UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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 5, 2005May 20, 2006
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto ____to____
Commission file number 1-303 |
Commission file number 1-303
THE KROGER CO.
(Exact name of registrant as specified in its charter)
THE KROGER CO. | ||
Ohio | 31-0345740 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) |
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) | ||
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. YesxNo¨o.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, (as definedor a non-accelerated. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). Yes xAct. (Check one): No ¨.
Large accelerated filerx | Accelerated filero | Non-accelerated filero |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨oNox.
There were 725,483,410 shares of Common Stock ($1 par value) outstanding as of December 9, 2005.
There were 722,514,243 shares of Common Stock ($1 par value) outstanding as of June 23, 2006. |
PART I - FINANCIAL INFORMATION
PART I - FINANCIAL INFORMATION |
Item 1. Financial Statements.
THE KROGER CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts)
(unaudited)
(unaudited)
Third Quarter Ended | Three Quarters Ended | |||||||||||
November 5, 2005 | November 6, 2004 | November 5, 2005 | November 6, 2004 | |||||||||
Sales | $ | 14,020 | $ | 12,854 | $ | 45,833 | $ | 42,739 | ||||
Merchandise costs, including advertising, warehousing, and transportation, excluding items shown separately below | 10,596 | 9,639 | 34,503 | 31,883 | ||||||||
Operating, general and administrative | 2,556 | 2,433 | 8,380 | 8,075 | ||||||||
Rent | 166 | 158 | 514 | 525 | ||||||||
Depreciation and amortization | 287 | 287 | 969 | 949 | ||||||||
Operating Profit | 415 | 337 | 1,467 | 1,307 | ||||||||
Interest expense | 114 | 117 | 394 | 442 | ||||||||
Earnings before income tax expense | 301 | 220 | 1,073 | 865 | ||||||||
Income tax expense | 116 | 77 | 397 | 317 | ||||||||
Net earnings | $ | 185 | $ | 143 | $ | 676 | $ | 548 | ||||
Net earnings per basic common share | $ | 0.26 | $ | 0.19 | $ | 0.93 | $ | 0.74 | ||||
Average number of common shares used in basic calculation | 724 | 736 | 725 | 738 | ||||||||
Net earnings per diluted common share | $ | 0.25 | $ | 0.19 | $ | 0.92 | $ | 0.73 | ||||
Average number of common shares used in diluted calculation | 732 | 742 | 731 | 746 |
First Quarter Ended | ||||||
May 20, 2006 | May 21, 2005 | |||||
Sales | $ | 19,415 | $ | 17,948 | ||
Merchandise costs, including advertising, warehousing, and transportation, | ||||||
excluding items shown separately below | 14,659 | 13,443 | ||||
Operating, general and administrative | 3,528 | 3,295 | ||||
Rent | 196 | 203 | ||||
Depreciation and amoritzation | 388 | 389 | ||||
Operating profit | 644 | 618 | ||||
Interest expense | 155 | 159 | ||||
Earnings before income tax expense | 489 | 459 | ||||
Income tax expense | 183 | 165 | ||||
Net earnings | $ | 306 | $ | 294 | ||
Net earnings per basic common share | $ | 0.42 | $ | 0.40 | ||
Average number of common shares used in basic calculation | 722 | 727 | ||||
Net earnings per diluted share | $ | 0.42 | $ | 0.40 | ||
Average number of common shares used in diluted calculation | 729 | 732 |
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)
(unaudited)
November 5, 2005 | January 29, 2005 | |||||||
ASSETS | ||||||||
Current assets | ||||||||
Cash – In stores | $ | 137 | $ | 144 | ||||
Cash – Temporary cash investments | 100 | — | ||||||
Total Cash | 237 | 144 | ||||||
Deposits in-transit | 562 | 506 | ||||||
Receivables | 664 | 661 | ||||||
Receivables - Taxes | — | 167 | ||||||
FIFO Inventory | 5,186 | 4,729 | ||||||
LIFO Credit | (400 | ) | (373 | ) | ||||
Prefunded employee benefits | — | 300 | ||||||
Property held for sale | 98 | 23 | ||||||
Prepaid and other current assets | 226 | 249 | ||||||
Total current assets | 6,573 | 6,406 | ||||||
Property, plant and equipment, net | 11,381 | 11,497 | ||||||
Goodwill | 2,192 | 2,191 | ||||||
Other assets and investments | 431 | 397 | ||||||
Total Assets | $ | 20,577 | $ | 20,491 | ||||
LIABILITIES | ||||||||
Current liabilities | ||||||||
Current portion of long-term debt, at face value, including obligations under capital leases and financing obligations | $ | 639 | $ | 71 | ||||
Accounts payable | 3,763 | 3,598 | ||||||
Deferred income taxes | 267 | 267 | ||||||
Other current liabilities | 2,548 | 2,380 | ||||||
Total current liabilities | 7,217 | 6,316 | ||||||
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 | 6,596 | 7,830 | ||||||
Adjustment to reflect fair value interest rate hedges (Note 11) | 25 | 70 | ||||||
Long-term debt including obligations under capital leases and financing obligations | 6,621 | 7,900 | ||||||
Deferred income taxes | 879 | 939 | ||||||
Other long-term liabilities | 1,777 | 1,796 | ||||||
Total Liabilities | 16,494 | 16,951 | ||||||
Commitments and Contingencies (Note 10) | ||||||||
SHAREOWNERS’ EQUITY | ||||||||
Preferred stock, $100 par, 5 shares authorized and unissued | — | — | ||||||
Common stock, $1 par, 1,000 shares authorized: 926 shares issued in 2005 and 918 shares issued in 2004 | 926 | 918 | ||||||
Additional paid-in capital | 2,494 | 2,432 | ||||||
Accumulated other comprehensive loss | (199 | ) | (202 | ) | ||||
Accumulated earnings | 4,211 | 3,541 | ||||||
Common stock in treasury, at cost, 201 shares in 2005 and 190 shares in 2004 | (3,349 | ) | (3,149 | ) | ||||
Total Shareowners’ Equity | 4,083 | 3,540 | ||||||
Total Liabilities and Shareowners’ Equity | $ | 20,577 | $ | 20,491 | ||||
January 28, | |||||||
May 20, 2006 | 2006 | ||||||
ASSETS | |||||||
Current assets | |||||||
Cash - In stores | $ | 133 | $ | 147 | |||
Cash - Temporary cash investments | 526 | 63 | |||||
Total cash | 659 | 210 | |||||
Deposits in-transit | 523 | 488 | |||||
Receivables | 696 | 686 | |||||
FIFO inventory | 4,855 | 4,886 | |||||
LIFO credit | (410 | ) | (400 | ) | |||
Prefunded employee benefits | 22 | 300 | |||||
Prepaid and other current assets | 311 | 296 | |||||
Total current assets | 6,656 | 6,466 | |||||
Property, plant and equipment, net | 11,402 | 11,365 | |||||
Goodwill | 2,192 | 2,192 | |||||
Other assets | 485 | 459 | |||||
Total Assets | $ | 20,735 | $ | 20,482 | |||
LIABILITIES | |||||||
Current liabilities | |||||||
Current portion of long-term debt including obligations under capital leases and financing | |||||||
obligations | $ | 743 | $ | 554 | |||
Accounts payable | 3,564 | 3,550 | |||||
Accrued salaries and wages | 635 | 742 | |||||
Deferred income taxes | 217 | 217 | |||||
Other current liabilities | 1,950 | 1,652 | |||||
Total current liabilities | 7,109 | 6,715 | |||||
Long-term debt including obligations under capital leases and financing obligations | |||||||
Face-value long-term debt including obligations under capital leases and financing | |||||||
obligations | 6,431 | 6,651 | |||||
Adjustment to reflect fair-value interest rate hedges | 12 | 27 | |||||
Long-term debt including obligations under capital leases and financing obligations | 6,443 | 6,678 | |||||
Deferred income taxes | 834 | 843 | |||||
Other long-term liabilities | 1,745 | 1,856 | |||||
Total Liabilities | 16,131 | 16,092 | |||||
Commitments and contingencies | |||||||
SHAREOWNERS' EQUITY | |||||||
Preferred stock, $100 par, 5 shares authorized and unissued | - | - | |||||
Common stock, $1 par, 1,000 shares authorized; 931 shares issued in 2006 and 927 shares | |||||||
issued in 2005 | 931 | 927 | |||||
Additional paid-in capital | 2,599 | 2,536 | |||||
Accumulated other comprehensive loss | (225 | ) | (243 | ) | |||
Accumulated earnings | 4,832 | 4,573 | |||||
Common stock in treasury, at cost, 211 shares in 2006 and 198 shares in 2005 | (3,533 | ) | (3,403 | ) | |||
Total Shareowners' Equity | 4,604 | 4,390 | |||||
Total Liabilities and Shareowners' Equity | $ | 20,735 | $ | 20,482 |
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 | ||||||||
November 5, 2005 | November 6, 2004 | |||||||
Cash Flows From Operating Activities: | ||||||||
Net earnings | $ | 676 | $ | 548 | ||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 969 | 949 | ||||||
LIFO charge | 27 | 31 | ||||||
Deferred income taxes | (62 | ) | 143 | |||||
Other | 35 | 34 | ||||||
Changes in operating assets and liabilities net of effects from acquisitions of businesses: | ||||||||
Inventories | (457 | ) | (492 | ) | ||||
Receivables | (3 | ) | 20 | |||||
Deposits in-transit | (56 | ) | 12 | |||||
Prepaid expenses | 321 | 314 | ||||||
Accounts payable | 344 | 331 | ||||||
Accrued expenses | 122 | (60 | ) | |||||
Accrued income taxes | 346 | 153 | ||||||
Contribution to company-sponsored pension plans | (300 | ) | (35 | ) | ||||
Long-term liabilities | 87 | 100 | ||||||
Net cash provided by operating activities | 2,049 | 2,048 | ||||||
Cash Flows From Investing Activities: | ||||||||
Capital expenditures, excluding acquisitions | (1,011 | ) | (1,280 | ) | ||||
Proceeds from sale of assets | 61 | 58 | ||||||
Other | (22 | ) | 7 | |||||
Net cash used by investing activities | (972 | ) | (1,215 | ) | ||||
Cash Flows From Financing Activities: | ||||||||
Proceeds from issuance of long-term debt | 13 | — | ||||||
Payments on long-term debt | (61 | ) | (777 | ) | ||||
Borrowings (payments) on bank revolver | (629 | ) | 263 | |||||
Financing charges incurred | — | (5 | ) | |||||
Debt prepayment costs | — | (25 | ) | |||||
Decrease in book overdrafts | (181 | ) | (102 | ) | ||||
Proceeds from issuance of capital stock | 76 | 33 | ||||||
Treasury stock purchases | (202 | ) | (249 | ) | ||||
Net cash used by financing activities | (984 | ) | (862 | ) | ||||
Net increase (decrease) in cash and temporary cash investments | 93 | (29 | ) | |||||
Cash and temporary cash investments: | ||||||||
Beginning of year | 144 | 159 | ||||||
End of quarter | $ | 237 | $ | 130 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid during the year for interest | $ | 442 | $ | 516 | ||||
Cash paid during the year for income taxes | $ | 112 | $ | 4 |
Quarter Ended | |||||||
May 20, | May 21, | ||||||
2006 | 2005 | ||||||
Cash Flows from Operating Activities | |||||||
Net earnings | $ | 306 | $ | 294 | |||
Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||
Depreciation and amortization | 388 | 389 | |||||
LIFO charge | 10 | 11 | |||||
Stock option expense | 22 | 3 | |||||
Pension expense for Company-sponsored plans | 49 | 43 | |||||
Deferred income taxes | (19 | ) | (20 | ) | |||
Gain on sale of property | (7 | ) | (5 | ) | |||
Other | 58 | 20 | |||||
Changes in operating assets and liabilities net of effects from acquisitions | |||||||
of businesses | |||||||
Store deposits in-transit | (35 | ) | (15 | ) | |||
Receivables | (16 | ) | 45 | ||||
Inventories | 32 | 53 | |||||
Prepaid expenses | 224 | 265 | |||||
Accounts payable | 68 | (135 | ) | ||||
Accrued expenses | (117 | ) | (59 | ) | |||
Income taxes receivable (payable) | 168 | 181 | |||||
Contribution to Company-sponsored pension plans | (150 | ) | (89 | ) | |||
Other | 3 | (8 | ) | ||||
Net cash provided by operating activities | 984 | 973 | |||||
Cash Flows from Investing Activities | |||||||
Payments for property and equipment | (420 | ) | (401 | ) | |||
Proceeds from sale of assets | 53 | 28 | |||||
Other | (3 | ) | (4 | ) | |||
Net cash used by investing activities | (370 | ) | (377 | ) | |||
Cash Flows from Financing Activities | |||||||
Proceeds from issuance of long-term debt | - | 6 | |||||
Payments on long-term debt | (25 | ) | (32 | ) | |||
Payments on bank revolver | - | (428 | ) | ||||
Financing charges incurred | (1 | ) | - | ||||
Proceeds from issuance of capital stock | 49 | 22 | |||||
Treasury stock purchases | (134 | ) | (153 | ) | |||
Decrease in book overdrafts | (54 | ) | (20 | ) | |||
Net cash used by financing activities | (165 | ) | (605 | ) | |||
Net increase (decrease) in cash and temporary cash investments | 449 | (9 | ) | ||||
Cash and temporary cash investments: | |||||||
Beginning of year | 210 | 144 | |||||
End of quarter | $ | 659 | $ | 135 | |||
Reconciliation of capital expenditures | |||||||
Payments for property and equipment | $ | (420 | ) | $ | (401 | ) | |
Changes in construction-in-progress payables | (30 | ) | - | ||||
Total capital expenditures | $ | (450 | ) | $ | (401 | ) | |
Disclosure of cash flow information | |||||||
Cash paid during the quarter for interest | $ | 179 | $ | 190 | |||
Cash paid during the quarter for income taxes | $ | 24 | $ | 5 |
The accompanying notes are an integral part of the Consolidated Financial Statements.
