UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended November 6, 2004May 21, 2005
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-303
THE KROGER CO.
(Exact name of registrant as specified in its charter)
Ohio | 31-0345740 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1014 Vine Street, Cincinnati, OH 45202 (Address of principal executive offices) (Zip Code) |
(513) 762-4000
(Registrant’s telephone number, including area code)
Unchanged
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨.
There were 732,174,961723,983,634 shares of Common Stock ($1 par value) outstanding as of December 10, 2004.June 24, 2005.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
THE KROGER CO.
CONSOLIDATED STATEMENTS OF EARNINGSOPERATIONS
(in millions, except per share amounts)
(unaudited)
Third Quarter Ended | Three Quarters Ended | First Quarter Ended | ||||||||||||||||
November 6, 2004 | November 8, 2003 | November 6, 2004 | November 8, 2003 | May 21, 2005 | May 22, 2004 | |||||||||||||
Sales | $ | 12,854 | $ | 12,141 | $ | 42,739 | $ | 40,757 | $ | 17,948 | $ | 16,905 | ||||||
Merchandise costs, including advertising, warehousing, and transportation, excluding items shown separately below | 9,632 | 9,016 | 31,866 | 30,048 | 13,437 | 12,518 | ||||||||||||
Operating, general and administrative | 2,440 | 2,368 | 8,092 | 7,787 | 3,301 | 3,214 | ||||||||||||
Rent | 158 | 153 | 525 | 499 | 203 | 212 | ||||||||||||
Depreciation and amortization | 287 | 280 | 949 | 904 | 389 | 372 | ||||||||||||
Earnings from operations | 337 | 324 | 1,307 | 1,519 | ||||||||||||||
Operating Profit | 618 | 589 | ||||||||||||||||
Interest expense | 117 | 148 | 442 | 476 | 159 | 172 | ||||||||||||
Earnings before income tax expense | 220 | 176 | 865 | 1,043 | 459 | 417 | ||||||||||||
Income tax expense | 77 | 66 | 317 | 391 | 165 | 154 | ||||||||||||
Net earnings | $ | 143 | $ | 110 | $ | 548 | $ | 652 | $ | 294 | $ | 263 | ||||||
Net earnings per basic common share | $ | 0.19 | $ | 0.15 | $ | 0.74 | $ | 0.87 | $ | 0.40 | $ | 0.35 | ||||||
Weighted average number of common shares used in basic calculation | 736 | 743 | 738 | 748 | ||||||||||||||
Average number of common shares used in basic calculation | 727 | 741 | ||||||||||||||||
Net earnings per diluted common share | $ | 0.19 | $ | 0.15 | $ | 0.73 | $ | 0.86 | $ | 0.40 | $ | 0.35 | ||||||
Weighted average number of common shares used in diluted calculation | 742 | 754 | 746 | 757 | ||||||||||||||
Average number of common shares used in diluted calculation | 732 | 749 |
The accompanying notes are an integral part of the Consolidated Financial Statements.
THE KROGER CO.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share amounts)
(unaudited)
November 6, 2004 | January 31, 2004 | May 21, 2005 | January 29, 2005 | |||||||||||||
ASSETS | ||||||||||||||||
Current assets | ||||||||||||||||
Cash, including temporary cash investments of $15 at January 31, 2004 | $ | 130 | $ | 159 | ||||||||||||
Store deposits in-transit (Note 1) | 567 | 579 | ||||||||||||||
Cash and temporary cash investments | $ | 135 | $ | 144 | ||||||||||||
Deposits in-transit | 521 | 506 | ||||||||||||||
Receivables | 644 | 740 | 616 | 661 | ||||||||||||
Inventory | 4,630 | 4,169 | ||||||||||||||
Receivables - Taxes | — | 167 | ||||||||||||||
FIFO Inventory | 4,676 | 4,729 | ||||||||||||||
LIFO Credit | (384 | ) | (373 | ) | ||||||||||||
Prefunded employee benefits | — | 300 | 36 | 300 | ||||||||||||
Prepaid and other current assets | 226 | 251 | 272 | 272 | ||||||||||||
Total current assets | 6,197 | 6,198 | 5,872 | 6,406 | ||||||||||||
Property, plant and equipment, net | 11,445 | 11,178 | 11,466 | 11,497 | ||||||||||||
Goodwill | 3,138 | 3,134 | 2,192 | 2,191 | ||||||||||||
Fair value interest rate hedges (Note 11) | — | 6 | ||||||||||||||
Other assets and investments | 311 | 247 | 394 | 397 | ||||||||||||
Total Assets | $ | 21,091 | $ | 20,763 | $ | 19,924 | $ | 20,491 | ||||||||
LIABILITIES | ||||||||||||||||
Current liabilities | ||||||||||||||||
Current portion of long-term debt, at face value, including obligations under capital leases | $ | 207 | $ | 248 | ||||||||||||
Current portion of long-term debt, at face value, including obligations under capital leases and financing obligations | $ | 71 | $ | 71 | ||||||||||||
Accounts payable | 3,906 | 3,637 | 3,445 | 3,598 | ||||||||||||
Accrued salaries and wages | 584 | 547 | 570 | 659 | ||||||||||||
Deferred income taxes | 138 | 138 | 267 | 267 | ||||||||||||
Other current liabilities | 1,573 | 1,595 | 1,676 | 1,721 | ||||||||||||
Total current liabilities | 6,408 | 6,165 | 6,029 | 6,316 | ||||||||||||
Long-term debt including obligations under capital leases | ||||||||||||||||
Long-term debt, at face value, including obligations under capital leases | 7,531 | 8,012 | ||||||||||||||
Adjustment to reflect fair value interest rate hedges (Note 11) | 82 | 104 | ||||||||||||||
Long-term debt including obligations under capital leases and financing obligations: | ||||||||||||||||
Long-term debt, at face value, including obligations under capital leases and financing obligations | 7,376 | 7,830 | ||||||||||||||
Adjustment to reflect fair value interest rate hedges (Note 12) | 57 | 70 | ||||||||||||||
Long-term debt including obligations under capital leases | 7,613 | 8,116 | ||||||||||||||
Long-term debt including obligations under capital leases and financing obligations | 7,433 | 7,900 | ||||||||||||||
Fair value interest rate hedges (Note 11) | 2 | — | ||||||||||||||
Deferred income taxes | 1,133 | 990 | 919 | 939 | ||||||||||||
Other long-term liabilities | 1,598 | 1,481 | 1,837 | 1,796 | ||||||||||||
Total Liabilities | 16,754 | 16,752 | 16,218 | 16,951 | ||||||||||||
Commitments and Contingencies (Note 12) | ||||||||||||||||
Commitments and Contingencies (Note 11) | ||||||||||||||||
SHAREOWNERS’ EQUITY | ||||||||||||||||
Preferred stock, $100 par, 5 shares authorized and unissued | — | — | — | — | ||||||||||||
Common stock, $1 par, 1,000 shares authorized: 917 shares issued at November 6, 2004, and 913 shares issued at January 31, 2004 | 917 | 913 | ||||||||||||||
Common stock, $1 par, 1,000 shares authorized: 921 shares issued in 2005 and 918 shares issued in 2004 | 921 | 918 | ||||||||||||||
Additional paid-in capital | 2,406 | 2,382 | 2,448 | 2,432 | ||||||||||||
Accumulated other comprehensive loss | (124 | ) | (124 | ) | (201 | ) | (202 | ) | ||||||||
Accumulated earnings | 4,217 | 3,667 | 3,835 | 3,541 | ||||||||||||
Common stock in treasury, at cost, 185 shares at November 6, 2004, and 170 shares at January 31, 2004 | (3,079 | ) | (2,827 | ) | ||||||||||||
Common stock in treasury, at cost, 198 shares in 2005 and 190 shares in 2004 | (3,297 | ) | (3,149 | ) | ||||||||||||
Total Shareowners’ Equity | 4,337 | 4,011 | 3,706 | 3,540 | ||||||||||||
Total Liabilities and Shareowners’ Equity | $ | 21,091 | $ | 20,763 | $ | 19,924 | $ | 20,491 | ||||||||
The accompanying notes are an integral part of the Consolidated Financial Statements.
THE KROGER CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions and unaudited)
Three Quarters Ended | Quarter Ended | |||||||||||||||
November 6, 2004 | November 8, 2003 | May 21, 2005 | May 22, 2004 | |||||||||||||
Cash Flows From Operating Activities: | ||||||||||||||||
Net earnings | $ | 548 | $ | 652 | $ | 294 | $ | 263 | ||||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||||||||||
Depreciation and amortization | 949 | 904 | 389 | 372 | ||||||||||||
LIFO charge | 31 | 34 | 11 | 11 | ||||||||||||
Deferred income taxes | 143 | 129 | (20 | ) | 46 | |||||||||||
Other | 34 | 22 | 18 | 1 | ||||||||||||
Changes in operating assets and liabilities net of effects from acquisitions of businesses: | ||||||||||||||||
Inventories | (492 | ) | (324 | ) | 53 | (71 | ) | |||||||||
Receivables | 20 | 54 | 45 | 63 | ||||||||||||
Store deposits in-transit | 12 | (290 | ) | |||||||||||||
Deposits in-transit | (15 | ) | 86 | |||||||||||||
Prepaid expenses | 314 | 305 | 265 | 204 | ||||||||||||
Accounts payable | 370 | 228 | (135 | ) | 82 | |||||||||||
Accrued expenses | (77 | ) | 129 | (59 | ) | (222 | ) | |||||||||
Accrued income taxes | 153 | 225 | 181 | 112 | ||||||||||||
Contribution to company-sponsored pension plan | (35 | ) | (100 | ) | ||||||||||||
Contribution to company-sponsored pension plans | (89 | ) | — | |||||||||||||
Other | 100 | (49 | ) | 35 | (6 | ) | ||||||||||
Net cash provided by operating activities | 2,070 | 1,919 | 973 | 941 | ||||||||||||
Cash Flows From Investing Activities: | ||||||||||||||||
Capital expenditures, excluding acquisitions | (1,277 | ) | (1,647 | ) | (401 | ) | (453 | ) | ||||||||
Proceeds from sale of assets | 58 | 38 | 28 | 14 | ||||||||||||
Payments for acquisitions, net of cash acquired | (25 | ) | (56 | ) | — | (4 | ) | |||||||||
Other | 7 | — | (4 | ) | (4 | ) | ||||||||||
Net cash used by investing activities | (1,237 | ) | (1,665 | ) | (377 | ) | (447 | ) | ||||||||
Cash Flows From Financing Activities: | ||||||||||||||||
Proceeds from issuance of long-term debt | — | 348 | 6 | — | ||||||||||||
Reductions in long-term debt | (514 | ) | (475 | ) | ||||||||||||
Debt prepayment costs | (25 | ) | (17 | ) | ||||||||||||
Payments for long-term debt | (460 | ) | (321 | ) | ||||||||||||
Financing charges incurred | (5 | ) | (3 | ) | — | (4 | ) | |||||||||
Increase (decrease) in book overdrafts | (102 | ) | 12 | (20 | ) | (79 | ) | |||||||||
Proceeds from interest rate swap terminations | — | 114 | ||||||||||||||
Proceeds from issuance of capital stock | 33 | 33 | 22 | 15 | ||||||||||||
Treasury stock purchases | (249 | ) | (302 | ) | (153 | ) | (121 | ) | ||||||||
Net cash used by financing activities | (862 | ) | (290 | ) | (605 | ) | (510 | ) | ||||||||
Net decrease in cash and temporary cash investments | (29 | ) | (36 | ) | (9 | ) | (16 | ) | ||||||||
Cash and temporary cash investments: | ||||||||||||||||
Beginning of year | 159 | 171 | 144 | 159 | ||||||||||||
End of quarter | $ | 130 | $ | 135 | $ | 135 | $ | 143 | ||||||||
Supplemental disclosure of cash flow information: | ||||||||||||||||
Cash paid during the year for interest | $ | 516 | $ | 518 | $ | 190 | $ | 215 | ||||||||
Cash paid during the year for income taxes | $ | 4 | $ | 34 | ||||||||||||
Cash paid (refunded) during the year for income taxes | $ | 5 | $ | (7 | ) | |||||||||||
Non-cash changes related to purchase acquisitions: | ||||||||||||||||
Fair value of assets acquired | $ | 19 | $ | 48 | $ | — | $ | 3 | ||||||||
Goodwill recorded | $ | 6 | $ | 9 | $ | — | $ | 1 | ||||||||
Liabilities assumed | $ | 1 | $ | 1 |
The accompanying notes are an integral part of the Consolidated Financial Statements.
NOTESTO TO CONSOLIDATED FINANCIAL STATEMENTS
All amounts are in millions except per share amounts.
Certain prior-year amounts have been reclassified to conform to current-year presentation.
1. ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation
The accompanying financial statements include the consolidated accounts of The Kroger Co. and its subsidiaries. The January 31, 200429, 2005 balance sheet was derived from audited financial statements and, due to its summary nature, does not include all disclosures required by Generally Accepted Accounting Principlesgenerally accepted accounting principles (“GAAP”). Significant intercompany transactions and balances have been eliminated. References to the “Company” in these Consolidated Financial Statements mean the consolidated company.
In the opinion of management, the accompanying unaudited Consolidated Financial Statements include all normal, recurring adjustments that are necessary for a fair presentation of results of operations for such periods but should not be considered as indicative of results for a full year. The financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted, pursuant to SEC regulations. Accordingly, the accompanying consolidated financial statements should be read in conjunction with the fiscal 20032004 Annual Report on Form 10-K of The Kroger Co. filed with the SEC on April 14, 2004,15, 2005, as amended.
The unaudited information included in the Consolidated Financial Statements for the third quarter and threefirst quarters ended November 6,May 21, 2005 and May 22, 2004 and November 8, 2003 includesinclude the results of operations of the Company for the 12-week and 40-week periods16-week period then ended.
