KROGER CO. (THE) The following analysis should be read in conjunction with the Consolidated Financial Statements.
USE OF NON-GAAP FINANCIAL MEASURES
The accompanying Consolidated Financial Statements, including the related notes,
are presented in accordance with generally accepted accounting principles
("GAAP"). We provide non-GAAP measures, including First-In, First-Out ("FIFO")
gross margin, FIFO operating profit, adjusted net earnings and adjusted net
earnings per diluted share because management believes these metrics are useful
to investors and analysts. These non-GAAP financial measures should not be
considered as an alternative to gross margin, operating profit, net earnings and
net earnings per diluted share or any other GAAP measure of performance. These
measures should not be reviewed in isolation or considered as a substitute for
our financial results as reported in accordance with GAAP.
We calculate FIFO gross margin as FIFO gross profit divided by sales. FIFO gross
profit is calculated as sales less merchandise costs, including advertising,
warehousing, and transportation expenses, but excluding the Last-In, First-Out
("LIFO") charge. Merchandise costs exclude depreciation and rent expenses. FIFO
gross margin is an important measure used by management as management believes
FIFO gross margin is a useful metric to investors and analysts because it
measures our day-to-day merchandising and operational effectiveness.
We calculate FIFO operating profit as operating profit excluding the LIFO charge. FIFO operating profit is an important measure used by management as management believes FIFO operating profit is a useful metric to investors and analysts because it measures our day-to-day operational effectiveness.
The adjusted net earnings and adjusted net earnings per diluted share metrics are important measures used by management to compare the performance of core operating results between periods. We believe adjusted net earnings and adjusted net earnings per diluted share are useful metrics to investors and analysts because they present more accurate year-over-year comparisons of our net earnings and net earnings per diluted share because adjusted items are not the result of our normal operations. Net earnings for the first two quarters of 2020 include the following, which we define as the "2020 Adjusted Items":
Charges to operating, general and administrative expenses ("OG&A") of
? million,
consideration and
(the "2020 OG&A Adjusted Items").
? Gains in other income (expense) of
the gain on investments (the "2020 Other Income (Expense) Adjusted Item").
Net earnings for the second quarter of 2020 include the following, which we define as the "2020 Second Quarter Adjusted Items":
Charges to OG&A of
? Home Chef contingent consideration and
transformation costs (the "2020 Second Quarter OG&A Adjusted Items").
Gains in other income (expense) of
? the gain on investments (the "2020 Second Quarter Other Income (Expense)
Adjusted Item").
Net earnings for the first two quarters of 2019 include the following, which we define as the "2019 Adjusted Items":
Charges to OG&A of
? to withdrawal liabilities for certain multi-employer pension funds and a
reduction to OG&A of
of Home Chef contingent consideration (the "2019 OG&A Adjusted Items").
Gains in other income (expense) of
? related to the sale of
related to the sale of You Technology; and
for the gain on investments (the "2019 Other Income (Expense) Adjusted Items").
15
Net earnings for the second quarter of 2019 include the following, which we define as the "2019 Second Quarter Adjusted Items":
Charges to OG&A of
? to withdrawal liabilities for a certain multi-employer pension fund and
million,
consideration (the "2019 Second Quarter OG&A Adjusted Items").
A charge in other income (expense) of
? the loss on investments (the "2019 Second Quarter Other Income (Expense)
Adjusted Item").
Please refer to the "Net Earnings per Diluted Share excluding the Adjusted Items" table below for reconciliations of certain non-GAAP financial measures reported in this Quarterly Report on Form 10-Q to the most comparable GAAP financial measure and related disclosure.
CAUTIONARY STATEMENT This discussion and analysis contains certain forward-looking statements about our future performance. These statements are based on management's assumptions and beliefs in light of the information currently available to it. Such statements are indicated by words such as "achieve," "affect," "believe," "committed," "continue," "could," "estimate," "expect," "future," "guidance," "maintain," "may," "positioned," "strategy," "trend," "will," and "would," and similar words or phrases. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially. These include the specific risk factors identified in "Risk Factors" and "Outlook" in our Annual Report on Form 10-K for our last fiscal year and any subsequent filings, as well as those identified in this Form 10-Q.
Various uncertainties and other factors could cause actual results to differ materially from those contained in the forward-looking statements. These include:
The extent to which our sources of liquidity are sufficient to meet our
requirements may be affected by the state of the financial markets and the
effect that such condition has on our ability to issue commercial paper at
acceptable rates. Our ability to borrow under our committed lines of credit,
? including our bank credit facilities, could be impaired if one or more of our
lenders under those lines is unwilling or unable to honor its contractual
obligation to lend to us, or in the event that global pandemics, including the
novel coronavirus, natural disasters or weather conditions interfere with the
ability of our lenders to lend to us. Our ability to refinance maturing debt
may be affected by the state of the financial markets.