NOTESTO CONSOLIDATED FINANCIAL STATEMENTSOTES TO
CONSOLIDATEDFINANCIALSTATEMENTS
All amounts are in millions except per share amounts.
Certain prior-year amounts have been reclassified to conform to current-year presentation.
1. ACCOUNTINGPOLICIES
Basis of Presentation and Principles of Consolidation
The accompanying financial statements include the consolidated accounts of The Kroger Co. and its subsidiaries. The January 29, 200528, 2006 balance sheet was derived from audited financial statements and, due to its summary nature, does not include all disclosures required by generally 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 statementsConsolidated Financial Statements should be read in conjunction with the fiscal 20042005 Annual Report on Form 10-K of The Kroger Co. filed with the SEC on April 15, 2005, as amended.7, 2006.
The unaudited information included in the Consolidated Financial Statements for the thirdfirst quarter ended May 20, 2006 and three quarters ended November 5,May 21, 2005 and November 6, 2004 include the results of operations of the Company for the 12-week and 40-week16-week periods then ended.
Vendor Allowances Stock-Based Compensation Expense
TheEffective January 29, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R),Share-Based Payment, using the modified prospective transition method and, therefore, has not restated results for prior periods. Under this method, the Company recognizes compensation expense for all vendor allowancesshare-based payments granted after January 29, 2006, as a reductionwell as all share-based payments granted prior to, but not yet vested, as of January 29, 2006, in merchandise costs whenaccordance with SFAS No. 123(R). Under the related product is sold. In most cases, vendor allowances are appliedfair value recognition provisions of SFAS No. 123(R), the Company recognizes share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award. Prior to the related product by item,adoption of SFAS No. 123(R), the Company accounted for share-based payments under Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” and therefore reduce the carrying valuedisclosure provisions of inventory by item. When it is not practicable to allocate vendor allowancesSFAS No. 123. For further information regarding the adoption of SFAS No. 123(R), see Note 2 to the product by item, vendor allowances are recognized as a reduction in merchandise costs based on inventory turns and recognized as the product is sold.Consolidated Financial Statements.
Store Closing and 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 on Financial Accounting Standards (“SFAS”)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 that no longer is needed for its originally intended purpose, is adjusted to income in the 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 the Company’s policy on impairment of 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 Company recorded asset impairments in the normal course of business totaling $10 in the first quarter of 2006 and $8 in the first quarter of 2005.
The following table summarizes accrual activity for future lease obligations of stores closed in the normal course of business.
Future Lease Obligations | |||||||
2006 | 2005 | ||||||
Balance at beginning of year | $ | 65 | $ | 65 | |||
Additions | — | 5 | |||||
Payments | (2 | ) | (2 | ) | |||
Adjustments | — | (4 | ) | ||||
Balance at end of First Quarter | $ | 63 | $ | 64 |
Future Lease Obligations | ||||||||
2005 | 2004 | |||||||
Balance at beginning of year | $ | 65 | $ | 35 | ||||
Additions | 19 | 23 | ||||||
Payments | (11 | ) | (7 | ) | ||||
Adjustments | (4 | ) | 3 | |||||
Balance at end of Third Quarter | $ | 69 | $ | 54 |
In addition, the Company maintains a $54$52 liability for facility closure costs for locations closed in California prior to the Fred Meyer merger a $14 liability relating to a charitable contribution required as a result of the Fred Meyer merger and a $9an $8 liability for store closing costs related to two distinct, formalized plans that coordinated the closing of several locations over relatively short periods of time in 2000 and 2001.
2. STOCKOPTIONPLANS
ThePrior to January 29, 2006, the Company appliesapplied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”) and related interpretations, to accountin accounting for its stock option plans. plans and provided the required pro-forma disclosures of SFAS No. 123. APB No. 25 provided for recognition of compensation expense for employee stock awards based on the intrinsic value of the award on the grant date.
The Company grants options for common stock (“stock options”) to employees, as well as to its non-employee directors, under various plans at an option price equal to the fair market value of the stock at the date of grant. Although equity awards may be made throughout the year, it has been the Company’s practice typically to make a general annual grant in conjunction with the May meeting of its Board of Directors. Stock options generally expire 10 years from the date of grant. Accordingly,Stock options vest in one year to five years from the date of grant or, for certain stock options, the earlier of the Company’s stock reaching certain pre-determined market prices or nine years and six months from the date of grant. Under APB No. 25, the Company doesdid not record stock-basedrecognize compensation expense for these options.stock option grants. At May 20, 2006, approximately 17 shares of common stock were available for future options under these plans.
In addition to the stock options described above, the Company awards restricted stock to employees under various plans. The restrictions on these awards generally lapse in one year to five years from the date of the awards and expense is recognized over the lapsing cycle. As of May 20, 2006, approximately six shares of common stock were available for future restricted stock awards under the 2005 Long-Term Incentive Plan (the “Plan”). The Company also makeshas the ability to convert shares available for issuance under the Plan to shares available for restricted stock awards. CompensationFour shares available for other awards can be converted into one share available for restricted stock awards. Under APB No. 25, the Company generally recorded expense included in net earnings for restricted stock awards totaled approximately $1 and $1, after-tax, forin an amount equal to the third quartersfair market value of 2005 and 2004, respectively.the underlying stock on the date of award.
All awards become immediately exercisable upon certain changes of control of the Company.
Historically, stock option awards were granted to various employees throughout the organization. Restricted stock expense totaled $4awards, however, were limited to approximately 150 associates, including members of the Board of Directors and $6, after-tax, forcertain members of senior management. Beginning in 2006, the first three quartersCompany began issuing a combination of 2005stock option and 2004, respectively. Therestricted stock awards to those employees who previously received only stock option awards, in an effort to further align those employees’ interests with those of the Company’s non-employee shareholders. As a result, the number of stock option awards granted in 2006 decreased and the number of restricted stock awards granted increased.
Changes in options outstanding under the stock option plans are more fully described insummarized below.
Stock Options
Shares subject | Weighted-average | ||||
to option | exercise price | ||||
Outstanding, year-end 2005 | 59.3 | $ | 19.03 | ||
Granted | 3.1 | $ | 19.94 | ||
Exercised | (4.3 | ) | $ | 11.21 | |
Canceled or Expired | (0.3 | ) | $ | 20.78 | |
Outstanding, May 20, 2006 | 57.8 | $ | 19.66 |
A summary of stock options outstanding and exercisable at May 20, 2006 follows:
Weighted- | ||||||||||||
average | ||||||||||||
remaining | Weighted- | Weighted- | ||||||||||
Number | contractual life | average | Options | average | ||||||||
Range of exercise prices | outstanding | (in years) | exercise price | exercisable | exercise price | |||||||
$ 7.10 - $14.93 | 11.1 | 4.40 | $ | 14.11 | 9.5 | $ | 13.97 | |||||
$14.94 - $16.39 | 6.6 | 8.86 | $ | 16.35 | 2.4 | $ | 16.32 | |||||
$16.40 - $17.31 | 11.5 | 6.02 | $ | 16.97 | 8.1 | $ | 16.90 | |||||
$17.32 - $23.00 | 15.5 | 5.24 | $ | 21.66 | 9.8 | $ | 22.05 | |||||
$23.01 - $31.91 | 13.1 | 3.79 | $ | 26.06 | 11.1 | $ | 26.06 | |||||
$ 7.10 - $31.91 | 57.8 | 5.32 | $ | 19.66 | 40.9 | $ | 19.90 |
The weighted-average remaining contractual life for options exercisable was approximately 4.6 years.
Restricted Stock
Restricted | Weighted- | ||||
shares | average grant- | ||||
outstanding | date fair value | ||||
Outstanding, year-end 2005 | 0.7 | $ | 17.85 | ||
Granted | 2.1 | $ | 19.93 | ||
Lapsed | (0.1 | ) | $ | 17.86 | |
Canceled or Expired | — | $ | — | ||
Outstanding, May 20, 2006 | 2.7 | $ | 19.46 |
Adoption of SFAS No. 123(R)
Effective January 29, 2006, the Company’s fiscal 2004 Annual Report on Form 10-K.
The following table illustratesCompany adopted the effect on net earnings, net earnings per basic common share and net earnings per diluted common share as ifprovisions of SFAS No. 123(R),Share-Based Payment, using the modified-prospective application method. Under this method, the Company recognized compensation costexpense for the first quarter ended May 20, 2006 for all options had been determinedshare-based awards granted prior to, but not yet vested as of January 29, 2006 based on the grant date fair market value recognition provisionestimated in accordance with the original provisions of SFAS No. 123,Accounting for Stock-Based Compensation. For all share-based awards granted on or after January 29, 2006, the Company recognized compensation expense based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R).
Third Quarter | Year-To-Date | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Net earnings, as reported | $ | 185 | $ | 143 | $ | 676 | $ | 548 | ||||||||
Add: Stock-based compensation expense included in net earnings, net of income tax benefits | 1 | 1 | 4 | 6 | ||||||||||||
Subtract: Total stock-based compensation expense determined under fair value method for all awards, net of income tax benefits | (9 | ) | (10 | ) | (26 | ) | (35 | ) | ||||||||
Pro forma net earnings | $ | 177 | $ | 134 | $ | 654 | $ | 519 | ||||||||
Net earnings per basic common share, as reported | $ | 0.26 | $ | 0.19 | $ | 0.93 | $ | 0.74 | ||||||||
Pro forma earnings per basic common share | $ | 0.25 | $ | 0.18 | $ | 0.90 | $ | 0.70 | ||||||||
Net earnings per diluted common share, as reported | $ | 0.25 | $ | 0.19 | $ | 0.92 | $ | 0.73 | ||||||||
Pro forma earnings per diluted common share | $ | 0.24 | $ | 0.18 | $ | 0.89 | $ | 0.70 |
To calculate pro forma stock-based compensation,In accordance with the Company estimatedprovisions of the modified-prospective application method, results for prior periods have not been restated. Compensation expense for all share-based awards described above was recognized using the straight-line attribution method applied to the fair value of each option grant, over the requisite service period associated with each award. The requisite service period is typically consistent with the vesting period, except as noted below. Because awards typically vest evenly over the requisite service period, compensation cost recognized through May 20, 2006 is at least equal to the grant-date fair value of the vested portion of all outstanding options. All of the Company’s stock-based incentive plans are considered equity plans under SFAS No. 123(R).
The weighted-average fair value of stock options granted during the first quarters ended May 20, 2006 and May 21, 2005, was $6.90 and $7.70, respectively. The fair value of each stock option grant was estimated on the date of the grant using the Black-Scholes option-pricing model, based on the assumptions shown in the table below. The Black-Scholes model utilizes extensive accounting judgment and financial estimates, including the term employees are expected to retain their stock options before exercising them, the volatility of the Company’s stock price over that expected term, the dividend yield over the term, and the number of awards expected to be forfeited before they vest. Using alternative assumptions in the calculation of fair value would produce fair values for stock option pricing model withgrants that could be different than those used to record stock-based compensation expense in the Consolidated Statement of Operations.
The following table reflects the weighted average assumptions used for grants in 2005 and 2004.awarded to option holders:
2006 | 2005 | ||
Risk-free interest rate | 5.07% | 4.11% | |
Expected dividend yield | 1.50% | N/A | |
Expected volatility | 27.60% | 30.83% | |
Expected term | 7.50 Years | 8.70 Years |
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 |
The weighted average fair value of options granted during 2005 and 2004 was $7.64 per share granted and $7.91 per share granted, respectively. The Company uses a risk-free interest rate was based uponon the yield of a treasury note maturingas of the grant date, continuously compounded, which matures at a date that approximates the option’s expected term.term of the options. During the years presented, prior to 2006, the Company did not pay a dividend, so an expected dividend rate was not included in the determination of fair value for options granted during fiscal year 2005. Using a dividend yield of 1.50% to value options issued in 2005 would have decreased the fair value of each option by approximately $1.60. Expected volatility was determined based upon historical stock volatilities. Implied volatility was also considered. Expected term was determined based upon a combination of historical exercise and cancellation experience as well as estimates of expected future exercise and cancellation experience.
Total stock compensation recognized in the quarter ended May 20, 2006 was $22, pre-tax. This included $19 related to stock options and $3 related to restricted shares. A total of $1 of the restricted stock expense was attributable to the wider distribution of restricted shares incorporated into the first quarter 2006 grant of share-based awards, and the remaining $2 of restricted stock expense related to previously issued restricted stock. As a result, the incremental compensation expense attributable to the adoption of SFAS No. 123(R) in the first quarter of 2006 was $20, pre-tax, or $13 and $0.02 per basic and diluted share, after tax. Stock compensation expense recognized in the quarter ended May 21, 2005, related entirely to restricted stock grants, was $3. These costs were recognized as operating, general and administrative costs in the Company’s Consolidated Statement of Operations for the quarters ended May 20, 2006 and May 21, 2005. The cumulative effect of applying a forfeiture rate to unvested restricted shares at January 29, 2006 was not material. The pro forma earnings effect of stock options in the prior year, in accordance with SFAS No. 123, is described below.
