The Kroger Co. 2012 Form 10-K Summary
Business context and reporting period
The filing is an annual report for the 53-week fiscal year ended February 2, 2013, referred to as fiscal 2012. The supplied request metadata identifies “2011 Q4,” which does not match the filing period. Kroger operates U.S. supermarkets, fuel centers, convenience stores, fine jewelry stores and manufacturing facilities. At year-end, it operated 2,424 supermarkets and multi-department stores, 786 convenience stores, 328 fine jewelry stores and 37 manufacturing plants, with approximately 343,000 employees. Retail operations represented more than 99% of consolidated sales and EBITDA.
Key financial metrics
| Metric | Fiscal 2012 | Fiscal 2011 |
|---|---|---|
| Sales | $96.751 billion | $90.374 billion |
| Net earnings attributable to Kroger | $1.497 billion | $602 million |
| Diluted EPS | $2.77 | $1.01 |
| Operating profit | $2.764 billion | $1.278 billion |
| Operating margin | 2.86% | 1.41% |
| Net cash from operating activities | $2.833 billion | $2.658 billion |
| Capital investments | $2.063 billion | $1.958 billion |
| Cash and temporary cash investments | $238 million | $188 million |
| Total debt, including lease and financing obligations | Approximately $8.9 billion | Approximately $8.2 billion |
| Total assets | $24.652 billion | $23.476 billion |
| Kroger shareowners’ equity | $4.207 billion | $3.981 billion |
Gross margin was 20.56%, compared with 20.89% in 2011. FIFO gross margin was 20.62%, compared with 21.13%. The LIFO charge declined to $55 million from $216 million. Net interest expense increased to $462 million from $435 million, while the effective tax rate increased to 34.5% from 29.3%. Return on invested capital was 13.4% in both years.
Identical supermarket sales increased 3.5% excluding fuel. Adjusted for the extra week, total sales increased 4.9% to $94.793 billion. Fuel sales increased 8.9% on a comparable basis, driven by a 7.8% increase in gallons sold and a 1.7% increase in average retail fuel prices.
Material changes versus the prior comparable period
- Reported net earnings increased substantially because fiscal 2011 included a $953 million pre-tax charge related to the consolidation of four multi-employer pension plans, while fiscal 2012 included a $115 million pre-tax benefit from the Visa/MasterCard settlement and a reduction in the UFCW consolidated pension obligation.
- Excluding disclosed adjustments and the extra week, adjusted diluted EPS increased 26% to $2.52 from $2.00.
- Operating profit improved primarily through higher FIFO non-fuel operating profit, lower LIFO expense, productivity gains and cost controls. Adjusted non-fuel FIFO operating margin increased to 3.19% from 3.07%.
- Gross margin declined because of the mix effect of low-margin fuel sales, investments in lower prices, increased shrink and higher warehousing costs.
- Debt increased by approximately $714 million, primarily because of higher commercial paper borrowings, pension funding, employee-benefit prefunding, share repurchases and the specialty-pharmacy purchase.
- Kroger repurchased approximately $1.3 billion of common shares and paid $267 million of dividends during the year. The October 2012 $500 million repurchase authorization had $466 million remaining at year-end.
- The company opened 18 stores and seven relocation stores, while closing 29 stores operationally and seven through relocations; year-end supermarket count declined to 2,424 from 2,435.
Liquidity, debt and commitments
Kroger generated $2.833 billion of operating cash flow, used $2.183 billion in investing activities and used $600 million in financing activities, resulting in a $50 million increase in cash. The company estimated approximately $5 billion of liquidity needs over the following twelve months, including working capital, capital expenditures, interest and scheduled debt payments.
At year-end, commercial paper borrowings were approximately $1.645 billion. Kroger maintained a $2 billion unsecured revolving credit facility, expandable by up to $500 million, maturing January 25, 2017, with no borrowings under the facility. The company reported a leverage ratio of 1.81 to 1 against a 3.50 to 1 covenant limit and a fixed-charge coverage ratio of 4.67 to 1 against a 1.70 to 1 minimum. Management expected liquidity and operating cash flow to be adequate, but planned to refinance approximately $1.5 billion of debt in 2013.
Total contractual obligations were $19.572 billion, including $8.476 billion of long-term debt, $5.003 billion of operating leases, $3.938 billion of long-term debt interest and $751 million of purchase obligations. The table excludes multi-employer pension contributions and certain benefit obligations.
Guidance, outlook and management commentary
- Fiscal 2013 diluted EPS guidance was $2.71 to $2.79, representing 8% to 11% growth from adjusted fiscal 2012 EPS of $2.52.
- Identical supermarket sales growth excluding fuel was expected at 2.5% to 3.5%.
- Capital investments were expected to be $2.1 billion to $2.4 billion, excluding acquisitions and purchases of leased facilities, with food-store square footage expected to grow approximately 1.5% before acquisitions and operational closings.
- The company expected a 2013 LIFO charge of approximately $55 million, interest expense of approximately $440 million and an effective tax rate of approximately 35.5%, excluding tax issue resolutions.
- Kroger expected FIFO non-fuel operating margins to expand slightly, supported by productivity and cost reductions that would be reinvested in pricing and customer experience.
- Management expected approximately $225 million of 2013 multi-employer pension contributions and no additional contributions to company-sponsored defined benefit plans after a $100 million contribution made in February 2013.
Risks, contingencies and unusual items
- Management estimated Kroger’s share of multi-employer pension-plan underfunding at $1.8 billion pre-tax, or $1.1 billion after-tax, as of December 31, 2012. Future contributions could rise because of weak investment returns, employer withdrawals, collective bargaining outcomes or adverse legislation.
- Major labor agreements were scheduled for negotiation in markets including Indianapolis, Houston, Dallas, Cincinnati and Seattle. Work stoppages or higher wage, health-care and pension costs could materially affect results.
- The company faces intense competition, cautious consumer spending, fuel-price volatility, inflation or deflation in product costs, product-safety exposure, technology and cybersecurity risks, adverse weather and regulatory changes.
- Various antitrust, wage-and-hour, civil-rights and product-liability claims were pending. Management considered the aggregate estimated loss range not material, but acknowledged that outcomes could differ materially from current estimates. The Ralphs tax litigation was dismissed with prejudice on November 14, 2012.
- Kroger was primarily self-insured for workers’ compensation and general liability claims, with a self-insurance liability of $537 million at year-end.
- The company recorded $18 million of long-lived-asset impairments but no goodwill impairment in fiscal 2012. Goodwill totaled $1.234 billion.
- Fiscal 2012 results benefited from the extra week, estimated at $58 million after tax, and from the Visa/MasterCard settlement and UFCW pension adjustment, totaling $74 million after tax.
Important facts for investors to verify
- Confirm the applicable period: this filing covers fiscal 2012, ended February 2, 2013, rather than 2011 Q4.
- Reconcile reported EPS of $2.77 to adjusted EPS of $2.52, including the extra-week benefit and other unusual items.
- Assess debt-refinancing execution, commercial paper reliance and covenant headroom, particularly against the $1.5 billion of planned 2013 refinancing.
- Monitor multi-employer pension underfunding, expected contributions and potential withdrawal liabilities.
- Evaluate whether projected identical-sales growth, margin expansion and cost savings offset investments in lower prices and rising employee and operating costs.
- Review the sensitivity of pension obligations, self-insurance reserves, litigation accruals, LIFO expense and impairment testing to changes in assumptions.