16
Our ability to achieve sales, earnings and incremental FIFO operating profit
goals may be affected by: COVID-19 related factors, risks and challenges,
including among others, the length of time that the pandemic continues, the
temporary inability of customers to shop due to illness, quarantine, or other
travel restrictions or financial hardship, shifts in demand away from
discretionary or higher priced products to lower priced products, or
stockpiling or similar pantry-filling activities, product shortages due to
potential constraints in plants and distribution facilities, reduced workforces
which may be caused by, but not limited to, the temporary inability of the
workforce to work due to illness, quarantine, or government mandates, temporary
store closures due to reduced workforces or government mandates, or the
availability and efficacy of a vaccine; labor negotiations or disputes; changes
in the types and numbers of businesses that compete with us; pricing and
promotional activities of existing and new competitors, including
non-traditional competitors, and the aggressiveness of that competition; our
response to these actions; the state of the economy, including interest rates,
? the inflationary and deflationary trends in certain commodities, changes in
tariffs, and the unemployment rate; the effect that fuel costs have on consumer
spending; volatility of fuel margins; changes in government-funded benefit
programs and the extent and effectiveness of any COVID-19 stimulus packages;
manufacturing commodity costs; diesel fuel costs related to our logistics
operations; trends in consumer spending; the extent to which our customers
exercise caution in their purchasing in response to economic conditions; the
uncertainty of economic growth or recession; changes in inflation or deflation
in product and operating costs; stock repurchases; our ability to retain
pharmacy sales from third party payors; consolidation in the healthcare
industry, including pharmacy benefit managers; our ability to negotiate
modifications to multi-employer pension plans; natural disasters or adverse
weather conditions; the effect of public health crises or other significant
catastrophic events, including the coronavirus; the potential costs and risks
associated with potential cyber-attacks or data security breaches; the success
of our future growth plans; the ability to execute on Restock
successful integration of merged companies and new partnerships.
Our ability to achieve these goals may also be affected by our ability to
? manage the factors identified above. Our ability to execute our financial
strategy may be affected by our ability to generate cash flow.
Our effective tax rate may differ from the expected rate due to changes in
? laws, the status of pending items with various taxing authorities, and the
deductibility of certain expenses. Statements elsewhere in this report and below regarding our expectations, projections, beliefs, intentions or strategies are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. While we believe that the statements are accurate, uncertainties about the general economy, our labor relations, our ability to execute our plans on a timely basis and other uncertainties described in this report could cause actual results to differ materially.
EXECUTIVE SUMMARY - OUR PATH TO DELIVERING CONSISTENT AND ATTRACTIVE TOTAL SHAREHOLDER RETURN
We delivered strong results in the second quarter and first two quarters of 2020. The COVID-19 pandemic has changed the landscape for food retail and our top priority is to provide a safe environment for associates and customers, as evidenced by our investment of more than$1 billion during the first two quarters of 2020 to reward associates and safeguard associates, customers and communities. We believe our customers are rewarding us for these priorities and the strategic choices we have made. We are growing market share and expect to deliver consistently attractive total shareholder returns for the long term. Our results continue to show thatKroger is a trusted brand and our customers choose to shop with us because they value the product quality and freshness, convenience, and digital offerings that we provide, even more during these unprecedented times. The strategic choices and investments made through RestockKroger to execute against our competitive moats - Fresh, Our Brands, Personalization and Seamless - have positionedKroger to meet the moment now and beyond 2020. Our data insights show customers are rediscovering their passion for cooking at home and have an aspiration to eat more healthily. We believe some of the changes in food at home consumption triggered by COVID-19 are likely to be structural and lasting. These factors led us to update our guidance for the rest of 2020 and lead us to believe our 2021 business results will be higher than we would have expected prior to the COVID-19 pandemic. 17 Our financial model is driven by our retail supermarket, fuel, and health and wellness businesses, in addition to our growing alternative profit businesses. Our financial strategy is to continue to use the strong free cash flow generated by the business and deploy it in the business in a disciplined way to drive long-term sustainable growth through the identification of high-return projects that support our strategy. We will allocate capital toward driving profitable sales growth in stores and digital, improve productivity, and build a seamless digital ecosystem and supply chain. At the same time, we are committed to maintaining our net debt to adjusted EBITDA range of 2.30 to 2.50 in order to keep our current investment-grade debt rating. We also expect to continue to grow our dividend over time, reflecting the confidence we have in our free cash flow, and expect to continue to return excess cash to investors via share repurchases. Our financial model has proven to be resilient throughout the economic cycle. We expect our model to deliver improved operating results over time and continued strong free cash flow, which will translate into a consistently strong and attractive total shareholder return over the long-term of 8% to 11%.
The following table provides highlights of our financial performance:
Financial Performance Data
($ in millions, except per share amounts)
Second Quarter Ended Two Quarters Ended
August 15, Percentage August 17, August 15, Percentage August 17,
2020 Change 2019 2020 Change 2019
Sales $ 30,489 8.2 % $
28,168
819 175.8 % 297 2,031 90.0 % 1,069
Adjusted net earnings attributable
to The Kroger Co. 581 62.7 % 357 1,553 64.7 % 943
Net earnings attributable to The
Kroger Co. per diluted common share 1.03 178.4 % 0.37 2.55 94.7 % 1.31
Adjusted net earnings attributable
to The Kroger Co. per diluted
common share 0.73 65.9 % 0.44 1.95 68.1 % 1.16
Operating profit 820 46.7 % 559 2,146 47.0 % 1,460
Adjusted FIFO operating profit 894 42.8 % 626 2,347 48.3 % 1,583
Dividends paid 126 11.5 % 113 254 12.4 % 226
Dividends paid per common share 0.160 14.3 % 0.140 0.320 14.3 % 0.280
Identical sales excluding fuel 14.6 % N/A 2.2 % 17.1 % N/A 1.8 %
FIFO gross margin rate, excluding
fuel, bps increase (decrease) 0.05 N/A (0.29) 0.29 N/A (0.36)
OG&A rate, excluding fuel and
Adjusted Items, bps increase
(decrease) (0.61) N/A (0.14) 0.04 N/A (0.13)
Reduction in total debt, including
obligations under finance leases
compared to prior fiscal year end 594 N/A
1,746 594 N/A 1,746
Share repurchases 247 N/A 8 669 N/A 23
18
OVERVIEW
Notable items for the second quarter and first two quarters of 2020 are:
Shareholder Return
? Net earnings attributable to
for the second quarter and
? Adjusted net earnings attributable to
of$0.73 for the second quarter and$1.95 for the first two quarters.