If compensation cost for the Company’s stock option plans for the first quarter ended May 21, 2005 had been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS No. 123, the Company’s net earnings and diluted earnings per common share would have been reduced to the pro forma amounts below:
First Quarter | |||
2005 | |||
Net earnings, as reported | $ | 294 | |
Add: Stock-based compensation expense included in net earnings, net of income tax benefits | 2 | ||
Subtract: Total stock-based compensation expense determined under fair value method for all awards, net of income tax benefits | (8 | ) | |
Pro forma net earnings | $ | 288 | |
Net earnings per basic common share, as reported | $ | 0.40 | |
Pro forma earnings per basic common share | $ | 0.40 | |
Net earnings per diluted common share, as reported | $ | 0.40 | |
Pro forma earnings per diluted common share | $ | 0.39 |
The total intrinsic value of options exercised in the first quarter of 2006 was $14. The total amount of cash received from the exercise of options granted under share-based payment arrangements was $48. As of May 20, 2006, there was $134 of total unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under the Company’s stock option plans. This cost is expected to be recognized over a weighted-average period of approximately 2 years. The total fair value of options that vested during the quarter was $34 for each of the quarters ended May 20, 2006 and May 21, 2005.
Shares issued as a result of stock option exercises may be newly issued shares or reissued treasury shares. Proceeds received from the exercise of stock options, and the related tax benefit, are utilized to repurchase shares of the Company’s stock. During the first quarter of 2006, the Company repurchased approximately 0.7 shares of stock in such a manner.
The Company’s stock option grants generally contain retirement-eligibility provisions allowing employees to retire and retain their awards. For share-based awards granted prior to the adoption of SFAS No. 123(R), compensation expense was calculated over the stated vesting periods, regardless of whether certain employees became retirement-eligible during the respective vesting periods. Upon the adoption of SFAS No. 123(R), the Company will continue this method of recognizing compensation expense for those awards granted prior to the adoption of SFAS No. 123(R). However, for awards granted on or after January 29, 2006, the Company will recognize expense for stock option grants containing retirement-eligibility provisions over the shorter of the vesting period or the period until employees become retirement-eligible. As a result of retirement-eligibility provisions in stock option awards granted in 2006, approximately $6 of compensation cost was recognized prior to the completion of stated vesting periods.
3. DEBTOBLIGATIONS
Long-term debt consists of:
May 20, | January 28, | ||||||
2006 | 2006 | ||||||
Credit Facility and Commercial Paper borrowings | $ | — | $ | — | |||
4.95% to 8.92% Senior Notes and Debentures due through 2031 | 6,390 | 6,390 | |||||
5.00% to 9.95% mortgages due in varying amounts through 2017 | 174 | 179 | |||||
Other | 166 | 178 | |||||
Total debt, excluding capital leases and financing obligations | 6,730 | 6,747 | |||||
Less current portion | (716 | ) | (527 | ) | |||
Total long-term debt, excluding capital leases and financing obligations | $ | 6,014 | $ | 6,220 |
November 5, 2005 | January 29, 2005 | |||||||
Credit Facility and Commercial Paper borrowings | $ | 65 | $ | 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 | 213 | 218 | ||||||
Other | 177 | 202 | ||||||
Total debt, excluding capital leases and financing obligations | 6,846 | 7,505 | ||||||
Less current portion | (613 | ) | (46 | ) | ||||
Total long-term debt, excluding capital leases and financing obligations | $ | 6,233 | $ | 7,459 | ||||
4. COMPREHENSIVEINCOME
Comprehensive income is as follows:
Third Quarter Ended | Year-To-Date | |||||||||||
November 5, 2005 | November 6, 2004 | November 5, 2005 | November 6, 2004 | |||||||||
Net earnings | $ | 185 | $ | 143 | $ | 676 | $ | 548 | ||||
Unrealized gain (loss) on hedging activities, net of tax(1) | 1 | — | 3 | — | ||||||||
Comprehensive income | $ | 186 | $ | 143 | $ | 679 | $ | 548 | ||||
First Quarter Ended | |||||
May 20, 2006 | May 21,2005 | ||||
Net earnings | $ | 306 | $ | 294 | |
Unrealized gain on hedging activities, net of tax(1) | 18 | 1 | |||
Comprehensive income | $ | 324 | $ | 295 |
(1) | Amount is net of tax of $11 for the first quarter of 2006 and $1 for the |
During 2006 and 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.
5. BENEFITPLANS
The following table provides the components of net periodic benefit costs for the Company-sponsored pension plans and other post-retirement benefits for the third quarter of 2005 and 2004.
Third Quarter | ||||||||||||||||
Pension Benefits | Other Benefits | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||
Service cost | $ | 26 | $ | 26 | $ | 3 | $ | 3 | ||||||||
Interest cost | 27 | 26 | 5 | 5 | ||||||||||||
Expected return on plan assets | (31 | ) | (28 | ) | — | — | ||||||||||
Amortization of: | ||||||||||||||||
Transition asset | — | — | — | — | ||||||||||||
Prior service cost | 1 | 1 | (2 | ) | (2 | ) | ||||||||||
Actuarial (gain) loss | 7 | 2 | — | — | ||||||||||||
Net periodic benefit cost | $ | 30 | $ | 27 | $ | 6 | $ | 6 | ||||||||
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 quartersquarter of 20052006 and 2004:2005.
First Quarter | |||||||||||||||
Pension Benefits | Other Benefits | ||||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||||
Components of net periodic benefit cost: | |||||||||||||||
Service cost | $ | 41 | $ | 38 | $ | 4 | $ | 3 | |||||||
Interest cost | 41 | 37 | 6 | 6 | |||||||||||
Expected return on plan assets | (47 | ) | (39 | ) | — | — | |||||||||
Amortization of: | |||||||||||||||
Prior service cost | 2 | 2 | (2 | ) | (2 | ) | |||||||||
Actuarial (gain) loss | 12 | 8 | — | — | |||||||||||
Net periodic benefit cost | $ | 49 | $ | 46 | $ | 8 | $ | 7 |
Year-To-Date | ||||||||||||||||
Pension Benefits | Other Benefits | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
Components of net periodic benefit cost: | ||||||||||||||||
Service cost | $ | 92 | $ | 85 | $ | 9 | $ | 8 | ||||||||
Interest cost | 92 | 87 | 16 | 17 | ||||||||||||
Expected return on plan assets | (100 | ) | (94 | ) | — | — | ||||||||||
Amortization of: | ||||||||||||||||
Transition asset | — | — | — | — | ||||||||||||
Prior service cost | 4 | 4 | (6 | ) | (5 | ) | ||||||||||
Actuarial (gain) loss | 21 | 7 | 1 | — | ||||||||||||
Net periodic benefit cost | $ | 109 | $ | 89 | $ | 20 | $ | 20 | ||||||||
The Company contributed $300$150 to the Company-sponsored pension plans in the first three quartersquarter of 2005 and may elect to make additional contributions during 2005 in order to maintain its desired funding status.2006.
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, in accordance with SFAS No. 87,Employers’ Accounting for Pensions.
6. INCOMETAXES
The effective income tax rate was 37.0%37.4% for the first three quartersquarter of 20052006 and 36.7%35.9% for the first three quartersquarter of 2004. In addition2005. The 2006 effective income tax rated differed from the federal statutory rate due to the effect of state taxes, thetaxes. The 2005 effective income tax rate differed from the federal statutory rate due to the effect of state taxes and a reduction ofin previously recorded tax contingency allowances resulting from a revision of the required allowances based on resolutions with tax authorities during the quarters and the third quarter effect of certain legal expenses that were not deductible for tax purposes.
7. EARNINGSPERCOMMONSHARE
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 net earnings and shares used in calculating earnings per basic common share to those used in calculating earnings per diluted common share:
First Quarter Ended | First Quarter Ended | ||||||||||||||
May 20, 2006 | May 21, 2005 | ||||||||||||||
Earnings | Shares | Per Share | Earnings | Shares | Per Share | ||||||||||
(Numerator) | (Denominator) | Amount | (Numerator) | (Denominator) | Amount | ||||||||||
Earnings per basic common share | $ | 306 | 722 | $ | 0.42 | $ | 294 | 727 | $ | 0.40 | |||||
Dilutive effect of stock options, | |||||||||||||||
restricted stock and warrants | 7 | 5 | |||||||||||||
Earnings per diluted common share | $ | 306 | 729 | $ | 0.42 | $ | 294 | 732 | $ | 0.40 |
Third Quarter Ended November 5, 2005 | Third Quarter Ended November 6, 2004 | |||||||||||||||
Earnings (Numerator) | Shares (Denominator) | Per Share Amount | Earnings (Numerator) | Shares (Denominator) | Per Share Amount | |||||||||||
Earnings per basic common share | $ | 185 | 724 | $ | 0.26 | $ | 143 | 736 | $ | 0.19 | ||||||
Dilutive effect of stock options and warrants | 8 | 6 | ||||||||||||||
Earnings per diluted common share | $ | 185 | 732 | $ | 0.25 | $ | 143 | 742 | $ | 0.19 | ||||||
Three Quarters Ended November 5, 2005 | Three Quarters Ended November 6, 2004 | |||||||||||||||
Earnings (Numerator) | Shares (Denominator) | Per Share Amount | Earnings (Numerator) | Shares (Denominator) | Per Share Amount | |||||||||||
Earnings per basic common share | $ | 676 | 725 | $ | 0.93 | $ | 548 | 738 | $ | 0.74 | ||||||
Dilutive effect of stock options and warrants | 6 | 8 | ||||||||||||||
Earnings per diluted common share | $ | 676 | 731 | $ | 0.92 | $ | 548 | 746 | $ | 0.73 | ||||||
The Company had options outstanding for approximately 2433 shares and 39 shares during the third quartersfirst quarter of 20052006 and 2004,2005, 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 2005 and 2004, the Company had options outstanding for approximately 25 and 31 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.
8. RECENTLYISSUEDACCOUNTING STANDARDS
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (Revised 2004),Share-Based Payment (“SFAS No. 123R”), which replaces SFAS No. 123, supersedes APB No. 25 and related interpretations and amends SFAS No. 95Statement 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 adoption of SFAS No. 123R, the Company is accounting for share-based compensation expense under the recognition and measurement provisions of APB No. 25, “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. 123R 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 expects the adoption to reduce net earnings by $0.04-$0.06 per diluted share during fiscal 2006.
In November 2004, the FASB 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 include costs of idle facilities, excess freight and handling costs and spoilage. SFAS No. 151 will becomebecame effective for the Company’s fiscal year beginning January 29, 2006. The adoption of SFAS No. 151 isdid not expected to have a material effect on the Company’s Consolidated Financial Statements.
In May 2005,February 2006, the FASB issued SFASStaff Position (“FSP”) No. 154,Accounting Changes123(R)-4, “Classification of Options and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods financial statementsSimilar Instruments Issued as Employee Compensation that Allow for changes in accounting principle, unless it is impracticable to determine eitherCash Settlement upon the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective applicationOccurrence of a change in accounting principle be limited toContingent Event.” FSP No. 123(R)-4 addresses the direct effectsclassification of options and similar instruments issued as employee compensation that allow for cash settlement upon the change. Indirect effectsoccurrence of a change in accounting principle shouldcontingent event. FSP No. 123(R)-4 provides that cash settlement features that can be recognized inexercised only upon the periodoccurrence of a contingent event that is outside the accounting change. SFAS No. 154 further requires a change in depreciation, amortizationemployee’s control does not require classifying the option or depletion method for long-lived, non-financial assets to be accounted forsimilar instrument as a change in accounting estimate effected by a change in accounting principle. SFASliability until it becomes probable that the event will occur. The Company adopted the provisions of FSP No. 154 will become effective for123(R)-4 during the Company’s fiscal year beginning January 29,first quarter of 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 the Company’s Consolidated Financial Statements.
In June 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased After Lease Inception or Acquired in a Business Combination.” EITF No. 05-6 requires that leasehold improvements acquired in a business combination be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals deemed to be reasonably assured at the date of acquisition. EITF No. 05-6 further requires that leasehold improvements that are placed into service significantly after and not contemplated at or near the beginning of the lease term shall be amortized over the shorter of the useful life of the assets or a term that includes the required lease periods and renewals deemed to be reasonably assured at the date of acquisition. EITF No. 05-6 became effective for the Company’s fiscal quarter beginning August 14, 2005. The adoption of EITF No. 05-6 did not have a material effect on the Company’s Consolidated Financial Statements.
In October 2005, the FASB issued FASB Staff Position FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period” (“FSP FAS 13-1”). FSP FAS 13-1 requires rental costs associated with building or ground leases incurred during a construction period to be recognized as rental expense and is effective for the first reporting period beginning after December 15, 2005. In addition, FSP FAS 13-1 requires lessees to cease capitalizing rental costs as of December 15, 2005 for operating lease agreements entered into prior to December 15, 2005. Early adoption is permitted. The Company was already in compliance with the provisions of FSP FAS 13-1, therefore it will have no effect on the Company’s Consolidated Financial Statements.9. GUARANTORSUBSIDIARIES
9. 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 5, 2005,May 20, 2006, a total of approximately $6.3 billion of Guaranteed Notes were outstanding. The Guarantor Subsidiaries and non-guarantor subsidiaries are direct or indirect wholly-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 representedrepresent less than 3% on an individual and aggregate basis of consolidated assets, pre-tax earnings, cash flow and equity. Therefore, the non-guarantor subsidiaries’ information is not separately presented in the tables below.