Store Closing Costsand Other Expense Allowances
All closed store liabilities related to exit or disposal activities initiated after December 31, 2002, are accounted for in accordance with Statement ofon Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The Company provides for closed store liabilities relating to the present value of the estimated remaining noncancellable lease payments after the closing date, net of estimated subtenant income. The Company estimates the net lease liabilities using a discount rate to calculate the present value of the remaining net rent payments on closed stores. The closed store lease liabilities usually are paid over the lease terms associated with the closed stores, which generally have remaining terms ranging from one to 20 years. Adjustments to closed store liabilities primarily relate to changes in subtenant income and lease buyouts. Adjustments are made for changes in estimates in the period in which the change becomes known. Store closing liabilities are reviewed quarterly to ensure that any accrued amount that is not a sufficient estimate of future costs, or isthat no longer is needed for its originally intended purpose, is adjusted to income in the period when the change is identified.proper period.
Owned stores held for disposal are reduced to their estimated net realizable value. Costs to reduce the carrying values of property, equipment and leasehold improvements are accounted for in accordance with SFAS No. 144, “Accounting for the Impairment or DisposalCompany’s policy on impairment of Long-Lived Assets.”long-lived assets. Inventory write-downs, if any, in connection with store closings, are classified in “Merchandise costs.” Costs to transfer inventory and equipment from closed stores are expensed as incurred.
The following table summarizes accrual activity for future lease obligations of stores closed in the normal course of business.
Future Lease Obligations | Future Lease Obligations | |||||||||||
Balance at January 31, 2004 | $ | 53 | ||||||||||
2005 | 2004 | |||||||||||
Balance at beginning of year | $ | 65 | $ | 35 | ||||||||
Additions | 29 | 5 | 14 | |||||||||
Payments | (6 | ) | (2 | ) | (3 | ) | ||||||
Adjustments | (16 | ) | (4 | ) | (3 | ) | ||||||
Balance at November 6, 2004 | $ | 60 | ||||||||||
Balances at First Quarter | $ | 64 | $ | 43 | ||||||||
2. STOCK OPTION PLANSStock Option Plans
The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations to account for its stock option plans. The Company grants options for common stock at an option price equal to the fair market value of the stock at the date of the grant. Accordingly, the Company does not record stock-based compensation expense for these options. The Company also makes restricted stock awards. Compensation expense included in net earnings for restricted stock awards totaled approximately $1$2 and $2,$3, after-tax, for the thirdfirst quarter of 2005 and 2004, and 2003, respectively. Restricted stock expense totaled $6 after-tax, for both the first three quarters of 2004 and 2003. The Company’s stock option plans are more fully described in the Company’s fiscal 20032004 Annual Report on Form 10-K.
The following table illustrates the effect on net earnings, net earnings per basic common share and net earnings per diluted common share as if compensation cost for all options had been determined based on the fair market value recognition provision of SFAS No. 123, “Accounting for Stock-Based Compensation:Compensation.”
Third Quarter | Year-to-date | First Quarter | ||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2005 | 2004 | |||||||||||||||||||
Net earnings, as reported | $ | 143 | $ | 110 | $ | 548 | $ | 652 | $ | 294 | $ | 263 | ||||||||||||
Add: Stock-based compensation expense included in net earnings, net of income tax benefits | 1 | 2 | 6 | 6 | 2 | 3 | ||||||||||||||||||
Subtract: Total stock-based compensation expense determined under fair value method for all awards, net of income tax benefits | (10 | ) | (10 | ) | (35 | ) | (37 | ) | (8 | ) | (13 | ) | ||||||||||||
Pro forma net earnings | $ | 134 | $ | 102 | $ | 519 | $ | 621 | $ | 288 | $ | 253 | ||||||||||||
Net earnings per basic common share, as reported | $ | 0.19 | $ | 0.15 | $ | 0.74 | $ | 0.87 | $ | 0.40 | $ | 0.35 | ||||||||||||
Pro forma earnings per basic common share | $ | 0.18 | $ | 0.14 | $ | 0.70 | $ | 0.83 | $ | 0.40 | $ | 0.34 | ||||||||||||
Net earnings per diluted common share, as reported | $ | 0.19 | $ | 0.15 | $ | 0.73 | $ | 0.86 | $ | 0.40 | $ | 0.35 | ||||||||||||
Pro forma earnings per diluted common share | $ | 0.18 | $ | 0.14 | $ | 0.70 | $ | 0.82 | $ | 0.39 | $ | 0.34 |
Store Deposits In-TransitTo calculate pro forma stock-based compensation, the Company estimated the fair value of each option grant, on the date of the grant, using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2005 and 2004.
2005 | 2004 | |||||
Weighted average expected volatility (based on historical volatility) | 30.83 | % | 30.13 | % | ||
Weighted average risk-free interest rate | 4.11 | % | 3.99 | % | ||
Expected term (based on historical results) | 8.7 years | 8.7 years |
Store deposits in-transit generally represent funds deposited to
The weighted average fair value of options granted during 2005 and 2004 was $7.64 and $7.91 respectively. The Company uses a risk-free interest rate based upon the Company’s bank accountsyield of a treasury note maturing at a date that approximates the end of the quarter related to sales, a majority of which were paid for with credit cards and checks, to which the Company does not have immediate access. In previous years, these items were netted against accounts payable. Store deposits in-transit totaled $567 and $579 for the third quarter of 2004 and the fourth quarter of 2003, respectively. Accounts payable totaled $3,906 and $3,637 for the third quarter of 2004 and the fourth quarter of 2003, respectively.option’s expected term.
2. M3. DERGER-RELATEDEBT COOSTSBLIGATIONS
The following table is a summary of the changes in accruals related to various business combinations:Long-term debt consists of:
Facility Closure Costs | Contributions | |||||||
Balance at January 31, 2004 | $ | 64 | $ | 15 | ||||
Payments | (6 | ) | (1 | ) | ||||
Balance at November 6, 2004 | $ | 58 | $ | 14 | ||||
The $58 liability for facility closure costs primarily represents the present value of lease obligations remaining through 2019 for locations closed in California prior to the Fred Meyer merger. The $14 liability relates to a charitable contribution required as a result of the Fred Meyer merger. The Company is required to complete this contribution by May 2006.
3. RESTRUCTURING CHARGES AND RELATED ITEMS
Restructuring charges
The following table summarizes the changes in the balances of liabilities associated with the 2001 restructuring plan:
Facility Closure Costs | ||||
Balance at January 31, 2004 | $ | 5 | ||
Payments | (1 | ) | ||
Balance at November 6, 2004 | $ | 4 | ||
The $4 liability for facility closure costs relates to the present value of lease obligations remaining through 2009 related to the consolidation of the Company’s Nashville division office.
Store closing liabilities
In 2001 and 2000, the Company implemented two distinct, formalized plans that coordinated the closings of several locations over relatively short periods of time. The following table summarizes the changes in the balances of the liabilities related to the closings:
Balances at January 31, 2004 | $ | 32 | ||
Payments | (18 | ) | ||
Balances at November 6, 2004 | $ | 14 | ||
The $14 liability for store closing liabilities relates to the present value of lease obligations remaining through 2020. Sales at the stores remaining under the plans totaled $19 and $25 for the rolling four-quarter periods ended November 6, 2004, and November 8, 2003, respectively. Net operating income or loss for these stores cannot be determined on a separately identifiable basis.
May 21, 2005 | January 29, 2005 | |||||||
Credit Facility and Commercial Paper borrowings | $ | 266 | $ | 694 | ||||
4.95% to 8.92% Senior Notes and Debentures due through 2031 | 6,391 | 6,391 | ||||||
5.00% to 10.23% mortgages due in varying amounts through 2017 | 217 | 218 | ||||||
Other | 191 | 202 | ||||||
Total debt, excluding capital leases and financing obligations | 7,065 | 7,505 | ||||||
Less current portion | (46 | ) | (46 | ) | ||||
Total long-term debt, excluding capital leases and financing obligations | $ | 7,019 | $ | 7,459 | ||||
4. GOODWILL, NET
The following table summarizes the changes in the Company’s net goodwill balance:
Balance at January 31, 2004 | $ | 3,134 | |||||
Balance at January 29, 2005 | $ | 2,191 | |||||
Goodwill recorded | 6 | — | |||||
Purchase accounting adjustments in accordance with SFAS No. 141 | (2 | ) | 1 | ||||
Balance at November 6, 2004 | $ | 3,138 | |||||
Balance at May 21, 2005 | $ | 2,192 | |||||
The Company reviews goodwill for impairment during the fourth quarter of each year, and also upon the occurrence of trigger events. The reviews are performed at the operating division level. Generally, fair value represents a multiple of earnings, or discounted projected future cash flows. Potential impairment is indicated when the carrying value of a division, including goodwill, exceeds its fair value. If potential for impairment exists, the fair value of a division is subsequently measured against the fair value of its underlying assets and liabilities, excluding goodwill, to estimate an implied fair value of the division’s goodwill. Impairment loss is recognized for any excess of the carrying value of the division’s goodwill over the implied fair value.
5. COMPREHENSIVE INCOME
Comprehensive income is as follows:
Third Quarter Ended | Three Quarters Ended | |||||||||||
November 6, 2004 | November 8, 2003 | November 6, 2004 | November 8, 2003 | |||||||||
Net earnings, as reported | $ | 143 | $ | 110 | $ | 548 | $ | 652 | ||||
Reclassification adjustment for losses included in net earnings, net of tax(1) | — | 1 | — | 22 | ||||||||
Unrealized gain on hedging activities, net of tax(2) | — | — | — | 3 | ||||||||
Comprehensive income | $ | 143 | $ | 111 | $ | 548 | $ | 677 | ||||
First Quarter Ended | ||||||
May 21, 2005 | May 22, 2004 | |||||
Net earnings | $ | 294 | $ | 263 | ||
Unrealized gain (loss) on hedging activities, net of tax(1) | 1 | — | ||||
Comprehensive income | $ | 295 | $ | 263 | ||
(1) |
Amount is net of tax of |
During 2003,2005, other comprehensive income consisted of reclassifications of previously deferred losses on cash flow hedges into net earnings as well as market value adjustments to reflect cash flow hedges at fair value as of the respective balance sheet dates. The reclassification adjustment for the year-to-date period of 2003 includes $12 of after-tax loss related to the second quarter 2003 Dynegy settlement that is more fully described in “Other Items” in the Management’s Discussion and Analysis section.
6. BENEFIT PLANS
The following table provides the components of net periodic benefit costs for the Company-sponsored pension plans and other post-retirement benefits for the first three quarters of 20042005 and 2003:2004:
Pension Benefits | Other Benefits | Pension Benefits | Other Benefits | |||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||||||||||||||||||
Service cost | $ | 85 | $ | 77 | $ | 8 | $ | 6 | $ | 38 | $ | 34 | $ | 3 | $ | 3 | ||||||||||||||||
Interest cost | 87 | 82 | 17 | 16 | 37 | 35 | 6 | 7 | ||||||||||||||||||||||||
Expected return on plan assets | (94 | ) | (94 | ) | — | — | (39 | ) | (38 | ) | — | — | ||||||||||||||||||||
Amortization of: | ||||||||||||||||||||||||||||||||
Transition asset | — | — | — | — | ||||||||||||||||||||||||||||
Prior service cost | 4 | 4 | (5 | ) | (4 | ) | 2 | (2 | ) | (2 | ) | (2 | ) | |||||||||||||||||||
Actuarial loss | 7 | 2 | — | — | ||||||||||||||||||||||||||||
Actuarial (gain) loss | 8 | 3 | — | — | ||||||||||||||||||||||||||||
Net periodic benefit cost | $ | 89 | $ | 71 | $ | 20 | $ | 18 | $ | 46 | $ | 32 | $ | 7 | $ | 8 | ||||||||||||||||
In addition to the $89 contributed to the Company-sponsored pension plans in the first quarter of 2005, the Company is required to make cash contributions totaling $53 during the balance of fiscal 2005. The Company may elect to make additional contributions during 2005 in order to maintain its desired funding status.
The Company also contributes to various multi-employer pension plans based on obligations arising from most of its collective bargaining agreements. These plans provide retirement benefits to participants based on their service to contributing employers. The Company recognizes expense in connection with these plans as contributions are funded, or as and if withdrawal liability is incurred, in accordance with GAAP.
7. INCOME TAXES
The effective income tax rate was 36.7%35.9% for the first three quartersquarter of 20042005 and 37.5%36.9% for the first three quartersquarter of 2003. The2004. In addition to the effect of state taxes, the effective income tax rate differed from the federal statutory rate primarily becausedue to a reduction of previously recorded tax contingency allowances resulting from a revision of the effect of state taxes and open itemsrequired allowances based on resolutions with various taxing authorities.tax authorities during the quarter.
8. EARNINGS PER COMMON SHARE
Earnings per basic common share equals net earnings divided by the weighted average number of common shares outstanding. Earnings per diluted common share equals net earnings divided by the weighted average number of common shares outstanding, after giving effect to dilutive stock options, restricted stock and warrants.