? Achieved operating profit of
billion for the first two quarters.
? Achieved adjusted FIFO operating profit of
and
? During the first two quarters of 2020, we generated cash from operations of
$5.4 billion .
During the first two quarters of 2020, we increased cash and temporary cash
investments by
? significant improvements in working capital and deferred tax payments as a
result of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES
Act") which was enacted in the first quarter of 2020.
? During the first two quarters of 2020, we returned
through share repurchases and dividend payments.
? During the first two quarters of 2020, we decreased total debt, including
obligations under finance leases, by$594 million . Other Financial Results
? Identical sales, excluding fuel, increased 14.6% for the second quarter and
17.1% for the first two quarters of 2020.
Digital revenue grew 127% in the second quarter and 107% in the first two
? quarters of 2020. Digital revenue primarily includes Pickup, Delivery, Ship and
pharmacy e-commerce sales. Significant Events
During the first two quarters of 2020, we invested more than
support and safeguard associates, customers and communities during the COVID-19
pandemic. These investments primarily relate to items within OG&A such as
? associate appreciation awards, expanded sick and emergency leave pay and
investments in associate and customer safety during the pandemic (collectively,
the "COVID-19 Investments"). Of the total, approximately
invested during the second quarter of 2020 (the "Second Quarter COVID-19 Investments").
During the first quarter of 2020, in addition to the recurring multi-employer
pension contributions we make in the normal course of business, we contributed
? an incremental
plans, helping stabilize future associate benefits (the "2020 Multi-Employer
Pension Contribution").
19
The following table provides a reconciliation of net earnings attributable toThe Kroger Co. to adjusted net earnings attributable toThe Kroger Co. and a reconciliation of net earnings attributable toThe Kroger Co. per diluted common share to adjusted net earnings attributable toThe Kroger Co. per diluted common share, excluding the 2020 and 2019 Adjusted Items. Net Earnings per Diluted Share excluding the Adjusted Items ($ in millions, except per share amounts) Second Quarter Ended Two Quarters Ended August 15, August 17, Percentage August 15, August 17, Percentage 2020 2019 Change 2020 2019 Change Net earnings attributable to TheKroger Co. $ 819 $ 297 $ 2,031 $ 1,069 (Income) expense adjustments Adjustment for pension plan withdrawal liabilities(1)(2) - 22 - 66 Adjustment for gain on sale of Turkey Hill Dairy(1)(3) - - - (80) Adjustment for gain on sale of You Technology(1)(4) - - - (52) Adjustment for (gain) loss on investments(1)(5) (278) 36 (590) (44) Adjustment for Home Chef contingent consideration(1)(6) 19 2 63 (16) Adjustment for transformation costs(1)(7) 21 - 49 - 2020 and 2019 Adjusted Items (238) 60 (478) (126) Net earnings attributable to TheKroger Co. excluding the Adjusted Items$ 581 $ 357
62.7 %
Net earnings attributable to TheKroger Co. per diluted common share$ 1.03 $ 0.37 $ 2.55 $ 1.31 (Income) expense adjustments Adjustment for pension plan withdrawal liabilities(8) - 0.03 - 0.08 Adjustment for gain on sale of Turkey Hill Dairy(8) - - - (0.10) Adjustment for gain on sale of You Technology(8) - - - (0.06) Adjustment for (gain) loss on investments(8) (0.35) 0.04 (0.75) (0.05) Adjustment for Home Chef contingent consideration(8) 0.02 - 0.08 (0.02) Adjustment for transformation costs(8) 0.03 - 0.07 - 2020 and 2019 Adjusted Items (0.30) 0.07 (0.60) (0.15) Adjusted net earnings attributable to TheKroger Co. per diluted common share$ 0.73 $ 0.44
65.9 %
Average number of common shares used in diluted calculation 786 805 787 805
(1) The amounts presented represent the after-tax effect of each adjustment,
which was calculated using discrete tax rates.
(2) The pre-tax adjustment for pension plan withdrawal liabilities was
second quarter of 2019 and
(3) The pre-tax adjustment for gain on sale of
(4) The pre-tax adjustment for gain on sale of You Technology was (
The pre-tax adjustment for (gain) loss on investments was (
(
The pre-tax adjustment for Home Chef contingent consideration was
was
The pre-tax adjustment for transformation costs was
of 2020 and
party professional consulting fees associated with business transformation
and cost saving initiatives.
(8) The amount presented represents the net earnings per diluted common share
effect of each adjustment.
20
RESULTS OF OPERATIONS
Sales
Total Sales
($ in millions)
Second Quarter Ended Two Quarters Ended
August 15, Percentage August 17, Percentage August 15, Percentage August 17, Percentage
2020 Change(1) 2019 Change(2) 2020 Change(3) 2019 Change(4)
Total sales to retail
customers without fuel(5) $ 28,034 14.0 % $ 24,598 2.4 %
2,281 (33.0) % 3,405 (9.9) % 4,973 (36.3) % 7,801 (6.5) %
Other sales(6) 174 5.5 % 165 (24.0) % 414 (3.0) % 427 (9.0) %
Total sales $ 30,489 8.2 % $ 28,168 0.5 % $ 72,038 10.1 % $ 65,419 (0.5) %
(1) This column represents the percentage change in the second quarter of 2020,
compared to the second quarter of 2019.