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 January 29, 200528, 2006 and for the third quartersfirst quarter ended May 20, 2006 and the three quarters ended, November 5, 2005 and November 6, 2004:May 21, 2005:
Condensed Consolidating
Balance Sheets
As of November 5, 2005May 20, 2006
The Kroger | Guarantor | |||||||||||
Co. | Subsidiaries | Eliminations | Consolidated | |||||||||
Current assets | ||||||||||||
Cash, including temporary cash investments | $ | 495 | $ | 164 | $ | — | $ | 659 | ||||
Deposits in-transit | 63 | 460 | — | 523 | ||||||||
Accounts receivable | 166 | 1,458 | (928 | ) | 696 | |||||||
Inventory, net | 448 | 3,995 | — | 4,443 | ||||||||
Prepaid and other current assets | 110 | 225 | — | 335 | ||||||||
Total current assets | 1,282 | 6,302 | (928 | ) | 6,656 | |||||||
Property, plant and equipment, net | 1,321 | 10,081 | — | 11,402 | ||||||||
Goodwill | 56 | 2,136 | — | 2,192 | ||||||||
Other assets and investments | 590 | 1,053 | (1,158 | ) | 485 | |||||||
Investment in and advances to subsidiaries | 11,659 | — | (11,659 | ) | — | |||||||
Total assets | $ | 14,908 | $ | 19,572 | $ | (13,745 | ) | $ | 20,735 | |||
Current liabilities | ||||||||||||
Current portion of long-term debt including obligations under capital | ||||||||||||
leases and financing obligations | $ | 743 | $ | — | $ | — | $ | 743 | ||||
Accounts payable | 1,424 | 4,226 | (2,086 | ) | 3,564 | |||||||
Other current liabilities | 78 | 2,724 | — | 2,802 | ||||||||
Total current liabilities | 2,245 | 6,950 | (2,086 | ) | 7,109 | |||||||
Long-term debt including obligations under capital leases and financing | ||||||||||||
obligations | ||||||||||||
Face value long-term debt including obligations under capital leases | ||||||||||||
and financing obligations | 6,431 | — | — | 6,431 | ||||||||
Adjustment to reflect fair value interest rate hedges | 12 | — | — | 12 | ||||||||
Long-term debt including obligations under capital leases and | ||||||||||||
financing obligations | 6,443 | — | — | 6,443 | ||||||||
Other long-term liabilities | 1,616 | 963 | — | 2,579 | ||||||||
Total liabilities | 10,304 | 7,913 | (2,086 | ) | 16,131 | |||||||
Shareowners’ Equity | 4,604 | 11,659 | (11,659 | ) | 4,604 | |||||||
Total liabilities and shareowners’ equity | $ | 14,908 | $ | 19,572 | $ | (13,745 | ) | $ 20,735 |
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||
Current assets | ||||||||||||||
Cash, including temporary cash investments | $ | 25 | $ | 212 | $ | — | $ | 237 | ||||||
Deposits in-transit | 60 | 502 | — | 562 | ||||||||||
Accounts receivable | 501 | 665 | (502 | ) | 664 | |||||||||
Net inventories | 408 | 4,378 | — | 4,786 | ||||||||||
Prepaid and other current assets | 69 | 255 | — | 324 | ||||||||||
Total current assets | 1,063 | 6,012 | (502 | ) | 6,573 | |||||||||
Property, plant and equipment, net | 1,303 | 10,078 | — | 11,381 | ||||||||||
Goodwill | 56 | 2,136 | — | 2,192 | ||||||||||
Other assets and investments | 548 | (117 | ) | — | 431 | |||||||||
Investment in and advances to subsidiaries | 10,719 | — | (10,719 | ) | — | |||||||||
Total assets | $ | 13,689 | $ | 18,109 | $ | (11,221 | ) | $ | 20,577 | |||||
Current liabilities | ||||||||||||||
Current portion of long-term debt including obligations under capital leases and financing obligations | $ | 639 | $ | — | $ | — | $ | 639 | ||||||
Accounts payable | 193 | 4,072 | (502 | ) | 3,763 | |||||||||
Other current liabilities | 241 | 2,574 | — | 2,815 | ||||||||||
Total current liabilities | 1,073 | 6,646 | (502 | ) | 7,217 | |||||||||
Long-term debt including obligations under capital leases and financing obligations | ||||||||||||||
Face value long-term debt including obligations under capital leases and financing obligations | 6,596 | — | — | 6,596 | ||||||||||
Adjustment to reflect fair value interest rate hedges | 25 | — | — | 25 | ||||||||||
Long-term debt including obligations under capital leases and financing obligations | 6,621 | — | — | 6,621 | ||||||||||
Other long-term liabilities | 1,912 | 744 | — | 2,656 | ||||||||||
Total liabilities | 9,606 | 7,390 | (502 | ) | 16,494 | |||||||||
Shareowners’ Equity | 4,083 | 10,719 | (10,719 | ) | 4,083 | |||||||||
Total liabilities and shareowners’ equity | $ | 13,689 | $ | 18,109 | $ | (11,221 | ) | $ | 20,577 | |||||
Condensed Consolidating
Balance Sheets
As of January 29, 200528, 2006
The Kroger | Guarantor | |||||||||||||
Co. | Subsidiaries | Eliminations | Consolidated | |||||||||||
Current assets | ||||||||||||||
Cash, including temporary cash investments | $ | 39 | $ | 171 | — | $ | 210 | |||||||
Deposits in-transit | 46 | 442 | — | 488 | ||||||||||
Accounts receivable | 1,088 | 526 | (928 | ) | 686 | |||||||||
Inventory, net | 460 | 4,026 | — | 4,486 | ||||||||||
Prepaid and other current assets | 355 | 241 | — | 596 | ||||||||||
Total current assets | 1,988 | 5,406 | (928 | ) | 6,466 | |||||||||
Property, plant and equipment, net | 1,255 | 10,110 | — | 11,365 | ||||||||||
Goodwill | 56 | 2,136 | — | 2,192 | ||||||||||
Other assets and investments | 591 | 968 | (1,100 | ) | 459 | |||||||||
Investment in and advances to subsidiaries | 10,808 | — | (10,808 | ) | — | |||||||||
Total assets | $ | 14,698 | $ | 18,620 | $ | (12,836 | ) | $ | 20,482 | |||||
Current liabilities | ||||||||||||||
Current portion of long-term debt including obligations under capital | ||||||||||||||
leases and financing obligations | $ | 554 | $ | — | $ | — | $ | 554 | ||||||
Accounts payable | 1,363 | 4,215 | (2,028 | ) | 3,550 | |||||||||
Other current liabilities | (151 | ) | 2,762 | — | 2,611 | |||||||||
Total current liabilities | 1,766 | 6,977 | (2,028 | ) | 6,715 | |||||||||
Long-term debt including obligations under capital leases and financing | ||||||||||||||
obligations | ||||||||||||||
Face value long-term debt including obligations under capital leases | ||||||||||||||
and financing obligations | 6,651 | — | — | 6,651 | ||||||||||
Adjustment to reflect fair value interest rate hedges | 27 | — | — | 27 | ||||||||||
Long-term debt including obligations under capital leases and | ||||||||||||||
financing obligations | 6,678 | — | — | 6,678 | ||||||||||
Other long-term liabilities | 1,864 | 835 | — | 2,699 | ||||||||||
Total liabilities | 10,308 | 7,812 | (2,028 | ) | 16,092 | |||||||||
Shareowners’ Equity | 4,390 | 10,808 | (10,808 | ) | 4,390 | |||||||||
Total liabilities and shareowners’ equity | $ | 14,698 | $ | 18,620 | $ | (12,836 | ) | $ | 20,482 |
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||
Current assets | ||||||||||||||
Cash, including temporary cash investments | $ | 32 | $ | 112 | — | $ | 144 | |||||||
Deposits in-transit | 20 | 486 | — | 506 | ||||||||||
Accounts receivable | 583 | 747 | (502 | ) | 828 | |||||||||
Net inventories | 415 | 3,941 | — | 4,356 | ||||||||||
Prepaid and other current assets | 275 | 297 | — | 572 | ||||||||||
Total current assets | 1,325 | 5,583 | (502 | ) | 6,406 | |||||||||
Property, plant and equipment, net | 1,277 | 10,220 | — | 11,497 | ||||||||||
Goodwill | 20 | 2,171 | — | 2,191 | ||||||||||
Other assets and investments | 642 | (245 | ) | — | 397 | |||||||||
Investment in and advances to subsidiaries | 10,518 | — | (10,518 | ) | — | |||||||||
Total assets | $ | 13,782 | $ | 17,729 | $ | (11,020 | ) | $ | 20,491 | |||||
Current liabilities | ||||||||||||||
Current portion of long-term debt including obligations under capital leases and financing obligations | $ | 71 | $ | — | $ | — | $ | 71 | ||||||
Accounts payable | 188 | 3,912 | (502 | ) | 3,598 | |||||||||
Other current liabilities | 319 | 2,328 | — | 2,647 | ||||||||||
Total current liabilities | 578 | 6,240 | (502 | ) | 6,316 | |||||||||
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 | 70 | — | — | 70 | ||||||||||
Long-term debt including obligations under capital leases and financing obligations | 7,867 | 33 | — | 7,900 | ||||||||||
Other long-term liabilities | 1,797 | 938 | — | 2,735 | ||||||||||
Total liabilities | 10,242 | 7,211 | (502 | ) | 16,951 | |||||||||
Shareowners’ Equity | 3,540 | 10,518 | (10,518 | ) | 3,540 | |||||||||
Total liabilities and shareowners’ equity | $ | 13,782 | $ | 17,729 | $ | (11,020 | ) | $ | 20,491 | |||||
Condensed Consolidating
Statements of Operations
For the Quarter Ended November 5, 2005May 20, 2006
The Kroger | Guarantor | |||||||||||||
Co. | Subsidiaries | Eliminations | Consolidated | |||||||||||
Sales | $ | 2,800 | $ | 16,911 | $ | (296) | $ | 19,415 | ||||||
Merchandise costs, including warehousing and transportation | 2,252 | 12,703 | (296) | 14,659 | ||||||||||
Operating, general and administrative | 521 | 3,007 | — | 3,528 | ||||||||||
Rent | 48 | 148 | — | 196 | ||||||||||
Depreciation and amortization | 47 | 341 | — | 388 | ||||||||||
Operating profit (loss) | (68 | ) | 712 | — | 644 | |||||||||
Interest expense | 153 | 2 | — | 155 | ||||||||||
Equity in earnings of subsidiaries | 502 | — | (502 | ) | — | |||||||||
Earnings (loss) before income tax expense | 281 | 710 | (502 | ) | 489 | |||||||||
Income tax expense | (25 | ) | 208 | — | 183 | |||||||||
Net earnings | $ | 306 | $ | 502 | $ | (502 | ) | $ | 306 | |||||
Condensed Consolidating | ||||||||||||||
Statements of Operations | ||||||||||||||
For the Quarter Ended May 21, 2005 | ||||||||||||||
The Kroger | Guarantor | |||||||||||||
Co. | Subsidiaries | Eliminations | Consolidated | |||||||||||
Sales | $ | 2,530 | $ | 15,705 | $ | (287 | ) | $ | 17,948 | |||||
Merchandise costs, including warehousing and transportation | 2,116 | 11,612 | (285 | ) | 13,443 | |||||||||
Operating, general and administrative | 475 | 2,820 | — | 3,295 | ||||||||||
Rent | 56 | 149 | (2 | ) | 203 | |||||||||
Depreciation and amortization | 25 | 364 | — | 389 | ||||||||||
Operating profit (loss) | (142 | ) | 760 | — | 618 | |||||||||
Interest expense | 150 | 9 | — | 159 | ||||||||||
Equity in earnings of subsidiaries | 489 | — | (489 | ) | — | |||||||||
Earnings (loss) before income tax expense | 197 | 751 | (489 | ) | 459 | |||||||||
Income tax expense (benefit) | (97 | ) | 262 | — | 165 | |||||||||
Net earnings | $ | 294 | $ | 489 | $ | (489 | ) | $ | 294 |
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||
Sales | $ | 2,013 | $ | 12,164 | $ | (157 | ) | $ | 14,020 | |||||
Merchandise costs, including warehousing and transportation | 1,541 | 9,210 | (155 | ) | 10,596 | |||||||||
Operating, general and administrative | 389 | 2,167 | — | 2,556 | ||||||||||
Rent | 34 | 134 | (2 | ) | 166 | |||||||||
Depreciation and amortization | 62 | 225 | — | 287 | ||||||||||
Operating profit (loss) | (13 | ) | 428 | — | 415 | |||||||||
Interest expense | 113 | 1 | — | 114 | ||||||||||
Equity in earnings of subsidiaries | 381 | — | (381 | ) | — | |||||||||
Earnings (loss) before income tax expense | 255 | 427 | (381 | ) | 301 | |||||||||
Income tax expense (benefit) | 70 | 46 | — | 116 | ||||||||||
Net earnings | $ | 185 | $ | 381 | $ | (381 | ) | $ | 185 | |||||
Condensed Consolidating
Statements of Operations
Cash Flows
For the Quarter Ended November 6, 2004May 20, 2006
The Kroger | Guarantor | |||||||||||
Co. | Subsidiaries | Consolidated | ||||||||||
Net cash provided by operating activities | $ | 1,424 | $ | (440 | ) | $ | 984 | |||||
Cash flows from investing activities: | ||||||||||||
Capital expenditures, excluding acquisitions | (28 | ) | (392 | ) | (420 | ) | ||||||
Other | 21 | 29 | 50 | |||||||||
Net cash used by investing activities | (7 | ) | (363 | ) | (370 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from issuance of long-term debt | — | — | — | |||||||||
Reductions in long-term debt | (25 | ) | — | (25 | ) | |||||||
Proceeds from issuance of capital stock | 49 | — | 49 | |||||||||
Treasury stock purchases | (134 | ) | — | (134 | ) | |||||||
Other | — | (55 | ) | (55 | ) | |||||||
Net change in advances to subsidiaries | (851 | ) | 851 | — | ||||||||
Net cash used by financing activities | (961 | ) | 796 | (165 | ) | |||||||
Net increase (decrease) in cash | 456 | (7 | ) | 449 | ||||||||
Cash: | ||||||||||||
Beginning of year | 39 | 171 | 210 | |||||||||
End of quarter | $ | 495 | $ | 164 | $ | 659 |
The Kroger Co. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||
Sales | $ | 1,611 | $ | 11,516 | $ | 12 | $ | (285 | ) | $ | 12,854 | |||||||
Merchandise costs, including warehousing and transportation | 1,306 | 8,606 | — | (273 | ) | 9,639 | ||||||||||||
Operating, general and administrative | 374 | 2,062 | (3 | ) | — | 2,433 | ||||||||||||
Rent | 28 | 142 | — | (12 | ) | 158 | ||||||||||||
Depreciation and amortization | 23 | 262 | 2 | — | 287 | |||||||||||||