The following table provides a reconciliation of earnings before the cumulative effect of an accounting change and shares used in calculating earnings per basic common share to those used in calculating earnings per diluted common share:
Third Quarter Ended November 6, 2004 | Third Quarter Ended November 8, 2003 | |||||||||||||||
Earnings (Numer- ator) | Shares (Denomi- nator) | Per Share Amount | Earnings (Numer- ator) | Shares (Denomi- nator) | Per Share Amount | |||||||||||
Earnings per basic common share | $ | 143 | 736 | $ | 0.19 | $ | 110 | 743 | $ | 0.15 | ||||||
Dilutive effect of stock options, restricted stock and warrants | 6 | 11 | ||||||||||||||
Earnings per diluted common share | $ | 143 | 742 | $ | 0.19 | $ | 110 | 754 | $ | 0.15 | ||||||
Three Quarters Ended November 6, 2004 | Three Quarters Ended November 8, 2003 | First Quarter Ended May 21, 2005 | First Quarter Ended May 22, 2004 | |||||||||||||||||||||||||||||
Earnings (Numer- ator) | Shares (Denomi- nator) | Per Share Amount | Earnings (Numer- ator) | Shares (Denomi- nator) | Per Share Amount | Earnings (Numerator) | Shares (Denominator) | Per Share Amount | Earnings (Numerator) | Shares (Denominator) | Per Share Amount | |||||||||||||||||||||
Earnings per basic common share | $ | 548 | 738 | $ | 0.74 | $ | 652 | 748 | $ | 0.87 | $ | 294 | 727 | $ | 0.40 | $ | 263 | 741 | $ | 0.35 | ||||||||||||
Dilutive effect of stock options, restricted stock and warrants | 8 | 9 | ||||||||||||||||||||||||||||||
Dilutive effect of stock options and warrants | 5 | 8 | ||||||||||||||||||||||||||||||
Earnings per diluted common share | $ | 548 | 746 | $ | 0.73 | $ | 652 | 757 | $ | 0.86 | $ | 294 | 732 | $ | 0.40 | $ | 263 | 749 | $ | 0.35 | ||||||||||||
The Company had options outstanding for approximately 39 shares and 2627 shares during the third quarterfirst quarters of 20042005 and 2003,2004, respectively, that were excluded from the computations of earnings per diluted common share because their inclusion would have had an anti-dilutive effect on earnings per share. For the first three quarters of 2004 and 2003, the Company had options outstanding for approximately 31 and 34 shares, respectively, that were excluded from the computations of diluted earnings per share because their inclusion would have had an anti-dilutive effect on earnings per share.
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In MayDecember 2004, the FASB issued Staff PositionSFAS No. 123 (Revised 2004), “Share-Based Payment” (“FSP”)SFAS No. 106-2, “Accounting123R”), which replaces SFAS No. 123, supersedes APB No. 25 and Disclosure Requirements Relatedrelated interpretations and amends SFAS No. 95 “Statement of Cash Flows.” The provisions of SFAS No. 123R are similar to those of SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements as compensation cost based on their fair value on the date of grant. Fair value of share-based awards will be determined using option pricing models (e.g. Black-Scholes or binomial models) and assumptions that appropriately reflect the specific circumstances of the awards.
Prior to the Medicare Prescription Drug, Improvementadoption of SFAS No. 123R, the Company is accounting for share-based compensation expense under the recognition and Modernization Actmeasurement provisions of 2003.” FSPAPB No. 106-2 supersedes FSP25, “Accounting for Stock Issued to Employees” and is following the accepted practice of recognizing share-based compensation expense over the explicit vesting period. SFAS No. 106-1, “Accounting123R will require the immediate recognition at the grant date of the full share-based compensation expense for grants to retirement eligible employees, as the explicit vesting period is non-substantive. The estimated effect of applying the explicit vesting period approach versus the non-substantive approach is not material to any period presented. The Company expects to adopt SFAS No. 123R in the first quarter of fiscal 2006 and Disclosure Requirements Relatedexpects the adoption to reduce net earnings by $0.04-$0.06 per diluted share during fiscal 2006.
In November 2004, the Medicare Prescription Drug, ImprovementFASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43 Chapter 4” which clarifies that inventory costs that are “abnormal” are required to be charged to expense as incurred as opposed to being capitalized into inventory as a product cost. SFAS No. 151 provides examples of “abnormal” costs to included costs of idle facilities, excess freight and Modernization Act of 2003,”handling costs and provides guidance on the accounting, disclosure and transition related to the Prescription Drug Act. FSPspoilage. SFAS No. 106-2 became151 will become effective for the Company in the third quarter of 2004.Company’s fiscal year beginning January 29, 2006. The adoption of FSPSFAS No. 106-2 had no151 is not expected to have a material effect on the Company’s Consolidated Financial Statements.
In November 2003,May 2005, the Emerging Issues Task Force (“EITF”) reachedFASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a consensus on Issuereplacement of APB Opinion No. 03-10, “Application20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of Issuethe change. SFAS No. 02-16 by Resellers154 also requires that retrospective application of a change in accounting principle be limited to Sales Incentives Offered to Consumers by Manufacturers.” Issue No. 03-10 addressesthe direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. SFAS No. 154 further requires a change in depreciation, amortization or depletion method for manufacturer sales incentives offered directlylong-live, non-financial assets to consumers, including manufacturer coupons. EITF Issuebe accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS No. 03-10 became154 will become effective for the CompanyCompany’s fiscal year beginning January 29, 2006.
FASB Interpretation No. 47 (“FIN 47”) “Accounting for Conditional Asset Retirement Obligations” was issued by the FASB in March 2005. FIN 47 provides guidance relating to the identification of and financial reporting for legal obligations to perform an asset retirement activity. The Interpretation requires recognition of a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of FIN 47 is not expected to have a material effect on February 1, 2004, the beginning of its first quarter of 2004. Adoption of EITF Issue No. 03-10 reduced the Company’s sales and merchandise costs by $17.3 during the first three quarters of 2004.
10. GUARANTOR SUBSIDIARIES
The Company’s outstanding public debt (the “Guaranteed Notes”) is jointly and severally, fully and unconditionally guaranteed by The Kroger Co. and certain of its subsidiaries (the “Guarantor Subsidiaries”). At November 6, 2004,May 21, 2005, a total of approximately $6.1$6.3 billion of Guaranteed Notes were outstanding. The Guarantor Subsidiaries and non-guarantor subsidiaries are direct or indirect wholly-ownedwholly owned subsidiaries of The Kroger Co. Separate financial statements of The Kroger Co. and each of the Guarantor Subsidiaries are not presented because the guarantees are full and unconditional and the Guarantor Subsidiaries are jointly and severally liable. The Company believes that separate financial statements and other disclosures concerning the Guarantor Subsidiaries would not be material to investors.
The non-guaranteeing subsidiaries represented less than 3% on an individual and aggregate basis of consolidated assets, pre-tax earnings, cash flow and equity, except for consolidated pre-tax earnings for the third quarter of 2004 and 2003.equity. Therefore, the non-guarantor subsidiaries’ information is not separately presented in the tables below. The non-guaranteeing subsidiaries, in aggregate, represented approximately 3.2% and 8.5% of third quarter 2004 and 2003, respectively, consolidated pre-tax earnings. Therefore, the non-guarantor subsidiaries’ information is separately presented in the Condensed Consolidating Statements of Earnings for the third quarter of 2004 and 2003.
There are no current restrictions on the ability of the Guarantor Subsidiaries to make payments under the guarantees referred to above. The obligations of each guarantor under its guarantee are limited to the maximum amount permitted under Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act, or any similar Federal or state law (e.g. laws requiring adequate capital to pay dividends) respecting fraudulent conveyance or fraudulent transfer.
The following tables present summarized financial information as of November 6, 2004,May 21, 2005, and January 31, 2004,29, 2005, and for the third quarter ended, and threefirst quarters ended November 6, 2004May 21, 2005 and November 8, 2003:May 22, 2004:
Condensed Consolidating
Balance Sheets
As of November 6, 2004May 21, 2005
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||||||||
Current assets | |||||||||||||||||||||||||||||
Cash, including temporary cash investments | $ | 22 | $ | 108 | $ | — | $ | 130 | $ | 26 | $ | 109 | $ | — | $ | 135 | |||||||||||||
Store deposits in-transit | 69 | 498 | — | 567 | |||||||||||||||||||||||||
Deposits in-transit | 58 | 463 | — | 521 | |||||||||||||||||||||||||
Accounts receivable | 82 | 562 | — | 644 | 506 | 612 | (502 | ) | 616 | ||||||||||||||||||||
Net inventories | 455 | 4,175 | — | 4,630 | 440 | 3,852 | — | 4,292 | |||||||||||||||||||||
Prepaid and other current assets | (40 | ) | 266 | — | 226 | 104 | 204 | — | 308 | ||||||||||||||||||||
Total current assets | 588 | 5,609 | — | 6,197 | 1,134 | 5,240 | (502 | ) | 5,872 | ||||||||||||||||||||
Property, plant and equipment, net | 1,239 | 10,206 | — | 11,445 | 1,464 | 10,002 | — | 11,466 | |||||||||||||||||||||
Goodwill | 19 | 3,119 | — | 3,138 | 56 | 2,136 | — | 2,192 | |||||||||||||||||||||
Other assets and investments | 578 | (267 | ) | — | 311 | — | 394 | — | 394 | ||||||||||||||||||||
Investment in and advances to subsidiaries | 11,584 | — | (11,584 | ) | — | 9,018 | — | (9,018 | ) | — | |||||||||||||||||||
Total assets | $ | 14,008 | $ | 18,667 | $ | (11,584 | ) | $ | 21,091 | $ | 11,672 | $ | 17,772 | $ | (9,520 | ) | $ | 19,924 | |||||||||||
Current liabilities | |||||||||||||||||||||||||||||
Current portion of long-term debt including obligations under capital leases | $ | 207 | $ | — | $ | — | $ | 207 | |||||||||||||||||||||
Current portion of long-term debt including obligations under capital leases and financing obligations | $ | 71 | $ | — | $ | — | $ | 71 | |||||||||||||||||||||
Accounts payable | 151 | 3,755 | — | 3,906 | 224 | 3,723 | (502 | ) | 3,445 | ||||||||||||||||||||
Other current liabilities | 55 | 2,240 | — | 2,295 | 276 | 2,237 | — | 2,513 | |||||||||||||||||||||
Total current liabilities | 413 | 5,995 | — | 6,408 | 571 | 5,960 | (502 | ) | 6,029 | ||||||||||||||||||||
Long-term debt including obligations under capital leases | |||||||||||||||||||||||||||||
Face value long-term debt including obligations under capital leases | 7,205 | 326 | — | 7,531 | |||||||||||||||||||||||||
Long-term debt including obligations under capital leases and financing obligations | |||||||||||||||||||||||||||||
Face value long-term debt including obligations under capital leases and financing obligations | 7,344 | 32 | — | 7,376 | |||||||||||||||||||||||||
Adjustment to reflect fair value interest rate hedges | 82 | — | — | 82 | 57 | — | — | 57 | |||||||||||||||||||||
Long-term debt including obligations under capital leases | 7,287 | 326 | — | 7,613 | |||||||||||||||||||||||||
Long-term debt including obligations under capital leases and financing obligations | 7,401 | 32 | — | 7,433 | |||||||||||||||||||||||||
Fair value interest rate hedges | 2 | — | — | 2 | |||||||||||||||||||||||||
Other long-term liabilities | 1,969 | 762 | — | 2,731 | (6 | ) | 2,762 | — | 2,756 | ||||||||||||||||||||
Total liabilities | 9,671 | 7,083 | — | 16,754 | 7,966 | 8,754 | (502 | ) | 16,218 | ||||||||||||||||||||
Shareowners’ Equity | 4,337 | 11,584 | (11,584 | ) | 4,337 | 3,706 | 9,018 | (9,018 | ) | 3,706 | |||||||||||||||||||
Total liabilities and shareowners’ equity | $ | 14,008 | $ | 18,667 | $ | (11,584 | ) | $ | 21,091 | $ | 11,672 | $ | 17,772 | $ | (9,520 | ) | $ | 19,924 | |||||||||||
Condensed Consolidating
Balance Sheets
As of January 31, 200429, 2005
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||
Current assets | ||||||||||||||||||||||||||||
Cash, including temporary cash investments | $ | 26 | $ | 133 | $ | — | $ | 159 | $ | 32 | $ | 112 | — | $ | 144 | |||||||||||||
Store deposits in-transit | 66 | 513 | — | 579 | ||||||||||||||||||||||||
Deposits in-transit | 20 | 486 | — | 506 | ||||||||||||||||||||||||
Accounts receivable | 106 | 634 | — | 740 | 583 | 747 | (502 | ) | 828 | |||||||||||||||||||
Net inventories | 414 | 3,755 | — | 4,169 | 415 | 3,941 | — | 4,356 | ||||||||||||||||||||