(2) This column represents the percentage change in the second quarter of 2019,
compared to the second quarter of 2018.
(3) This column represents the percentage change in the first two quarters of
2020, compared to the first two quarters of 2019.
(4) This column represents the percentage change in the first two quarters of
2019, compared to the first two quarters of 2018.
Digital sales, primarily including Pickup, Delivery, Ship and pharmacye-commerce sales, grew approximately 127% and 31% in the second quarter of (5) 2020 and 2019, respectively. Digital sales grew approximately 107% and 37% in
the first two quarters of 2020 and 2019, respectively. These sales are
included in the "total sales to retail customers without fuel" line above.
Other sales primarily relate to external sales at food production plants,
data analytic services and third party media revenue. The decrease in other (6) sales in the first two quarters of 2020, compared to the first two quarters
of 2019, is primarily due to the sale of You Technology and
during the first quarter of 2019, partially offset by an increase in data
analytic services and third party media revenue.
Total sales were $30.5 billion in the second quarter of 2020, compared to $28.2
billion in the second quarter of 2019. This increase was due to an increase in
total sales to retail customers without fuel, partially offset by a reduction in
supermarket fuel sales. Total sales to retail customers without fuel increased
14.0% in the second quarter of 2020, compared to the second quarter of 2019.
This increase was primarily due to our identical sales increase, excluding fuel,
of 14.6%, partially offset by decreased sales due to the deconsolidation of
Lucky's Market in the fourth quarter of 2019. The significant increase in
identical sales, excluding fuel, was caused by unprecedented demand for products
across grocery and fresh departments due to the COVID-19 pandemic and growth in
market share. Market share contributed to our identical sales increase,
excluding fuel, as our sales outpaced the general growth in the food retail
industry during the second quarter of 2020. The increase in identical sales,
excluding fuel, was broad based across all retail divisions and all product
categories. During the pandemic, customers reduced trips while significantly
increasing basket value.
Total supermarket fuel sales decreased 33% in the second quarter of 2020,
compared to the second quarter of 2019, primarily due to a decrease in fuel
gallons sold of 15.0% and a decrease in the average retail fuel price of 21.3%.
The decrease in fuel gallons sold was slightly better than the national trend,
which decreased due to the COVID-19 pandemic. The decrease in the average retail
fuel price was caused by a decrease in the product cost of fuel.
21
Total sales were$72.0 billion in the first two quarters of 2020, compared to$65.4 billion in the first two quarters of 2019. This increase was due to an increase in total sales to retail customers without fuel, partially offset by a reduction in supermarket fuel sales and decreased sales due to the disposal ofTurkey Hill Dairy and You Technology in the first quarter of 2019. Total sales to retail customers without fuel increased 16.5% in the first two quarters of 2020, compared to the first two quarters of 2019. This increase was primarily due to our identical sales increase, excluding fuel, of 17.1%, partially offset by decreased sales due to the deconsolidation of Lucky's Market in the fourth quarter of 2019. The significant increase in identical sales, excluding fuel, was caused by unprecedented demand for products across grocery and fresh departments due to the COVID-19 pandemic and growth in market share. Market share contributed to our identical sales increase, excluding fuel, as our sales outpaced the general growth in the food retail industry during the first two quarters of 2020. The increase in identical sales, excluding fuel, was broad based across all retail divisions and remained heightened throughout the first two quarters of 2020. During the pandemic, customers reduced trips while significantly increasing basket value. Total supermarket fuel sales decreased 36.3% in the first two quarters of 2020, compared to the first two quarters of 2019, primarily due to a decrease in fuel gallons sold of 20.5% and a decrease in the average retail fuel price of 19.9%. The decrease in fuel gallons sold was reflective of the national trend, which decreased due to the COVID-19 pandemic. The decrease in the average retail fuel price was caused by a decrease in the product cost of fuel. We calculate identical sales, excluding fuel, as sales to retail customers, including sales from all departments at identical supermarket locations,Kroger Specialty Pharmacy businesses and ship-to-home solutions. We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters. Although identical sales is a relatively standard term, numerous methods exist for calculating identical sales growth. As a result, the method used by our management to calculate identical sales may differ from methods other companies use to calculate identical sales. We urge you to understand the methods used by other companies to calculate identical sales before comparing our identical sales to those of other such companies. Our identical sales, excluding fuel, results are summarized in the following table. We used the identical sales, excluding fuel, dollar figures presented below to calculate percentage changes for the second quarter and first two quarters
of
2020.
Identical Sales
($ in millions)
Second Quarter Ended
August 15, Percentage August 17, Percentage
2020 Change(1) 2019 Change(2)
Excluding fuel centers $ 27,761 14.6 % $ 24,226 2.2 %
(1) This column represents the percentage change in identical sales in the second
quarter of 2020, compared to the second quarter of 2019.
(2) This column represents the percentage change in identical sales in the second
quarter of 2019, compared to the second quarter of 2018.
Two Quarters Ended
August 15, Percentage August 17, Percentage
2020 Change(1) 2019 Change(2)
Excluding fuel centers $ 65,898 17.1 % $ 56,272 1.8 %
(1) This column represents the percentage change in identical sales in the first
two quarters of 2020, compared to the first two quarters of 2019.