Operating profit (loss) | (120 | ) | 444 | 13 | — | 337 | ||||||||||||
Interest expense | 105 | 6 | 6 | — | 117 | |||||||||||||
Equity in earnings of subsidiaries | 317 | — | — | (317 | ) | — | ||||||||||||
Earnings (loss) before income tax expense | 92 | 438 | 7 | (317 | ) | 220 | ||||||||||||
Income tax expense (benefit) | (51 | ) | 126 | 2 | — | 77 | ||||||||||||
Net earnings | $ | 143 | $ | 312 | $ | 5 | $ | (317 | ) | $ | 143 | |||||||
Condensed Consolidating
Statements of Operations
For the Three Quarters Ended November 5, 2005
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||
Sales | $ | 6,502 | $ | 39,992 | $ | (661 | ) | $ | 45,833 | |||||
Merchandise costs, including warehousing and transportation | 5,173 | 29,985 | (655 | ) | 34,503 | |||||||||
Operating, general and administrative | 1,251 | 7,129 | — | 8,380 | ||||||||||
Rent | 123 | 397 | (6 | ) | 514 | |||||||||
Depreciation and amortization | 104 | 865 | — | 969 | ||||||||||
Operating profit (loss) | (149 | ) | 1,616 | — | 1,467 | |||||||||
Interest expense | 387 | 7 | — | 394 | ||||||||||
Equity in earnings of subsidiaries | 1,149 | — | (1,149 | ) | — | |||||||||
Earnings (loss) before income tax expense | 613 | 1,609 | (1,149 | ) | 1,073 | |||||||||
Income tax expense (benefit) | (63 | ) | 460 | — | 397 | |||||||||
Net earnings | $ | 676 | $ | 1,149 | $ | (1,149 | ) | $ | 676 | |||||
Condensed Consolidating
Statements of Operations
For the Three Quarters Ended November 6, 2004
The Kroger Co. | Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||
Sales | $ | 6,004 | $ | 37,531 | $ | (796 | ) | $ | 42,739 | |||||
Merchandise costs, including warehousing and transportation | 4,861 | 27,778 | (756 | ) | 31,883 | |||||||||
Operating, general and administrative | 1,163 | 6,912 | — | 8,075 | ||||||||||
Rent | 140 | 425 | (40 | ) | 525 | |||||||||
Depreciation and amortization | 82 | 867 | — | 949 | ||||||||||
Operating profit (loss) | (242 | ) | 1,549 | — | 1,307 | |||||||||
Interest expense | 415 | 27 | — | 442 | ||||||||||
Equity in earnings of subsidiaries | 989 | — | (989 | ) | — | |||||||||
Earnings (loss) before income tax expense | 332 | 1,522 | (989 | ) | 865 | |||||||||
Income tax expense (benefit) | (216 | ) | 533 | 317 | ||||||||||
Net earnings | $ | 548 | $ | 989 | $ | (989 | ) | $ | 548 | |||||
Condensed Consolidating
Statements of Cash Flows
For the Quarter Ended November 5,May 21, 2005
The Kroger | Guarantor | |||||||||||
Co. | Subsidiaries | Consolidated | ||||||||||
Net cash provided by operating activities | $ | (820 | ) | $ | 1,793 | $ | 973 | |||||
Cash flows from investing activities: | ||||||||||||
Capital expenditures, excluding acquisitions | (33 | ) | (368 | ) | (401 | ) | ||||||
Other | 9 | 15 | 24 | |||||||||
Net cash used by investing activities | (24 | ) | (353 | ) | (377 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from issuance of long-term debt | 6 | — | 6 | |||||||||
Reductions in long-term debt | (459 | ) | (1 | ) | (460 | ) | ||||||
Proceeds from issuance of capital stock | 22 | — | 22 | |||||||||
Treasury stock purchases | (153 | ) | — | (153 | ) | |||||||
Other | (2 | ) | (18 | ) | (20 | ) | ||||||
Net change in advances to subsidiaries | 1,424 | (1,424 | ) | — | ||||||||
Net cash used by financing activities | 838 | (1,443 | ) | (605 | ) | |||||||
Net decrease in cash | (6 | ) | (3 | ) | (9 | ) | ||||||
Cash: | ||||||||||||
Beginning of year | 32 | 112 | 144 | |||||||||
End of quarter | $ | 26 | $ | 109 | $ | 135 |
The Kroger Co. | Guarantor Subsidiaries | Consolidated | ||||||||||
Net cash provided by operating activities | $ | 1,071 | $ | 978 | $ | 2,049 | ||||||
Cash flows from investing activities: | ||||||||||||
Capital expenditures, excluding acquisitions | (125 | ) | (886 | ) | (1,011 | ) | ||||||
Other | 17 | 22 | 39 | |||||||||
Net cash used by investing activities | (108 | ) | (864 | ) | (972 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from issuance of long-term debt | 13 | — | 13 | |||||||||
Payments on long-term debt | (28 | ) | (33 | ) | (61 | ) | ||||||
Payments on bank revolver | (629 | ) | — | (629 | ) | |||||||
Proceeds from issuance of capital stock | 76 | — | 76 | |||||||||
Treasury stock purchases | (202 | ) | — | (202 | ) | |||||||
Other | 1 | (182 | ) | (181 | ) | |||||||
Net change in advances to subsidiaries | (201 | ) | 201 | — | ||||||||
Net cash used by financing activities | (970 | ) | (14 | ) | (984 | ) | ||||||
Net increase (decrease) in cash | (7 | ) | 100 | 93 | ||||||||
Cash: | ||||||||||||
Beginning of year | 32 | 112 | 144 | |||||||||
End of quarter | $ | 25 | $ | 212 | $ | 237 | ||||||
10. COMMITMENTS AND CONTINGENCIES
Condensed Consolidating
Statements of Cash Flows
For the Quarter Ended November 6, 2004
The Kroger Co. | Guarantor Subsidiaries | Consolidated | ||||||||||
Net cash provided by operating activities | $ | 481 | $ | 1,567 | $ | 2,048 | ||||||
Cash flows from investing activities: | ||||||||||||
Capital expenditures, excluding acquisitions | (136 | ) | (1,144 | ) | (1,280 | ) | ||||||
Other | 17 | 48 | 65 | |||||||||
Net cash used by investing activities | (119 | ) | (1,096 | ) | (1,215 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Payments on long-term debt | (777 | ) | — | (777 | ) | |||||||
Borrowings on bank revolver | 256 | 7 | 263 | |||||||||
Proceeds from issuance of capital stock | 33 | — | 33 | |||||||||
Treasury stock purchases | (249 | ) | — | (249 | ) | |||||||
Other | (32 | ) | (100 | ) | (132 | ) | ||||||
Net change in advances to subsidiaries | 403 | (403 | ) | — | ||||||||
Net cash used by financing activities | (366 | ) | (496 | ) | (862 | ) | ||||||
Net decrease in cash | (4 | ) | (25 | ) | (29 | ) | ||||||
Cash: | ||||||||||||
Beginning of year | 26 | 133 | 159 | |||||||||
End of quarter | $ | 22 | $ | 108 | $ | 130 | ||||||
10. COMMITMENTSAND CONTINGENCIES
The Company continuously evaluates contingencies based upon the best available evidence.
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 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. The liability for workers’ compensation risks is accounted for on a present value basis. The liability for general liability risks is 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 District Court Central District of California, Case No. CV04-0687) alleging that the Mutual Strike Assistance Agreement (the “Agreement”) between the Company, Albertson’s, Inc. and Safeway Inc. (collectively, the “Retailers”), which was designed to prevent the union from placing disproportionate pressure on one or more of the Retailers by picketing such Retailer(s) but not the other Retailer(s) during the labor dispute in southern California, violated Section 1 of the Sherman Act. The lawsuit seeks declarative and injunctive relief. Under the Agreement, the Company paid approximately $147 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,In December, 2005, the Court denied a motion for a summary judgment filed by the defendants. Ralphs and the other defendants filed a notice of an interlocutory appeal to the United States Court of Appeals for the Ninth Circuit. On November 29, 2005, the appellate court dismissed the appeal. 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.
The United States Attorney’s Office for the Central District of California is investigatingnotified the hiring practices ofCompany that a federal grand jury had returned an indictment against Ralphs Grocery Company (“Ralphs”), a wholly-owned subsidiary of The Kroger Co., with regard to Ralphs’ hiring practices during the labor dispute from October 2003 through February 2004. Among2004 (United Statesof America v. Ralphs Grocery Company, United States District Court for the matters under investigation is whetherCentral District of California, CR No. 05-1210 PA). The indictment alleges a criminal conspiracy and other criminal activity resulting in some locked-out employees werebeing allowed or encouraged to work under false identities or false Social Security numbers, despite Company policy forbidding such conduct. A grand juryTrial has convened to consider whether such acts violated federal criminal statutes. The Company expects that Ralphs will be indicted on charges that its conduct violated federal law.been set for August 15, 2006. In addition, these alleged hiring practices are the subject of claims that Ralphs’ conduct of the lockout was unlawful, and that Ralphs is 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. That decision is being appealed by the charging parties to the General Counsel of the NLRB.
During the first quarter of 2006, the Company increased its reserves associated with legal proceedings arising from these matters. The amounts potentially claimedcurrent quarter charge reduced earnings by $0.03 per diluted share and increased the amount of reserves established for this contingency. Ralphs expects to enter into an agreement that will include a plea of guilty to some of the charges in the indictment and will, if approved by the Court, resolve both the criminal litigation with Ralphs and the NLRB matter are substantial, but based onproceedings. The Company can provide no assurance that such an agreement will be entered into, or that if it is entered into, it will be approved by the information presently available toCourt. The amount reserved by the Company management does not expect the ultimate resolutionrepresents its best estimate of this matter to have a material effect on the financial condition of the Company.its exposure in connection with these legal proceedings.
On September 8, 2005, the Los Angeles City Attorney’s office filed a misdemeanor complaint against a subsidiary of the Company, Ralphs Grocery Company (People v. Ralphs Grocery Company, Superior Court of California, County of Los Angeles, Case No. 5CR02616) regarding alleged violations of the California Water Code. Ralphs operates a system at one store location to treat groundwater within an underground basement because of the presence of naturally occurring petroleum associated with the nearby La Brea tar pits, which system is subject to a discharge permit issued by the California Regional Water Quality Control Board. On December 1, 2005, Ralphs executed a civil consent judgment under which the misdemeanor complaint is to be dismissed and Ralphs will pay a civil penalty.
On November 24, 2004, the Company was notified by the office of the United States Attorney for the District of Colorado that the Drug Enforcement Agency (“DEA”) had referred a matter to it for investigation regarding alleged violation of the Controlled Substances Act by the Company’s King Soopers division. The government alleges that ineffective controls and procedures, as well as improper record keeping, permitted controlled substances to be diverted from pharmacies operated by King Soopers. As a result of these allegations, the Company has retained a consultant to assist it in reviewing its policies and procedures, record keeping and training in its pharmacies, and is taking corrective action, as warranted. On October 20, 2005, the Company resolved this matter by agreeing to pay a $7 civil penalty, agreeing to implement a comprehensive compliance program, and agreeing to an additional $3 payment if it fails to comply with the compliance program.
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 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 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 belief 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 therefor. 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 projects. As of November 5, 2005,May 20, 2006, the Company was a partner with 50% ownership in two real estate joint ventures for which it has guaranteed approximately $11$7 of debt incurred by the ventures. Based on the covenants underlying this indebtedness as of November 5, 2005,May 20, 2006, 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 20042005 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.
The Company contributed $300$150 to its Company-sponsored pension plans in the first three quartersquarter of 2005.2006. The Company expects these contributions towill reduce its minimum required contributions in future years. Among other things, investment performance of plan assets, the interest rates required to be used to calculate pension obligations and future changes in legislation will determine the amounts of any additional contributions. While the Company has no required contributions due in 2006, the Company expects to make voluntary contributions to Company-sponsored pension plans totaling approximately $100 - $150 during fiscal 2006.