Prepaid and other current assets | 271 | 280 | — | 551 | 275 | 297 | — | 572 | ||||||||||||||||||||
Total current assets | 883 | 5,315 | — | 6,198 | 1,325 | 5,583 | (502 | ) | 6,406 | |||||||||||||||||||
Property, plant and equipment, net | 1,129 | 10,049 | — | 11,178 | 1,277 | 10,220 | — | 11,497 | ||||||||||||||||||||
Goodwill | 21 | 3,113 | — | 3,134 | 20 | 2,171 | — | 2,191 | ||||||||||||||||||||
Fair value interest rate hedges | 6 | — | — | 6 | ||||||||||||||||||||||||
Other assets and investments | 576 | (329 | ) | — | 247 | 642 | (245 | ) | — | 397 | ||||||||||||||||||
Investment in and advances to subsidiaries | 11,916 | — | (11,916 | ) | — | 10,518 | — | (10,518 | ) | — | ||||||||||||||||||
Total assets | $ | 14,531 | $ | 18,148 | $ | (11,916 | ) | $ | 20,763 | $ | 13,782 | $ | 17,729 | $ | (11,020 | ) | $ | 20,491 | ||||||||||
Current liabilities | ||||||||||||||||||||||||||||
Current portion of long-term debt including obligations under capital leases | $ | 242 | $ | 6 | $ | — | $ | 248 | ||||||||||||||||||||
Current portion of long-term debt including obligations under capital leases and financing obligations | $ | 71 | $ | — | $ | — | $ | 71 | ||||||||||||||||||||
Accounts payable | 218 | 3,419 | — | 3,637 | 188 | 3,912 | (502 | ) | 3,598 | |||||||||||||||||||
Other current liabilities | 623 | 1,657 | — | 2,280 | 319 | 2,328 | — | 2,647 | ||||||||||||||||||||
Total current liabilities | 1,083 | 5,082 | — | 6,165 | 578 | 6,240 | (502 | ) | 6,316 | |||||||||||||||||||
Long-term debt including obligations under capital leases | ||||||||||||||||||||||||||||
Face value long-term debt including obligations under capital leases | 7,699 | 313 | — | 8,012 | ||||||||||||||||||||||||
Long-term debt including obligations under capital leases and financing obligations | ||||||||||||||||||||||||||||
Face value long-term debt including obligations under capital leases and financing obligations | 7,797 | 33 | — | 7,830 | ||||||||||||||||||||||||
Adjustment to reflect fair value interest rate hedges | 104 | — | — | 104 | 70 | — | — | 70 | ||||||||||||||||||||
Long-term debt including obligations under capital leases | 7,803 | 313 | — | 8,116 | ||||||||||||||||||||||||
Long-term debt including obligations under capital leases and financing obligations | 7,867 | 33 | — | 7,900 | ||||||||||||||||||||||||
Other long-term liabilities | 1,634 | 837 | — | 2,471 | 1,797 | 938 | — | 2,735 | ||||||||||||||||||||
Total liabilities | 10,520 | 6,232 | — | 16,752 | 10,242 | 7,211 | (502 | ) | 16,951 | |||||||||||||||||||
Shareowners’ Equity | 4,011 | 11,916 | (11,916 | ) | 4,011 | 3,540 | 10,518 | (10,518 | ) | 3,540 | ||||||||||||||||||
Total liabilities and shareowners’ equity | $ | 14,531 | $ | 18,148 | $ | (11,916 | ) | $ | 20,763 | $ | 13,782 | $ | 17,729 | $ | (11,020 | ) | $ | 20,491 | ||||||||||
Condensed Consolidating
Statements of EarningsOperations
For the Quarter Ended November 6, 2004May 21, 2005
The Kroger Co. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||||||||||
Sales | $ | 1,611 | $ | 11,516 | $ | 12 | $ | (285 | ) | $ | 12,854 | $ | 2,530 | $ | 15,705 | $ | (287 | ) | $ | 17,948 | ||||||||||||
Merchandise costs, including warehousing and transportation | 1,306 | 8,599 | –– | (273 | ) | 9,632 | 2,116 | 11,606 | (285 | ) | 13,437 | |||||||||||||||||||||
Operating, general and administrative | 374 | 2,069 | (3 | ) | –– | 2,440 | 475 | 2,826 | — | 3,301 | ||||||||||||||||||||||
Rent | 28 | 142 | –– | (12 | ) | 158 | 56 | 149 | (2 | ) | 203 | |||||||||||||||||||||
Depreciation and amortization | 23 | 262 | 2 | — | 287 | 25 | 364 | — | 389 | |||||||||||||||||||||||
Earnings (loss) from operations | (120 | ) | 444 | 13 | — | 337 | ||||||||||||||||||||||||||
Operating profit (loss) | (142 | ) | 760 | — | 618 | |||||||||||||||||||||||||||
Interest expense | 105 | 6 | 6 | — | 117 | 150 | 9 | — | 159 | |||||||||||||||||||||||
Equity in earnings of subsidiaries | (317 | ) | — | — | 317 | — | 489 | — | (489 | ) | — | |||||||||||||||||||||
Earnings (loss) before tax expense | 92 | 438 | 7 | (317 | ) | 220 | ||||||||||||||||||||||||||
Tax expense (benefit) | (51 | ) | 126 | 2 | — | 77 | ||||||||||||||||||||||||||
Earnings (loss) before income tax expense | 197 | 751 | (489 | ) | 459 | |||||||||||||||||||||||||||
Income tax expense (benefit) | (97 | ) | 262 | — | 165 | |||||||||||||||||||||||||||
Net earnings | $ | 143 | $ | 312 | $ | 5 | $ | (317 | ) | $ | 143 | $ | 294 | $ | 489 | $ | (489 | ) | $ | 294 | ||||||||||||
Condensed Consolidating
Statements of EarningsOperations
For the Quarter Ended November 8, 2003
The Kroger Co. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||
Sales | $ | 1,642 | $ | 10,706 | $ | 12 | $ | (219 | ) | $ | 12,141 | |||||||
Merchandise costs, including warehousing and Transportation | 1,358 | 7,865 | — | (207 | ) | 9,016 | ||||||||||||
Operating, general and administrative | 347 | 2,031 | (10 | ) | — | 2,368 | ||||||||||||
Rent | 35 | 130 | — | (12 | ) | 153 | ||||||||||||
Depreciation and amortization | 21 | 258 | 1 | — | 280 | |||||||||||||
Earnings (loss) from operations | (119 | ) | 422 | 21 | — | 324 | ||||||||||||
Interest expense | 140 | 2 | 6 | — | 148 | |||||||||||||
Equity in earnings of subsidiaries | (271 | ) | — | — | 271 | — | ||||||||||||
Earnings (loss) before tax expense | 12 | 420 | 15 | (271 | ) | 176 | ||||||||||||
Tax expense (benefit) | (98 | ) | 159 | 5 | — | 66 | ||||||||||||
Net earnings | $ | 110 | $ | 261 | $ | 10 | $ | (271 | ) | $ | 110 | |||||||
Condensed Consolidating
Statements of Earnings
For the Three Quarters Ended November 6,May 22, 2004
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||||||||
Sales | $ | 6,004 | $ | 37,531 | $ | (796 | ) | $ | 42,739 | $ | 2,221 | $ | 14,958 | $ | (274 | ) | $ | 16,905 | ||||||||||
Merchandise costs, including warehousing and transportation | 4,861 | 27,761 | (756 | ) | 31,866 | 1,730 | 11,046 | (258 | ) | 12,518 | ||||||||||||||||||
Operating, general and administrative | 1,163 | 6,929 | –– | 8,092 | 474 | 2,740 | — | 3,214 | ||||||||||||||||||||
Rent | 140 | 425 | (40 | ) | 525 | 64 | 164 | (16 | ) | 212 | ||||||||||||||||||
Depreciation and amortization | 82 | 867 | — | 949 | 40 | 332 | — | 372 | ||||||||||||||||||||
Earnings (loss) from operations | (242 | ) | 1,549 | — | 1,307 | |||||||||||||||||||||||
Operating profit (loss) | (87 | ) | 676 | — | 589 | |||||||||||||||||||||||
Interest expense | 415 | 27 | — | 442 | 156 | 16 | — | 172 | ||||||||||||||||||||
Equity in earnings of subsidiaries | (989 | ) | — | 989 | — | 412 | — | (412 | ) | — | ||||||||||||||||||
Earnings (loss) before tax expense | 332 | 1,522 | (989 | ) | 865 | |||||||||||||||||||||||
Tax expense (benefit) | (216 | ) | 533 | — | 317 | |||||||||||||||||||||||
Earnings (loss) before income tax expense | 169 | 660 | (412 | ) | 417 | |||||||||||||||||||||||
Income tax expense (benefit) | (94 | ) | 248 | — | 154 | |||||||||||||||||||||||
Net earnings | $ | 548 | $ | 989 | $ | (989 | ) | $ | 548 | $ | 263 | $ | 412 | $ | (412 | ) | $ | 263 | ||||||||||
Condensed Consolidating
Statements of Earnings
For the Three Quarters Ended November 8, 2003
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||
Sales | $ | 5,264 | $ | 36,207 | $ | (714 | ) | $ | 40,757 | |||||
Merchandise costs, including warehousing and transportation | 4,273 | 26,449 | (674 | ) | 30,048 | |||||||||
Operating, general and administrative | 1,059 | 6,728 | — | 7,787 | ||||||||||
Rent | 126 | 413 | (40 | ) | 499 | |||||||||
Depreciation and amortization | 67 | 837 | — | 904 | ||||||||||
Earnings (loss) from operations | (261 | ) | 1,780 | — | 1,519 | |||||||||
Interest expense | 448 | 28 | — | 476 | ||||||||||
Equity in earnings of subsidiaries | (1095 | ) | — | 1,095 | — | |||||||||
Earnings (loss) before tax expense | 386 | 1,752 | (1,095 | ) | 1,043 | |||||||||
Tax expense (benefit) | (266 | ) | 657 | — | 391 | |||||||||
Net earnings | $ | 652 | $ | 1,095 | $ | (1,095 | ) | $ | 652 | |||||
Condensed Consolidating
Statements of Cash Flows
For the Three Quarter Ended November 6, 2004May 21, 2005
The Kroger Co. | Guarantor Subsidiaries | Consolidated | The Kroger Co. | Guarantor Subsidiaries | Consolidated | |||||||||||||||||||
Net cash provided by operating activities | $ | 481 | $ | 1,589 | $ | 2,070 | ||||||||||||||||||
Net cash provided (used) by operating activities | $ | (820 | ) | $ | 1,793 | $ | 973 | |||||||||||||||||
Cash flows from investing activities: | ||||||||||||||||||||||||
Capital expenditures | (136 | ) | (1,141 | ) | (1,277 | ) | (33 | ) | (368 | ) | (401 | ) | ||||||||||||
Other | 17 | 23 | 40 | 9 | 15 | 24 | ||||||||||||||||||
Net cash used by investing activities | (119 | ) | (1,118 | ) | (1,237 | ) | (24 | ) | (353 | ) | (377 | ) | ||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||||||
Proceeds from issuance of long-term debt | 6 | — | 6 | |||||||||||||||||||||
Reductions in long-term debt | (521 | ) | 7 | (514 | ) | (459 | ) | (1 | ) | (460 | ) | |||||||||||||
Proceeds from issuance of capital stock | 33 | — | 33 | 22 | — | 22 | ||||||||||||||||||
Treasury stock purchases | (249 | ) | — | (249 | ) | (153 | ) | — | (153 | ) | ||||||||||||||
Other | (32 | ) | (100 | ) | (132 | ) | (2 | ) | (18 | ) | (20 | ) | ||||||||||||
Net change in advances to subsidiaries | 403 | (403 | ) | — | 1,424 | (1,424 | ) | — | ||||||||||||||||
Net cash (used) by financing activities | (366 | ) | (496 | ) | (862 | ) | ||||||||||||||||||
Net cash provided (used) by financing activities | 838 | (1,443 | ) | (605 | ) | |||||||||||||||||||
Net (decrease) in cash and temporary cash investments | (4 | ) | (25 | ) | (29 | ) | ||||||||||||||||||
Net decrease in cash and temporary cash investments | (6 | ) | (3 | ) | (9 | ) | ||||||||||||||||||
Cash and temporary cash investments: | ||||||||||||||||||||||||
Beginning of year | 26 | 133 | 159 | 32 | 112 | 144 | ||||||||||||||||||
End of quarter | $ | 22 | $ | 108 | $ | 130 | $ | 26 | $ | 109 | $ | 135 | ||||||||||||
Condensed Consolidating
Statements of Cash Flows
For the Three QuartersQuarter Ended November 8, 2003May 22, 2004
The Kroger Co. | Guarantor Subsidiaries | Consolidated | The Kroger Co. | Guarantor Subsidiaries | Consolidated | |||||||||||||||||||
Net cash provided (used) by operating activities | $ | (205 | ) | $ | 2,124 | $ | 1,919 | $ | (59 | ) | $ | 1,000 | $ | 941 | ||||||||||
Cash flows from investing activities: | ||||||||||||||||||||||||
Capital expenditures | (110 | ) | (1,537 | ) | (1,647 | ) | (27 | ) | (426 | ) | (453 | ) | ||||||||||||
Other | (40 | ) | 22 | (18 | ) | — | 6 | 6 | ||||||||||||||||
Net cash used by investing activities | (150 | ) | (1,515 | ) | (1,665 | ) | (27 | ) | (420 | ) | (447 | ) | ||||||||||||
Cash flows from financing activities: | ||||||||||||||||||||||||
Proceeds from issuance of long-term debt | 248 | 100 | 348 | |||||||||||||||||||||
Reductions in long-term debt | (438 | ) | (37 | ) | (475 | ) | (319 | ) | (2 | ) | (321 | ) | ||||||||||||
Proceeds from issuance of capital stock | 33 | — | 33 | 15 | — | 15 | ||||||||||||||||||
Proceeds from interest rate swap terminations | 114 | — | 114 | |||||||||||||||||||||
Treasury stock purchases | (302 | ) | — | (302 | ) | (121 | ) | — | (121 | ) | ||||||||||||||
Other | (24 | ) | 16 | (8 | ) | (5 | ) | (78 | ) | (83 | ) | |||||||||||||
Net change in advances to subsidiaries | 702 | (702 | ) | — | 518 | (518 | ) | — | ||||||||||||||||
Net provided (used) by financing activities | 333 | (623 | ) | (290 | ) | 88 | (598 | ) | (510 | ) | ||||||||||||||
Net increase (decrease) in cash and temporary cash investments | (22 | ) | (14 | ) | (36 | ) | 2 | (18 | ) | (16 | ) | |||||||||||||
Cash and temporary cash investments: | ||||||||||||||||||||||||
Beginning of year | 43 | 128 | 171 | 26 | 133 | 159 | ||||||||||||||||||
End of quarter | $ | 21 | $ | 114 | $ | 135 | $ | 28 | $ | 115 | $ | 143 | ||||||||||||
11. FAIR VALUE INTEREST RATE HEDGES
In the first quarter of 2003, the Company reconfigured a portion of its interest derivative portfolio by terminating six interest rate swap agreements that were accounted for as fair value hedges. Approximately $114 of proceeds received as a result of these terminations were recorded as adjustments to the carrying values of the underlying debt and are being amortized over the remaining lives of the debt. As of November 6, 2004, the unamortized balances totaled approximately $85.
During the first two quarters of 2003, the Company initiated 10 new interest rate swap agreements that are being accounted for as fair value hedges. During the second quarter of 2004, the Company terminated three of the interest rate swap agreements. As of November 6, 2004, liabilities totaling $2 have been recorded to reflect the fair value of the remaining interest rate swap agreements, offset by reductions in the fair value of the underlying debt.