(2) This column represents the percentage change in identical sales in the first
two quarters of 2019, compared to the first two quarters of 2018.
22
Gross Margin, LIFO and FIFO Gross Margin
We define gross margin as sales minus merchandise costs, including advertising, warehousing, and transportation. Rent expense, depreciation and amortization expense, and interest expense are not included in gross margin. Our gross margin rate, as a percentage of sales, was 22.76% for the second quarter of 2020, compared to 21.87% for the second quarter of 2019. The increase in rate in the second quarter of 2020, compared to the second quarter of 2019, resulted primarily from decreased fuel sales, which have a lower gross margin rate, an increase in our fuel gross margin, growth in our alternative profit stream portfolio, effective negotiations to achieve savings on the cost of products sold, a lower LIFO charge and decreased shrink, transportation and advertising costs, as a percentage of sales, reflecting the significant increase in sales volumes, partially offset by continued investments in lower prices for our customers and a change in our product sales mix, including lower relative sales in higher gross margin categories such as deli/bakery. Our gross margin rate, as a percentage of sales, was 23.64% for the first two quarters of 2020, compared to 22.06% for the first two quarters of 2019. The increase in rate in the first two quarters of 2020, compared to the first two quarters of 2019, resulted primarily from decreased fuel sales, which have a lower gross margin rate, an increase in our fuel gross margin, growth in our alternative profit stream portfolio, effective negotiations to achieve savings on the cost of products sold and decreased shrink, transportation and advertising costs, as a percentage of sales, reflecting the significant increase in sales volumes, partially offset by continued investments in lower prices for our customers and a change in our product sales mix, including lower relative sales in higher gross margin categories such as deli/bakery. Our LIFO charge was$23 million for the second quarter of 2020 compared to$30 million for the second quarter of 2019. Our LIFO charge was$54 million for the first two quarters of 2020 compared to$46 million for the first two quarters of 2019. Our LIFO charge reflects an increase in our expected annualized product cost inflation for 2020, primarily driven by grocery, meat and pharmacy. Our FIFO gross margin rate, which excludes the second quarter LIFO charge, was 22.83% for the second quarter of 2020, compared to 21.98% for the second quarter of 2019. Our fuel sales lower our FIFO gross margin rate due to the very low FIFO gross margin rate, as a percentage of sales, of fuel sales compared to non-fuel sales. Excluding the effect of fuel, our FIFO gross margin rate increased 5 basis points in the second quarter of 2020, compared to the second quarter of 2019. This increase resulted primarily from growth in our alternative profit stream portfolio, effective negotiations to achieve savings on the cost of products sold and decreased shrink, transportation and advertising costs, as a percentage of sales, reflecting the significant increase in sales volumes, partially offset by continued investments in lower prices for our customers and a change in our product sales mix, including lower relative sales in higher gross margin categories such as deli/bakery. Our FIFO gross margin rate, which excludes the first two quarters LIFO charge, was 23.72% for the first two quarters of 2020, compared to 22.13% for the first two quarters of 2019. Excluding the effect of fuel, our FIFO gross margin rate increased 29 basis points in the first two quarters of 2020, compared to the first two quarters of 2019. This increase resulted primarily from growth in our alternative profit stream portfolio, effective negotiations to achieve savings on the cost of products sold and decreased shrink, transportation and advertising costs, as a percentage of sales, reflecting the significant increase in sales volumes, partially offset by continued investments in lower prices for our customers and a change in our product sales mix, including lower relative sales in higher gross margin categories such as deli/bakery.
Operating, General and Administrative Expenses
OG&A expenses consist primarily of employee-related costs such as wages, healthcare benefit costs, retirement plan costs, utilities, and credit card fees. Rent expense, depreciation and amortization expense, and interest expense are not included in OG&A.
23
OG&A expenses, as a percentage of sales, were 17.37% for the second quarter of 2020, compared to 17.08% for the second quarter of 2019. The increase in the second quarter of 2020, compared to the second quarter of 2019 resulted primarily from the 2020 Second Quarter OG&A Adjusted Items, the Second Quarter COVID-19 Investments, growth in our digital channel as a result of heightened demand during the pandemic and the effect of decreased fuel sales, which increases our OG&A rate, as a percentage of sales, partially offset by the effect of increased sales due to the pandemic which decreases our OG&A rate, as a percentage of sales, the 2019 Second Quarter OG&A Adjusted Items and broad based improvement of RestockKroger cost savings initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions. Our fuel sales lower our OG&A rate, as a percentage of sales, due to the very low OG&A rate, as a percentage of sales, of fuel sales compared to non-fuel sales. Excluding the effect of fuel, the 2020 Second Quarter OG&A Adjusted Items and the 2019 Second Quarter OG&A Adjusted Items, our OG&A rate decreased 61 basis points in the second quarter of 2020, compared to the second quarter of 2019. This decrease resulted primarily from the effect of increased sales due to the pandemic which decreases our OG&A rate, as a percentage of sales, and broad based improvement of RestockKroger cost savings initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions, partially offset by the Second Quarter COVID-19 Investments and growth in our digital channel as a result of heightened demand during the pandemic. OG&A expenses, as a percentage of sales, were 18.00% for the first two quarters of 2020, compared to 17.01% for the first two quarters of 2019. The increase in the first two quarters of 2020, compared to the first two quarters of 2019 resulted primarily from the 2020 Multi-Employer Pension Contribution, the 2020 OG&A Adjusted Items, the COVID-19 Investments, growth in our digital channel as a result of heightened demand during the pandemic and the effect of decreased fuel sales, which increases our OG&A rate, as a percentage of sales, partially offset by the effect of increased sales due to the pandemic which decreases our OG&A rate, as a percentage of sales, the 2019 OG&A Adjusted Items and broad based improvement of RestockKroger cost savings initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions. Excluding the effect of fuel, the 2020 OG&A Adjusted Items and the 2019 OG&A Adjusted Items, our OG&A rate increased 4 basis points in the first two quarters of 2020, compared to the first two quarters of 2019. This increase resulted primarily from the 2020 Multi-Employer Pension Contribution, the COVID-19 Investments and growth in our digital channel as a result of heightened demand during the pandemic, partially offset by the effect of increased sales due to the pandemic which decreases our OG&A rate, as a percentage of sales and broad based improvement of RestockKroger cost savings initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions. Excluding the effect of fuel, the 2020 OG&A Adjusted Items, the 2019 OG&A Adjusted Items and the 2020 Multi-Employer Pension Contribution, our OG&A rate improved 32 basis points. Rent Expense Rent expense decreased, as a percentage of sales, in both the second quarter and first two quarters of 2020, compared to the same periods in 2019. This decrease resulted primarily from the effect of increased sales due to the pandemic which decreases our rent expense, as a percentage of sales.
