financial Performance
- Kroger operates supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities, and in-store health clinics. Results include Harris Teeter, acquired January 28, 2014.
- Identical supermarket sales excluding fuel increased 4.8% in the quarter and 4.7% for the first two quarters. This represented the company’s 43rd consecutive quarter of positive identical supermarket sales growth.
- Management attributed sales growth to Harris Teeter, increased customer households and transactions, product cost inflation, higher fuel gallons sold, and fuel pricing effects.
Key Financial Metrics
| Metric | Second quarter 2014 | Second quarter 2013 | First two quarters 2014 | First two quarters 2013 |
|---|---|---|---|---|
| Sales | $25,310 | $22,686 | $58,271 | $52,683 |
| Operating profit | $644 | $595 | $1,574 | $1,474 |
| Operating margin | 2.54% | 2.62% | 2.70% | 2.80% |
| Net earnings attributable to Kroger | $347 | $317 | $848 | $798 |
| Diluted earnings per share | $0.70 | $0.60 | $1.68 | $1.52 |
| Net cash from operating activities | Not separately provided | Not separately provided | $2,750 | $2,613 |
- Sales increased 11.6% in the quarter and 10.6% year to date, primarily because of Harris Teeter and positive identical sales.
- Net earnings increased 9.5% in the quarter and 6.3% year to date. Diluted EPS increased 16.7% and 10.5%, respectively, helped by earnings growth and share repurchases.
- Gross margin was 20.44% in the quarter and 20.71% year to date, compared with 20.40% and 20.51% in the prior-year periods.
- FIFO gross margin was 20.54% in the quarter and 20.81% year to date. Excluding fuel, FIFO gross margin rates declined 12 basis points in the quarter and 5 basis points year to date, reflecting investments in lower prices, partly offset by Harris Teeter.
- The LIFO charge increased to $26 for the quarter and $54 year to date, versus $13 and $30 in the comparable periods.
- Interest expense increased to $112 for the quarter and $259 year to date, primarily because of higher debt used to finance Harris Teeter and share repurchases.
- The effective tax rate declined to 34.2% from 35.5% in the quarter and to 34.7% from 35.5% year to date.
- Return on invested capital was 13.6% for the rolling four quarters, compared with 13.5% in the prior-year period.
Cash Flow, Debt, and Liquidity
- Operating cash flow increased to $2,750 from $2,613. Investing cash outflows increased to $1,313 from $1,137, primarily because of higher capital investments.
- Financing cash outflows increased to $1,590 from $1,274, driven primarily by increased share repurchases.
- Cash and temporary cash investments were $248 at August 16, 2014, compared with $401 at February 1, 2014.
- Total debt, including capital leases and financing obligations, was approximately $11.2 billion at quarter-end, compared with $11.3 billion at fiscal year-end and $7.9 billion at the end of the prior-year second quarter. The filing reports a carrying value of total debt of $10,661 and an estimated fair value of $11,667.
- Commercial paper outstanding was $1.1 billion. Kroger had no borrowings under its $2,750 unsecured revolving credit facility or $75 million of uncommitted money-market lines. The revolving facility can be increased by up to $750, subject to conditions, and terminates June 30, 2019 unless extended.
- Kroger was in compliance with its debt covenants, including a maximum leverage ratio of 3.50:1.00 and minimum fixed-charge coverage ratio of 1.70:1.00.
- Management estimated next-twelve-month liquidity needs of approximately $4.6 billion and believes operating cash flow and available borrowing capacity will be adequate. Approximately $1.1 billion of commercial paper and $300 million of senior notes mature during the next twelve months.
- Capital investments, excluding acquisitions and purchases of leased facilities, were $1.4 billion year to date versus $1.1 billion in the prior-year period. Share repurchases totaled $1.2 billion for 27.4 million shares.
Material Changes and Unusual Items
- Harris Teeter materially increased sales, assets, store square footage, and certain expense rates. Total food-store square footage increased 8.2% year over year, primarily because of the merger.
- Kroger recorded an $87 pre-tax charge, or $56 after tax and $0.11 per diluted share, related to commitments and withdrawal liabilities arising from restructuring certain multi-employer pension obligations. Excluding this item, year-to-date adjusted net earnings were $904, or $1.79 per diluted share.
- Long-lived assets with a $27 carrying value were written down to $10, producing a $17 impairment charge year to date, compared with a $25 charge in the prior-year period.
- On August 18, 2014, after quarter-end, Kroger acquired Vitacost.com for approximately $280 in cash. Vitacost.com reported 2013 revenue of approximately $383 and a net loss of approximately $14. The transaction was financed with commercial paper.
- Kroger amended and expanded its revolving credit facility on June 30, 2014, from $2.0 billion to $2.75 billion.
Guidance, Outlook, and Risks
- Fiscal 2014 adjusted diluted EPS guidance was $3.22–$3.28, excluding the pension-plan agreements. Identical supermarket sales excluding fuel were expected to grow 3.5%–4.25%.
- Management expected slightly higher full-year FIFO non-fuel operating margin excluding the pension charge, approximately $100 of annual LIFO expense, approximately $485 of interest expense, and capital investments of approximately $2.8–$3.0 billion excluding mergers, acquisitions, and leased-facility purchases.
- Management expected a 34%–35% effective tax rate in the third and fourth quarters, no goodwill impairment in 2014, and $225–$250 of contributions to multi-employer pension funds, excluding obligations restructured in the first quarter.
- Key risks include labor negotiations, underfunded multi-employer pension plans, competition and pricing pressure, fuel-margin volatility, inflation or deflation, consumer spending trends, cyber and data-security incidents, pharmacy reimbursement changes, execution of Harris Teeter and Vitacost.com integration, refinancing conditions, capital-project costs, LIFO estimates, taxes, litigation, and potential goodwill impairment.
- Pending litigation includes antitrust, wage-and-hour, civil-rights, and product-liability claims, including potential class actions. Management believes aggregate exposure is not material, but acknowledges that outcomes could differ materially from estimates.
Investor Verification Items
- Verify the applicable period: the supplied filing is for August 16, 2014, despite request metadata referring to 2013 Q2.
- Reconcile reported GAAP earnings and EPS with adjusted results excluding the $56 after-tax pension-plan charge.
- Assess Harris Teeter and Vitacost.com integration, including resulting leverage, synergies, margins, and capital requirements.
- Monitor refinancing of $1.1 billion of commercial paper and $300 million of senior notes due within twelve months.
- Evaluate the sustainability of identical-sales growth against lower-price investments, fuel-margin volatility, labor costs, and competitive pressure.
- Review multi-employer pension exposure, future contributions, labor negotiations, and related withdrawal liabilities.
- Confirm subsequent-period accounting for the Vitacost.com acquisition and the effect of newly issued revenue-recognition guidance.