KROGER CO quarterly report, Q1 FY2011

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The Kroger Co. Form 10-Q Summary

Reporting period: First quarter ended May 21, 2011, comprising 16 weeks. The request metadata identifies “2010 Q1,” but the filing text clearly reports the first quarter of fiscal 2011 and compares it with the quarter ended May 22, 2010. Financial statements are unaudited and presented in millions, except per-share amounts.

Business Context and Key Financial Metrics

  • Kroger operates supermarkets, fuel centers, convenience stores, jewelry stores, manufacturing facilities, and in-store health clinics in the United States.
  • Sales were $27.461 billion, compared with $24.738 billion in the prior-year quarter.
  • Operating profit was $811 million, representing an operating margin of approximately 2.95%, versus $723 million and approximately 2.92% previously.
  • Net earnings attributable to Kroger were $432 million, or $0.70 diluted earnings per share, versus $374 million and $0.58, respectively.
  • Net margin attributable to Kroger was approximately 1.57%, compared with approximately 1.51% in the prior-year quarter.
  • FIFO gross margin was 21.42%, down from 22.63%. Excluding fuel, the FIFO gross margin rate declined 4 basis points.
  • Operating, general and administrative expense was $4.327 billion, or 15.76% of sales, compared with 16.91% previously.
  • Interest expense was $138 million, compared with $132 million. The effective income tax rate increased to 37.4% from 36.5%.
  • Net cash provided by operating activities was $1.235 billion, compared with $1.553 billion. Capital expenditures were $521 million in cash payments, or $580 million including changes in construction-in-progress payables.
  • Cash used in investing activities was $509 million. Cash used in financing activities was $1.120 billion, including $544 million of treasury stock purchases and $507 million of long-term debt payments.
  • Cash and temporary cash investments were $431 million at May 21, 2011, down from $825 million at January 29, 2011.
  • Total debt, including current and long-term portions of capital leases and financing obligations, was approximately $7.4 billion, down $511 million from year-end 2010 and $145 million from the prior-year quarter-end.
  • The company had no borrowings under its $2 billion revolving credit facility, its $100 million of uncommitted money-market lines, or commercial paper. Letters of credit reducing revolver availability totaled $66 million.
  • Share repurchases totaled 23.2 million shares for $544 million, at an average price of $23.55 per share. The quarterly dividend increased to $0.105 per share from $0.095.

Material Changes Versus the Prior Comparable Period

  • Total sales increased 11.0%, driven by higher identical supermarket sales, higher fuel prices, and increased fuel gallons sold.
  • Identical supermarket sales excluding fuel increased 4.6%; all 18 supermarket divisions reported positive growth. Identical sales including fuel increased 9.8%.
  • Supermarket fuel sales increased 52.0%, reflecting a 30.0% increase in average retail fuel prices and a 16.9% increase in gallons sold.
  • Net earnings increased 15.5%, while diluted earnings per share increased 20.7%, benefiting from higher earnings and share repurchases.
  • Operating profit increased $88 million, primarily from increased supermarket sales, productivity improvements, and cost controls, partially offset by higher LIFO, credit-card, health-care, and pension costs.
  • The LIFO charge increased to $46 million from $15 million, primarily because of higher expected product-cost inflation.
  • Operating cash flow decreased $318 million, primarily because working-capital benefits were lower than in the prior-year quarter.
  • Financing cash usage increased by $289 million, primarily because treasury stock purchases increased from $80 million to $544 million.
  • The company repaid $478 million of senior notes maturing in the quarter. Long-term debt excluding capital leases and financing obligations declined to $6.392 billion from $6.885 billion at year-end.

Guidance, Outlook, Risks, and Unusual Items

  • Fiscal 2011 diluted EPS guidance was increased to $1.85–$1.95, with management expecting results near the top end of the range. The outlook includes an estimated annual LIFO charge of approximately $150 million.
  • Management expects 2011 identical supermarket sales growth excluding fuel of 3.5%–4.5%, fuel margins of approximately $0.115 per gallon, and interest expense of approximately $445 million.
  • Capital investments excluding acquisitions and leased-facility purchases are expected to be $1.7–$1.9 billion, with food-store square footage expected to grow approximately 1.0%–1.5% before acquisitions and operational closings.
  • Management expects a 2011 effective tax rate of approximately 37.0%, no cash contribution to company-sponsored defined-benefit pension plans, and approximately $300 million of contributions to multi-employer pension plans, subject to collective bargaining.
  • Liquidity needs over the next 12 months are estimated at approximately $2.4 billion. Management believes operating cash flow and available borrowing sources will be sufficient to meet anticipated requirements.
  • Key risks include labor negotiations and potential work stoppages, competitive pricing, commodity and fuel-cost inflation, changing consumer spending, product-cost volatility, fuel-margin volatility, interest rates, access to commercial paper and bank facilities, pension underfunding, litigation, goodwill impairment, adverse weather, and regulatory or tax changes.
  • A pending Ralphs tax case had potential adverse cash exposure of up to approximately $527 million, including interest, as of May 21, 2011. The Tax Court had issued an opinion upholding Kroger’s position, but remaining issues and potential appeals were unresolved.
  • Kroger disclosed substantial multi-employer pension-plan underfunding and expects meaningful increases in related expense over the next several years. Withdrawal from certain plans could trigger substantial withdrawal liability.
  • Management did not anticipate additional goodwill impairments in 2011. No material changes in market-risk exposure were reported, and disclosure controls were assessed as effective.

Important Facts for Investors to Verify

  1. Confirm the reporting-period discrepancy: the filing is for the quarter ended May 21, 2011, not 2010 Q1.
  2. Reconcile the strong sales and EPS growth with lower FIFO gross margin and the increasing LIFO charge.
  3. Assess the sustainability of earnings growth excluding fuel-price effects and share repurchases.
  4. Review liquidity after the $544 million share repurchase program, planned capital spending, debt maturities, and the $2.4 billion estimated liquidity requirement.
  5. Monitor fuel margins, product-cost inflation, and the projected $150 million annual LIFO charge.
  6. Evaluate labor negotiations and the potential effect of multi-employer pension underfunding and future contribution increases.
  7. Review the Ralphs tax litigation and other legal contingencies, including the potential $527 million adverse tax-case payment.