Depreciation and Amortization Expense
Depreciation and amortization expense decreased, as a percentage of sales, in both the second quarter and first two quarters of 2020, compared to the same periods in 2019. This decrease resulted primarily from the effect of increased sales due to the pandemic which decreases our depreciation expense, as a percentage of sales, partially offset by decreased fuel sales, which increases our depreciation expense, as a percentage of sales, additional depreciation on capital investments, excluding mergers and lease buyouts during the rolling four quarter period ending with the second quarter of 2020 of$2.9 billion and a decrease in the average useful life on these capital investments. Our strategy under RestockKroger includes initiatives to enhance the customer experience in stores, improve our process efficiency and integrate our digital shopping experience through technology developments. As such, the percentage of capital investments related to digital and technology has grown compared to the prior year, which has caused a decrease in the average depreciable life of our capital portfolio. 24
Operating Profit and FIFO Operating Profit
Operating profit was$820 million , or 2.69% of sales, for the second quarter of 2020, compared to$559 million , or 1.98% of sales, for the second quarter of 2019. Operating profit, as a percentage of sales, increased 71 basis points in the second quarter of 2020, compared to the second quarter of 2019, due to improved sales to retail customers without fuel, a higher gross margin rate, decreased rent and depreciation and amortization expenses, as a percentage of sales, partially offset by increased OG&A expense, as a percentage of sales, and decreased fuel earnings. Operating profit was$2.1 billion , or 2.98% of sales, for the first two quarters of 2020, compared to$1.5 billion , or 2.23% of sales, for the first two quarters of 2019. Operating profit, as a percentage of sales, increased 75 basis points in the first two quarters of 2020, compared to the first two quarters of 2019, due to improved sales to retail customers without fuel, a higher gross margin rate, decreased rent and depreciation and amortization expenses, as a percentage of sales, and increased fuel earnings, partially offset by increased OG&A expense, as a percentage of sales. FIFO operating profit was$843 million , or 2.76% of sales, for the second quarter of 2020, compared to$589 million , or 2.09% of sales, for the second quarter of 2019. FIFO operating profit, excluding the 2020 and 2019 Second Quarter Adjusted Items, increased 74 basis points in the second quarter of 2020, compared to the second quarter of 2019, due to improved sales to retail customers without fuel, a higher gross margin rate, decreased rent and depreciation and amortization expenses, as a percentage of sales, partially offset by increased OG&A expense, as a percentage of sales, and decreased fuel earnings. FIFO operating profit was$2.2 billion , or 3.05% of sales, for the first two quarters of 2020, compared to$1.5 billion , or 2.30% of sales, for the first two quarters of 2019. FIFO operating profit, excluding the 2020 and 2019 Adjusted Items, increased 86 basis points in the first two quarters of 2020, compared to the first two quarters of 2019, due to improved sales to retail customers without fuel, a higher gross margin rate, decreased rent and depreciation and amortization expenses, as a percentage of sales, and increased fuel earnings, partially offset by increased OG&A expense, as a percentage of sales.
Specific factors contributing to the operating trends for operating profit and FIFO operating profit above are discussed earlier in this section.
The following table provides a reconciliation of operating profit to FIFO operating profit, and to Adjusted FIFO operating profit, excluding the 2020 and 2019 Adjusted Items.
Operating Profit excluding the Adjusted Items
($ in millions)
Second Quarter Ended Two Quarters Ended
August 15, August 17, August 15, August 17,
2020 2019 2020 2019Operating profit$ 820 $ 559 $ 2,146 $ 1,460 LIFO charge 23 30 54 46 FIFO Operating profit 843 589 2,200 1,506 Adjustment for pension plan withdrawal liabilities - 27 - 86 Adjustment for Home Chef contingent consideration 25 2 85 (21) Adjustment for transformation costs 29 - 67 - Other (3) 8 (5) 12 2020 and 2019 Adjusted items 51 37 147 77 Adjusted FIFO operating profit excluding the adjusted items above$ 894 $ 626 $ 2,347 $ 1,583 25 Income Taxes The effective income tax rate was 22.7% in the second quarter of 2020, compared to 24.5% in the second quarter of 2019. The effective income tax rate was 23.2% for the first two quarters of 2020, compared to 23.3% for the first two quarters of 2019. The effective income tax rate for the second quarter and first two quarters of 2020 differed from the federal statutory rate due to the effect of state income taxes, partially offset by the utilization of tax credits and deductions and the benefit from share-based payments. The effective income tax rate for the second quarter of 2019 and the first two quarters of 2019 differed from the federal statutory rate due to the effect of state income taxes and tax expense related to share-based payments, partially offset by the utilization of tax credits and deductions.