12. COMMITMENTSAND CONTINGENCIES
The Company continuouslycontinually evaluates contingencies based upon the best available evidence.information.
Management believes that allowances for loss have been provided to the extent necessary and that its assessment of contingencies is reasonable. Allowances for loss are included in other current liabilities and other long-term liabilities. To the extent that resolution of contingencies or an updated allowance analysis results in amounts that vary from management’s estimates, future earnings will be charged or credited.
The principal contingencies are described below.
Insurance — The Company’s workers’ compensation risks are self-insured in certain states. In addition, other workers’ compensation risks and certain levels of insured general liability risks are based on retrospective premium plans, deductible plans, and self-insured retention plans. LiabilitiesThe liability for workers’ compensation risks areis accounted for on a present value basis. LiabilitiesThe liability for general liability risks areis not present-valued. Actual claim settlements and expenses incident thereto may differ from the provisions for loss.
Litigation — On February 2, 2004, the Attorney General for the State of California filed an action in Los Angeles federal court (California, ex rel Lockyer v. Safeway, Inc. dba Vons, a Safeway Company; Albertson’s, Inc. and Ralphs Grocery Company, a division of The Kroger Co., United States Attorney’s Office for theDistrict Court Central District of California, informedCase No. CV04-0687) alleging that the Mutual Strike Assistance Agreement (the “Agreement”) between the Company, that it is investigatingAlbertson’s, Inc. and Safeway Inc. (collectively, the hiring practices“Retailers”), which was designed to prevent the union from placing disproportionate pressure on one or more of Ralphs Grocery Company, a wholly-owned subsidiary of The Kroger Co.,the Retailers by picketing such Retailer(s) but not the other Retailer(s) during the labor dispute from October 2003 through February 2004. Among matters under investigation isin southern California, violated Section 1 of the allegationSherman Act. The lawsuit seeks declarative and injunctive relief. Under the Agreement, the Company paid approximately $147 million to the other Retailers. The lawsuit raises claims that some locked-out employees were enabledcould question the validity of those payments, as well as claims that the retailers unlawfully restrained competition. On May 25, 2005, the Court denied a motion for summary judgment filed by the defendants. Ralphs and the other defendants have filed a notice of an interlocutory appeal to work under false identities or false Social Security numbers, despite Company policy forbidding such conduct. A grand jury has convened to consider whether such acts violated federal criminal statutes.the United States Court of Appeals for the Ninth Circuit. The Company continues to believe it has strong defenses against this lawsuit and is cooperating with the investigation, and itvigorously defending it. Although this lawsuit is too earlysubject to determine whether charges will be filed or what potential penalties Ralphs may face. In addition, these alleged practices are the subject of claims that Ralphs’ conduct of the lockout was unlawful, and that Ralphs should be liable under the National Labor Relations Act (“NLRA”). The Los Angeles Regional Office of the National Labor Relations Board (“NLRB”) has notified the charging parties that all charges alleging that Ralphs’ lockout violated the NLRA have been dismissed. The charging parties have appealed that decisionuncertainties inherent to the General Counsellitigation process, based on the information presently available to the Company, management does not expect that the ultimate resolution of this action will have a material effect, favorable or adverse, on the NLRB.Company’s financial condition, results of operations or cash flows.
TheRalphs Grocery Company is involvedthe defendant in a group of civil actions initially filed in 2003 and for which a coordination order was issued on January 20, 2004, inThe Great Escape Promotion Cases pending in the Superior Court of California, County of Los Angeles, Case No. JCCP No. 4343. The plaintiffs allege that Ralphs violated various legal actionslaws protecting consumers in connection with a promotion pursuant to which Ralphs offered travel awards to customers. The plaintiffs are seeking to certify a class of several hundred thousand customers who, they allege, were harmed by Ralphs’ inability to fulfill the promotion. In a separate action styledPeople v. Ralphs Grocery Co., San Diego County Superior Court, Case No. GIC 832986, the California Attorney General brought an action based on similar allegations. Ralphs agreed to and did resolve that matter to the satisfaction of the Attorney General in a Stipulation of Final Judgment providing relief for all customers who, to Ralphs knowledge, had qualified for and sought travel awards under the promotion. Despite having resolved the litigation with the Attorney General, the Company cannot predict the outcome ofThe Great Escape Promotion Cases nor the dollar amount of damages for which Ralphs may be found additionally liable. Based on the information presently available to the Company, however, management does not believe the ultimate outcome will have a material effect on the Company’s financial condition.
Other matters are described under the heading “Legal Proceedings” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005.
Various claims and lawsuits arising in the normal course of business.business, including suits charging violations of certain antitrust and civil rights laws, are pending against the Company. Some of these purport or have been determined to be class actions and/or seek substantial damages. Any damages that may be awarded in an antitrust case will be automatically trebled. Although occasional adverse decisions (or settlements) may occur,it is not possible at this time to evaluate the merits of all these claims and lawsuits, nor their likelihood of success, the Company believesis of the belief that the final disposition of such mattersany resulting liability will not have a material adverse effect on the Company’s financial positionposition.
The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made adequate provisions therefore. Nonetheless, assessing and predicting the outcomes of these matters involves substantial uncertainties. It remains possible that despite management’s current belief, material differences in actual outcomes or changes in management’s evaluation or predictions could arise that could have a material adverse effect on the Company’s financial condition or results of operation.
Guarantees – The Company periodically enters into real estate joint ventures in connection with the development of certain properties. The Company usually sells its interest in such partnerships upon completion of the Company.projects. As of May 21, 2005, the Company was a partner with 50% ownership in two real estate joint ventures for which it has guaranteed approximately $8 of debt incurred by the ventures. Based on the covenants underlying this indebtedness as of May 21, 2005, it is unlikely that the Company will be responsible for repayment of these obligations.
Assignments –The Company is contingently liable for leases that have been assigned to various third parties in connection with facility closings and dispositions. The Company could be required to satisfy obligations under leases if any of the assignees are unable to fulfill their lease obligations. Due to the wide distribution of the Company’s assignments among third parties, and various other remedies available, the Company believes the likelihood that it will be required to satisfy a material amount of these obligations is remote.
Benefit Plans– The Company administers certain non-contributory defined benefit retirement plans for substantially all non-union employees and some union-represented employees as determined by the terms and conditions of collective bargaining agreements. Funding for the pension plans is based on a review of the specific requirements and an evaluation of the assets and liabilities of each plan.
In addition to providing pension benefits, the Company provides certain health care benefits for retired employees. Funding for the retiree health care benefits occurs as claims or premiums are paid.
The determination of the obligation and expense for the Company’s pension and other post-retirement benefits is dependent on the
Company’s selection of assumptions used by actuaries in calculating those amounts. Those assumptions are described in the Company’s fiscal 20032004 Annual Report on Form 10-K and include, among others, the discount rate, the expected long-term rate of return on plan assets, and the rates of increase in compensation and health care costs. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect the recognized expense and recorded obligation in such future periods. While the Company believes that the assumptions are appropriate, significant differences in actual experience or significant changes in assumptions may materially affect the pension and other post-retirement obligations and future expense.
In addition to the $14 and $100$89 contributed during the second quarter of 2004 andto Company-sponsored pension plans in the first quarter of 2003, respectively,2005, the Company contributed $21is required to the company-sponsored pension plansmake cash contributions totaling $53 during the third quarterbalance of 2004.fiscal 2005. The Company may elect to make additional contributions during 2005 in order to maintain its desired funding levels. Among other things, investment performance of plan assets, the interest rates required to be used to calculate the pension obligations and future changes in legislation will determine the amounts of any additional contributions.
The Company also participates incontributes to various multi-employer pension plans for substantially all employees represented by unions. The Company is required to make contributions to these plans in amounts established underbased on obligations arising from most of its collective bargaining agreements. Pension expense for theseThese plans is recognized as contributions are funded. Benefits are generallyprovide retirement benefits to participants based on a fixed amounttheir service to contributing employers. The benefits are paid from assets held in trust for each yearthat purpose. Trustees are appointed in equal number by employers and unions The trustees typically are responsible for determining the level of service. The Company contributed $169benefits to these plans in fiscal 2003. The Company would have contributed an additional $13be provided to these plans in 2003 had there been no labor disputes. participants as well as for such matters as the investment of the assets and the administration of the plans.
Based on the most recent information available to it, the Company it believes that the present value of actuarial accrued liabilities in most or all of these multi-employer plans continuesubstantially exceeds the value of the assets held in trust to be underfunded. Based on various factors,pay benefits. Although underfunding couldcan result in the imposition of an excise tax equal to 5% of the deficiency in the first year of a funding deficiency and 100% of the deficiency thereafter, until corrected. As a result, we expecttaxes on contributing employers, increased contributions can reduce underfunding so that contributions to these plans will continue to increase and the benefit levels and related issues will continue to create collective bargaining challenges. Several of our recently completed labor agreements, including Ralphs in southern California, resulted in a reduction of liabilities. These multi-employer fundsexcise taxes are managed by trustees, appointed by management of the employers (including Kroger) and the labor unions in equal number, who have fiduciary obligations to act prudently. Thus, while we expect contributions to these funds to continue to increase as they have in recent years, the amount of the increase will depend upon the outcome of collective bargaining, actions taken by trustees and the actual return on assets held in these funds and the discount rate used in each fund. For these reasons, it is not practicable to determine the amount by which the Company’s multi-employer pension contributions will increase.triggered. Moreover, if the Company were to exit certain markets it may be requiredor otherwise cease making contributions to paythese funds, the Company could trigger a substantial withdrawal liability. Any adjustmentsadjustment for withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably estimated.determined, in accordance with GAAP.
12. FAIR VALUE INTEREST RATE HEDGES
In 2003, the Company reconfigured a portion of its interest derivative portfolio by terminating six interest rate swap agreements that were accounted for as fair value hedges. Approximately $114 of proceeds received as a result of these terminations were recorded as adjustments to the carrying values of the underlying debt and are being amortized over the remaining lives of the debt. As of May 21, 2005, the unamortized balances totaled approximately $75.
At the end of the first quarter of 2005, the Company maintained 10 interest rate swap agreements that are being accounted for as fair value hedges. As of May 21, 2005, liabilities totaling $18 have been recorded to reflect the fair value of these new agreements, offset by reductions in the fair value of the underlying debt.
13. SUBSEQUENT EVENTS
On December 9, 2004,June 23, 2005, the Company’s shareholders approved The Kroger Co. 2005 Long-Term Incentive Plan (the “Plan”). A summary of the Plan is set forth in the Company’s Current Report on Form 8-K filed on June 23, 2005.
On June 28, 2005, Fitch Ratings changed its rating outlook on the Company announced an offeringto negative from stable and affirmed the Company’s long-term credit rating of $300, 4.95% senior notes due in 2015. The Company expects net proceeds fromBBB.
On June 29, 2005, Standard & Poor’s Ratings Services downgraded the offering of approximately $297. The Company intendsCompany’s long-term credit rating to use the net proceeds from the offering to repay amounts under our credit facilities and short-term borrowings, and for other general corporate purposes. The transaction is expected to settle on December 20, 2004. The Company initiated three new interest rate swap agreements related to this offering.BBB- with a stable outlook.
ITEMItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.Operations
The following analysis should be read in conjunction with the Consolidated Financial Statements.
OVERVIEW
We are pleasedTotal sales increased 6.2% and identical sales (as defined below) increased 3.8% with our sales performance in the third quarter. Kroger’s identical food-store sales showed strong improvement over the second quarter. Our continued focus on fulfilling our customers’ needs is an important part of our strategy to increase earnings through strong, sustainable identical food-store sales growth.
The improved identical-sales performance in the third quarter versus the second quarter continues to move us toward our sales targets for the year. Based on year-to-date performance, however, it will be a challenge to achieve the Company’s previously announced identical food-store sales target of 1.3% for the full fiscal year, which excludes fuel and 2.4% without fuel. Our total sales growth was broad-based across the organization, driven by strong sales at our food stores affected by labor disputes.
The Company experienced a 141-day work stoppageand fuel centers, improvement in southern California, and a very good performance at our convenience and jewelry stores.
We will continue targeting the areas of our business that ended February 29, 2004. Theour customers have told us are most important to them. By placing the “customer first” we are committed to making sure that every decision we make positively influences the way our customers feel about Kroger.
In southern California, market remains competitive and we are focused on improving identical food-storecontinue to rebuild our business. Identical sales in that market to pre-strike levels. Identical food-store sales for(as defined below) without fuel at Ralphs and Food 4 Less together, as compared to the third quarter of 2002, are down slightly less than 1% for the full quarter. We believe a comparison to 2002 results is more representative due to the disruption caused by the labor dispute in 2003. Ralphs continues to be down, partially offset by sales increases at Food 4 Less. We continue to emphasize store conditions, associate training, and competitive pricing. Our identical food-store sales trends did improvewere both positive in the thirdfirst quarter and, on a combined basis, increased 1.3% from a year ago. In addition, operating profit at both Ralphs and Food 4 Less compared to the second quarter. We continue to make progress and executewere in line with our business plan in southern California.expectations.
DuringOn the third quarter, major labor contracts covering nearly 20,000 associates in Seattle, Cincinnati and at Food 4 Lessstrength of our first-quarter financial performance, we are raising our earnings estimate for fiscal 2005. We now expect earnings for the full year to exceed $1.24 per fully diluted share, an increase of $0.03 per share from the previous guidance. We expect our 2005 earnings per share growth to be fueled by continued progress in southern California, were ratified withoutlower interest expense, and fewer shares outstanding as a work stoppage. In each case, we continued to make progress toward our goalresult of labor cost competitiveness. These new agreements have included a variety of measures to bring our labor costs more in line with the competition, including modest cost sharing by our associates for health care benefits and caps on cost increases in health care plans.
