KR

Business Context and Reporting Period

Company: The Kroger Co.
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended February 2, 2002 (52 weeks).
Business Overview: One of the largest grocery retailers in the United States, operating 2,418 supermarkets, 789 convenience stores, 227 fuel centers, and 427 fine jewelry stores. The company also manufactures and processes food products. Operations are consolidated into a single reportable segment representing approximately 99% of sales.

Key Financial Metrics

Note: Fiscal 2001 included 53 weeks; comparisons are adjusted in management commentary where applicable.

Material Changes vs. Prior Period

• Sales Growth: Total sales increased 2.2% to $50.1 billion. Adjusted for the 53rd week in the prior year and divestitures, sales increased 4.2%. Identical food store sales rose 0.9%.
• Profitability: Net earnings increased 18.9% to $1.043 billion. Gross profit margin improved to 27.35% due to coordinated purchasing and increased corporate brand sales.
• One-Time Charges: The company recorded $284 million in total merger-related costs, one-time items, restructuring charges, and impairment charges in 2002, compared to $351 million in 2001.
  • Impairment Charges: $91 million in 2002 (vs. $191 million in 2001) related to underperforming store locations.
  • Energy Contracts: An $81 million pre-tax loss was recorded in Q3 2001 due to energy purchase contracts no longer qualifying for the "normal purchases and normal sales" exception under SFAS No. 133.
  • Restructuring: A $37 million charge was recorded for the "Strategic Growth Plan" announced in December 2001.
• Capital Expenditures: Increased to $2.1 billion in 2002 (excluding acquisitions) from $1.6 billion in 2001, primarily for new store construction.

Guidance, Outlook, and Risks

• Strategic Growth Plan: Management aims to achieve identical supermarket store sales growth of 2% to 3% above product cost inflation. The plan targets a reduction of merchandising and operating costs by over $500 million over two years.
• Earnings Guidance:
  • Fiscal 2002 & 2003: Expected annual EPS growth of 10%-12% (before one-time items).
  • Long-term: Target of 13%-15% annual EPS growth beginning in fiscal 2004.
• Free Cash Flow: Estimated at $550-$650 million for fiscal 2002.
• Accounting Changes: Adoption of SFAS No. 142 (Goodwill) effective February 3, 2002, will eliminate goodwill amortization, expected to improve fiscal 2002 net earnings by approximately $96 million.
• Risks and Contingencies:
  • Labor Relations: 83 collective bargaining agreements expire in 2002; prolonged work stoppages could materially affect operations.
  • Competition: Intense competition from supercenters and mass merchandisers may pressure prices and margins.
  • Debt Covenants: The company is subject to restrictive covenants based on EBITDA and fixed charge coverage ratios. A downgrade in credit rating could increase borrowing costs.
  • Legal: Various pending claims, including antitrust and civil rights suits, though management believes liabilities will not be material.

Investor Verification Checklist

• Energy Contract Liability: Verify the remaining liability of $78 million related to electricity purchase contracts and the impact of future mark-to-market adjustments.
• Goodwill Impairment Review: Monitor the initial goodwill impairment review required by SFAS No. 142, as the outcome could significantly impact future earnings.
• Labor Contract Expirations: Track the status of the 83 collective bargaining agreements expiring in 2002, particularly those in Southern California and Dallas.
• Debt Refinancing: Confirm the successful refinancing of the $1.875 billion Senior Credit Facility and the 364-day facility scheduled for May 2002.
• Working Capital: Assess progress on the goal to reduce net operating working capital by $500 million by the end of Q3 2004.