Net Earnings and Net Earnings Per Diluted Share
Our net earnings are based on the factors discussed in the Results of Operations section.
Net earnings were$1.03 per diluted share for the second quarter of 2020 compared to net earnings of$0.37 per diluted share for the second quarter of 2019. Adjusted net earnings of$0.73 per diluted share for the second quarter of 2020 represented an increase of 65.9% compared to adjusted net earnings of$0.44 per diluted share for the second quarter of 2019. The increase in adjusted net earnings per diluted share resulted primarily from increased FIFO operating profit without fuel and lower weighted average common shares outstanding due to common share repurchases, partially offset by decreased fuel earnings and a higher income tax expense. Net earnings were$2.55 per diluted share for the first two quarters of 2020 compared to net earnings of$1.31 per diluted share for the first two quarters of 2019. Adjusted net earnings of$1.95 per diluted share for the first two quarters of 2020 represented an increase of 68.1% compared to adjusted net earnings of$1.16 per diluted share for the first two quarters of 2019. The increase in adjusted net earnings per diluted share resulted primarily from increased FIFO operating profit without fuel, increased fuel earnings and lower weighted average common shares outstanding due to common share repurchases, partially offset by a higher income tax expense.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Information
Net cash provided by operating activities
We generated$5.4 billion of cash from operations in the first two quarters of 2020 compared to$3.3 billion in the first two quarters of 2019. Net earnings including noncontrolling interests, adjusted for non-cash items and other impacts, generated approximately$3.7 billion of operating cash flow in the first two quarters of 2020 compared to$2.4 billion in the first two quarters of 2019. Cash provided by operating activities for changes in working capital was$1.7 billion in the first two quarters of 2020 compared to$845 million in the first two quarters of 2019. The increase in cash provided by operating activities for changes in working capital in the first two quarters of 2020, compared to the first two quarters of 2019, was primarily due to the following:
A decrease in FIFO inventory at the end of the second quarter of 2020 due to
? accelerated timing of inventory sell-through resulting from elevated demand for
our products during the pandemic;
Increased trade accounts payable at the end of the second quarter of 2020,
? primarily related to inventory purchases to meet elevated demand during the
pandemic and improved vendor terms;
An increase in accrued salaries and wages at the end of the second quarter of
? 2020, primarily related to an increase in employee headcount in response to the
pandemic; and
Cash flows from income taxes were favorable in the first two quarters of 2020
? compared to the first two quarters of 2019, primarily due to favorable changes
in the timing of certain deductions including changes enacted under the CARES
Act;
? Partially offset by proceeds from a contract associated with the sale of a
business that benefited the first two quarters of 2019.
26
Cash paid for interest increased in the first two quarters of 2020, compared to the first two quarters of 2019, primarily due to the timing of certain semi-annual senior notes interest payments that were paid during the first quarter of 2020 which were accrued as of the end of fiscal year 2019.
Net cash used by investing activities
Investing activities used cash of$1.3 billion in the first two quarters of 2020 compared to$1.0 billion in the first two quarters of 2019. The amount of cash used by investing activities increased in the first two quarters of 2020 compared to the first two quarters of 2019, primarily due to the following:
? Decreased proceeds from the sale of assets in the first two quarters of 2020
compared to the first two quarters of 2019; and
? Proceeds from the sale of businesses that benefited the first two quarters of
2019, partially offset by
Reduced payments for property and equipment in the first two quarters of 2020
? to ensure the focus of our teams was on addressing our most important
priorities during the pandemic.
Net cash used by financing activities
We used$1.6 billion of cash for financing activities in the first two quarters of 2020 compared to$2.0 billion during the first two quarters of 2019. The amount of cash used for financing activities for the first two quarters of 2020, compared to the first two quarters of 2019, decreased primarily due to increased proceeds from issuance of long-term debt and decreased payments on long-term debt, partially offset by increased payments on commercial paper and share
repurchases. Debt Management As ofAugust 15, 2020 , we maintained a$2.75 billion (with the ability to increase by$1 billion ), unsecured revolving credit facility that, unless extended, terminates onAugust 29, 2022 . Outstanding borrowings under the credit facility, commercial paper borrowings, and some outstanding letters of credit reduce funds available under the credit facility. As ofAugust 15, 2020 , we had no outstanding commercial paper and no borrowings under our revolving credit facility. The outstanding letters of credit that reduce funds available under our credit facility totaled$2 million as ofAugust 15, 2020 . Our bank credit facility and the indentures underlying our publicly issued debt contain various financial covenants. As ofAugust 15, 2020 , we were in compliance with the financial covenants. Furthermore, management believes it is not reasonably likely that we will fail to comply with these financial covenants in the foreseeable future. Total debt, including both the current and long-term portions of obligations under finance leases, decreased$594 million as ofAugust 15, 2020 compared to our fiscal year end 2019 debt of$14.1 billion . This decrease resulted primarily from net payments on commercial paper borrowings of$1.2 billion partially offset by the issuance of$500 million of senior notes bearing an interest
rate of 2.20%.