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 benefits are paid from assets held in trust for that purpose. Trustees are appointed in equal number by employers and unions. The trustees typically are responsible for determining the level of benefits to be provided to 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 believes that the present value of actuarial accrued liabilities in most or all of these multi-employer plans substantially exceeds the value of the assets held in trust to pay benefits. Because the Company is only one of a number of employers contributing to these plans, it is difficult to ascertain what the Company’s “share” of the underfunding would be, although we anticipate the Company’s contributions to these plans will increase each year. Although underfunding can result in the imposition of excise taxes on contributing employers, other factors such as increased contributions, changes in benefits and improved investment performance can reduce underfunding so that excise taxes are not triggered. Moreover, if the Company were to exit certain markets or otherwise cease making contributions to these funds, the Company could trigger a substantial withdrawal liability. Any adjustment for withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably determined, in accordance with SFAS No. 87,Employers’ Accounting for Pensions.
11. 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 November 5, 2005,May 20, 2006, the unamortized balances totaled approximately $67.$58.
At the end of the thirdfirst quarter of 2005,2006, the Company maintained 10ten interest rate swap agreements that are being accounted for as fair value hedges. As of November 5, 2005,May 20, 2006, liabilities totaling $42$46 have been recorded to reflect the fair value of these new agreements, offset by reductions in the fair value of the underlying debt.
12. SUBSEQUENT EVENTS
On November 17, 2005, In addition, the Company entered intomaintained three forward-starting interest rate swap agreements, with an aggregate notional amount totaling $750. A forward-starting interest rate swap is an agreement that effectively hedges future benchmark interest rates, including general corporate spreads, on debt for an established periodAs of time. The Company entered intoMay 20, 2006, assets totaling $29 million have been recorded to reflect the forward-starting interest rate swapsfair value of these agreements, offset by increases in order to lock in fixed interest rates on the Company’s forecasted issuance of debt in fiscal 2007 and 2008. The forward-starting interest rate swaps were designated as cash-flow hedges as defined by SFAS No. 133.Other Comprehensive Income.
On December 9, 2005, the Company announced a set of corporate governance enhancements. The Company’s board of directors voted to recommend that shareholders approve at the next shareholder meeting in June 2006: the declassification of the board of directors in conjunction with the elimination of cumulative voting; the elimination of the supermajority necessary to engage in certain transactions with shareholders owning 10% or more of the Company’s shares; and opting out of the Ohio control share acquisition statute. The board of directors also will allow the Company’s warrant dividend plan, or poison pill, to expire March 19, 2006; adopted a policy requiring shareholder approval of new severance arrangements with senior executives that would exceed 2.99 times average W-2 earnings over the prior five years; and adopted a policy requiring a director receiving more “withheld” votes than “for” votes to tender his or her resignation, which resignation would be acted on by either the board’s Corporate Governance Committee or the remainder of the board.
On December 14, 2005, the Company disclosed on a Current Report on Form 8-K the adoption of the 2006 Long-Term Bonus Plan.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following analysis should be read in conjunction with the Consolidated Financial Statements.
OVERVIEW
OVERVIEW
ThirdFirst quarter total sales increased 9.1%8.2% to $19.4 billion. This growth continues to be broad-based across all divisions and identicalstore departments. Growth was particularly strong in Grocery, Produce, Natural Foods, and Fuel. Identical supermarket sales (as defined below) increased 6.6%7.2% with fuel and 3.7%5.6% without fuel. This continues a positive trend, asOnce again, by either measure, this was our ninth consecutive quarter of increased identical supermarket sales, excluding fuel, and ourrepresents Kroger’s highest identical supermarket sales since the merger with Fred Meyer in 1999. Further, this growth was broad-based across all ofIt is also the country and across all major categories. The strongest categories included produce, grocery, drug and general merchandise and fuel, in terms of both dollars and gallons. While our retail fuel margins for the quarter were strong, on a year-to-date basis they were more normalized. All but one of our divisions experienced anothereleventh consecutive quarter of positive identical supermarket sales. Identical sales, growth is a core part of our strategy.excluding fuel.
Kroger’s business strategy is squarely aimed at consistently meeting the needs ofstrategic plan requires balance among several elements and a consistent approach to managing our customers through service, selection and value.business. In the third quarter, our associates continuedwe balanced investments in gross margin and improved customer service with operating cost reductions to focus on improving theprovide a better shopping experience for our customers. This commitmentWe continue to placingbelieve this strategy is the “customer first” helped driveappropriate path to build sustainable earnings growth and long-term value for our growth in customer traffic and average transaction size.shareholders.
DuringNet earnings were $306.4 million or $0.42 per diluted share. These results included two items that affected our first-quarter earnings by $0.05 per diluted share. Effective January 29, 2006, we adopted the thirdfair value recognition provisions of SFAS 123(R) for recognizing stock option expense. This reduced earnings by $0.02 per diluted share. Also, based on developments during the quarter, we continued to rebuildincreased our business in southern California, which includesreserve associated with the legal proceedings arising from hiring practices at its Ralphs subsidiary during the 2003-2004 labor dispute. The current quarter charge reduced earnings by $0.03 per diluted share and Food 4 Less stores. Identical sales in that region, without fuel, grew 2.9% overincreased the prior-year period. While the paceamount of reserves established for this contingency. The reserves represent our best estimate of our recoveryexposure in southern California has been slower than we would like, we see additional opportunities for growth in that market and our teams at Ralphs and Food 4 Less are clearly focused on seizing those opportunities.connection with these legal proceedings.
Our results for the third quarter reflected a variety of items that together had little effect on earnings per share. These items include $0.02 of income resulting from the settlement of a previous class-action credit card suit and the reversal of an unrelated tax contingency. These benefits were offset by a combined $0.03 of expense resulting from: the effect of hurricanes Katrina and Rita; an increase in certain legal reserves, some of which are non-deductible for tax purposes; and a writedown to fair market value of assets held for sale.
On the strength of Kroger’s year-to-datefirst quarter financial performance, we are confident we willraising our sales guidance. Kroger now expects identical supermarket sales growth, excluding fuel sales, to exceed our earnings estimate of $1.24 per fully diluted share4% for fiscal 2005. We expect this earnings growth to be driven by improved results in southern California and the balance of the Company, lower interest expense and fewer shares outstanding as a result of stock buybacks.year or approximately 4.5% for the full year. Additionally, our guidance for earning per share growth in 2006 remains at 6-8%, including the legal reserve charge recognized in the first quarter.
RESULTS OF OPERATIONS
RESULTSOF OPERATIONS
Net Earnings
Net earnings totaled $185$306 million for the thirdfirst quarter of 2005,2006, an increase of 29.3%4.1% from net earnings of $143 million for the third quarter of 2004. Net earnings totaled $676$294 million for the first three quartersquarter of 2005, an increase of 23.4% from net earnings of $548 million for the first three quarters of 2004.2005. 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.growth, offset by stock option expensing and charges recorded to increase legal reserves described above.
Earnings of $0.25 per diluted share for the third quarter of 2005 represented an increase of 31.6% over net earnings of $0.19 per diluted share for the third quarter of 2004. Earnings of $0.92$0.42 per diluted share for the first three quartersquarter of 20052006 represented an increase of 26.0%5.0% over net earnings of $0.73$0.40 per diluted share for the first three quartersquarter of 2004.2005. Earnings per share growth resulted from increased net earnings and the repurchase of Company stock. Over the past four quarters, we have repurchased 1612 million shares of the Company’s stock for a total investment of $272$233 million.
Sales
Total Sales
(in millions)
(In millions)
Third Quarter | Year-To-Date | |||||||||||||||||||||||
2005 | Percentage Increase | 2004 | Percentage Increase | 2005 | Percentage Increase | 2004 | Percentage Increase | |||||||||||||||||
Total supermarket sales without fuel | $ | 12,156.8 | 4.9 | % | $ | 11,588.4 | 3.8 | % | $ | 40,413.0 | 4.4 | % | $ | 38,719.4 | 2.9 | % | ||||||||
Total supermarket fuel sales | $ | 987.9 | 70.0 | % | 581.1 | 59.7 | % | 2,733.4 | 55.2 | % | 1,761.7 | 59.3 | % | |||||||||||
Total supermarket sales | $ | 13,144.7 | 8.0 | % | $ | 12,169.5 | 5.5 | % | $ | 43,146.4 | 6.6 | % | $ | 40,481.1 | 4.6 | % | ||||||||
Other sales(1) | 875.8 | 27.9 | % | 684.5 | 12.1 | % | 2,687.0 | 19.0 | % | 2,258.0 | 10.8 | % | ||||||||||||
Total sales | $ | 14,020.5 | 9.1 | % | $ | 12,854.0 | 5.9 | % | $ | 45,833.4 | 7.2 | % | $ | 42,739.1 | 4.9 | % | ||||||||
First Quarter | ||||||||||
Percentage | Percentage | |||||||||
2006 | Increase | 2005 | Increase | |||||||
Total supermarket sales without fuel | $ | 16,973.2 | 5.9% | $ | 16,027.0 | 3.9% | ||||
Total supermarket fuel sales | $ | 1,294.5 | 39.8% | 925.7 | 47.3% | |||||
Total supermarket sales | $ | 18,267.7 | 7.8% | $ | 16,952.7 | 5.6% | ||||
Other sales(1) | 1,147.5 | 15.3% | 995.0 | 17.8% | ||||||
Total sales | $ | 19,415.2 | 8.2% | $ | 17,947.7 | 6.2% |
(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 was primarily the result of identical store sales increases square footage growth, and increased fuel gallons, as well as inflation in fuel and other commodities. Identical store sales growth for the first quarter of 2006 was 7.2% including supermarket fuel operations and 5.6% excluding supermarket fuel operations. Increased customer count and average transaction size in the first three quartersquarter of 20052006 were primarilyboth responsible for our increases in identical supermarket sales, excluding fuel.
We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters.Differences between total supermarket sales and identical supermarket sales primarily relate to changes in supermarket square footage. Our identical supermarket sales results are summarized in the table below. The identical supermarket dollar figures presented were used to calculate thirdfirst quarter 20052006 percent changes.
Identical Supermarket Sales
(in millions)
(In millions)
First Quarter | ||||||||
2006 | 2005 | |||||||
Including fuel centers | $ | 17,462.2 | $ | 16,293.0 | ||||
Excluding fuel centers | $ | 16,248.4 | $ | 15,387.8 | ||||
Including fuel centers | 7.2 | % | 3.8 | % | ||||
Excluding fuel centers | 5.6 | % | 2.4 | % |
Third Quarter | ||||||||
2005 | 2004 | |||||||
Including fuel centers | $ | 12,481.0 | $ | 11,712.7 | ||||
Excluding fuel centers | $ | 11,555.7 | $ | 11,142.1 | ||||
Including fuel centers | 6.6 | % | 3.2 | % | ||||
Excluding fuel centers | 3.7 | % | 1.8 | % |
We define a supermarket as comparable when it has been in operation for five full quarters, including expansions and relocations. Our comparable supermarket sales results are summarized in the table below. The comparable supermarket dollar figures presented were used to calculate the thirdfirst quarter 20052006 percent changes.
Comparable Supermarket Sales
(in millions)
(In millions)
Third Quarter | ||||||||
2005 | 2004 | |||||||
Including fuel centers | $ | 12,836.1 | $ | 11,966.5 | ||||
Excluding fuel centers | $ | 11,874.6 | $ | 11,389.0 | ||||
Including fuel centers | 7.3 | % | 3.7 | % | ||||
Excluding fuel centers | 4.3 | % | 2.2 | % |
First Quarter | ||||||||
2006 | 2005 | |||||||
Including fuel centers | $ | 17,859.5 | $ | 16,617.9 | ||||
Excluding fuel centers | $ | 16,605.8 | $ | 15,698.4 | ||||
Including fuel centers | 7.5 | % | 4.4 | % | ||||
Excluding fuel centers | 5.8 | % | 2.8 | % |
FIFO Gross Margin
We calculate First-In, First-Out (“FIFO”) Gross Margin as follows: Sales minus merchandise costs plus Last-In, First-Out (“LIFO”) charge. Merchandise costs include advertising, 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 6261 basis points to 24.48%24.55% for the thirdfirst quarter of 20052006 from 25.10%25.16% for the thirdfirst quarter of 2004.2005. Excluding the effect of retail fuel operations, our FIFO gross margin rate decreased sixnine basis points for the thirdfirst quarter of 20052006 compared to the thirdfirst quarter of 2004.2005. The growth in our retail fuel sales lowers our FIFO gross margin rate due to the very low FIFO gross margin on retail fuel sales as compared to non-fuel sales. Improvements in shrink, advertising and warehousing costs helped offset higher energy costs and our investments in targeted retail price reductions for our customers. We estimate higher energy costs decreased our thirdfirst quarter FIFO gross margin rate eightthree basis points.
Our FIFO gross margin rate declined 69 basis points to 24.78% for the first three quarters of 2005 from 25.47% for the first three quarters of 2004. Of this decline, the effect of retail fuel operations accounted for a 54 basis point reduction in our FIFO gross margin rate.