Negotiations continue with the UFCW at King Soopers in Denver, and Smith’s and Food 4 Less in Las Vegas. We remain hopeful that we can reach new agreements in those markets without work stoppages. Looking ahead to 2005, we have major UFCW contracts expiring in Roanoke, the Atlanta area, Portland (non-food), Columbus, and Dallas (clerks). We also have various Teamsters contracts expiring, including one in southern California and a separate one that covers several facilities in the Midwest. We continue to be committed to achieving a cost structure that enables us to grow our business and create more good jobs, while providing our associates with competitive wages and benefits.
For a more detailed discussion of our expectations and uncertainties related to those expectations, please see the “Outlook” section, below.stock buybacks.
RESULTSOF OPERATIONS
Net Earnings
Net earnings totaled $294 million for the first quarter of 2005, an increase of 11.8% from net earnings of $263 million for the first quarter of 2004. The increase in our net earnings was the result of improvement in southern California and the leveraging of fixed costs by strong identical sales growth.
Earnings per share of $0.40 per diluted share for the first quarter of 2005 represented an increase of 14.3% over net earnings of $0.35 per diluted share for the first quarter of 2004. Earnings per share growth resulted from increased net earnings and the repurchase of Company stock. Over the past four quarters, we have repurchased 20 million shares of the Company’s stock for a total investment of $323 million.
Sales
Total Sales
(In millions)
First Quarter, 2005 | Percentage Increase | First Quarter, 2004 | Percentage Increase | ||||||||||
Total supermarket sales without fuel | $ | 16,027.0 | $ | 3.9 | % | $ | 15,433.5 | 2.7 | % | ||||
Total supermarket fuel sales | $ | 925.7 | $ | 47.3 | % | 626.2 | 47.4 | % | |||||
Total supermarket sales | $ | 16,952.7 | 5.6 | % | $ | 16,059.7 | 3.9 | % | |||||
Other sales(1) | 995.0 | 17.8 | % | 844.9 | 4.8 | % | |||||||
Total sales | $ | 17,947.7 | 6.2 | % | $ | 16,904.6 | 3.9 | % | |||||
(1) | Other sales primarily relate to sales at convenience and jewelry stores and sales by our manufacturing plants to outside firms. |
The change in our total sales foris driven by identical store sales and square footage growth, as well as inflation in fuel and other commodities. Increased customer count and average transaction size in the thirdfirst quarter of 2004 were $12.9 billion, an increase of 5.9% over total sales of $12.1 billion for the third quarter of 2003. Total food2005 drove identical store sales increased 5.5% including fuel and 3.8% excluding fuel. For the first three quarters of 2004, total sales were $42.7 billion, an increase of 4.9% over total sales of $40.8 billion for the first three quarters of 2003. Total food store sales for the first three quarters of 2004 increased 4.5% including fuel, and 3.0% excluding fuel over total food store sales for the first three quarters of 2003. The difference between total sales and total food store sales primarily relates to sales at convenience and jewelry stores and sales by manufacturing plants to outside firms.
We define a food storesupermarket as an identical store when the storeit has been in operation without expansion or relocation for five full quarters. Differences between total food storesupermarket sales and identical food storesupermarket sales primarily relate to changes in food storesupermarket square footage. Our identical food storesupermarket sales results which exclude the West Virginia stores closed during the labor dispute and include Ralphs and Food 4 Less stores in southern California, are summarized in the table below. The Ralphs and Food 4 Less stores in southern California together accounted for 0.1% of the increase. The identical food storesupermarket dollar figures presented were used to calculate percentage changes for the thirdfirst quarter of 2004.2005 percent changes.
Identical Food StoreSupermarket Sales
(inIn millions)
Third Quarter | ||||||||
2004 | 2003 | |||||||
Including supermarket fuel centers | $ | 11,422.8 | $ | 11,073.6 | ||||
Excluding supermarket fuel centers | $ | 10,904.2 | $ | 10,712.5 | ||||
Including supermarket fuel centers | 3.2 | % | 0.2 | % | ||||
Excluding supermarket fuel centers | 1.8 | % | (0.6 | )% |
First Quarter | ||||||||
2005 | 2004 | |||||||
Including fuel centers | $ | 15,990.5 | $ | 15,401.4 | ||||
Excluding fuel centers | $ | 15,142.4 | $ | 14,789.0 | ||||
Including fuel centers | 3.8 | % | 1.3 | % | ||||
Excluding fuel centers | 2.4 | % | 0.3 | % |
We define a food storesupermarket as a comparable store when the storeit has been in operation for five full quarters, including expansions and relocations. Our comparable food storesupermarket sales results excluding the West Virginia stores closed during the labor dispute and including Ralphs and Food 4 less stores in southern California, are summarized in the table below. The comparable food storesupermarket dollar figures presented were used to calculate percentage changes for the thirdfirst quarter of 2004.2005 percent changes.
Comparable Food StoreSupermarket Sales
(inIn millions)
Third Quarter | ||||||||
2004 | 2003 | |||||||
Including supermarket fuel centers | $ | 11,755.1 | $ | 11,341.1 | ||||
Excluding supermarket fuel centers | $ | 11,218.3 | $ | 10,976.0 | ||||
Including supermarket fuel centers | 3.7 | % | 0.8 | % | ||||
Excluding supermarket fuel centers | 2.2 | % | (0.1 | )% |
We are very pleased with our sales performance in the third quarter of 2004. We believe our strong identical food-store sales growth is a reflection of our continued focus on fulfilling our customers’ needs.
First Quarter | ||||||||
2005 | 2004 | |||||||
Including fuel centers | $ | 16,447.1 | $ | 15,757.1 | ||||
Excluding fuel centers | $ | 15,565.4 | $ | 15,137.2 | ||||
Including fuel centers | 4.4 | % | 1.8 | % | ||||
Excluding fuel centers | 2.8 | % | 0.8 | % |
FIFO Gross Margin
We calculate First-In, First-Out (“FIFO”) Gross Margin as follows: Sales minus merchandise costs plus Last-In, First OutFirst-Out (“LIFO”) charge. Merchandise costs include advertising, shrink, warehousing and transportation, but exclude depreciation expenses and rent expense. FIFO gross margin is an important measure used by management to evaluate merchandising and operational effectiveness.
Our FIFO gross margin rate declined 6782 basis points to 25.16%25.19% for the thirdfirst quarter of 20042005 from 25.83%26.01% for the thirdfirst quarter of 2003.2004. Of this decline, the effect of fuel sales accounted for a 6642 basis point reduction in our FIFO gross margin rate. Our year-to-date FIFO gross margin rate declined 85 basis points to 25.51% in 2004 from 26.36% in 2003. The effect of fuel sales accounted for a 48 basis point reduction in our year-to-date FIFO gross margin rate. The declining gross margin rate on non-fuel sales reflects our continuing investment in lower retail prices.
The estimated effect of the labor dispute, more fully describedprices, partially offset by our improvements in “Other Items,” also affected our FIFO gross margin rates.shrink.
Operating, General and Administrative Expenses
Operating, general and administrative (“OG&A”) expenses consist primarily of employee-related costs such as wages, health care benefit costs and retirement plan costs. RentAmong other items, rent expense, depreciation and amortization expense, and interest expense are not included in OG&A.
OG&A expenses, as a percent of sales, decreased 5262 basis points to 18.98%18.39% for the thirdfirst quarter of 20042005 from 19.50%19.01% for the thirdfirst quarter of 2003. Fuel2004. Of this decline, the effect of fuel sales accounted for a decrease33 basis point reduction in our OG&A rate. The declining rate of 33 basis points duringon non-fuel sales reflects our strong sales, strong cost control efforts across the third quarter of 2004.Company and lower health care costs, partially offset by increases in loss contingencies for various outstanding legal matters. The 2004 OG&A
expenses rate was affected by the southern California labor dispute. OG&A at the supermarket divisions, not affected by work stoppages,excluding Ralphs and excluding the effect of fuel, increased 23declined nine basis points, of which incentive plan and employee benefit costs accounted for most of the increase. For the year-to-date period, OG&A expenses, as a percent of sales, decreased 18 basis points to 18.93% in 2004 from 19.11% in 2003. Fuel sales accounted for a decrease in our OG&A rate of 33 basis points for the year-to-date period of 2004.points.
Rent Expense
Rent expense as a percentwas $203 million, or 1.13% of total sales, was 1.23% and 1.26% infor the thirdfirst quarter of 2004 and 2003, respectively. For2005, compared to $212 million, or 1.26% of sales, for the year-to-date period, rent expense, as a percentfirst quarter of total sales, was 1.23% and 1.22% for 2004 and 2003, respectively.2004. The increasedecline in rent expense as a percent of sales, was primarily related toreflects our emphasis on ownership of real estate combined with continued focus on the closing under performingof underperforming stores. We closed 20 stores, including 14 operational closings, in the third quarter of 2004 compared to 16 stores during the third quarter of 2003. For the year-to-date periods, we closed 63 stores, including 47 operational closings, in 2004 and 27 stores in 2003.
Depreciation and Amortization Expense
Depreciation expense as a percentwas $389 million, or 2.17% of total sales, was 2.24% and 2.31% infor the thirdfirst quarter of 2004 and 2003, respectively.2005 compared to $372 million, or 2.20% of sales, for the first quarter of 2004. The decrease in depreciation expense, as a percent of sales, was the result of our continued tightening ofsales leverage obtained from strong identical sales growth, partially offset by capital expenditures in addition to leverage from our increased sales. For the year-to-date periods, depreciation expense, as a percent of total sales, was 2.22% in both 2004 and 2003.investments.
Interest Expense
Interest expense as a percent of total sales, was .91%$159 million and 1.22%$172 million in the third quarterfirst quarters of 2005 and 2004, and 2003, respectively. Interest expense for the third quarter of 2003, as a percent of total sales, was negatively affected by 15 basis points by premiums paid in connection with the repurchase of $100 million of long-term bonds. The remaining decreasereduction in interest expense asfor 2005, when compared to 2004, reflects a percent of sales, is related to lower overall net borrowings and lower average borrowing costs. For the year-to-date periods of 2004 and 2003, interest expense, as a percent$509 million reduction of total sales, was 1.03% and 1.17%, respectively. The year-to-date decrease in interest expense, as a percent of sales, was primarily related to lower net borrowings and lower borrowing costs in 2004 compared to 2003.debt.
Income Taxes
We expect the effective tax rate for fiscal 2004 will be in the range of 37.0%. Our effective income tax rate was 35.0%35.9 % for the thirdfirst quarter of 20042005 and 37.5%36.9% for the thirdfirst quarter of 2003. For the year-to-date periods of 2004 and 2003, our effective income tax rate was 36.7% and 37.5%, respectively. The effective income tax rates differ from the federal statutory rate primarily due2004. In addition to the effect of state taxes, and open items with various taxing authorities.
Net Earnings
Net earnings totaled $143 million, or $0.19 per diluted share, in the third quartereffective income tax rate differed from the federal statutory rate due to a reduction of 2004. These results represent an increase of 30%previously recorded tax contingency allowances resulting from net earnings of $110 million, or $0.15 per diluted share for the third quarter of 2003. Results in the third quarter of 2003 include the items described below in “Other Items” and “Previously Reported Estimated Effect of Labor Disputes.” Those items represented approximately $0.13 of after-tax expense per diluted share in the third quarter of 2003, consistinga revision of the estimated effects of the labor disputes and the premiums paid in connectionrequired allowances based on resolutions with the repurchase of $100 million of long-term bonds.
Net earnings for the first three quarters of 2004 totaled $548 million, or $0.73 per diluted share. These results represent a decrease of 16.0% from net earnings of $652 million, or $0.86 per diluted share for the first three quarters of 2003. Results of both year-to-date periods included the items described below in “Other Items” and “Previously Reported Estimated Effect of Labor Disputes.” For the first three quarters of 2004 and 2003, those items represented approximately $0.15 and $0.18, respectively, of after-tax expense per diluted share.
OTHER ITEMS
The following table summarizes items that affected Kroger’s financial resultstax authorities during the periods presented. These items should not be considered alternatives to net earnings, net cash provided by operating activities or any other Generally Accepted Accounting Principles (“GAAP”) measure of performance or liquidity. These items should not be viewed in isolation or considered substitutes for Kroger’s results as reported in accordance with GAAP. Due to the nature of these items, as described below, it is important to identify these items and review them in conjunction with Kroger’s financial results reported in accordance with GAAP.
These items include charges and credits that were recorded as components of OG&A expense and interest expense.
Third Quarter | Year-to-date | ||||||||||||||
(In millions except per share amounts) | 2004 | 2003 | 2004 | 2003 | |||||||||||
Items affecting OG&A | |||||||||||||||
Adjustment to charitable contribution liability | $ | — | $ | — | $ | — | $ | 5 | |||||||
Energy purchase commitments – market value adjustment | — | — | — | (4 | ) | ||||||||||
Energy purchase commitments – Dynegy settlement | — | — | — | (62 | ) | ||||||||||
Power outage | — | — | — | (9 | ) | ||||||||||
Reduction of lease liabilities – store closing plans | — | — | — | 10 | |||||||||||
Total affecting OG&A | — | — | — | (60 | ) | ||||||||||
Items affecting interest | |||||||||||||||
Debt prepayment premium | — | (18 | ) | (25 | ) | (18 | ) | ||||||||
Total affecting interest | — | (18 | ) | (25 | ) | (18 | ) | ||||||||
Total pre-tax loss | — | (18 | ) | (25 | ) | (78 | ) | ||||||||
Income tax effect | — | 7 | 9 | 29 | |||||||||||
Total after-tax loss | $ | — | $ | (11 | ) | $ | (16 | ) | $ | (49 | ) | ||||
Diluted shares | 742 | 754 | 746 | 757 | |||||||||||
Estimated diluted per share loss | $ | — | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.06 | ) |
Items Affecting Operating, General and Administrative Expense and Interest Expense
Lease liabilities – Store closing plans
In connection with the 2001 asset impairment review described below, we recorded pre-tax OG&A expenses of $20 million in 2001 for the present value of lease liabilities for the leased stores identified for closure. In 2000, we also recorded pre-tax expenses of $67 million for the present value of lease liabilities for similar store closings. The 2000 liabilities pertained primarily to stores acquired in the Fred Meyer merger, or to stores operated prior to the merger that were in close proximity to stores acquired in the merger, that were identified as under-performing stores. In both years, liabilities were recorded for the planned closings of the stores.