Common Share Repurchase Program
During the second quarter of 2020, we invested$247 million to repurchase 7.3 millionKroger common shares at an average price of$33.89 per share. For the first two quarters of 2020, we invested$669 million to repurchase 21.6 millionKroger common shares at an average price of$30.99 per share. The shares repurchased in the first two quarters of 2020 were reacquired under the following share repurchase programs:
On
repurchase program to reacquire shares via open market purchase or privately
? negotiated transactions, block trades, or pursuant to trades intending to
comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended
(the "November 2019 Repurchase Program"), and
A program that uses the cash proceeds from the exercises of stock options by
? participants in
associated tax benefits.
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As of August 15, 2020 , there was $33 million remaining under the November 2019
Repurchase Program. On September 11, 2020 , our Board of Directors approved a
$1.0 billion share repurchase program to reacquire shares via open market
purchase or privately negotiated transactions, block trades, or pursuant to
trades intending to comply with Rule 10b5-1 under the Securities Exchange Act of
1934, as amended (the "September 2020 Repurchase Program"). The September 2020
Repurchase Program authorization replaced the existing November 2019 Repurchase
Program.
Dividends
The following table provides dividend information ($ in millions, except per
share amounts):
Second Quarter Ended Two Quarters Ended
August 15, August 17, August 15, August 17,
2020 2019 2020 2019
Cash dividends paid $ 126 $ 113 $ 254 $ 226 Cash dividends paid per common share$ 0.16 $ 0.14 $
0.32 $ 0.28
Liquidity Needs
Based on current operating trends, we believe that cash flows from operating
activities and other sources of liquidity, including borrowings under our
commercial paper program and bank credit facility, will be adequate to meet our
liquidity needs for the next twelve months and for the foreseeable future beyond
the next twelve months. Our liquidity needs include anticipated requirements for
working capital, capital investments, interest payments and scheduled principal
payments of debt and commercial paper, offset by cash and temporary cash
investments on hand at the end of the second quarter of 2020. We generally
operate with a working capital deficit due to our efficient use of cash in
funding operations and because we have consistent access to the capital markets.
We have approximately $1.0 billion of senior notes maturing in the next twelve
months, which are included in our estimated liquidity needs. We expect to
satisfy these obligations using cash generated from operations, temporary cash
investments on hand, or through the issuance of additional senior notes or
commercial paper. We believe we have adequate coverage of our debt covenants to
continue to maintain our current investment grade debt ratings and to respond
effectively to competitive conditions.
We held cash and temporary cash investments of $2.8 billion as of the end of the
second quarter of 2020, reflecting improved operating performance, significant
improvements in working capital and deferred tax payments as a result of the
CARES Act. We expect working capital to improve for the year, although not to
the level experienced in the first two quarters of 2020, which was inflated by
significant sales growth due to COVID-19. We remain committed to our dividend
and share repurchase program and we will be evaluating the optimal use of any
excess free cash flow, consistent with our previously stated capital allocation
strategy.
The CARES Act, which was enacted on March 27, 2020 , includes measures to assist
companies in response to the COVID-19 pandemic. These measures include deferring
the due dates of tax payments and other changes to income and non-income-based
tax laws. As permitted under the CARES Act, we will defer the remittance of the
employer portion of the social security tax. The social security tax provision
requires that the deferred employment tax be paid over two years, with half of
the amount required to be paid by December 31, 2021 and the other half by
December 31, 2022 . During the first two quarters of 2020, we deferred the
employer portion of social security tax of $329 million which is included in
"Other long-term liabilities" in our Consolidated Balance Sheets. We expect to
defer a total of approximately $600 to $650 million of payments related to the
employer's portion of social security tax in 2020.
For additional information about our debt activity in the first two quarters of
2020, including the drawdown and repayments under our revolving credit facility,
forward-starting interest rate swap agreements and our senior notes issuance,
see Note 2 to the Consolidated Financial Statements.
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CAPITAL INVESTMENTS
Capital investments, excluding mergers, acquisitions and the purchase of leased
facilities, totaled $683 million for the second quarter of 2020 compared to $676
million for the second quarter of 2019. Capital investments, excluding mergers,
acquisitions and the purchase of leased facilities, totaled $1.4 billion in the
first two quarters of 2020 and $1.6 billion in the first two quarters of 2019.
During the rolling four quarter period ended with the second quarter of 2020, we
opened, expanded, relocated or acquired 21 supermarkets and also completed 98
major within-the-wall remodels. Total supermarket square footage at the end of
the second quarter of 2020 remained relatively consistent with the end of the
second quarter of 2019. Excluding mergers, acquisitions and operational
closings, total supermarket square footage at the end of the second quarter of
2020 increased 0.5% over the end of the second quarter of 2019.
CRITICAL ACCOUNTING POLICIES
We have chosen accounting policies that we believe are appropriate to report
accurately and fairly our operating results and financial position, and we apply
those accounting policies in a consistent manner. Our critical accounting
policies are summarized in our Annual Report on Form 10-K for the fiscal year
ended February 1, 2020 .
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and other factors we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could vary from those estimates. NEW ACCOUNTING STANDARDS Refer to Note 5 and Note 6 to the Consolidated Financial Statements for recently adopted accounting standards and recently issued accounting standards not yet adopted as ofAugust 15, 2020 . 29
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