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. Among 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 6919 basis points to 18.23%18.17% for the thirdfirst quarter of 20052006 from 18.92%18.36% for the thirdfirst quarter of 2004. Of this decline, the2005. The effect of retail fuel operations accounted for a 6640 basis point reduction in our OG&A rate. The growth in our retail fuel sales lowers our OG&A rate due to the very low OG&A rate on retail fuel sales as compared to non-fuel sales. The declininghigher rate on non-fuel sales was primarily the result of our continued recovery in southern California, strong sales, labor productivity improvements, lower health care costs,stock option expensing and $12.9 million of settlement income related to a previous class-action credit card lawsuit. These improvements were partially offset by increased pension costs, credit card fees and incentive plan expenses, as well aslegal reserves for the Ralphs hiring matter. Excluding the effect of hurricanes Katrina and Rita, anretail fuel operations, the increase in legal reserves for certain legal matters and a writedown to fair market value of assets held for sale. We estimate higher energy costs increased our third quarterstock option expense, OG&A rate ninedeclined 16 basis points.
OG&A expenses, Leverage from strong identical sales, along with good cost controls in areas such as a percentenergy usage and labor productivity helped us overcome some of sales, decreased 61 basis points to 18.28% for the first three quarters of 2005 from 18.89% for the first three quarters of 2004. Of this decline, retailsignificant increases in fuel operations accounted for a 46 basis point reduction in our OG&A rate. In addition to the items affecting the third quarter 2005 rate, the year-to-date declining rate on non-fuel sales was negatively affected by increased loss contingencies for some outstanding legal matters.and energy-related costs that many companies are facing.
Rent Expense
Rent expense was $166$196 million, or 1.19%1.01% of sales, for the thirdfirst quarter of 2005,2006, compared to $158$203 million, or 1.23%1.13% of sales, for the thirdfirst quarter of 2004.2005. The increasedecrease in rent expense resulted from increased store closing activities duringwas the thirdresult of lower closed-store future rent liabilities booked in the first quarter of 2005. For2006 compared to the year-to-date period, rent expense, as a percentfirst quarter of total sales, was 1.12% and 1.23% for 2005, and 2004, respectively. This decline in rent expense reflects our emphasis on the ownership of real estate combined with a continued focus on the closing of underperforming stores.
Depreciation Expense
Depreciation expense was $287$388 million, or 2.05% of total sales, for the third quarter of 2005 compared to $288 million, or 2.24% of total sales, for the third quarter of 2004. Depreciation expense was $969 million, or 2.12%2.00% of total sales, for the first three quartersquarter of 20052006 compared to $949$389 million, or 2.22%2.17% of total sales, for the first three quartersquarter of 2004.2005. The increasedecrease in depreciation expense, forin total dollars, was the year-to-date period reflects our continued emphasis onresult of lower capital expenditures in the ownership of real estate.previous fiscal year. The decrease in depreciation expense, as a percent of sales, was the result of sales leverage obtained from strong identical supermarket sales growth and improved efficiency in capital investment.
Interest Expense
InterestNet interest expense was $114$155 million, or 0.81%0.80% of total sales, and $117$159 million, or 0.90%0.89% of total sales, in the third quartersfirst quarter of 2006 and 2005, and 2004, respectively. For the year-to-date period, interest expense was $394 million, or 0.86% of total sales, in 2005 and $442 million, or 1.03% of total sales in 2004. The reduction in net interest expense for 2005,2006, when compared to 2004, reflects2005, resulted from a $660$318 million reduction in total debt as well as a $24.7and an increase in temporary cash investments totaling $463 million prepayment premium paid in the second quarter of 2004 as the result of the call of our $750 million, 7.375% bonds.
at May 20, 2006.
Income Taxes
Our effective income tax rate was 38.4%37.4% for the thirdfirst quarter of 20052006 and 35.0%35.9% for the thirdfirst quarter of 2004. For the year-to-date period, our2005. The 2006 effective income tax rated differed from the federal statutory rate was 37.0% in 2005 and 36.7% in 2004, respectively. In additiondue to the effect of state taxes, thetaxes. The 2005 effective income tax rate differed from the federal statutory rate due to the effect of state taxes and a reduction ofin previously recorded tax contingency allowances resulting from a revision of the required allowances based on resolutions with tax authorities during the quarters and the third quarter effect of certain legal expenses that were not deductible for tax purposes.
LLIQUIDITYANDCAPITALRESOURCES
Cash Flow Information
Net cash provided by operating activities
We generated $2.0 billion$984 million of cash from operating activities during the first three quarters of both 2005 and 2004.quarter 2006, compared to $973 million in 2005. The increase in cash generated by our net earnings was offset by a cash contribution of $300 millionpayments to our Company-sponsored pension plan in the first three quarters of 2005 comparedand higher accounts receivable balances were offset by higher net earnings and non-cash charges to a $35record stock option expense and increase legal reserves, as well as increased accounts payable balances. We contributed $150 million cash contributionto Company-sponsored pension plans during the first three quartersquarter of 2004.2006 compared to $89 million during the first quarter of 2005.
Net cash used by investing activities
Investing activities used $1.0 billion$370 million of cash during the first three quartersquarter of 20052006 compared to $1.2 billion$377 million during the first three quartersquarter of 2004.2005. The amount of cash used by investing activities decreased in 20052006 versus 20042005 due to decreasedhigher cash proceeds from asset sales, partially offset by an increase in capital expenditures during the first three quarters of 2005.spending.
Net cash used by financing activities
Financing activities used $984$165 million of cash in the first three quartersquarter of 20052006 compared to $862$605 million in the first three quartersquarter of 2004.2005. The increasedecrease in the amount of cash used by financing activities was the result of increaseddecreased debt reduction and lower treasury stock purchases, partially offset by an increase in the amount of cash proceeds from the issuance of capital stock and a decrease in stock repurchase activity.
stock.
Debt Management
As of November 5, 2005,May 20, 2006, we maintained a $1.8 billion, five-year revolving credit facility that terminates in 20092010 and a $700 million five-year credit facility that terminates in 2007. Outstanding borrowings under the credit agreements and commercial paper borrowings, and some outstanding letters of credit, reduce funds available under the credit agreements. In addition to the credit agreements, we maintain a $75$50 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 agreements. As of November 5, 2005, ourMay 20, 2006, we had no outstanding commercial paper borrowings under our credit agreement totaled $65 million.agreement. We had no borrowings under the money market line as of November 5, 2005.May 20, 2006. The outstanding letters of credit that reduced the funds available under our credit agreements totaled $313$340 million as of November 5, 2005.May 20, 2006.
Our bank credit facilities and the indentures underlying our publicly issued debt contain various restrictive covenants. As of November 5, 2005,May 20, 2006, 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 and lease-financing obligations, decreased $560$318 million to $7.3$7.2 billion as of the end of the thirdfirst quarter of 2005,2006, from $7.8$7.5 billion as of the end of the thirdfirst quarter of 2004.2005. Total debt decreased $710$46 million as of the end of the thirdfirst quarter of 20052006 from $8.0$7.2 billion as of year-end 2004.2005. The decreases in 20052006 resulted from the use of cash flow from operations to reduce outstanding debt and lower mark-to-market adjustments.
We expect to fund current year debt maturities with cash on-hand.
Common Stock Repurchase Program
During the thirdfirst quarter of 2005,2006, we invested $12$134 million to repurchase 0.66.7 million shares of Kroger stock at an average price of $19.97 per share. For the first three quarters of 2005, we invested $202 million to repurchase 12.3 million shares of Kroger stock at an average price of $16.51$19.90 per share. These shares were reacquired under twothree separate stock repurchase programs. The first is a $500 million repurchase program that was authorized by Kroger’s Board of Directors inon September 16, 2004. The second is a $500 million repurchase program, authorized by Kroger’s Board of Directors on May 4, 2006, which replaced the prior $500 million authorization. The third 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. During the first three quartersquarter of 2005,2006, we purchased approximately 11.86.0 million shares, totaling $195$120 million, under our $500 million stock repurchase programprograms and we purchased an additional 0.50.7 million shares, totaling $7$14 million, under our program to repurchase common stock funded by the proceeds and tax benefits from stock option exercises. As of November 5, 2005,May 20, 2006, we had approximately $158$487 million remaining under the September 2004May 2006 repurchase program.
CCAPITALEXPENDITURES
Capital expenditures excluding acquisitions, totaled $1.0 billion$450 million for the first three quartersquarter of 2005 and $1.3 billion2006 compared to $401 million for the first three quartersquarter of 2004. The decrease reflects our continued emphasis on the tightening of capital and our increasing focus on remodel, merchandising and productivity projects.
2005. During the thirdfirst quarter of 2005,2006, we opened, acquired, expanded or relocated ten16 food stores and also completed 4339 within-the-wall remodels. In total, we operated 2,5102,483 supermarkets and multi-department stores at the end of the thirdfirst quarter of 20052006 versus 2,531 food stores in operation2,524 at the end of the thirdfirst quarter of 2004.2005. Total food store square footage increased 0.6%decreased 0.2% over the thirdfirst quarter of 2004.2005. Excluding acquisitions and operational closings, total food store square footage increased 2.0%1.6% over the thirdfirst quarter of 2004.
CCRITICAL 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. OurExcept as noted below, our critical accounting policies are summarized in the Company’s 2004our 2005 Annual Report on Form 10-K as amended.filed with the SEC on April 7, 2006.
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 STANDARDSStock-Based Compensation Expense
In December 2004,Effective January 29, 2006, we adopted the FASB issued SFAS No. 123 (Revised 2004),Share-Based Payment (“SFAS No. 123R”), which replaces SFAS No. 123, supersedes APB No. 25 and related interpretations and amends SFAS No. 95Statement of Cash Flows. Thefair value recognition provisions of SFAS No. 123R are similar123(R), using the modified prospective transition method, and therefore have not restated results for prior periods. Under this method, we recognize compensation expense for all share-based payments granted after January 29, 2006, as well as all share-based payments granted prior to, thosebut not yet vested, as of January 29, 2006, in accordance with SFAS No. 123(R). Under the fair value recognition provisions of SFAS No. 123; however, SFAS No. 123R requires all123(R), we recognize share-based payments to employees, including grantscompensation expense, net of employee stock options, to be recognized inan estimated forfeiture rate, over 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 circumstancesrequisite service period of the awards.
award. Prior to the adoption of SFAS No. 123R,123(R), we are accountingaccounted for share-based compensation expensepayments under the recognition and measurement provisions of APB No.Accounting Principles Board Opinion no. 25 “Accounting for Stock Issued to Employees” and the disclosure provisions of SFAS No. 123. Compensation expense for all share-based awards described above was recognized using the straight-line attribution method applied to the fair value of each option grant, over the requisite service period associated with each award. The requisite service period is typically consistent with the vesting period, except as noted below. Because awards typically vest evenly over the requisite service period, compensation cost recognized through May 20, 2006 is at least equal to the grant-date fair value of the vested portion of all outstanding options.
The weighted-average fair value of stock options granted during the first quarters ended May 20, 2006 and May 21, 2005, was $6.90 and $7.70, respectively. The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model, based on the assumptions shown in the table below. The Black-Scholes model utilizes extensive accounting judgment and financial estimates, including the term employees are followingexpected to retain their stock options before exercising them, the accepted practicevolatility of recognizing share-basedour stock price over that expected term, the dividend yield over the term, and the number of awards expected to be forfeited before they vest. Using alternative assumptions in the calculation of fair value would produce fair values for stock option grants that could be different than those used to record stock-based compensation expense overin the explicit vesting period. SFAS No. 123R will requireConsolidated Statements of Operations.
The following table reflects the immediate recognition atweighted average assumptions used for grants awarded to option holders:
2006 | 2005 | |||
Risk-free interest rate | 5.07% | 4.11% | ||
Expected dividend yield | 1.50% | N/A | ||
Expected volatility | 27.60% | 30.83% | ||
Expected term | 7.50 Years | 8.70 Years |
The weighted average risk-free interest rate was based on the yield of a treasury note as of the grant date, continuously compounded, which matures at a date that approximates the expected term of the fulloptions. During the year presented, prior to 2006, we did not pay a dividend, so an expected dividend rate was not included in the determination of fair value for options granted during fiscal year 2005. Using a dividend yield of 1.50% to value options issued in 2005 would have decreased the fair value of each option by approximately $1.60. Expected volatility was determined based upon historical stock volatilities. Implied volatility was also considered. Expected term was determined based upon a combination of historical exercise and cancellation experience as well as estimates of expected future exercise and cancellation experience.
Total stock compensation recognized in the quarter ended May 20, 2006 was $22 million, pre-tax. This included $19 million related to stock options and $3 million related to restricted shares. A total of $1 million of the restricted stock expense was attributable to the wider distribution of restricted shares in the first quarter 2006 grant of share-based awards, and the remaining $2 million of restricted stock expense related to previously issued restricted stock. As a result, the incremental compensation expense for grantsattributable to retirement eligible employees, as the explicit vesting period is non-substantive. The estimated effectadoption 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. 123R123(R) in the first quarter of fiscal2006 was $20 million, pre-tax, or $13 million and $0.02 per basic and diluted share, after tax. Stock compensation expense recognized in the quarter ended May 21, 2005, related entirely to restricted stock grants, was $3 million. These costs were recognized as operating, general and administrative costs in ourConsolidated Statements of Operations for the quarters ended May 20, 2006 and expectMay 21, 2005. The cumulative effect of applying a forfeiture rate to unvested restricted shares at January 29, 2006 was not material. The pro forma earnings effect of stock options in the prior year, in accordance with SFAS No. 123, is described below.