Due to operational changes, performance improved at five stores that had not yet closed. As a result of this improved performance, in the first quarter of 2003 we modified our original plans and determined that these five locations would remain open. Additionally, closing and exit costs at other locations included in the original plans were less costly than anticipated. In total, we recorded pre-tax income of $10 million in the first quarter of 2003 to adjust these liabilities to reflect the outstanding lease commitments at the locations remaining under the plans.
Power Outage
In the second quarter of 2003, we recorded a $9 million pre-tax expense for the August power outage in northwest Ohio and Michigan. The majority of the expense related to uninsured product losses. Generally, we classify uninsured product and property losses as OG&A expense.
Energy purchase commitments
During March through May 2001, we entered into four separate commitments to purchase electricity from Dynegy, Inc. (“Dynegy”) in California. At the inception of the contracts, forecasted electricity usage indicated that it was probable that all of the electricity would be utilized in our operations. We, therefore, accounted for the contracts in accordance with the normal purchases and normal sales exception under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, and no amounts were initially recorded in the financial statements related to these purchase commitments.
During the third quarter of 2001, we determined that one of the contracts, and a portion of a second contract, provided for supplies in excess of our expected demand for electricity. This precluded use of the normal purchases and normal sales exception under SFAS No. 133 for those contracts, and required the contracts to be marked to fair value through current-period earnings. We, therefore, recorded a pre-tax charge of $81 million in the third quarter of 2001 to accrue liabilities for the estimated fair value of these contracts through the December 2006 ending date of the commitments. We re-designated the remaining portion of the second contract as a cash flow hedge of future purchases under the contract. The other two purchase commitments continued to qualify for the normal purchases and normal sales exception under SFAS No. 133 through June 2003.
SFAS No. 133 required the excess contracts to be marked to fair value through current-period earnings each quarter. In the first quarter of 2003, we recorded a pre-tax charge of $3 million to mark the excess contracts to fair value as of May 24, 2003.
On July 3, 2003, we reached an agreement through which we ended supply arrangements with Dynegy in California related to these four power supply contracts. The Federal Energy Regulatory Commission approved the settlement agreement on July 23, 2003. On August 27, 2003, we paid $107 million, before the related tax benefits, to settle disputes with Dynegy related to prior over-payments, terminate two of the four contracts effective July 6, 2003, and terminate the remaining two agreements effective September 1, 2003. As a result of the settlement, we recorded $62 million of pre-tax expense in the second quarter of 2003.
Debt prepayment premium
During the second quarter of 2004, we called for redemption our $750 million, 7.375% bonds due in March 2005. The call was funded on July 7, 2004, through a combination of available cash, commercial paper, and credit facility borrowings. We incurred a premium of $24.7 million, pre-tax, in connection with the redemption and anticipate a reduction in interest expense of approximately $21 million, pre-tax, for the current year, as a result of the debt reduction
During the third quarter of 2003, we incurred expenses totaling $18 million, pre-tax, related to premiums paid in connection with the repurchase of $100 million of long-term bonds, and the write-off of the related deferred financing costs.
PREVIOUSLY REPORTED ESTIMATED EFFECTOF LABOR DISPUTES
The following table summarizes the estimated effect of labor disputes on Kroger’s financial results that were previously reported for the periods presented. These items should not be considered alternatives to net earnings, net cash provided by operating activities or any other GAAP measure of performance or liquidity. These items should not be viewed in isolation or considered substitutes for Kroger’s results as reported in accordance with GAAP. Due to the nature of these items, as described below, it is important to identify these items and review them in conjunction with Kroger’s financial results reported in accordance with GAAP.
Included in the estimated effect of labor disputes for prior periods were charges and credits that were recorded as components of merchandise costs and OG&A expense. The 2003 calculation includes the effect of both the southern California and West Virginia strikes. The estimated effect includes all costs associated with the work stoppages, including expenses under the Mutual Strike Assistance Agreement (“the Agreement”) in southern California entered into with Safeway Inc. and Albertson’s, Inc., and post-strike recovery expenses through the second quarter of 2004.
In the third quarter of 2004, we discontinued reporting the strike effect.
Third Quarter | Year-to-date | ||||||||||||||
(In millions except per share amounts) | 2004 | 2003 | 2004 | 2003 | |||||||||||
Estimated effect of labor disputes on: | |||||||||||||||
FIFO gross margin(1) | $ | — | $ | (97 | ) | $ | (133 | ) | $ | (97 | ) | ||||
OG&A | — | (46 | ) | (18 | ) | (46 | ) | ||||||||
Total pre-tax loss | — | (143 | ) | (151 | ) | (143 | ) | ||||||||
Income tax effect | — | 54 | 56 | 54 | |||||||||||
Total after-tax loss | $ | — | $ | (89 | ) | $ | (95 | ) | $ | (89 | ) | ||||
Diluted shares | 742 | 754 | 746 | 757 | |||||||||||
Estimated diluted per share loss | $ | — | $ | (0.12 | ) | $ | (0.13 | ) | $ | (0.12 | ) |
For the dispute-affected regions, we compared actual results to budgeted results from the start of the disputes through the first two quarters of 2004. In establishing budgets for 2004, we took into account trends existing in the market as well as changes in our business plan strategies. Based on those budgets, the estimated effects included the difference between reported sales and sales projections less reported merchandising costs and merchandising cost projections and the difference between reported OG&A and OG&A projections.
Differences affecting FIFO gross margin included incremental warehousing, distribution, advertising and inventory shrinkage expenses incurred during the labor dispute, as well as the investment in FIFO gross margin, through targeted retail price reductions, and advertising in order to regain our sales during the post-strike recovery period. Differences in OG&A included costs associated with hiring and training replacement workers, costs associated with bringing in employees from other Kroger divisions to work on a temporary basis, expenses under the Agreement and costs related to hiring and training workers to replace union members who did not return to work after the labor dispute ended.
LIQUIDITYAND CAPITAL RESOURCES
Cash Flow Information
Net cash provided by operating activities
We generated $2.1 billion and $1.9 billion$973 million of cash from operating activities induring the first three quartersquarter of 2004 and 2003, respectively. Our decrease in 2004 net earnings was offset by a small net2005 compared to $941 million during the first quarter of 2004. The increase in cash provided fromgenerated by our operating activities was primarily related to increased net earnings and changes in operating assets, and liabilities and reducedpartially offset by a cash contributionscontribution of $89 million to our Company sponsoredCompany-sponsored pension plans. The decreaseplan in our accounts payable balances in 2003 was primarily related to our decision to discontinue the practicefirst quarter of transferring deposits to our concentration account prior to receiving credit for those deposits from other banks. Accrued liabilities declined in 2004 due to the payment of the accrued liability to Retailers under the Agreement described in “Previously Reported Estimated Effect of Labor Disputes.”2005.
Net cash used by investing activities
Investing activities used $1.2 billion$377 million of cash during the first three quartersquarter of 20042005 compared to $1.7 billion$447 million during the first three quartersquarter of 2003.2004. The amount of cash used by investing activities decreased in 20042005 versus 20032004 due to a decline indecreased capital expenditures in 2004. The buyoutduring the first quarter of a synthetic lease that used $202 million of cash in 2003.2005.
Net cash used by financing activities
Financing activities used $0.9 billion$605 million of cash in the first three quartersquarter of 20042005 compared to $0.3 billion$510 million in the first three quartersquarter of 2003.2004. The increase in the amount of cash used by financing activities was the result of the increased use of cash to reduce net outstanding debt totaling $514 million in the first three quarters of 2004 compared to $127 million for the first three quarters of 2003, combined with a reduction in the amount of book overdrafts. In addition, we received proceeds totaling $114 million related to the termination of several interest rate swap agreements during the first three quarters of 2003.and treasury stock repurchase activity.
Debt Management
OnAs of May 21, 2004,2005, we announced we had executedmaintained a new$1.8 billion, five-year revolving credit facility totaling $1.8 billion. The new facility replaced our $1.0 billion 364-day and $812.5 million five-year credit facilities. In addition to the new $1.8 billion credit facility, maturingthat terminates in 2009 we continue to maintainand a $700 million five-year credit facility that maturesterminates in 2007. Outstanding borrowings under the credit agreements and commercial paper borrowings, and some outstanding letters of credit, reduce funds available under the credit facilities.agreements. In addition to the credit agreements, we hadmaintain a $75 million money market line, borrowings under which also reduce the amount of funds available under our credit agreements. The money market line borrowings allow us to borrow from banks at mutually agreed upon rates, usually at rates below the rates offered under the credit facilities.agreements. As of November 6, 2004,May 21, 2005, our outstanding credit agreement and commercial paper borrowings totaled $662$266 million. We had no borrowings under the money market line as of November 6, 2004.May 21, 2005. The outstanding letters of credit that reduced the funds available under our credit agreements totaled $290 million as of May 21, 2005. We have the credit facilities totaled $283 million at such time.ability to refinance these borrowings on a long-term basis, and have presented the amounts accordingly.
As of November 6, 2004,At May 21, 2005, we also had a $100 million pharmacy receivable securitization facility that provided capacity incremental to the $2.5 billion of credit facilitiesagreements described above. Funds received under this $100 million facility do not reduce funds available under the credit facilities.agreements. Collection rights to some of Kroger’sour pharmacy accounts receivable balances are sold to initiate the drawing of funds under the facility. As of November 6, 2004,May 21, 2005, we had utilizationno borrowings under the pharmacy receivable securitization facility totaling $92 million.this $100 million facility.
Our bank credit facilities and the indentures underlying our publicly issued debt contain various restrictive covenants. As of November 6, 2004,May 21, 2005, we were in compliance with these financial covenants. Furthermore, management believes it is not reasonably likely that Kroger will fail to comply with these financial covenants in the foreseeable future.
Total debt, including both the current and long-term portions of capital leases, decreased $607$509 million to $7.8$7.5 billion as of the end of the thirdfirst quarter of 2004,2005, from $8.4$8.0 billion as of the end of the thirdfirst quarter of 2003.2004. Total debt decreased $543$467 million to $7.8 billion as of the end of the thirdfirst quarter of 20042005 from $8.4$8.0 billion as of year-end 2003.2004. The decreases in 20042005 resulted from the use of cash flow from operations to reduce outstanding debt and lower mark-to-market adjustments.
On December 9, 2004, we announced an offering of $300 million, 4.95% senior notes due in 2015. We expect net proceeds from the offering of approximately $297 million, which we will use to repay amounts under our credit facilities and short-term borrowings, and for other general corporate purposes. The transaction is expected to settle on December 20, 2004. We initiated three new interest rate swap agreements related to this offering.
Common Stock Repurchase Program
During the thirdfirst quarter of 2004,2005, we invested $83$153 million to repurchase 5.49.5 million shares of Kroger stock at an average price of $15.18$16.06 per share. These shares were reacquired under threetwo separate stock repurchase programs. The first is a $500 million repurchase program that was authorized by Kroger’s Board of Directors in December 2002. The second is a $500 million repurchase program that was authorized by Kroger’s Board of Directors in September 2004. The thirdsecond is a program that uses the cash proceeds from the exercises of stock options by participants in Kroger’s stock option and long-term incentive plans as well as the associated tax benefits. ForIn the first three quartersquarter of 2004,2005, we acquired 15.5purchased approximately 9.0 million shares, for a total investment of $249 million.totaling $145 million, under our $500 million stock repurchase program and we purchased an additional 0.5 million shares, totaling $7 million, under our program to repurchase common stock funded by the proceeds and tax benefits from stock option exercises. As of November 6, 2004,May 21, 2005, we had $422$208 million remaining under the September 2004 $500 million authorization. As of December 10, 2004, we had $390 million remaining under the $500 million authorization.repurchase program.
CAPITAL EXPENDITURES
Capital expenditures excluding acquisitions totaled $429$401 million for the thirdfirst quarter of 20042005 compared to $563$453 million for the thirdfirst quarter of 2003. Year-to-date,2004. The decrease reflects our continued emphasis on the tightening of capital expenditures, excluding acquisitions, totaled $1.3 billion in 2004 and $1.6 billion in 2003. Capital expenditures in 2003 included purchases of assets totaling $202 million which were previously financed under a synthetic lease.our increasing focus on remodel, merchandising and productivity projects.
During the thirdfirst quarter of 2004,2005, we opened, acquired, expanded or relocated 3014 food stores and also completed 3334 within-the-wall remodels. In total, we operated 2,531 food2,524 supermarkets and multi-department stores at the end of the thirdfirst quarter of 20042005 versus 2,5302,536 food stores in operation at the end of the thirdfirst quarter of 2003.2004. Total food store square footage increased 1.2%2.2%, excluding acquisitions and operational closings, over the thirdfirst quarter of 2003.2004.
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 the Company’s 2004 Annual Report on Form 10-K.
The preparation of financial statements in conformity with generally accepted accounting principles 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.
RECENTLY ISSUED ACCOUNTING STANDARDS
In MayDecember 2004, the FASB issued Staff PositionSFAS No. 123 (Revised 2004), “Share-Based Payment” (“FSP”)SFAS No. 106-2, “Accounting123R”), which replaces SFAS No. 123, supersedes APB No. 25 and Disclosure Requirements Relatedrelated interpretations and amends SFAS No. 95 “Statement of Cash Flows.” The provisions of SFAS No. 123R are similar to those of SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements as compensation cost based on their fair value on the date of grant. Fair value of share-based awards will be determined using option pricing models (e.g. Black-Scholes or binomial models) and assumptions that appropriately reflect the specific circumstances of the awards.