If compensation cost for our stock option plans for the first quarter ended May 21, 2005 had been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS No. 123, our net earnings and diluted earnings per common share would have been reduced to the pro forma amounts below:
First Quarter | ||||
(In millions, except per share amounts) | 2005 | |||
Net earnings, as reported | $ | 294 | ||
Add: Stock-based compensation expense included in net earnings, net of income tax benefits | 2 | |||
Subtract: Total stock-based compensation expense determined under fair value method for all | ||||
awards, net of income tax benefits | (8 | ) | ||
Pro forma net earnings | $ | 288 | ||
Net earnings per basic common share, as reported | $ | 0.40 | ||
Pro forma earnings per basic common share | $ | 0.40 | ||
Net earnings per diluted common share, as reported | $ | 0.40 | ||
Pro forma earnings per diluted common share | $ | 0.39 |
As of May 20, 2006, there was $134 million of total unrecognized compensation cost related to non-vested stock-based compensation arrangements granted under our stock option plans. This cost is expected to be recognized over a weighted-average period of approximately 2 years. The total fair value of options that vested during the quarter was $34 million in each of the quarters ended May 20, 2006 and May 21, 2005.
Our stock option grants generally contain retirement-eligibility provisions allowing employees to retire and retain their awards. For share-based awards granted prior to the adoption of SFAS No. 123(R), compensation expense was calculated over the stated vesting periods, regardless of whether certain employees became retirement-eligible during the respective vesting periods. Upon the adoption of SFAS No. 123(R), we continued this method of recognizing compensation expense for those awards granted prior to reduce net earnings by $0.04-$0.06 per diluted share during fiscal 2006.the adoption of SFAS No. 123(R). However, for awards granted on or after January 29, 2006, we will recognize expense for stock option grants containing retirement-eligibility provisions over the shorter of the vesting period or the period until employees become retirement-eligible. As a result of retirement-eligibility provisions in stock option awards granted in 2006, approximately $6 million of compensation cost was recognized prior to the completion of stated vesting periods.
Shares issued as a result of stock option exercises may be newly issued shares or reissued treasury shares. We expect to fund these exercises with treasury shares.
Self-Insurance Costs
We are self-insured for property-related losses. We have purchased stop-loss coverage to limit our exposure to losses in excess of $25 million on a per claim basis, except in the case of an earthquake, which is at a stop-loss of $50 million per claim.
RECENTLYISSUEDACCOUNTINGSTANDARDS
In November 2004, the FASB 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 rather thanas opposed to being capitalized into inventory as a product cost. SFAS No. 151 provides examples of “abnormal” costs to include costs of idle facilities, excess freight and handling costs and spoilage. SFAS No. 151 will becomebecame effective for our fiscal year beginning January 29, 2006. The adoption of SFAS No. 151 isdid not expected to have a material effect on our Consolidated Financial Statements.
In May 2005,February 2006, the FASB issued SFASStaff Position (“FSP”) No. 154,Accounting Changes123(R)-4, “Classification of Options and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods’ financial statementsSimilar Instruments Issued as Employee Compensation that Allow for changes in accounting principle, unless it is impracticable to determine eitherCash Settlement upon the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective applicationOccurrence of a change in accounting principle be limited toContingent Event.” FSP No. 123(R)-4 addresses the direct effectsclassification of options and similar instruments issued as employee compensation that allow for cash settlement upon the change. Indirect effectsoccurrence of a change in accounting principle shouldcontingent event. FSP No. 123(R)-4 provides that cash settlement features that can be recognized inexercised only upon the periodoccurrence of a contingent event that is outside the accounting change. SFAS No. 154 further requires a change in depreciation, amortizationemployee’s control does not require classifying the option or depletion method for long-lived, non-financial assets to be accounted forsimilar instrument as a change in accounting estimate effected by a change in accounting principle. SFASliability until it becomes probable that the event will occur. We adopted the provisions of FSP No. 154 will become effective for our fiscal year beginning January 29,123(R)-4 during the first quarter of 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 isdid not expected to have a material effect on our Consolidated Financial Statements.
In June 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased After Lease Inception or Acquired in a Business Combination.” EITF No. 05-6 requires that leasehold improvements acquired in a business combination be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals deemed to be reasonably assured at the date of acquisition. EITF No. 05-6 further requires that leasehold improvements that are placed into service significantly after, and not contemplated at or near the beginning of the lease term, shall be amortized over the shorter of the useful life of the assets or a term that includes the required lease periods and renewals deemed to be reasonably assured at the date of acquisition. EITF No. 05-6 became effective for our second fiscal quarter beginning August 14, 2005. The adoption of EITF No. 05-6 did not have a material effect on the Company’s Consolidated Financial Statements.OUTLOOK
In October 2005, the FASB issued FASB Staff Position FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period” (“FSP FAS 13-1”). FSP FAS 13-1 requires rental costs associated with building or ground leases incurred during a construction period to be recognized as rental expense and is effective for the first reporting period beginning after December 15, 2005. In addition, FSP FAS 13-1 requires lessees to cease capitalizing rental costs as of December 15, 2005 for operating lease agreements entered into prior to December 15, 2005. Early adoption is permitted. We were already in compliance with the provisions of FSP FAS 13-1, therefore it will have no effect 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 such as “are confident,“comfortable,” “committed,” “will,” “expect,” “will,“goal,” “plan,” “is focused on,“should,” “intend,” “target,” “believe,” and “anticipate,” “plan,” 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.
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.significantly for 2006.
Other factors and assumptions not identified above could also cause actual results to differ materially from those set forth in the forward-looking information.statements. Accordingly, actual events and results may vary significantly from those included in, contemplated or implied by forward-looking statements made by us or our representatives.
Item 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 15, 2005, as amended.7, 2006.
Item 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 5, 2005.May 20, 2006. 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 with the evaluation described above, there was no change in Kroger’s internal control over financial reporting during the quarter ended November 5, 2005,May 20, 2006, that has materially affected, or is reasonably likely to materially affect, Kroger’s internal control over financial reporting.
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 District Court Central District of California, Case No. CV04-0687) alleging that the Mutual Strike Assistance Agreement (the “Agreement”) between the Company, Albertson’s, Inc. and Safeway Inc. (collectively, the “Retailers”), which was designed to prevent the union from placing disproportionate pressure on one or more of the Retailers by picketing such Retailer(s) but not the other Retailer(s) during the labor dispute in 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,In December, 2005, the Court denied a motion for a summary judgment filed by the defendants. Ralphs and the other defendants filed a notice of an interlocutory appeal to the United States Court of Appeals for the Ninth Circuit. On November 29, 2005, the appellate court dismissed the appeal. 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.
The United States Attorney’s Office for the Central District of California is investigatingnotified the hiring practices ofCompany that a federal grand jury had returned an indictment against Ralphs Grocery Company (“Ralphs”), a wholly-owned subsidiary of The Kroger Co., with regard to Ralphs’ hiring practices during the labor dispute from October 2003 through February 2004. Among2004 (United Statesof America v. Ralphs Grocery Company, United States District Court for the matters under investigation is whetherCentral District of California, CR No. 05-1210 PA). The indictment alleges a criminal conspiracy and other criminal activity resulting in some locked-out employees werebeing allowed or encouraged to work under false identities or false Social Security numbers, despite Company policy forbidding such conduct. A grand juryTrial has convened to consider whether such acts violated federal criminal statutes. The Company expects that Ralphs will be indicted on charges that its conduct violated federal law.been set for August 15, 2006. In addition, these alleged hiring practices are the subject of claims that Ralphs’ conduct of the lockout was unlawful, and that Ralphs is 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. That decision is being appealed by the charging parties to the General Counsel of the NLRB.
During the first quarter of 2006, the Company increased its reserves associated with legal proceedings arising from these matters. The amounts potentially claimedcurrent quarter charge reduced earnings by $0.03 per diluted share and increased the amount of reserves established for this contingency. Ralphs expects to enter into an agreement that will include a plea of guilty to some of the charges in the indictment and will, if approved by the Court, resolve both the criminal litigation with Ralphs and the NLRB matter are substantial, but based onproceedings. The Company can provide no assurance that such an agreement will be entered into, or that if it is entered into, it will be approved by the information presently available tocourt. The amount reserved by the Company management does not expect the ultimate resolutionrepresents its best estimate of this matter to have a material effect on the financial condition of the Company.its exposure in connection with these legal proceedings.
On September 8, 2005, the Los Angeles City Attorney’s office filed a misdemeanor complaint against a subsidiary of the Company, Ralphs Grocery Company (People v. Ralphs Grocery Company, Superior Court of California, County of Los Angeles, Case No. 5CR02616) regarding alleged violations of the California Water Code. Ralphs operates a system at one store location to treat groundwater within an underground basement because of the presence of naturally occurring petroleum associated with the nearby La Brea tar pits, which system is subject to a discharge permit issued by the California Regional Water Quality Control Board. On December 1, 2005, Ralphs executed a civil consent judgment under which the misdemeanor complaint is to be dismissed and Ralphs will pay a civil penalty.
On November 24, 2004, the Company was notified by the office of the United States Attorney for the District of Colorado that the Drug Enforcement Agency (“DEA”) had referred a matter to it for investigation regarding alleged violation of the Controlled Substances Act by the Company’s King Soopers division. The government alleges that ineffective controls and procedures, as well as improper record keeping, permitted controlled substances to be diverted from pharmacies operated by King Soopers. As a result of these allegations, the Company has retained a consultant to assist it in reviewing its policies and procedures, record keeping and training in its pharmacies, and is taking corrective action, as warranted. On October 20, 2005, the Company resolved this matter by agreeing to pay a $7 million civil penalty, agreeing to implement a comprehensive compliance program, and agreeing to an additional $3 million payment if it fails to comply with the compliance program.
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 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 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 belief 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.therefor. 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.
(c)
Period(1) | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(3) (in millions) | ||||||
First four weeks | ||||||||||
August 14, 2005 to September 10, 2005 | 190,000 | $ | 19.70 | 190,000 | $ | 166 | ||||
Second four weeks | ||||||||||
September 11, 2005 to October 8, 2005 | 206,465 | $ | 20.34 | 200,000 | $ | 162 | ||||
Third four weeks | ||||||||||
October 9, 2005 to November 5, 2005 | 208,539 | $ | 19.88 | 200,000 | $ | 158 | ||||
Total | 605,004 | $ | 19.97 | 590,000 | $ | 158 |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. | |
(a) | On March 20, 2006, the Company issued 14,985 shares of common stock to Linda McLaughlin Figel and on April 7, 2006, the Company issued 245,163 shares of common stock to the Resnik Family Trust of 1996. These shares were issued upon conversion of warrants that were issued in a private placement transaction not involving a public offering pursuant to Section 4(2) of the Securities Act of 1933, as amended. The conversion of the warrants into common stock was an exempt exchange under Section 3(a)(9) of the Securities Act. The shares issued to Ms. Figel were issued pursuant to a “cashless” exercise of warrants and the Company received no proceeds. The shares issued to the trust were issued pursuant to an exercise in exchange for cash. The proceeds of $2.9 million were used for general corporate purposes. |
(c) | |
ISSUER PURCHASES OF EQUITY SECURITIES | |||||||||
Total Number | Maximum | ||||||||
of Shares | Dollar Value of | ||||||||
Purchased as | Shares that May | ||||||||
Part of | Yet Be | ||||||||
Publicly | Purchased | ||||||||
Total Number | Average | Announced | Under the Plans | ||||||
of Shares | Price Paid | Plans or | or Programs(3) | ||||||
Period(1) | Purchased | Per Share | Programs(2) | (in millions) | |||||
First four weeks | |||||||||
January 29, 2006 to February 25, 2006 | 1,625,000 | $ | 19.00 | 1,625,000 | $ | 83 | |||
Second four weeks | |||||||||
February 26, 2006 to March 25, 2006 | 1,670,000 | $ | 20.41 | 1,125,000 | $ | 61 | |||
Third four weeks | |||||||||
March 26, 2006 to April 22, 2006 | 1,615,000 | $ | 20.20 | 1,500,000 | $ | 30 | |||
Fourth four weeks | |||||||||
April 23, 2006 to May 20, 2006 | 1,800,000 | $ | 19.99 | 1,800,000 | $ | 487 | |||
Total | 6,710,000 | $ | 19.90 | 6,050,000 | $ | 487 |
(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 September 16, 2004, |
(3) | Amounts shown in this column reflect amounts remaining under the $500 million stock repurchase program referenced in clause (ii) of Note 2 above. Amounts |
Item 6. Exhibits.
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.
Item 6. Exhibits. | ||||
EXHIBIT | ||||
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.
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Exhibit Index
Amended Articles of Incorporation | |||
- | Regulations amended as of June 22, 2006. | ||
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. | |
- | Rule 13a–14(a) / 15d–14(a) Certifications – Chief Executive | ||
- | Rule 13a–14(a) / 15d–14(a) Certifications – Chief Financial | ||
- | Section 1350 | ||
- | 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. | |||
Dated: | June 29, 2006 | By: | /s/ David B. Dillon |
David B. Dillon | |||
Chairman of the Board and Chief Executive Officer | |||
Dated: | June 29, 2006 | By: | /s/ J. Michael Schlotman |
J. Michael Schlotman | |||
Senior Vice President and Chief Financial Officer |
Exhibit Index | |
Exhibit 3.1 - | Amended Articles of Incorporation as filed with the Ohio Secretary of State on June 22, 2006. |
Exhibit 3.2 - | Regulations amended as of June 22, 2006. |
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. |