Prior to the Medicare Prescription Drug, Improvementadoption of SFAS No. 123R, we are accounting for share-based compensation expense under the recognition and Modernization Actmeasurement provisions of 2003.” FSPAPB No. 106-2 supersedes FSP25, “Accounting for Stock Issued to Employees” and are following the accepted practice of recognizing share-based compensation expense over the explicit vesting period. SFAS No. 106-1, “Accounting123R will require the immediate recognition at the grant date of the full share-based compensation expense for grants to retirement eligible employees, as the
explicit vesting period is non-substantive. The estimated effect of applying the explicit vesting period approach versus the non-substantive approach is not material to any period presented. We expect to adopt SFAS No. 123R in the first quarter of fiscal 2006 and Disclosure Requirements Relatedexpect the adoption to reduce net earnings by $0.04-$0.06 per diluted share during fiscal 2006.
In November 2004, the Medicare Prescription Drug, ImprovementFASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43 Chapter 4” which clarifies that inventory costs that are “abnormal” are required to be charged to expense as incurred as opposed to being capitalized into inventory as a product cost. SFAS No. 151 provides examples of “abnormal” costs to included costs of idle facilities, excess freight and Modernization Act of 2003,”handling costs and provides guidance on the accounting, disclosure and transition related to the Prescription Drug Act. FSPspoilage. SFAS No. 106-2 became151 will become effective for the third quarter of 2004.our fiscal year beginning January 29, 2006. The adoption of FSPSFAS No. 106-1 had no151 is not expected to have a material effect on our Consolidated Financial Statements.
In November 2003,May 2005, the Emerging Issues Task Force (“EITF”) reachedFASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a consensus on Issuereplacement of APB Opinion No. 03-10, “Application20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of Issuethe change. SFAS No. 02-16 by Resellers154 also requires that retrospective application of a change in accounting principle be limited to Sales Incentives Offered to Consumers by Manufacturers.” Issue No. 03-10 addressesthe direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. SFAS No. 154 further requires a change in depreciation, amortization or depletion method for manufacturer sales incentives offered directlylong-live, non-financial assets to consumers, including manufacturer coupons. EITF Issuebe accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS No. 03-10 became154 will become effective for Kroger on February 1, 2004,our fiscal year beginning January 29, 2006.
FASB Interpretation No. 47 (“FIN 47”) “Accounting for Conditional Asset Retirement Obligations” was issued by the beginningFASB in March 2005. FIN 47 provides guidance relating to the identification of our first quarterand financial reporting for legal obligations to perform an asset retirement activity. The Interpretation requires recognition of 2004. Adoption of EITF Issue No. 03-10 reduced our sales and merchandise costs by $17.3 milliona liability for the first three quartersfair value of 2004. We expecta conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of EITF Issue No. 03-10 willFIN 47 is not expected to have a similarmaterial effect for the balance of fiscal 2004.on our Consolidated Financial Statements.
OUTLOOK
This discussion and analysis contains certain forward-looking statements about Kroger’s future performance. These statements are based on management’s assumptions and beliefs in light of the information currently available. Such statements relate to, among other things: projected change in net earnings; identical sales growth; expected pension plan contributions; our ability to generate operating cash flow; projected capital expenditures; square footage growth; opportunities to reduce costs; cash flow requirements; and our operating plan for the future; and are indicated by words or phrases such as “comfortable,” “committed,” “expect,” “goal,” “should,” “intend,” “target,” “believe,” “anticipate,” and similar words or phrases. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially.
Statements elsewhere in this report and below regarding our expectations, projections, beliefs, intentions or strategies are forward-looking statements within the meaning of Section 21 E of the Securities Exchange Act of 1934. 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 below could cause actual results to differ materially from those statements.materially.
Various uncertainties and other factors could cause us to fail to achieve our goals. These include:
We cannot fully foresee the effects of changes in economic conditions on Kroger’s business. We have assumed economic and competitive situations will not change significantly for 2004.
2005. Other factors and assumptions not identified above could also cause actual results to differ materially from those set forth in the forward-looking information. Accordingly, actual events and results may vary significantly from those included in, or contemplated or implied by forward-looking statements made by us or our representatives.
ITEMItem 3. Quantitative and Qualitative Disclosures About Market Risk.
There have been no other significant changes in our exposure to market risk from the information provided in Item 7A. Quantitative and Qualitative Disclosures About Market Risk on our Form 10-K filed with the SEC on April 14, 2004.15, 2005, as amended.
ITEMItem 4. Controls and Procedures.
The Chief Executive Officer and the Chief Financial Officer, together with a disclosure review committee appointed by the Chief Executive Officer, evaluated Kroger’s disclosure controls and procedures as of the quarter ended November 6, 2004.May 21, 2005. Based on that evaluation, Kroger’s Chief Executive Officer and Chief Financial Officer concluded that Kroger’s disclosure controls and procedures were effective as of the end of the period covered by this report.
In connection withAs of January 29, 2005, we did not maintain effective controls over the evaluation described above, there was no changedetermination of deferred income tax balances related to a business combination. As of May 21, 2005, we have fully remediated this material weakness in Kroger’s internal control over financial reporting duringreporting. Specifically, we implemented controls over the quarter ended November 6, 2004,processes and procedures in calculating deferred income tax liabilities related to the business combination to ensure that has materially affected, or is reasonably likely to materially affect, Kroger’s internal control over financial reporting.the deferred income tax liabilities and allocated goodwill were fairly stated in accordance with generally accepted accounting principles.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Litigation — On February 2, 2004, the Attorney General for the State of California filed an action in Los Angeles federal court (California, ex rel Lockyer v. Safeway, Inc. dba Vons, a Safeway Company; Albertson’s, Inc. and Ralphs Grocery Company, a division of The Kroger Co., United States Attorney’s office for theDistrict Court Central District of California, informedCase No. CV04-0687) alleging that the Mutual Strike Assistance Agreement (the “Agreement”) between the Company, that it is investigatingAlbertson’s, Inc. and Safeway Inc. (collectively, the hiring practices“Retailers”), which was designed to prevent the union from placing disproportionate pressure on one or more of Ralphs Grocery Company, a wholly-owned subsidiary of The Kroger Co.,the Retailers by picketing such Retailer(s) but not the other Retailer(s) during the labor dispute from October 2003 through February 2004. Among matters under investigationin southern California, violated Section 1 of the Sherman Act. The lawsuit seeks declarative and injunctive relief. Under the Agreement, the Company paid approximately $147 million to the other Retailers. The lawsuit raises claims that could question the validity of those payments, as well as claims that the retailers unlawfully restrained competition. On May 25, 2005, the Court denied a motion for summary judgment filed by the defendants. Ralphs and the other defendants have filed a notice of an interlocutory appeal to the United States Court of Appeals for the Ninth Circuit. The Company continues to believe it has strong defenses against this lawsuit and is vigorously defending it. Although this lawsuit is subject to uncertainties inherent to the litigation process, based on the information presently available to the Company, management does not expect that the ultimate resolution of this action will have a material effect, favorable or adverse, on the Company’s financial condition, results of operations or cash flows.
Ralphs Grocery Company is the allegationdefendant in a group of civil actions initially filed in 2003 and for which a coordination order was issued on January 20, 2004, inThe Great Escape Promotion Cases pending in the Superior Court of California, County of Los Angeles, Case No. JCCP No. 4343. The plaintiffs allege that some locked-out employeesRalphs violated various laws protecting consumers in connection with a promotion pursuant to which Ralphs offered travel awards to customers. The plaintiffs are seeking to certify a class of several hundred thousand customers who, they allege, were enabledharmed by Ralphs’ inability to workfulfill the promotion. In a separate action styledPeople v. Ralphs Grocery Co., San Diego County Superior Court, Case No. GIC 832986, the California Attorney General brought an action based on similar allegations. Ralphs agreed to and did resolve that matter to the satisfaction of the Attorney General in a Stipulation of Final Judgment providing relief for all customers who, to Ralphs knowledge, had qualified for and sought travel awards under false identities or false Social Security numbers, despite Company policy forbidding such conduct. A grand jury has convened to consider whether such acts violated federal criminal statutes. The Company is cooperatingthe promotion. Despite having resolved the litigation with the investigation, and it is too early to determine whether charges will be filed or what potential penaltiesAttorney General, the Company cannot predict the outcome ofThe Great Escape Promotion Cases nor the dollar amount of damages for which Ralphs may face. In addition, these alleged practicesbe found additionally liable. Based on the information presently available to the Company, however, management does not believe the ultimate outcome will have a material effect on the Company’s financial condition.
Other matters are the subject of claims that Ralphs’ conduct of the lockout was unlawful, and that Ralphs should be liabledescribed under the National Labor Relations Act (“NLRA”). The Los Angeles Regional Office ofheading “Legal Proceedings” in the National Labor Relations Board (“NLRB”) has notifiedCompany’s Annual Report on Form 10-K for the charging parties that all charges alleging that Ralphs’ lockout violated the NLRA have been dismissed. The charging parties have appealed that decision to the General Counsel of the NLRB.fiscal year ended January 29, 2005.
Various claims and lawsuits arising in the normal course of business, including suits charging violations of certain antitrust and civil rights laws, are pending against the Company. Some of these suits purport or have been determined to be class actions and/or seek substantial damages. Any damages that may be awarded in an antitrust casescase will be automatically trebled. Although it is not possible at this time to evaluate the merits of all these claims and lawsuits, nor their likelihood of success, the Company is of the opinionbelief that any resulting liability will not have a material adverse effect on the Company’s financial position.
The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made adequate provisions therefore. Nonetheless, assessing and predicting the outcomes of these matters involves substantial uncertainties. It remains possible that despite management’s current belief, material differences in actual outcomes or changes in management’s evaluation or predictions could arise that could have a material adverse effect on the Company’s financial condition or results of operation.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) | On |
(b)(c)
Period(1) | Total Number of Shares Repurchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Maximum (in millions) | Total Number of Shares Repurchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Maximum (in millions) | ||||||||||||
First four weeks | ||||||||||||||||||||
August 15, 2004 to September 11, 2004 | — | $ | — | — | $ | 21 | ||||||||||||||
January 30, 2005 to February 26, 2005 | 975,000 | $ | 17.38 | 975,000 | $ | 336 | ||||||||||||||
Second four weeks | ||||||||||||||||||||
September 12, 2004 to October 9, 2004 | 1,107,100 | $ | 15.70 | 1,107,100 | $ | 487 | ||||||||||||||
February 27, 2005 to March 26, 2005 | 1,825,000 | $ | 16.34 | 1,825,000 | $ | 306 | ||||||||||||||
Third four weeks | ||||||||||||||||||||
October 10, 2004 to November 6, 2004 | 4,336,471 | $ | 15.05 | 4,335,500 | $ | 422 | ||||||||||||||
March 27, 2005 to April 23, 2005 | 3,325,000 | $ | 15.73 | 3,325,000 | $ | 254 | ||||||||||||||
Fourth four weeks | ||||||||||||||||||||
April 24, 2005 to May 21, 2005 | 3,380,000 | $ | 15.85 | 2,905,000 | $ | 208 | ||||||||||||||
Total | 5,443,571 | $ | 15.18 | 5,442,600 | $ | 422 | 9,505,000 | $ | 16.06 | 9,030,000 | $ | 208 |
(1) | The reported periods conform to the Company’s fiscal calendar composed of thirteen 28-day periods. The |
(2) | Shares were repurchased under (i) a $500 million stock repurchase program, authorized by the Board of Directors on |
(3) | Amounts shown in this column reflect amounts remaining under the $500 million stock repurchase |
Item 6. Exhibits and ReportsExhibits.
EXHIBIT 3.1 - Amended Articles of Incorporation of the Company are hereby incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 8-K.10-Q for the quarter ended October 3, 1998. The Company’s Regulations are incorporated by reference to Exhibit 4.2 of the Company’s Registration Statement on Form S-3 as filed with the Securities and Exchange Commission on January 28, 1993, and bearing Registration No. 33-57552.
EXHIBIT 4.1 - Instruments defining the rights of holders of long-term debt of the Company and its subsidiaries are not filed as Exhibits because the amount of debt under each instrument is less than 10% of the consolidated assets of the Company. The Company undertakes to file these instruments with the Commission upon request.
EXHIBIT 31.1 – Rule 13a–14(a) / 15d–14(a) Certifications – Chief Executive Officer
EXHIBIT 31.2 – Rule 13a–14(a) / 15d–14(a) Certifications – Chief Financial Officer
EXHIBIT 32.1 – Section 1350 Certifications
EXHIBIT 99.1 - Additional Exhibits - Statement of Computation of Ratio of Earnings to Fixed Charges.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
THE KROGER CO.
THE KROGER CO. | ||||
Dated: | By: | /s/ David B. Dillon | ||
David B. Dillon | ||||
Chairman of the Board and Chief Executive Officer | ||||
Dated: | By: | /s/ J. Michael Schlotman | ||
J. Michael Schlotman | ||||
Senior Vice President and Chief Financial Officer |
Exhibit Index
Exhibit 3.1 - | Amended Articles of Incorporation of the Company are hereby incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended October 3, 1998. The Company’s Regulations are incorporated by reference to Exhibit 4.2 of the Company’s Registration Statement on Form S-3 as filed with the Securities and Exchange Commission on January 28, 1993, and bearing Registration No. 33-57552. | |
Exhibit 4.1 - | Instruments defining the rights of holders of long-term debt of the Company and its subsidiaries are not filed as Exhibits because the amount of debt under each instrument is less than 10% of the consolidated assets of the Company. The Company undertakes to file these instruments with the Commission upon request. | |
Exhibit 31.1 - | Rule 13a–14(a) / 15d–14(a) Certifications – Chief Executive Officer | |
Exhibit 31.2 - | Rule 13a–14(a) / 15d–14(a) Certifications – Chief Financial Officer | |
Exhibit 32.1 - | Section 1350 Certifications | |
Exhibit 99.1 - | Additional Exhibits - Statement of Computation of Ratio of Earnings to Fixed Charges. |